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DISCLOSURE LEVEL AND BANKRUPTCY RISK

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DISCLOSURE LEVEL AND BANKRUPTCY RISK Powered By Docstoc
					     Filing for Bankruptcy Protection, Governance Mechanisms and
                         Corporate Disclosure

        Walid Ben-Amar and Daniel Zeghal, Telfer School of Management University of Ottawa, Canada



                                                      ABSTRACT

       This study examines the disclosure practices of a sample of US firms filing for bankruptcy protection. Financial
distress and, eventually, bankruptcy provide an interesting setting in which to examine managers’ incentives to
communicate with outside investors. We examine also the relationship between governance attributes and the extent of
voluntary disclosure in the annual report. Our results show that financially distressed firms disclose more information
in the MD&A relative to their future plans and less summary financial information than healthy firms in the year prior
to bankruptcy filing. We also find a significant relationship between external block holder ownership and board
leadership structure and the disclosure level in the MD&A section of the annual report. These findings contribute to the
literature related to disclosure strategies of firms facing financial distress and to the growing literature on the
association between corporate governance attributes and discretionary disclosure.
Keywords : Financial Distress, Corporate Governance, Corporate Disclosure.

                                                   INTRODUCTION

       This paper focuses on the disclosure practices of US firms filing for Chapter 11 bankruptcy protection. We
examine also the relationship between financial condition, corporate governance attributes and the disclosure level in
the annual report. Prior literature (Frost, 1997; Holder-Webb, 2003; Carcello and Neal, 2003) suggests that managers of
financially distressed firms may face significant challenges in communicating with outside investors. The deterioration
of the firm‟s financial condition challenges the credibility of managers' abilities to disclose their superior knowledge of
the firm‟s future performance to external investors and other stakeholders (Frost, 1997; Holder-Webb, 2003). In this
context, managers will proceed to a cost-benefit analysis to decide if they should increase the disclosure level when
their firm enters financial distress. First, given that overcoming financial difficulties often requires access to capital
markets, managers may try to reduce information asymmetries through an increase in the extent of corporate disclosure
(Holder-Webb, 2003). Second, managers can choose also to increase the level of disclosure in order to reduce litigation
costs (Skinner, 1994; 1997). Managers of firms filing for bankruptcy protection may, however, choose to limit their
voluntary disclosure level so as not to announce bad news that could increase uncertainty about the firm's potential
recovery from distress (Holder-Webb, 2003). The risk of litigation can also reduce managers‟ incentives to provide
voluntary disclosure, particularly forward-looking information (Skinner, 1997; Healy and Palepu, 2001).
       We next examine the association between financial distress (filing for chapter 11 bankruptcy protection),
governance attributes (ownership structure, board composition and leadership structure) and the extent of disclosure in
the annual report. Recent accounting research (Chau and Gray, 2002; Chen and Jaggi, 2000; Eng and Mak, 2003; Gul
and Leung, 2004; Cheng and Courtenay, 2006; Lim et al., 2007) relates corporate governance mechanisms to voluntary
disclosure. Our study contributes to this growing literature by exploring the relationship between governance and
disclosure level when companies face financial distress. Given the communication challenges faced by managers of
firms filing for bankruptcy protection (Frost, 1997; Holder-Webb, 2003), our study examines if better governed firms
are associated with a higher disclosure level in the annual report.
       This study compares disclosure levels of a sample of 59 US firms filing for bankruptcy protection to a control
sample of 59 healthy firms. We use Botosan (1997) index to measure the voluntary disclosure level in annual reports.
We did not find any significant difference between the overall disclosure scores of the two samples. However, the
analysis of subcategories of Botosan's disclosure index shows that distressed firms disclosed more information in the
MD&A than did healthy firms. Our multivariate results show also a significant relationship between external block
holder ownership and board leadership structure and the disclosure level in the MD&A section of the annual report.
These findings add to the growing literature on the association between corporate governance and voluntary disclosure
level.
       The remainder of the paper is organized as follows. Section 2 presents a review of the literature. The third section
discusses the research method and describes the sample. The fourth section presents the study‟s results and the fifth
section concludes the paper.

