Compliant Firms Research Articles

Compliance and multidimensional firm performance: Evaluating the efficacy of rule-based code of corporate governance

This study seeks to evaluate the efficacy of the Pakistani Code of Corporate Governance by finding out its impact on firm's performance and efficiency. This exploration is done in the context that Securities & Exchange Commission of Pakistan's choice of corporate governance regulations is heavily influenced by Anglo-Saxon approach, whereas de-facto realities of Pakistani corporate environment are quite in contrast.Using a panel data of 119 firms for the period of 8years i.e. 2003 to 2010, and using a multidimensional performance framework i.e. financial performance and technical efficiency, we find that the extent of compliance has increased since the issuance of code in 2002. After controlling for firm size, growth, dividend payout, age and leverage, we find significant positive impact of compliance on firm's performance (ROA, ROE and ROCE). We also find a weak positive relationship between compliance and technical efficiency. We suggest that compliance is not linearly related with financial performance and we find that high compliant firms are less profitable than average or low compliant firms. This implies that one-size-fit all approach along with mandatory compliance is a questionable approach for Pakistani firms.This study is first in Pakistan in providing empirical evidence on efficacy of the rule-based Code of Corporate Governance and also adds to growing but underdeveloped literature on compliance and firm performance in emerging/developing economies. Further, this study offers insight to policy makers on the efficacy of current corporate governance regulations and offers a research framework for assessing the extent of compliance, effectiveness and economic impact of code of corporate governance.

Marketing an Islamic index: perceived value of KMI30 Index

PurposeThe purpose of this paper is to understand if there is a customer perceived value for shareholders in investing in Islamic stocks, by using KMI30 index of Karachi Stock Exchange as a case study. The findings are then used to devise a conceptual model, highlighting the value of an Islamic branded index and for companies included on the index for market participants, Shari'ah‐compliant firms, and governments.Design/methodology/approachThis is an exploratory research paper. A detailed literature review is followed by a quantitative analysis of the return series of 18 constituents of the KMI30 index. The analysis looks at performance before and after the launch of the index, to identify if inclusion on the Islamic index has impacted the average returns and volatility of the constituents and if it is considered as value added by the investors.FindingsAnalysis reveals that the KMI30 index is marginally less volatile than the KSE100 index and has relatively better returns, even in the most volatile times at the Karachi Stock Exchange. Most of the constituents under analysis have posted better returns after inclusion on the index, with 40 per cent of them showing less volatility. Though the trends are not clearly visible, there is an indication of increased returns and reduced volatility, both in the Islamic index and its constituents.Research limitations/implicationsThis study is the first step in analyzing if shareholders perceive inclusion of a company on the Islamic index as value added, resulting in increased share prices, better returns, and decreased volatility. Due to the lack of literature on the subject, the nature of the study is exploratory. Further analysis is required to understand if the changes in returns and volatility are due to investor perceptions. This study has implications for the organizations to understand the perception of investors about including companies on the Islamic index. If investors attach value to this proposition then it will be worthwhile for companies to invest resources in making their organization Shari'ah compliant and marketing it from that perspective. Additionally, this study will add to the knowledge of the regulators regarding whether the Islamic index is achieving its objectives of providing investment opportunities to investors offering better returns with less risk, besides being “Halal”.Originality/valueThere is a lack of studies that look at Islamic investments from the marketing perspective. Also, to the best of the authors' knowledge, no studies have analyzed the KMI30 index, either from a finance or marketing perspective. This study is the authors' contribution to the interdisciplinary body of knowledge and ever‐increasing literature on emerging markets in the context of Islamic investments.

Further Examination of the Market Valuation of Environmental Capital Expenditures by Pulp and Paper Companies

In this study I use the US pulp and paper industry to explore the equity market’s valuation of environmental capital expenditures. I replicate and extend a study by Clarkson, Li, and Richardson that bifurcates the industry into high and low polluting groups. As with their study, I find evidence indicating that the market values environmental capital expenditures by over-compliant firms while attaching no such value to the same expenditures by minimally compliant firms. I do not find that the market assesses unrecorded liabilities to firms that are minimally compliant. My extension also seeks to address two possible specification issues in the Clarkson, et. Al. approach. The first, levels model they used is unbiased but inefficient. Their model scaled by common shares outstanding attempts to rectify this inefficiency but may not be the optimal choice of scaling variable. My results suggest that a “Best Available Technology” approach to environmental regulation may carry additional incentives provided by the capital markets.

