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The Relationship betweenVoluntary Disclosure andIndependent Directors inthe Presence of a DominantShareholderLorenzo Patelli a & Annalisa Prencipe ba Erasmus School of Economics, Rotterdam, theNetherlandsb Università Bocconi, Milan, ItalyPublished online: 24 Apr 2007.

To cite this article: Lorenzo Patelli & Annalisa Prencipe (2007): The Relationshipbetween Voluntary Disclosure and Independent Directors in the Presence of a DominantShareholder, European Accounting Review, 16:1, 5-33

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The Relationship between VoluntaryDisclosure and IndependentDirectors in the Presence of aDominant Shareholder

LORENZO PATELLI� & ANNALISA PRENCIPE��

�Erasmus School of Economics, Rotterdam, the Netherlands and ��Universita Bocconi, Milan,

Italy

ABSTRACT Differently from prior studies that examine the role of stand-alone controlsystems within the relationship between owners and managers, our study investigatesthe correlation between two control mechanisms – voluntary disclosure andindependent directors – in companies characterized by the presence of a dominantshareholder that is supposed to mitigate the classical agency problem. Based on agencytheory, we hypothesize that the two mechanisms tend to coexist, since the presence ofeither one reduces the costs of introducing the other. Two further effects – thereputation and the domino effect – contribute to determine a positive relationshipbetween the two mechanisms. We carried out the empirical analysis on 175 non-financial Italian listed companies, all controlled by a dominant shareholder. Voluntarydisclosure is measured through three alternative disclosure indexes. Independentdirectors are identified not only according to a formal/legal definition, but also throughstricter criteria. The empirical test is based on a multivariate analysis controlling forsize, residual ownership diffusion, leverage, profitability and labour pressure. Resultssupport our hypothesis and are robust to alternative criteria to identify dominantshareholders. Our study contributes to a better understanding of the relationshipbetween different control mechanisms in particular agency settings.

1. Introduction

After the well-known recent accounting scandals, control mechanisms are

increasingly attracting interest among researchers, professionals and regulators

European Accounting Review

Vol. 16, No. 1, 5–33, 2007

Correspondence Address: Annalisa Prencipe, Universita L. Bocconi, IAFC, Piazza Sraffa 11, 20136

Milan, Italy. Tel.: þ39 02 5836 2574; Fax:þ39 02 5836 2561; E-mail: annalisa.prencipe@unibocconi.it

0963-8180 Print=1468-4497 Online/07=010005–29 # 2007 European Accounting AssociationDOI: 10.1080/09638180701265820Published by Routledge Journals, Taylor & Francis on behalf of the EAA.

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all around the world. This paper empirically tests the relationship between two

control mechanisms (i.e. voluntary disclosure and independent directors)

within a setting characterized by the presence of a dominant shareholder.1

According to the Agency Theory, both independent directors and disclosure

are mechanisms able to reduce the agency costs arising from the separation

between ownership and control. A number of empirical studies provided evi-

dence that the inclusion of independent directors is actually effective in reducing

agency problems in particular settings (e.g. Brickley and James, 1987; Weisbach,

1988; Kosnik, 1990; Lee et al., 1992; Bushee and Noe, 2000; Erhardt et al.,

2003). Several empirical studies have shown that also disclosure is used to

reduce agency costs (Ahmed and Courtis, 1999) consistent with what is predicted

by the theory.

Notwithstanding the large amount of research on control mechanisms, only

little evidence has been provided so far regarding any possible interaction

between corporate disclosure and independent directors. Do they tend to

coexist? Or are they alternative control mechanisms? Prior empirical research

on the relationship between these two mechanisms is fairly limited and has pro-

vided conflicting results (e.g. Forker, 1992; Eng and Mak, 2003).

In particular, the literature lacks empirical research significantly supporting the

existence of a relationship between the level of voluntary disclosure and the

number of board independent directors within companies characterized by the

presence of a dominant shareholder. In this case the core agency relationship is

the one between controlling and non-controlling shareholders rather than the

usually investigated relationship between owners and managers. Independent

directors are supposed to mitigate the dominant shareholder–minority share-

holders agency conflicts, as stated by some recent studies (e.g. Anderson and

Reeb, 2003a,b, 2004; Park and Shin, 2004). However, in this situation the con-

trolling shareholders play a dominant role and there is a risk of collusion

between them and the independent directors. This might potentially lead to a

weakening of the role played by the latter as a control mechanism.

This study aims at contributing to the extant literature on the topic by examin-

ing the relationship between voluntary disclosure and independent directors as

control mechanisms in the agency conflict between dominant and minority share-

holders, while controlling for the effects of other correlated variables, such as

firm size, leverage, residual ownership diffusion, profitability and labour

pressure. We hypothesize a positive relationship between the two control mech-

anisms due to a main effect (i.e. the agency effect) and two side effects (i.e. the

reputation effect and what we call the ‘domino effect’).

Moreover, this study proposes alternative definitions of ‘independent direc-

tors’ and ‘dominant shareholders’. So far, in the accounting literature indepen-

dent directors have generally been identified on the basis of a formal (legal)

definition. In this paper we question the validity of this definition and we carry

out a number of robustness tests using more stringent criteria, aimed at minimiz-

ing the spuriousness of the traditional proxy for independent directors. In

6 L. Patelli & A. Prencipe

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particular, we exclude from independent directors those who are at the same time

involved in several boards, and/or those who have been members of the same

board for a long period of time. Also, the accounting literature has generally

defined a company as dominated by a controlling shareholder when there is at

least one owner who has 10% or more of the voting rights. Whether this threshold

is appropriate to distinguish companies characterized by the presence of a domi-

nant shareholder from the others has never been questioned. In this study, as

robustness checks, we propose alternative and more stringent thresholds to

define dominant shareholders.

Differently from most prior studies on the topic which focus on Asian

countries, our analysis is based on a western European country, that is, Italy.

This empirical setting is particularly suitable for our research purposes since it

is dominated by companies characterized by the presence of a dominant

shareholder.