                                                RELATED LITERATURE

Financial Distress and Corporate Disclosure
       Financial distress and bankruptcy protection filings provide an interesting setting in which to examine whether
managers can effectively communicate with investors in a situation where their credibility has been challenged (Frost,
1997; Holder-Webb, 2003). The deterioration in the firm‟s financial results, leading eventually to bankruptcy, casts
substantial doubt on the managerial skills of the managers (Frost, 1997). Moreover, financially troubled firms often
receive modified audit reports during the periods prior to the filing for bankruptcy protection. Frost (1997, page 164)
claims that the receipt of such an audit report is also an „unfavorable signal about financial uncertainties and
accounting and auditing deficiencies‟. Holder-Webb (2003) argues that financial distress and filing for bankruptcy
increase also the uncertainty around a firm‟s future cash flows. As a consequence, Holder-Webb (2003) predicts that
managers of firms facing financial distress may choose to increase the voluntary disclosure level in order to mitigate
this uncertainty and attenuate the possible increase in the cost of capital.
       The litigation cost hypothesis (Skinner, 1994) predicts that the threat of shareholder litigation can have two
effects on managers‟ disclosure decisions. First, the possibility of legal actions against managers for inadequate or non-
timely disclosure may encourage them to increase their disclosure level and to accelerate the disclosure of even bad
news (Skinner, 1994; 1997). Skinner (1994) finds that firms with bad earnings news are more likely to pre-disclose the
poor earnings performance than are firms with good news. Second, litigation can also reduce managers' incentives to
increase voluntary disclosure, particularly forward looking information (Healy and Palepy, 2001).
       Prior accounting research on financially distressed firms mostly examined factors leading to bankruptcy (Altman,
1968; Ohlson, 1980; Elloumi and Gueyié, 2001; Charitou et al., 2004). Other studies (De Angelo et al., 1994; Rosner,
2003; Charitou et al., 2007) have investigated the accounting policies chosen by financially troubled companies.
However, and despite the theoretical predictions on the communication challenges encountered by managers of
financially distressed firms, limited evidence exists on their disclosure strategies. Frost (1997) examines the disclosure
practices of 81 UK firms that received first time modified audit reports during 1982-1990. She finds that there is no
difference in the overall extent of disclosure, measured by the number of press releases (PR) filed and the total PR
pages of text filed during the sample period, between the financially troubled or the healthy firms. Distressed firms
exhibit a high frequency of negative tone disclosures indicative of their deteriorated financial condition. Her results also
show that distressed firms tend to make disclosures about expected future performance that are overly optimistic
relative to the actual outcome. Carcello and Neal (2003) relate corporate governance to the optimism in financial
disclosures made by financially distressed firms. They document a positive relation between the percentage of affiliated
directors on the audit committee and optimistic disclosures for companies facing financial distress. Finally, Holder-
Webb (2003) examines the disclosure policy of 136 US firms entering financial distress for the first time between 1990
and 1995. She considers a firm as financially distressed if it has a Z-Score lower than 1.20. Using a proprietary
instrument to measure the quality of disclosure in the MD&A section, Holder-Webb (2003) finds a significant increase
in the disclosure quality in the year of the initial distress. Her results show also that this increase in disclosure is limited
to firms that did not subsequently go bankrupt.
Corporate Governance and Voluntary Disclosure
      The agency literature (Jensen and Meckling, 1976; Fama and Jensen, 1983) discusses a number of corporate
governance mechanisms that are designed to reduce the agency costs resulting from the separation of ownership and
control. These mechanisms include inside ownership, outside block holders and board composition and structure.
Building on the corporate governance literature, our study explores the relation between ownership structure, board
composition and leadership structure, and the disclosure level in the annual report of firms filing for chapter 11
bankruptcy protections.

Ownership Structure
       Jensen and Meckling (1976) suggest that the separation of ownership and control results in agency costs due to
the conflict of interests between managers and shareholders. At low levels of managerial ownership, agency costs are
likely to be high leading to an increase in the external demand for informative disclosure in order to monitor managers‟
actions (Fama and Jensen, 1983). Therefore, the disclosure level is expected to be greater in widely held rather than in
closely held firms.
       Prior accounting research has generally confirmed a negative relationship between managerial equity ownership
and the extent of disclosure. Ruland et al. (1990) and Karamanou and Vafeas (2005) report a negative association
between inside ownership concentration and the disclosure of managers‟ earnings forecasts while Gelb (2000)
documents a negative relation between managerial shareholdings and disclosure quality (as measured by analysts‟
ratings of firms' disclosure) in the US. Hossain et al. (1994) find that ownership concentration is negatively related to
the voluntary disclosure level in annual reports of listed Malaysian companies. Chau and Gray (2002) as well as Eng
and Mak (2003) confirm the negative association between managerial ownership and the level of voluntary disclosure
in Hong Kong and Singapore.
       Moreover, Shleifer and Vishny (1986) argue that large external block holders should have an effect on firm value
through their monitoring activities. Large shareholders have greater incentives to effectively monitor managers because
of the large ownership stake held in the firm and their large resources allowing them to perform extensive research for
information. This active monitoring should enhance managerial efficiency and the quality of corporate decision making
and financial reporting. Ajinkya et al. (2005) as well as Karamanou and Vafeas (2005) report a positive relationship
between institutional ownership and the likelihood of management earnings forecasts disclosure. Eng and Mak (2003)
show also a positive association between large governmental ownership and the extent of voluntary disclosure in
Singapore.