Board Structure and Monitoring: New Evidence from CEO Turnover

We use the 2003 NYSE and NASDAQ listing rules concerning board and committee independence as a quasi-natural experiment to examine the causal relations between board structure and CEO monitoring. Noncompliant firms forced to raise board independence or adopt a fully independent nominating committee significantly increase their forced CEO turnover sensitivity to performance relative to compliant firms. Nominating committee independence is important even when firms have an independent board, and the effect is stronger when the CEO was on the committee. We conclude that more independent boards and fully independent nominating committees lead to more rigorous CEO monitoring and discipline.

Section 404 of the Sarbanes-Oxley act and its capital market effects

Starting with November 15, 2004, Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404) requires all accelerated firms (with at least $75 million in public equity) to report on the effectiveness of their internal controls over financial reporting. There has been some controversy regarding the burden that it casts on companies and whether the benefits outweigh the costs of compliance. Reporting under SOX is meant to improve investor confidence concerning the stock of a specific company by adding credibility to its financial statements. An increase in the quality of financial information should determine a narrowing of the bid-ask spread. I identify the cost components of the market makers bid-ask spread for a sample of stocks surrounding the implementation of SOX 404. The expectation is that market makers react to the implementation of Section 404 as if information asymmetry has diminished. The study uses the model developed by Bollen et al.(2004) to separate the cost components of the bid-ask spread for a sample of compliant firms in the period surrounding the implementation of SOX 404. Key words: Bid-ask spread, informed trading, information asymmetry, internal controls, adverse selection cost.

Tradeoffs between Internal and External Governance: Board Structure and Antitakeover Provisions

We use the 2002 NYSE and NASDAQ listing requirements mandating firms to have a majority of independent directors on the board as an exogenous shock to examine the interaction between internal and external governance. Relative to compliant firms, non-compliant firms significantly reduced exposure to three external governance mechanisms: the market for corporate control, shareholder activism, and credit markets, by adding antitakeover provisions, adopting officer and director protection provisions, and reducing debt levels, respectively. The results are stronger in firms with greater exposure to the relevant external governance mechanism. The evidence suggests that firms treat internal and external governance as substitutes.

Private and Public Control of Management

This paper investigates the design of a leniency policy to fight corporate crime. The manager may breach the law and report evidence to the authority. The shareholder writes the manager's incentive scheme and possibly reports evidence to the authority. The authority designs a leniency policy to deter fraud by both (i) exacerbating agency problems within non-compliant firms and (ii) alleviating them within compliant firms. Depending on the authority's ability to sanction the manager, it may be socially desirable to instigate a within-firm race to the courthouse.

How Costly is Sox 404? Evidence from Real Operations

This study investigates the impact of SOX 404 compliance on firm real operations. We focus on a sample of firms that report internal control deficiencies under SOX 404. We hypothesize that this group of firms had likely chosen relatively weak internal controls pre-SOX 404 based on cost-benefit tradeoff but were forced to increase spending on internal control under SOX 404. Using a difference-in-difference research design, we show that these firms not only experience difficulty in liquidity management, but also cut back on investment including capital spending, R&D spending and employment growth. The observed patterns are more pronounced for firms facing more severe financial constraint. Lastly, we show that firms with higher SOX 404 compliance costs are less likely to remediate control deficiencies in the following year and more likely to stop financial reporting altogether. This study suggests that SOX 404 compliance imposes real costs on compliant firms that outweigh potential benefits.

Can Technological Innovations Improve Private Regulation in the Global Economy?