For the empirical test, our sample includes all non-financial companies listed

on the Italian Stock Exchange (i.e. Borsa Italiana). We hand-collected data on

board composition, voluntary disclosure and financial figures. We refer to the

Corporate Governance Report disclosed by each company in order to count the

number of independent directors out of the total number of directors. We

content-analysed 175 annual reports to determine each company’s voluntary dis-

closure level according to an instrument adapted from the one proposed by

Botosan (1997). The Botosan score – a list of items weighted according to

their relevance – was adjusted in order to adapt it to the Italian regulation on dis-

closure. Publicly available companies’ financial statements provided further

information for additional variables.

The findings obtained are useful to better understand the relationship between

the two control mechanisms in the presence of a dominant shareholder. Our study

examines voluntary disclosure and independent directors, offering an attempt to

organically analyse the mechanisms used to solve the control problem. The

review conducted by Chenhall (2003) on published accounting papers studying

control systems reveals that scholars tend to study these systems as stand-alone

mechanisms, meaning that most of the studies examine one control system, sep-

arated from the others. This leads to limited and, in some cases, misleading

results because of inconsistent theoretical frameworks and relevant omitted vari-

ables. Chenhall’s review calls for research to conceive control systems as organic

interacting mechanisms (Chenhall, 2003). Our study examines the relationship

between an external (i.e. voluntary disclosure) and an internal (i.e. independent

directors) control mechanism. In addition, our study offers regulators useful evi-

dence to assess the adoption of new control mechanisms such as independent

directors by companies characterized by the presence of a dominant shareholder.

The remainder of this paper is organized as follows. Section 2 develops the

theoretical framework, presents prior literature and formulates our hypothesis.

Section 3 describes the research method. Section 4 provides the results of the

empirical tests. Section 5 concludes.

Voluntary Disclosure and Independent Directors 7

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2. Literature Review and Hypothesis

Independent Directors and Voluntary Disclosure as Control Mechanisms

Control mechanisms aim to reduce the agency problem arising from the separ-

ation between ownership and management: they are employed to ensure that

the managers act in the interest of the owners (Jensen and Meckling, 1976).

There can be both internal and external mechanisms: the former control and

orient managers’ behaviour (e.g. corporate governance structures or compen-

sation packages); the latter provide information about managers’ action to exter-

nal stakeholders (e.g. financial statements and voluntary disclosure).

The board of directors is one of the most crucial internal control mechanisms,

since it is delegated, by the shareholders, to take decisions. Therefore, it is

expected to operate as a supervisor of the management’s behaviour on the

owners’ behalf. However, the effectiveness of the board as a control mechanism

can be limited if the members of the board are at the same time managers of the

company. In fact, top managers are often involved in the boards since they have

valuable information for decision making and they know the company’s activity

in depth. As stated by Fama (1980) and Fama and Jensen (1983), the prevalence

of top managers in the board of directors can lead to collusion and transfer of

stockholders’ wealth. In some companies, the board includes members that are,

at the same time, managers and shareholders. In such a case the risk of a transfer

of wealth from owners to managers is reduced, but a new risk may arise, that is,

the risk of transfer from minority/outsider shareholders to controlling/insider

ones. In order to reduce these risks, boards usually also include a number of

so-called independent directors, that is, professionals with neither management

role nor business or ownership ties to the company, with high institutional exper-

tise and a professional reputation to defend.

Independent directors are expected to have a special role in assuring the respect

of legality and in limiting agency problems, since the risk of collusion with the top

management or controlling shareholders is reduced (Fama and Jensen, 1983).

Empirical research supports this theory: the presence of independent directors on

the board reduces occurrences of financial statement fraud (e.g. Beasley, 1996)

and is effective in reducing agency costs in particular settings (e.g. Brickley and

James, 1987; Weisbach, 1988; Kosnik, 1990; Lee et al., 1992; Bushee and Noe,

2000; Erhardt et al., 2003). However, extant literature does not provide consistent

evidence on the correlation between independent directors and corporate perform-

ance (e.g. MacAvoy et al., 1983; Hermalin and Weisbach, 1991; Mehran, 1995;

Klein, 1998; Bhagat and Black, 2000; Dulewicz and Herbert, 2004).2

Voluntary disclosure is an external control mechanism: it aims to reduce the

agency problem between insiders and outside shareholders or lenders, providing

information about financial and non-financial results achieved by managers. The

Agency Theory (Jensen and Meckling, 1976) posits that insiders have incentives

to provide information about their activities instead of leaving to the outside share-

holders the task to investigate about them. This is because the costs borne by the

8 L. Patelli & A. Prencipe

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managers to disclose such information (the so-called bonding costs) are lower than

the costs the principals would bear to control insiders’ activities from outside (the

so-called monitoring costs). Previous empirical studies provide evidence that dis-

closure is used to reduce agency costs. However, findings are not always consistent

(for a wide review see Ahmed and Courtis, 1999). This seems to be due to the

variety of national settings analysed and the different operationalizations of the

variables (e.g. Courtis, 1979; Chow and Wong-Boren, 1987; Wallace et al.,

1994; Hossain et al., 1995; Meek et al., 1995; Raffournier, 1995; Depoers, 2000;

Prencipe, 2004).

Prior Empirical Research

Notwithstanding the large amount of research supporting the role of the two

mechanisms in solving the agency problem, limited discussion has been

carried out on their relationship so far. Earlier studies tried to empirically test

the relationship between voluntary disclosure and independent directors, but

they provided mixed results which are not able to support satisfactory con-

clusions. Forker (1992) argues that the presence of non-executive directors on

corporate boards reduces the benefits to withhold information for managers,

thus giving incentive to disclose more information. Nevertheless, he does not

find significant empirical support for his hypothesis. Chen and Jaggi (2000)

find that in Hong Kong the total number of independent directors on corporate

boards is positively associated with the comprehensiveness of financial disclos-

ures, but they focus on mandatory instead of voluntary disclosure. In this

sense, their work should be considered as a test of another typical role of indepen-

dent directors, namely, legal compliance. They also show that this association is

not significant if the analysis includes only companies with highly concentrated

ownership (what they define as ‘family-controlled firms’). Another Hong Kong-

based study (Ho and Wong, 2001) does not find any significant relationship

between the proportion of independent directors and the extent of voluntary dis-

closure provided by listed firms. This result is similar to Haniffa and Cooke

(2002) in Malaysia. In Singapore, Eng and Mak (2003) find empirical evidence

that an increase in outside directors reduces the level of corporate disclosure.