Board Independence
       The board of directors is central to the corporate governance system of a public corporation because of the
fiduciary duty it has towards shareholders (Dalton et al., 1998). The agency literature assumes that outside (non-
executive) directors are independent from management and represent shareholders' interests and therefore should be
more effective than inside directors in the monitoring of management (Fama and Jensen, 1983).
       Chen and Jaggi (2000) argue that outsider dominated boards should be more concerned with investors‟ demands
for informative disclosure and should enhance the comprehensiveness of firm disclosure. Chen and Jaggi (2000) report
a positive association between board independence and the comprehensiveness of financial disclosures in Hong-Kong.
Cheng and Courtenay (2006) find that board independence is positively related to the level of voluntary disclosure for a
sample of firms listed on the Singapore stock exchange while Lim et al. (2007) show also a positive relation between
board independence and voluntary disclosure level in the annual reports of Australian companies.
       However, Forker (1992) did not document any significant association between corporate governance attributes
and share option disclosure quality while Ho and Wong (2001) did not report any significant relation between the
proportion of independent directors and the extent of voluntary disclosure for a sample of listed companies in Hong-
Kong. Eng and Mak (2003) find even a negative relationship between board independence and level of voluntary
disclosure. Their results suggest that board independence substitutes for accounting disclosure rather than
complementing it.
CEO Duality
       Recently, shareholder activists and regulators have argued that boards of directors where the CEO role is
combined with that of the chairman may be less effective and independent than the ones where these two positions are
held by two different persons (Dalton et al., 1998; Kang and Zardkoohi, 2005). From the perspective of agency theory,
CEO duality leads to an increase in CEO power and thus promotes his entrenchment and should reduce the board
effectiveness. In contrast, scholars from the organization theory field advocate that duality improves firm performance
since it provides clear leadership to the CEO (Kang and Zardkoohi, 2005).
       Recent accounting research has also looked to the relationship between CEO duality and disclosure policy. Gul
and Leung (2004) argue that CEO duality should lower board effectiveness in the monitoring of management as well as
the transparency of corporate disclosures to external stakeholders. Their results confirm that CEO duality is associated
negatively to disclosure level for a sample of Hong Kong companies. However, Cheng and Courtenay (2006) did not
report any significant association between CEO duality and the extent of voluntary disclosure in Singapore.

                                                  METHODOLOGY

Sample Selection
      The sample used in this study consists of 118 publicly traded US companies, 59 of which filed for Chapter 11
bankruptcy protection during the calendar year 2001, 2002 or 2003. Each of the financially distressed companies is
matched with a financially healthy firm, creating a choice-based sample control group of 59 publicly traded US
companies. The initial sample of companies was collected from the website www.bankruptcydata.com. These are
publicly traded US companies which have filed for Chapter 11 bankruptcy protection during the calendar year 2001,
2002 or 2003. To get a broad picture of the financial features of these bankrupt companies, we analyzed each
company‟s annual report for the year immediately prior to the fiscal year preceding the year of applying for bankruptcy.
Annual reports are gathered from EDGAR database, denoted as 10-k reports.
      Similarly to Botosan (1997) and Carcello and Neal (2003), we limit our sample and analysis to publicly held
manufacturing companies (SIC Codes 2000-3999). The final sample included 59 manufacturing companies that filed for
bankruptcy protection during the calendar years 2001, 2002 or 2003. We also form a control group by matching each
bankrupt company with a healthy firm that meets the following criteria: (1) Financial condition: Control group
companies are defined as those actively operating publicly traded US firms which have never been involved in a
bankruptcy case; (2) Firm Industry: A control group company is in the same industry as its paired financial distressed
firm (same two digit SIC Code); (3) Firm Size: For the fiscal year to be examined for each bankrupt company, a control
group firm has to share similar total assets based on book value with its paired company.