Those supplying private regulation in the global economy face two fundamental challenges if they are to ameliorate the problems for which they create these systems: targets must conform to, while demanders must have proof of, regulatory compliance. This paper explores an important area absent from assessments as to whether, when, and how, private regulatory bodies are successful in improving behavior and rewarding compliant firms: the role of technological innovations. Employing an inductive, comparative case study analysis, we offer an analytical framework that distinguishes technological innovations that improve trackingmechanismsfrom innovations that directly improve on-the-groundperformance. We illustrate the utility of the analytical framework through an assessment of technological innovations in shaping “non-state market driven” global certification programs governing forestry, fisheries, coffee, e-waste, and climate.

An examination of voluntary financial instruments disclosures in excess of mandatory requirements by UK FTSE 100 non‐financial firms

PurposeThe purpose of this paper is to address “the existing literature gap on the information content of derivatives reporting”. Prior work finds failings in compliance with mandatory reporting requirements in respect of financial instruments and derivative financial instruments. Instead of identifying weaknesses in compliance the paper identifies where firms over‐comply or in other words, where firms voluntarily disclose more than they are required and whether this is incremental information or serves another purpose.Design/methodology/approachThe paper reviews the financial instruments disclosures of the FTSE 100 non‐financial IFRS 7 compliant firms. Based on these results, on a case‐by‐case basis the authors address potential causes and rationale for this extra disclosure.FindingsPrior research suggests that it is counter intuitive to argue that firms will provide voluntary disclosure in a mandatory reporting environment because information of this sort tends to be proprietary and competition sensitive, not to mention costly to prepare. However, it is found that firms have voluntarily published information in excess of the requirements and the authors suggest that this extra detail is most commonly associated with a legitimation strategy.Originality/valueIn spite of the importance of derivatives usage and management in addition to the increased and often complex reporting requirements, the authors are not aware of any previous study of this type.

The Determinants and Value Impact of Regulatory Compliance: An Analysis of Insider Trading Disclosures

This paper investigates the determinants of regulatory compliance and its effect on informational efficiency. Exploiting a unique enforcement and reporting framework for corporate insider trading in Italy, we present three main findings. First, board governance, such as chief executive-chairman duality and the proportion of non-executive directors, does not increase the propensity of firms to comply with regulation. Second, firms with concentrated ownership and control, together with those run by families and cooperatives are most likely to comply with regulation. Third, the market responds less to reporting by fully compliant firms and those with strong family control.

The UK Code of Corporate Governance: Link Between Compliance and Firm Performance

Listed companies in the UK are required to comply or give reasons for non-compliance with the recommendations of the UK code of corporate governance called The Combined Code. Prior studies investigating the relationship between compliance and firm performance have found the link to be either non-existent or at best weak. This study, taking a more holistic view of compliance develops an index of non-compliance for a panel of FTSE350 companies for four years (2000-2003). Using total shareholder return (TSR) as the measure of firm performance, we find that the Index is negatively related to TSR, implying that more compliant firms have higher returns. Contrary to the widely held assumption that governance variables are endogenous, our direct test for the endogeneity of the Index finds no evidence of endogeneity. This implies that causation runs from the Index to performance. One reason for the clear contrast of our findings with previous work could be our choice of performance measurement. Assuming that compliance with the Code is a means of signaling to investors that firms are well governed and by implication working in the interests of shareholders, the effects of such positive perceptions can be argued to fall more on market driven measures of firm performance than on measures that rely on accounting based values, such as the various proxies for Tobin's Q. Another reason could be the emphasis on constructing a finely tuned, comprehensive index, incorporating elements of compliance with both the letter as well as the spirit of the Code. Overall, our results suggest that for today's informed and discerning investors, compliance matters not just as a box ticking exercise but as a real change in the governance of large listed companies, for which they are willing to pay a premium.