The analysis of previous research shows that just one study tested the hypothesis in

relation to companies characterized by the presence of a dominant shareholder, but it

failed to provide statistically significant results. Moreover, most of the evidence pro-

vided is relative to Asian countries, with the exception of one study (Forker, 1992).

However, this study is focused on a more general definition of ‘non-executive’

(instead of ‘independent’) directors and does not find relevant results.

Hypothesis

In an agency theory framework, we argue that the two control mechanisms in

question are likely to coexist. Specifically, we hypothesize that the level of

Voluntary Disclosure and Independent Directors 9

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voluntary disclosure and the percentage of independent directors on the board are

positively correlated.

Under the assumption of rationality, individuals balance potential benefits

against costs whenever they take a decision (Williamson, 1985). As concerns

benefits, in an agency-like setting, control mechanisms like independent directors

and voluntary disclosure lower the agency conflicts between insiders (agents) and

outsiders (principals). On the other side, from the insiders’ standpoint, introducing

a control mechanism reduces the chances for opportunistic behaviour, that is,

reduces the chances for perquisites and other personal benefits (Jensen and Meck-

ling, 1976). This represents a cost that the agents compare to the above-mentioned

benefits when they decide about the introduction of a control mechanism.

More specifically, companies balance costs and benefits when they set the level

of voluntary disclosure and the number of independent directors. From the insi-

ders’ standpoint, a major cost deriving from a higher level of disclosure consists

in the limitation of opportunistic behaviour and, as a consequence, of personal

advantages. Actually, a higher level of disclosure allows the principals to find

out the opportunistic behaviour and to sanction the agents, who are therefore

less motivated to carry out such a kind of behaviour. But if the chances for oppor-

tunistic actions are already ex ante limited by other internal control mechanisms,

like independent directors, the cost for the release of more information becomes

lower. In other words, we can say that the presence of independent directors

makes the release of voluntary information less costly because the insiders

have less to hide, that is, less benefits to get from retaining information. Similarly,

also the vice versa applies. As stated above, a higher level of disclosure ex ante

reduces the chances for opportunistic behaviour by enhancing external control.

One of the costs related to the introduction of independent members on the

board, from the agents’ point of view, consists in lowering the chances for per-

sonal benefits arising from opportunistic behaviour. Again, if the opportunities

for such benefits are lowered ex ante thanks to disclosure, the costs deriving

from the inclusion of a higher number of independent directors on the board

become lower, ceteris paribus. Therefore, in an agency-like setting, we expect

that voluntary disclosure and independent directors are positively correlated,

since the existence of either of the two mechanisms reduces the costs (i.e. the

loss of benefits) for the insiders arising from introducing the other.

In addition to the above-discussed agency effect, we base our expectation on

two side effects. First, we identify a reputation effect connected to the two mech-

anisms. Independent directors have incentives to defend or build their reputation

as expert monitors (e.g. Kaplan and Reishus, 1990). As a consequence, once

appointed, they plausibly use disclosure to signal to the financial market that

they are effectively fulfilling their duties. At the same time, companies which

have a strong reputation for their transparency because of their high level of dis-

closure, have a stronger incentive to defend such a reputation by introducing a

higher number of independent directors, even if this is not mandatory. The repu-

tation effect for the company persists even when legally defined independent

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directors lack substantial independence. Second, there is what we call a ‘domino

effect’ between the two control mechanisms. Independent directors, in perform-

ing their role, not only directly monitor the behaviour of the insiders, but also

push them to strengthen and improve other control mechanisms, like the

release of voluntary information to the external world. The reputation effect

and the domino effect contribute to strengthening the positive relationship

between voluntary disclosure and independent directors mainly due to the

agency problem.

The existence of a dominant shareholder, who is typically involved in the man-

agement activity, makes the separation between owners and managers less severe

(e.g. Jensen and Meckling, 1976; Anderson and Reeb, 2003a,b). However, a differ-

ent agency conflict between the controlling shareholder and the minority investors

arises (e.g. Shleifer and Vishny, 1997): dominant shareholders can take decisions

in their own interests and expropriate wealth from minority shareholders. Several

studies document the existence of such an agency problem (e.g. Demsetz and Lehn,

1985; Claessens et al., 2000; DeAngelo and DeAngelo, 2000; Morck et al., 2000;

Faccio and Lang, 2002).3 Moreover, the economic press on recent financial scan-

dals (for example, Cirio and Parmalat in Italy) shows how different the interests of

controlling shareholders from those of minority investors can be.

Independent directors are potentially an important control mechanism also in

the presence of a dominant shareholder (e.g. Shleifer and Vishny, 1986, 1997;

Anderson and Reeb, 2004; Park and Shin, 2004), since they protect the interests

of non-controlling shareholders. But it must be noticed that in such a setting

independent directors are normally appointed by the dominant shareholder, who

is the same individual they are supposed to monitor. If they perform an effective

monitoring role on behalf of non-controlling shareholders, we can expect that

the positive relationship with disclosure still holds. However, their monitoring

role can be limited by the collusion with the dominant shareholder.

Nevertheless, even if not eliminated, the risk of collusion by independent

directors is limited by two main factors. First, the independent directors have

the same legal responsibility as insider directors. This represents an incentive

to perform at least some form of monitoring activity on the decisions of the

latter. Second, financial market operators are aware of the risk of collusion

when independent members of the board are appointed by controlling share-

holders.4 If the appointed directors are not recognized as upright professionals,

with the right expertise to monitor the insiders and to assure legality, and with

a strong incentive to defend their reputation in the business community, pro-

fessional investors are likely to consider their monitoring role unfavourably.

As a consequence, higher agency costs would be reflected in investment

valuations. This represents an incentive for companies to appoint renowned

professionals, and an incentive for the independent directors to perform their

monitoring activity and to signal to the market that they are fulfilling their

duties in order to protect their reputation by disclosing more voluntary

information.