Variables Definition
Dependent Variable (DISCSCORE)
      Our dependent variable is the disclosure score obtained using the Botosan (1997) disclosure index. To study the
disclosure behavior of financially troubled firms during the year preceding the filing for bankruptcy protection, we
examined voluntary disclosure in the annual report. The aggregate disclosure score is obtained by summing the
disclosure scores on five categories of voluntary information disclosed in the annual report: background information,
summary of historical results, key non financial statistics, projected information and management and discussion
analysis (Botosan, 1997). The Botosan disclosure index has been used in previous accounting research investigating the
determinants of corporate voluntary disclosures (for example, Cahan et al., 2005; Kumar et al., 2008).
      We follow the same scoring methodology as Botosan (1997) to assess voluntary disclosure level in the annual
report. Due to budgetary restrictions, only one independent rater (a graduate student) familiar with the content analysis
methodology was hired to undertake the disclosure scoring. The student was provided with the disclosure index scoring
sheet as well as the scoring guidelines and was instructed to read annual reports and rate each category of the disclosure
index. One of the paper‟s authors supervised the student‟s work and was available to help and advise him with
questions and methodological issues.
Explanatory Variables
Financial Distress (DISTRESS)
      Bradbury (2007, page 297) argues that prior accounting research has used various definitions of financial distress
such as „bankruptcy, dividend reductions, debt covenant violations, continuing losses and going concern audit opinions‟.
Similarly to Charitou et al. (2007) approach, we measure financial distress through a dichotomous variable that takes
the value of one if the firm has filed for Chapter 11 bankruptcy protection during the study period (2001-2003) and zero
otherwise. This information is obtained from the website www.bankruptcydata.com.

Corporate Governance Variables
Ownership structure (INOWN and EXTOWN)
      We measure inside ownership as the total shareholding by all company directors and executives as a whole. Large
external block holder ownership is measured as the cumulative equity ownership held by significant shareholders (i.e.,
with equity ownership of 5% and more). This information is collected from proxy circulars.

Board Independence (INDEPENDENCE)
     Board independence is measured as the ratio of independent directors to the board size (total number of directors).
Independent directors are defined as board members who are not company‟s executives or their family members,
employees of the firm‟s subsidiaries or gray directors. This information is also gathered from proxy circulars.

CEO Duality (DUALITY)
      CEO duality is measured through a dummy variable that takes the value of one when the CEO role is combined
with that of the chairman of the board and zero otherwise. We obtain this information from proxy circulars.

Control Variables
Firm Size
     Prior research has suggested that firm size is a key determinant of the extent of voluntary disclosure (Chow and
Wong-Boren, 1987; Lang and Lundholm, 1993; Ahmed and Courtis, 1999; Eng and Mak, 2003). Larger firms are
expected to disclose more information. Firm size is measured as the natural logarithm of total assets.

Firm Leverage
      Ahmed and Courtis (1999) show also that firm leverage is positively related to firm disclosure level. However,
other studies (Eng and Mak, 2003) document a negative association between a firm‟s debt ratio and the extent of
voluntary disclosure. Firm leverage is measured through the ratio of total debt to total assets.

