Compliance with Disclosure Principles and Financial Performance: Empirical Evidence from Sri Lankan Listed Companies

Abstract

This study attempts to examine the relationship between the quality of a firm's disclosure principles related to corporate governance practices and such firm’s financial performance, through the construction of a broad firm-specific Information and Disclosure Index (IDI) for a sample of 130 listed companies in Sri Lanka for the period of 2009 to 2016. The Signalling theory indicates that better disclosure is related to superior performance of firms, and thus has been used as the theoretical basis of this study in addition to the Agency theory. The data required for the study was collected using secondary sources, i.e., using the audited annual report data and articles of associations of respective companies. IDI was constructed using fifteen components to measure the compliance level of disclosures related corporate governance principles as stipulated in the CA Sri Lanka, OECD and UK codes of best practices on corporate governance, which was then used to score each company on a dichotomous scale. Financial Performance was measured by Return on Equity (internal financial performance of a firm) and Tobin’s Q (to present the external market performance of a firm). In order to examine the relationship between the disclosures (IDI) and financial performance, both a Pearson’s correlation and panel regression analyses (including the Hausman testing) were performed after data screening and cleaning as well as the diagnostics tests. In terms of the main findings, the descriptive analysis indicates that more than 70% (mean) of Sri Lankan firms have complied with disclosure principles of corporate governance practices, and the panel regression analysis indicated that firms with sound corporate governance disclosure (i.e., higher IDI) have significantly superior internal financial performance (measured via ROE). Thus, this study provides empirical support for the Signaling and Agency theoretical perspectives in the context of compliance requirements of disclosure, which leads to higher financial performance. Accordingly, as policy implications, regulators and policymakers need to establish monitoring mechanisms to ensure that firms comply with governance principles via formal institutional changes leading to stricter enforcement.

Keywords: corporate governance, information disclosure, signaling theory, agency theory