Voluntary Disclosure and Independent Directors 11

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Based on the above-mentioned arguments, we believe that the agency effect is

still present in companies characterized by the presence of a dominant share-

holder. We expect that those members of boards appointed as independent direc-

tors still exercise control, even if a lower level of independence can partially limit

the monitoring role performed on the board. In other words, we expect that the

agency, reputation and domino effect still hold in the presence of a dominant

shareholder. Therefore, we formulate the following hypothesis:

HP: The level of voluntary disclosure is positively correlated with the pro-

portion of independent members on the board of directors in companies

characterized by the presence of a dominant shareholder.

3. Method

Institutional Setting

The present study aims to provide evidence on the relationship between the level

of voluntary disclosure and the proportion of independent directors in the pre-

sence of a dominant shareholder by conducting an empirical analysis on Italian

companies. No empirical study on such a relationship has been previously

carried out with reference to Italy, even if the Italian institutional setting seems

to be particularly suitable for this purpose.

First, the Italian stock market is dominated by companies characterized by the

presence of a dominant shareholder. The accounting literature normally considers

this to occur when there is a shareholder who possesses at least 10% of the share

capital or, according to a more stringent criterion, of the voting rights (e.g. Chen

and Jaggi, 2000; Park and Shin, 2004). The majority of Italian listed companies

meet this definition.

Second, in 1999, a special commission composed of experts and professionals

issued a document named ‘Codice di Autodisciplina’ (Corporate Governance

Code, CGC) in order to provide listed companies with a non-mandatory bench-

mark for their corporate governance structures (Borsa Italiana, 1999). The docu-

ment was then revised in 2002. The CGC is a sort of ‘code of best practice’

designed in the shareholders’ interest. As concerns the composition of the

board of directors, it states that an adequate number of members should be ‘inde-

pendent’ (Borsa Italiana, 2002). ‘Independent directors’ are defined as non-

executive (i.e. outside) directors who: (i) have no relevant business relationships

with the company, its subsidiaries, its managers, its executive directors and its

controlling shareholders; (ii) are not owners of such a quantity of shares which

can give them the power to control the company and are not part of an agreement

with other shareholders which gives them the power to control the company; and

(iii) are not immediate family members of executive directors of the company or

of other persons who are in the situations referred to in points (i) and (ii).

Since the benchmark model is not mandatory and it does not indicate a fixed

number of independent directors to be included in the board, we can find

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enough variety in the behaviour of Italian companies on this issue. Also, after the

issue of the CGC, the Italian Stock Exchange issued a document suggesting all

listed companies provide information concerning their corporate governance

mechanisms, and specifically the composition of the board of directors and the

number of independent members included in it (Borsa Italiana, 2003). Therefore,

the Italian financial market is also suitable for the purpose of the present study

because information about independent directors is generally available.

Sample

We initially considered all non-financial companies listed on the Milan Stock

Exchange in 2002 (199 in total), including all the stock-market segments (i.e.

MIB30; MIDEX; Star; Nuovo Mercato; Others). We did not consider financial

companies because of the different accounting regulation. We hand-collected

data from the 2002 annual reports of each sample company to measure the dis-

closure level and the control variables. We are aware that the annual report

does not represent the unique source of information disclosed by companies.

This is the reason why many authors adopt official rankings of disclosure level

instead of a direct analysis of annual reports. The annual ranking of corporate dis-

closure practices published by the Association for Investment and Management

Research (AIMR) is a typical example of an index used in several international

articles in order to measure the disclosure level (e.g. Welker, 1995; Bamber and

Cheon, 1998). AIMR rankings capture analysts’ assessments of the informative-

ness of various aspects of firms’ disclosure practices (Healy et al., 1999). AIMR

index is applicable to empirical samples based on US companies. The absence of

a robust official index ad hoc constructed for Italian listed companies did not

allow us to use a publicly available ranking. Lang and Lundholm (1993) and

Botosan (1997) demonstrated the existence of a positive correlation between

the annual report disclosure level and the amount of disclosure provided via

other means. We downloaded the annual reports from the Italian Stock Exchange

website and the companies’ websites. Eleven annual reports were not available.5

In eight cases we found annual reports following non-Italian accounting stan-

dards. These were related to foreign companies or subsidiaries of foreign

groups. In order to avoid possible regulation-related biases in the results, we

did not include these companies in the final sample.

We hand-collected data from the corporate governance reports disclosed by

each of the sample companies to compute the percentage of independent directors

on the board. Three companies did not disclose their reports. As a consequence,

we did not include them in our final sample.

Finally, we excluded two companies that have been recently involved in account-

ing frauds in order to avoid any bias due to illegal behaviour and non-reliable dis-

closure. Our final sample consists of 175 companies. All of them are characterized

by the presence of a dominant shareholder, that is, a shareholder owning at least

10% of the voting rights. Table 1 summarizes the sample selection process.

Voluntary Disclosure and Independent Directors 13

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Dependent Variable

In order to measure the level of voluntary disclosure, we adapted the disclosure score

proposed by Botosan in 1997, which proved to be a valid measure for disclosure

extent. This score is based exclusively on information reported in annual reports

and it measures the overall level of disclosure as the sum of the scores achieved by

five different categories of information, namely, background information (BCKG),

summary of historical results (HIST), key non-financial statistics (NONF), projected

information (PROJ), and management discussion and analysis (MNGT).6 The score

is based on a list of items selected on the basis of the existing literature on corporate

disclosure. Regulation has also been considered in order to distinguish voluntary

from mandatory pieces of information. Each item is weighted according to its rel-

evance. Since Botosan’s score was designed to analyse the voluntary disclosure of

US companies, we partially modified it in order to make it suitable for the Italian insti-

tutional setting. We analysed the Italian regulation (in order to distinguish mandatory

from voluntary information for Italian companies) and we reviewed more recent

studies on disclosure focused on European countries (e.g. Depoers, 2000; Prencipe,

2004). Moreover, we submitted our instrument to three experienced auditors and

three financial analysts to test its suitability for the Italian setting.