                                                        RESULTS

Descriptive Statistics
      Table 1 provides a description of major financial characteristics of financially troubled and healthy firms (Panel-
A) as well as their governance attributes (Panel-B). As may be expected, financially distressed companies exhibit a
deteriorated financial situation in the year preceding the application for bankruptcy protection. Financially troubled
firms are characterized by significantly higher leverage ratio (total debt/total assets) and lower earnings, working capital
and Altman's Z score (Altman, 1968) than healthy firms. These results are in accordance with prior studies (Frost, 1997;
Elloumi and Guyié, 2001; Holder-Webb, 2003) that compared the financial condition of healthy and distressed firms.
The difference between total assets and sales of the two groups is not significant at conventional levels. The evidence
presented in Panel A of Table 1 is consistent with the view that sample firms were experiencing financial difficulties
that eventually led them to file for bankruptcy protection. Panel B of Table 1 presents a description of governance
mechanisms of our sample firms. With the exception of large external shareholders, the results of Table 1 show that the
two groups do not differ with respect to inside ownership, board independence and CEO duality.
                                                    Table 1: Descriptive Statistics
                                Financially Distressed Firms                        Healthy Firms                             Mann-Whitney
                                           (N=59)                                      (N=59)                                 Z-Stat
                          Mean             Median      Stand Dev      Mean           Median       Stand Dev
                                                  Panel A Financial Characteristics
Total Assets              827.577          193.700     1633.308       835.857        187.343      1694.315                    -0.083
Sales - net               697.774          238.115     1155.374       826.444        219.216      1580.342                    -0.379
Leverage (%)              57.279           45.874      55.422         27.841         24.800       26.645                      -4.235 ***
Retained Earnings         -210.130         -62.004     586.924        261.320        37.816       804.406                     -6.451 ***
Net Income                -102.258         -32.412     208.026        23.818         7.381        88.092                      -7.016 ***
Working Capital           -25.006          2.602       274.158        106.864        49.996       216.790                     -4.115 ***
Z-Score                   0.156            0.560       5.447          4.121          3.126        4.107                       -6.689 ***
                                             Panel B Corporate Governance Attributes
Inside Ownership          0.229            0.126       0.236          0.247          0.148        0.225                       -0.584
External Block            0.299            0.267       0.253          0.174          0.134        0.180                       -2.678 ***
Holder Ownership
Board Independence        0.594               0.600        0.185            0.611            0.666          0.173             -0.521
CEO Duality               0.530               1.00         0.504            0.540            1.00           0.502             -0.184

Sample of 59 US firms which filed for chapter 11 bankruptcy protection during the period 2001-2003 matched with a sample of 59 financially healthy
firms. See Table 1 for variable definitions. * significant at the 10% level, ** significant at the 5% level, *** significant at the 1% level.


Univariate Results
      Table 2 presents a comparison of overall disclosure scores between healthy and financially distressed firms during
the year preceding the filing for bankruptcy protection. The results presented in Table 3 show that distressed and
healthy firms have comparable disclosure levels. The mean overall disclosure score is slightly higher for troubled
companies (29.56 versus 28.92) but the difference between the two groups is not statistically significant at the
conventional levels. Our mean total overall disclosure score is comparable to the Botosan (1997) mean disclosure score
(30.0). Table 2 results fail to confirm that financially troubled firms in our sample disclose more voluntary information
in their annual report than a matched sample of financially healthy firms. These results are, however, similar to those
shown by Frost (1997) who did not report any significant difference in disclosure strategies between firms receiving
modified audit reports and financially healthy firms.
      In Table 2, we look also to disclosure scores of the five sub-categories of Botosan's disclosure index: background
information provided, summary of historical results, key non-financial statistics, projected information and management
and discussion analysis. Even if the two groups show similar overall disclosure scores, significant differences may exist
between the disclosure practices of the sample and control firms.

                                                Table 2: Disclosure Score Distribution
                                              Distressed Firms                 Healthy Firms                      Mean Difference
                                               (N= 59)                          (N=59)                            Mann-Whitney (Z-Stat)
                                              Mean         Stand Dev           Mean         Stand Dev
1. Background Information                     9.22         3.13                8.63         2.55                  -0.972
Provided
2. Summary of Historical Results              3.81           1.02              4.27            1.01               -2.411 **
3. Key Non-Financial Statistics               5.22           2.38              5.71            2.60               -1.073
4. Projected Information Provided             3.51           2.88              3.34            2.83               -0.353
5. Management and Discussion                  7.80           2.09              6.97            1.77               -2.396 **
   Analysis

DISCLOSURE SCORE                              29.56          5.67              28.92           6.02               -0.763
Sample of 59 US firms which filed for chapter 11 bankruptcy protection during the period 2001-2003 matched with a sample of 59 financially healthy
firms. See Table 1 for variable definitions. * significant at the 10% level, ** significant at the 5% level, *** significant at the 1% level.