How do Regulators Regulate? Enforcement of the Pure Food and Drugs Act, 1907–38

Economists have devoted relatively little attention to analyzing how government officials actually enforce regulation. This is a significant omission, since the efficacy of regulatory enforcement and the effects of regulation on economic outcomes may depend on how regulators regulate. This article sheds light on these issues by examining how the fledgling Food and Drug Administration (FDA) enforced the Pure Food and Drugs Act from 1907 to 1938. I argue that because the FDA's ability to enforce this law through deterrence was limited, effective enforcement could be obtained only in those instances where the agency had the capacity to offer benefits to compliant firms in the way of quality certification or direct assistance in improving product quality. The available evidence on the FDA's enforcement activities is consistent with this prediction. The analysis presented may help to explain why contemporary regulatory agencies spend considerable resources on advisory enforcement activities.

Economic consequences of SEC disclosure regulation: evidence from the OTC bulletin board

This paper examines the economic consequences of a regulatory change mandating OTCBB firms to comply with reporting requirements under the 1934 Securities Exchange Act. This change substantially increases mandated disclosures for firms previously not filing with the SEC. We document that the imposition of disclosure requirements results in significant costs for smaller firms, forcing them off the OTCBB. SEC regulation also has significant benefits. Firms previously filing with the SEC experience positive stock returns and permanent increases in liquidity, suggesting positive externalities from disclosure regulation. Newly Compliant firms exhibit significant increases in liquidity consistent with improved disclosure reducing information asymmetry.

The Sarbanes-Oxley Act of 2002 and Security Market Behavior: Early Evidence

The Sarbanes-Oxley Act of 2002 (the Act) was enacted in response to numerous corporate and accounting scandals, and was aimed at reinforcing corporate accountability and professional responsibility in order to restore investor confidence in corporate America. This study examines the market reaction to the Act and finds a positive (negative) abnormal return at the time of several legislative events that increased (decreased) the likelihood of the passage of the Act. We find that the Act was wealth-increasing on average, and that the market reaction is more positive for more compliant firms with effective corporate governance, reliable financial reporting, and credible audit functions prior to its enactment. Investors interpreted the Act as good news and led toward the restoration of investor confidence in public financial information. Overall, our results suggest that the induced benefits of the Act significantly outweigh its imposed compliance costs.

Economic Consequences of SEC Disclosure Regulation: Evidence from the OTC Bulletin Board

This paper examines the economic consequences of a regulatory change mandating OTCBB firms to comply with reporting requirements under the 1934 Securities Exchange Act. This change substantially increases mandated disclosures for firms previously not filing with the SEC. We document that the imposition of disclosure requirements results in significant costs for smaller firms, forcing them off the OTCBB. SEC regulation also has significant benefits. Firms previously filing with the SEC experience positive stock returns and permanent increases in liquidity, suggesting positive externalities from disclosure regulation. Newly compliant firms exhibit significant increases in liquidity consistent with improved disclosure reducing information asymmetry.

Corporate Income Tax Evasion and Managerial Preferences

This paper investigates the role of managerial preferences in shaping corporate income tax evasion. Using noncompliance with the personal income tax as a measure of taste for evasion, the empirical results from a sample of corporate income tax returns show that managerial preferences play an important role in determining noncompliance with the corporate income tax. Basic sample tabulations show that, when compared to compliant firms, noncompliant firms are three times more likely to be managed by executives who have understated personal taxes. In addition, results from multivariate analyses suggest that the amount of underreported income is significantly higher in the presence of such executives.

Statutory interpretation, capture, and tort law: the regulatory compliance defense

The regulatory compliance defense holds firms liable whose products or product warnings fail to satisfy federal regulatory standards, but does not exculpate firms that comply. Rather, compliance is relevant evidence for a jury to consider in a products liability action. This article argues that the defense should exculpate compliant firms as a matter of law. A Congress that thought about the matter would prefer this judicial construction of an unclear safety statute. To defend this view, the article argues that a legislature can have intentions in a normatively meaningful sense, that claims that a Congress or its agencies are captured by special interests should be nonjusticiable, and that, when a court is in doubt as to what a legislature intended, it should adopt that construction of the relevant statute that would be easiest for the legislature to correct if the court errs. In this case, it is easier for Congress to correct a construction that it intended to exculpate compliant firms than a construction that it did not.