We report the list of items included in our final score (hereafter called

DSCORE) and a summary of the weighting procedure in the Appendix. We

made three major adjustments to the original score proposed by Botosan. First,

since our objective was to measure voluntary disclosure, we eliminated those

items which are mandatory under the Italian regulation (e.g. number of employ-

ees). Second, we included those items which were mandatory according to the US

accounting standards (and therefore were excluded from Botosan’s score), yet

they are voluntary according to the Italian accounting regulation. In particular,

we included a sixth category of information related to segment reporting

(SEGM). In Italy, listed companies are required to break sale revenues down

into categories of activities and geographical areas, whenever this information

Table 1. Sample selection

Market segment– MIB30 & MIDEX 32– Star 32– Nuovo Mercato 43– Other 92

Population of non-financial listed firms in 2002 199– Annual reports according to non-Italian rules (8)– Annual reports not available (11)– Corporate Governance Report not available (3)– Companies involved in accounting frauds (2)

Final sample 175

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is considered to be relevant.7 The disclosure of any other segment items is volun-

tary. Thus, we included them in the DSCORE. We also included other voluntary

items in each category of information based on what has been proposed by prior

studies on disclosure (e.g. organizational structure and liquidity ratios, as proposed

by Depoers, 2000) and what was suggested by the experts we interviewed (e.g. earn-

ings per share). Third, we adapted the list of items in light of the common practice

followed by the Italian companies to avoid including items with no occurrence in

the sample. For example, our DSCORE does not include those items originally con-

sidered by Botosan (e.g. rejection/defect rates, ratio of inputs to outputs) which are

never provided by Italian companies as shown by a recent research paper (Pozza

et al., 2003). Our weighting procedure mainly follows the one used by Botosan.

The Appendix provides details on the weighting procedure.

In the computation of the DSCORE, we avoided penalizing those companies

for which not all of the items included in the list were relevant (e.g. R&D infor-

mation for merchandizing companies; segment information for single-segment

companies). We assigned a potential maximum score to each company by exclud-

ing the items identified as ‘not-relevant’ for it. We calculated our dependent vari-

able (i.e. DSCORE) for each company by dividing the total disclosure score it

reached (sum of the partial scores) by the potential maximum score assigned to it.

Independent Variable

In the accounting literature, independent directors have generally been identified

on the basis of a legal definition. We are aware that this is a spurious measure for

the independence of board members. In fact, legally defined independent direc-

tors are perhaps not so independent in substance. Even if formally independent,

some directors can be influenced by personal relationships with the managers or

with the dominant shareholder. This is particularly likely when the same member

has sat on the same board for a long period of time. In addition, independent

directors can sit on several boards at the same time. This might limit their moni-

toring activity.

Notwithstanding these limitations, consistently with the extant literature we

decided in the first instance to adopt a legal definition of independence. Consid-

ering that it is not possible to objectively measure the substantial independence of

the board members, such a kind of definition provides an empirically observable

indicator and is not subjectively assessed by the researcher. Moreover, the use of

a definition consistent with previous studies helps the comparability of results.

Later on, in the robustness checks section, we propose alternative definitions of

independence based on the exclusion of those members whose ‘independence’ or

whose ‘effectiveness’ in the monitoring activity can be assumed to be not sub-

stantial, in order to overcome, at least partially, the limits of the legal definition.

Therefore, based on what was disclosed by the companies in their corporate

governance report, we counted the number of independent directors over the

total number of directors. The proportion of independent directors (INDIR) is

Voluntary Disclosure and Independent Directors 15

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the main independent variable in our model. We chose the proportion and not the

absolute number of directors since the effectiveness of the monitoring activity is

expected to be proportional to the weight they have on the total number of

members on the board. Moreover, this is consistent with the variable used by

earlier studies (e.g. Beasley, 1996; Chen and Jaggi, 2000; Ho and Wong, 2001;

Eng and Mak, 2003; Gul and Leung, 2004).

Control Variables

To isolate the relationship between voluntary disclosure and independent

directors we considered several control variables.

First, we included the residual ownership diffusion as a control variable in the

empirical model, in order to control for the effect of ownership structure within

the relationship between voluntary disclosure and independent directors.

Residual ownership diffusion is a measure of the level of dispersion of the

shares not owned by the dominant or other significant shareholders. It is hypoth-

esized that companies with more widespread shares have a larger number of

shareholders who are not directly involved in the management of the company

and, consequently, the agency costs due to information asymmetry with man-

agers and controlling shareholders are higher. Since the annual report is typically

the main source of information for small shareholders, financial statements are

considered a means to reduce information asymmetry. Thus, residual ownership

diffusion is expected to be positively correlated with voluntary disclosure. Prior

empirical studies support the existence of such a relationship (e.g. McKinnon and

Dalimunthe, 1993; Raffournier, 1995; Haniffa and Cooke, 2002). In our empiri-

cal setting characterized by companies with highly concentrated ownership, we

expect that residual ownership diffusion may affect the level of disclosure,

since – as argued earlier in the paper – an agency relationship still exists

between the small shareholders not directly involved in the management of the

company and the controlling shareholders. Moreover, a previous study on volun-

tary disclosure in Italian listed companies finds significant statistical evidence

supporting our expectation (Prencipe, 2004). We measured residual ownership

diffusion (ROWNDIF) as the percentage of share capital owned by unknown

shareholders, possessing less than 2% of the share capital of the company. In

Italy, owners of more than 2% of the share capital of a listed company are

required to declare their ownership position to the CONSOB, the Italian Stock

Exchange Commission. Therefore, this type of information is publicly available.

On the other hand, shareholders who possess less than 2% of the share capital are

‘unknown’. Therefore, the percentage of capital owned by unknown shareholders

is calculated as 100% less the total percentage of capital owned by known

shareholders. Prior studies on disclosure adopt similar measures (e.g. McKinnon

and Dalimunthe, 1993; Raffournier, 1995; Prencipe, 2004).