      The results in Table 2 show that financially troubled and healthy firms do not differ in the disclosure of items
related to background information, key non-financial statistics or projected information. The existence of litigation costs
may reduce the managers‟ incentive to disclose more information, particularly forward looking information (Healy et al.,
2001). However, Table 2 reveals significant differences between the two groups in the disclosure of historical financial
results. Financially distressed companies provided less information about their prior financial performance than did
healthy firms. These results seem to be consistent with the argument that financially distressed firms put less emphasis
on the causes of their deteriorated financial condition.
       Finally, the results in Table 2 show that financially distressed firms were more likely to have made disclosure
about the annual changes in their performance in the MD&A section of the annual report than were healthy firms. For
example, financially troubled companies gave more discussion and explanation for changes in operating income and
capital expenditure or R&D. Given that the „MD&A section of the annual report is intended to convey information
about year-to year changes that is not recoverable from the basic financial statements‟ (Botosan, 1997, page 333),
these results confirm that managers of financially distressed firms disclosed more information in this section of the
annual report to give more explanations for changes in firm performance in order to reduce information asymmetry with
outside investors. These results are similar to those of Holder-Webb (2003) who documents an increase in the MD& A
disclosure quality for a sample of firms entering into financial distress. Given the importance and relevance of
information discussed in the MD&A section of the annual report, managers of distressed firms provided more non-
financial information in this section about their capital expenditures and R&D that will help outside investors assess the
company‟s ability to recover from this deteriorated financial condition.

Multivariate Results
       Table 3 presents the results of our multivariate regression that looked to the relationship between financial
condition, corporate governance and the extent of voluntary disclosure in the annual report. The dependent variable
DISCSCORE is a count data variable (non-negative integer) censored at zero and has a discrete form. Rock et al. (2001)
argue that ordinary least squares regression is inappropriate with non-negative integer dependent variables. They add
(page 353) that „an econometric procedure that fails to account for this count-date (nonnegative integer) nature of the
dependent variable can generate impossible predicted values, result in biased/inconsistent parameter estimates and
invalid inferences.‟ Therefore, and similarly to Tinaikar (2006), we rely on a generalized linear model (GLM) for the
estimation of our regression of disclosure score on financial condition and corporate governance variables. Two
distributions account for the characteristics of the count data (nonnegative and integer value): The Poisson and the
negative binomial distributions (Rock et al., 2001; Tinaikar, 2006). Given that the variance of the disclosure score in
this study is greater than its mean, we use the negative binomial model for estimating our regression model.
       Table 3 presents the results of a negative binomial regression of disclosure score on financial condition, corporate
governance and control variables. The dependent variable in Model 1 is the overall disclosure score. The results of
Table 3 - Model 1 show that financial distresses as well as governance mechanisms are not related to the overall
disclosure strategy. Firm size is the only significant variable (0.034, p value 0.01). As documented by prior research
(Meek et al., 1995; Ahmed and Courtis, 1999; Eng and Mak, 2003), larger firms disclose more information in their
annual report. Table 3 – Model 2 presents the results of the regression of the disclosure score in the MD&A section
(subcategory five in the Botosan index) on financial distress (filing for bankruptcy protection), corporate governance
and control variables. Our results show that financially distressed firms disclose significantly more information in the
MD&A section of the annual report than do healthy firms (0.106, p value 0.05). These results are consistent with
Holder-Webb (2003) who has documented a significant increase in the MD&A disclosure level of financially troubled
firms.
       We find also a significant positive relationship between large external shareholders and the extent of disclosure in
the MD&A section (0.002, p value 0.10). These results are consistent with those shown in Chau and Gray (2002),
Ajinkya et al. (2005) and Karamanou and Vafeas (2005). Our findings suggest that large external shareholders,
including institutional investors, play an effective monitoring role pressuring managers to disclose a higher level of
relevant information in the MD&A section of the annual report to make more informed decisions about the acquisition
or the sale of their investment in the company. The results of the regression (Model 2) indicate also a negative
association between CEO duality and the extent of disclosure in the MD&A section. These results are consistent with
the empirical findings of Gul and Leung (2004) and suggest that CEO duality might limit board effectiveness in
monitoring mangers and demands for more informative disclosures. Finally, as expected, we find a positive association
between firm size and the MD&A disclosure level.
       In Model 3 of Table 3, we test the relationship between the summary financial disclosure score (sub-category 2 in
the Botosan disclosure index) and financial distress, corporate governance and control variables. The regression results
show that financially distressed firms disclose less information related to their historical financial results than do
healthy firms (-0.093, p value 0.05). Combined with the results of Model 2, these results indicate that financially
distressed firms put less emphasis in their disclosure strategy on the causes of financial trouble. These firms
communicate more information in the MD&A section that is not recoverable from financial statements to explain
changes in the firm‟s operational and financial performance. We find also a positive relation between board
independence and the disclosure of historical financial information (0.269, p. value 0.10).
       The results of regression 3 show also a negative association between external large block holders and the financial
disclosure level (-0.002,p value 0.05). These results suggest that at high level of ownership concentration, agency costs
are low as is the demand for informative historical financial disclosure. Combined with the results of model 2, these
findings show that external block-holders favor the disclosure of relevant non financial information non recoverable
from financial statements to the disclosure of historical financial information about the firm performance. Finally, we
document that firm size is positively related to the extent of historical financial disclosure (0.039, p value 0.01).