Second, we considered prior literature on the economic variables associated

with voluntary disclosure. In particular, we referred to the meta-analysis

16 L. Patelli & A. Prencipe

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conducted by Ahmed and Courtis (1999), who review 29 studies on the topic. The

two authors find that corporate size, listing status, leverage and profitability are

the main determinants of voluntary disclosure level. Specifically, all these vari-

ables are positively correlated with disclosure. Since listing status does not

vary among the companies analysed in the present study, we only included

size, leverage and profitability in our empirical model. Similarly to prior

studies on the determinants of corporate disclosure, size is measured as the

natural logarithm of sales (LSAL), leverage is the equity to total assets ratio

(LEV) and profitability is the Return on Investment (ROI), computed as the Oper-

ating Income divided by Total Assets.

Finally, within the European context, the labour pressure is expected to be

significantly related with the amount of information voluntarily disclosed by

the companies (Depoers, 2000). Unions can use this information to increase

their bargaining power. Therefore, in case of high labour pressure, companies

tend to disclose less information to deter demands for higher wages. We

measured labour pressure as the labour charges on turnover ratio (LABC) and

expect a negative effect on disclosure.

Overall, we include five control variables in the empirical model, namely, size

(LSAL), leverage (LEV), profitability (ROI), residual ownership diffusion

(ROWNDIF) and labour pressure (LABC). We expect voluntary disclosure

(DSCORE) to be negatively correlated with labour pressure and positively

Table 2. Description of variables and measurement

Variable Description Measurement Data source

DSCORE Disclosure level Sum of six partialdisclosure scoresrelated to differentcategories ofinformation divided bythe potential maximumscore assigned to eachcompany

Financial Statements

INDIR Independentdirectors

Proportion of theindependent members onboard

Italian Stock Exchangewebsite(www.borsaitalia.it)

LSAL Size Natural logarithm of totalsales

Financial Statements

LEV Leverage Equity/Total Assets Financial StatementsROI Profitability Operating income divided

by total assetsFinancial Statements

LABC Labour pressure Labour charges on turnover Financial StatementsROWNDIF Residual

ownershipdiffusion

Percentage of share capitalowned by shareholderswho possess less than2% of the share capital

Italian Stock ExchangeCommission website(www.consob.it)

Voluntary Disclosure and Independent Directors 17

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correlated with size, leverage, profitability and residual ownership diffusion.

Table 2 reports the definition of each variable used in the empirical analysis

and the main source used to collect data to measure them.

4. Results

Descriptive Statistics

Table 3 provides descriptive statistics for the dependent and the independent vari-

ables, after excluding four outliers.8 On average, companies in the sample report

1,822 million euro of Total Sales and 0.39 of the Equity to Total Assets ratio

(LEV). The average Return on Investment (ROI) is 2.21% with 44 (25.7% of

the total sample) companies reporting a negative operating income. The

average Labour Charges on Turnover ratio (LABC) is 21.48%. On average,

35.21% of the share capital is owned by unknown shareholders (ROWNDIF).

Table 3. Descriptive statistics

Variable Min Max Median Mean St. dev.

Voluntary disclosure indexes (dependent variables)BCKG 0.00 0.58 0.19 0.19 0.10HIST 0.00 1.00 0.00 0.17 0.23SEGM 0.00 1.00 0.30 0.17 0.25NONF 0.00 0.50 0.00 0.07 0.10PROJ 0.00 0.33 0.00 0.04 0.07MNGT 0.00 0.78 0.18 0.19 0.12DSCORE 0.01 0.47 0.14 0.15 0.08

Determinants of voluntary disclosure (independent variables)INDIR 0.00 1.00 0.33 0.36 0.19LSAL 8.06 17.97 12.42 12.53 1.74LEV 0.02 0.93 0.36 0.39 0.19ROI 20.57 0.97 0.03 0.02 0.13LABC 0.02 1.36 0.18 0.21 0.16ROWNDIF 4.81 73.84 34.62 35.21 14.52

BCKG: partial disclosure scores related to the background information divided by the maximum score

assigned to each company for this category; HIST: partial disclosure scores related to the summary of

historical results divided by the maximum score assigned to each company for this category; SEGM:

partial disclosure scores related to the segment information divided by the maximum score assigned to

each company for this category; NONF: partial disclosure scores related to key non-financial statistics

divided by the maximum score assigned to each company for this category; PROJ: partial disclosure

scores related to projected information divided by the maximum score assigned to each company for

this category; MNGT: partial disclosure scores related to the management discussion and analysis

divided by the maximum score assigned to each company for this category; DSCORE: disclosure

score as the sum of the six partial disclosure scores related to the different categories of information

divided by the maximum score assigned to each company; INDIR: proportion of the independent

members on board; LSAL: natural logarithm of sales; LEV: Equity to Total Assets ratio; ROI:

Operating Income divided by Total Assets; LABC: Labour charges on Turnover ratio; ROWNDIF:

percentage of share capital owned by shareholders who posses less than 2% of the share capital.

18 L. Patelli & A. Prencipe

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The variation in the proportion of independent directors reported by the Italian

companies is high, ranging from 0 to 100%. The average ratio of indepen-

dent directors to total directors on the board (INDIR) is 35.57%

(median ¼ 33.33%). The median number of independent directors sitting on

the board is three. Independent directors represent more than 15% of the

members of the board of directors in 158 companies (92.39% of the total

sample). Eight companies (4.68% of the total sample) declare to have zero inde-

pendent directors; one company declares that all the members of its board of

directors are independent. Ten companies (5.84% of the total sample) do not

specify the names of the independent directors. Eighty-three companies

(48.5% of the total) disclose whether their independent directors sit on other

boards. One hundred and fourteen out of 308 independent directors with available

information sit on more than one board. Other studies show that the average

number of independent directors does not dramatically vary over time and

across market segments (SpencerStuart, 2004).

The mean value of DSCORE is 14.66% (median ¼ 13.77%), with a range of

0.72–47.2% and standard deviation of 7.73%. These results show that there is

a good variation in voluntary disclosure practices among Italian listed companies.

On average, companies disclose high volume of management information

(MNGT) to discuss financial results. However, their annual reports contain

little projected information (PROJ). Voluntary disclosure appears to be concen-

trated on current financial information as highlighted also by the low percentage

of non-financial information (NONF).

Regression Analysis

After excluding the above-mentioned four outliers, the regression analysis was

carried out on 171 observations. We tested multicollinearity among the indepen-

dent variables using the Variance Inflation Factor (VIF). VIFs of all the variables

were lower than two. Therefore, all the proposed independent variables were

included in the regression analysis.

We used the following regression model to test the hypothesized relationship

between voluntary disclosure and independent directors:

DSCOREi ¼ aþ b1INDIRi þ b2LSALi þ b3LEVi þ b4ROIi þ b5LABCi

þ b6ROWNDIFi þ 1i

where

i ¼ firm 1 through N (N: sample size);

DSCORE ¼ disclosure score as the sum of the partial weighted disclosure scores

related to the different categories of information divided by the potential

maximum score assigned to each company;

Voluntary Disclosure and Independent Directors 19

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INDIR ¼ proportion of the independent members on the board;

LSAL ¼ natural logarithm of sales;

LEV ¼ equity to total assets ratio;

ROI ¼ operating income divided by total assets;

LABC ¼ labour charges on turnover ratio;

ROWNDIF ¼ percentage of share capital owned by shareholders who possess

less than 2% of the share capital;

1 ¼ residual.

Table 4 reports the empirical results. The model shows an Adjusted R2 of

24.41%, which is higher than in earlier studies on the topic (e.g. Beasley,

1996; Eng and Mak, 2003). At the 0.01 level of significance, the hypothesis

that all the explanatory variable coefficients are simultaneously equal to zero is

rejected. Results strongly support our hypothesis: INDIR is significantly

( p-value , 0.01) and positively related to DSCORE. While controlling for

other significant determinants of disclosure, INDIR is associated with the level

of voluntary disclosure. The positive sign of the coefficient suggests that the

two control mechanisms tend to coexist.

As concerns the control variables, LSAL is positively related to the level of

voluntary disclosure ( p-value , 0.01). Contrary to what has been found by

prior studies, LEV has an insignificant coefficient ( p-value . 0.10). This can

Table 4. Multivariate least squares regression results (whiteheteroscedasticity – consistent standard errors and covariance)DSCOREi ¼ aþ b1INDIRi þ b2LSALi þ b3LEVi þ b4ROIi þ

b5LABCi þ b6ROWNDIFi þ 1i

Variable Coefficient Prob.

Intercept 2 0.140 0.025INDIR 0.109 0.001LSAL 0.016 0.000LEV 0.041 0.150ROI 20.011 0.773LABC 0.004 0.877ROWNDIF 0.000 0.062Adjusted R2 0.2441F-Statistics 10.151Prob. 0.0000No. obs. 171

DSCORE: disclosure score as the sum of the six partial disclosure scores

related to the different categories of information divided by the maximum

score assigned to each company; INDIR: proportion of the independent

members on board; LSAL: natural logarithm of sales; LEV: Equity to

Total Assets ratio; ROI: Operating Income divided by Total Assets;

LABC: Labour charges on Turnover ratio; ROWNDIF: percentage of

share capital owned by shareholders who possess less than 2% of the

share capital.

20 L. Patelli & A. Prencipe

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be related to the peculiar context of the Italian companies which are mainly

financed through the banking system. Since they normally tend to establish a con-

fidential relationship with banks, information is likely to be provided to them

more through informal and private channels than through annual reports. There-

fore, the confidential relationship between companies and banks might offset the

expected positive effect of leverage on the amount of information disclosed in

annual reports. Similarly, ROI has an insignificant coefficient in the regression

model ( p-value . 0.10). In our empirical setting, profitability is not a statistically

significant determinant of the level of discretionary information disclosed by

listed companies. In their review, Ahmed and Courtis (1999) report a large diver-

sity of results across studies regarding the relationship between profitability and

voluntary disclosure. Also, the coefficient of LABC is not statistically significant

( p-value . 0.10), suggesting that labour pressure is not a relevant determinant of

voluntary disclosure for Italian listed companies. ROWNDIF has a significant

positive coefficient in the regression model ( p-value , 0.10), suggesting that

residual ownership diffusion has a marginal positive effect on voluntary disclos-

ure. The inclusion of further control variables proposed by Depoers (2000) in the

regression model does not change the results.9

We performed an additional analysis in order to test the relationship between the

proportion of independent directors and each category of information included in

the disclosure score (BCKG, HIST, NONF, PROJ, SEGM, MNGT), controlling for

the factors included in our empirical model. Results (reported in Table 5) show that

INDIR is significantly correlated with the level of disclosure as concerns back-

ground information, key non-financial statistics, and management discussion and

analysis ( p-values ,0.05); whereas INDIR is not significantly correlated with

the level of disclosure as concerns the summary of historical results, projected

information and segment information ( p-values . 0.10). These results suggest

that the presence of independent directors is particularly correlated to the cat-

egories of information providing explanations for a better understanding of

current performances. The three partial disclosure categories that are significantly

correlated to INDIR (i.e. background information, non-financial statistics and man-

agement discussion and analysis) consist of information about the strategies, the

objectives and the motivations for current results, based on both financial and

non-financial data. They are particularly useful for outsiders to understand the

way the insiders behaved during the last period. This is consistent with our expec-

tation that the presence of independent directors makes the insiders more willing to

disclose information about their performance since they have less to loose (in terms

of personal opportunistic benefits) from such release. Differently, the presence of

independent directors is not significantly correlated to historical information

(related to past periods), segment information and future projected information,

even if the regression coefficients are positive for each information category. To

sum up, the inclusion of independent directors on the board seems to foster particu-

larly financial and non-financial information about the last period more than infor-

mation about past or future projected results.

Voluntary Disclosure and Independent Directors 21

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Table 5. Multivariate least squares regression results for six information categories (white heteroscedasticity – consistent standard errors andcovariance) Yi ¼ aþ b1INDIRi þ b2LSALi þ b3LEVi þ b4ROIiþ b5LABCi þ b6ROWNDIFi þ 1i

Independent variable

BCKG HIST NONF PROJ SEGM MNGT

Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob.