                         Table 3: Financial Condition, Corporate Governance and Disclosure Level
                         Expected                   Model 1                           Model 2                                 Model 3
                         Sign                Dependent variable:                 Dependent variable :                   Dependent variable:
                                            Overall disclosure score            MD&A disclosure score                 Financial disclosure score

                                          Coefficient          t-stat         Coefficient         t-stat           Coefficient        t-stat

DISTRESS                 +/-              0.010                0.29           0.106               2.13 **          -0.093             -1.99 **

INOWN                    -                -0.089               -1.14          0.162               1.44             -0.131             -1.11

EXTOWN                   +/-              0.001                0.91           0.002               1.68 *           -0.002             -2.03 **

INDEPENDENCE             +                0.037                0.28           -0.114              -0.63            0.269              1.70 *

CEO DUALITY              -                -0.037               -1.04          -0.088              -1.79 *          0.005              0.12

SIZE                     +                0.034                3.64 ***       0.056               3.89 ***         0.039              2.83 ***

LEVERAGE                 +                -0.039 x 10-3        -0.13          -0.060 x 10-2       -1.08            -0.021 x10-3       -0.05

INTERCEPT                                 3.182                24.92 ***      1.714               8.98 ***         1.097              7.72 ***

Log
Pseudolikelihood                          -365.069                            -252.295                             -204.050
Prob >Chi2                                0.002                               0.001                                0.000
No. observations                          118                                 118                                  118

This table presents the results of a negative binomial regression of disclosure scores on financial condition, corporate governance and control
variables. The sample consists of 59 US firms which filed for chapter 11 bankruptcy protection during the period 2001-2003 matched with a sample
of 59 financially healthy firms. See Table 1 for variable definitions. Heteroskedasticity-adjusted (White, 1980) standard errors are used to compute t-
statistics. * significant at the 10% level, ** significant at the 5% level, *** significant at the 1% level.


                                                                 CONCLUSION

       This paper examined the disclosure behavior of a sample of financially distressed firms during 2001-2003. We
define financial distress as the filing for Chapter 11 bankruptcy protection during the study period. We explored also
the relationship between financial condition, corporate governance and the disclosure level in the annual report.
       Using the Botosan (1997) disclosure index as a measure of voluntary disclosure level in the annual report, we did
not find a significant difference between the overall disclosure scores of healthy and financially distressed firms.
However, the analysis of subcategories of the disclosure index shows that financially distressed firms disclosed more
information in the MD&A and less summary financial information than did healthy firms. These results suggest a
strategic disclosure behavior by managers of financially distressed firms. Rather than focusing on the causes of the
deterioration of the firm‟s financial condition (summary historical information), managers disclose more information
about the changes in the firm‟s current performance. This relevant information should convince potential investors and
creditors about the firm‟s potential recovery from the deteriorated financial condition and should help access to external
financing.
       Our multivariate results show also a significant relationship between external block holder ownership and board
leadership structure and the disclosure level in the MD&A section of the annual report. We find also a significant
negative association between external block ownership and the level of financial disclosure in the annual report. These
results add to the growing literature on the association between corporate governance and voluntary disclosure.
       As with similar studies, this paper is not without limitations. First, this study has examined disclosure practices of
firms filing for bankruptcy protection in the US during the period 2001-2003. This period has witnessed several
accounting scandals as well as the enactment of the Sarbanes-Oxley Act. These changes to the information environment
and financial reporting practices for US listed firms may limit the generalization of the study‟s results. Second, this
paper relies on a disclosure index to assess the level of voluntary disclosure in the annual report. Even though the
disclosure level in the annual report should be positively correlated with the amount of disclosures through other
communication media (Botosan, 1997), our disclosure score might not capture all discretionary disclosures provided by
the company.

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