Intercept 20.051 0.502 20.414 0.015 20.089 0.235 20.122 0.066 20.301 0.092 20.102 0.257INDIR 0.125 0.001 0.140 0.156 0.118 0.007 0.039 0.202 0.154 0.142 0.123 0.018LNSAL 0.011 0.036 0.032 0.012 0.010 0.084 0.010 0.039 0.036 0.004 0.019 0.004LEV 0.089 0.043 0.196 0.030 0.008 0.836 0.021 0.451 20.087 0.397 20.011 0.805ROI 20.096 0.025 0.157 0.303 20.066 0.094 20.987 0.325 0.012 0.913 0.021 0.764LABC 20.002 0.653 20.064 0.416 20.011 0.799 0.044 0.234 0.156 0.144 0.007 0.842ROWNDIF 0.001 0.074 0.002 0.167 20.000 0.623 0.000 0.527 0.003 0.030 0.000 0.276

Adjusted R2 0.1138 0.1020 0.0705 0.0413 0.1206 0.1317F-Statistics 4.6391 4.2172 3.1493 2.2204 4.8844 5.298Prob. 0.0002 0.0005 0.0060 0.0436 0.0001 0.0000No. obs. 171 171 171 171 171 171

BCKG: partial disclosure scores related to the background information divided by the maximum score assigned to each company for this category; HIST: partial

disclosure scores related to the summary of historical results divided by the maximum score assigned to each company for this category; SEGM: partial disclosure

scores related to the segment information divided by the maximum score assigned to each company for this category; NONF: partial disclosure scores related to key

non-financial statistics divided by the maximum score assigned to each company for this category; PROJ: partial disclosure scores related to projected information

divided by the maximum score assigned to each company for this category; MNGT: partial disclosure scores related to the management discussion and analysis

divided by the maximum score assigned to each company for this category; INDIR: the proportion of the independent members on board; LSAL: natural logarithm

of sales; LEV: Equity to Total Assets ratio; ROI: Operating Income divided by Total Assets; LABC: Labour charges on Turnover ratio; ROWNDIF: percentage of

share capital owned by shareholders who possess less than 2% of the share capital.

22

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Robustness Checks

To assess the level of voluntary disclosure, we adopted an index developed by

Botosan with some adjustments (reported in the Appendix). As a robustness

check, we tested our hypothesis measuring voluntary disclosure with two alterna-

tive scores. First, we constructed an unweighted disclosure score by simply

counting the number of disclosure items reported in the annual reports. Omitting

the weighting procedure (see Appendix) leads to a disclosure score exclusively

determined by the amount of information provided with no consideration for

the typology of information (for instance, qualitative vs. quantitative infor-

mation). Further, the unweighted score partially checks for the biases affecting

the weighting systems. Second, we replicated Botosan’s disclosure score by con-

sidering only the items proposed by Botosan and omitting our adjustments.10

Table 6 reports results of two regression analyses with the unweighted score

and the Botosan score as the two dependent variables. Results confirm that

INDIR, LSAL and ROWNDIF have significant and positive coefficients

( p-value , 0.10) reinforcing the conclusion that voluntary disclosure is signifi-

cantly influenced by the proportion of independent directors, the firm’s size

and the residual ownership diffusion.

Table 6. Robustness checks: MLS regressions for alternative scores (white heteroscedas-ticity – consistent standard errors and covariance) Yi ¼ aþ b1INDIRi þ b2LSALi þ

b3LEVi þ b4ROIi þ b5LABCi þ b6ROWNDIFi þ 1i where Y can be:2 DSCORE Unweighted: unweighted sum of the disclosure items reported in the annual

reports;2 DSCORE Botosan: sum of the disclosure items originally proposed by Botosan (1997)

Independent variable

DSCORE Unweighted DSCORE Botosan

Coeff. Prob. Coeff. Prob.

Intercept 20.114 0.033 20.127 0.006INDIR 0.096 0.002 0.080 0.002LSAL 0.014 0.000 0.016 0.000LEV 0.029 0.261 0.032 0.199ROI 20.015 0.664 20.058 0.010LABC 0.006 0.799 0.006 0.789ROWNDIF 0.001 0.065 0.000 0.095

Adjusted R2 0.2468 0.2677F-Statistic 10.2868 10.9912Prob. 0.0000 0.0000No. obs. 171 171

DSCORE: disclosure score as the sum of the six partial disclosure scores related to the different categories

of information divided by the maximum score assigned to each company; INDIR: proportion of the inde-

pendent members on board; LSAL: natural logarithm of sales; LEV: Equity to Total Assets ratio; ROI:

Operating Income divided by Total Assets; LABC: Labour charges on Turnover ratio; ROWNDIF:

percentage of share capital owned by shareholders who possess less than 2% of the share capital.

Voluntary Disclosure and Independent Directors 23

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In addition, we conducted robustness checks considering the independent vari-

ables of our model. So far, to identify the independent directors on the boards we

have relied on the legal definition (reported in a previous section), based on the

information disclosed by the companies in their corporate governance reports.

The reasons for such a choice have been highlighted earlier. As pointed out

especially by the popular press, some of the independent directors have a

similar kind of relationship with the company’s managers (or the dominant share-

holder) as the other board members, even though they meet the legal require-

ments to be identified as independent (e.g. Il Mondo, 2003, 2004). This might

be a case of non-substantial independence leading to ineffective monitoring.

This case is particularly likely to occur when board members sit on the same

board for a long time and they are members of many boards simultaneously.

Therefore, we sophisticated our empirical measure of independent directors

and conducted robustness checks on our regression model.

First of all, we excluded from the number of independent directors those

members who have sat on the same board for a long period of time. These

members are more likely to have established personal relationships with the man-

agers (or the dominant shareholder) they should monitor. In particular, we con-

structed an alternative variable for independent directors by excluding from the

total number of independent directors those members who were already part of

the same board in 1998, that is, prior to the introduction of the CGC (INDIR98).

Results (reported in Table 7) confirm that there is a significant positive relationship

between the level of disclosure and the proportion of independent directors.

Second, we excluded those members who sit on many boards of directors at the

same time. As acknowledged by the professional literature (e.g. Incorvati, 2004),

these directors are likely to have fewer resources (mainly in terms of time) to

perform their monitoring role effectively. We run the regression model with

two alternative variables for independent directors, by excluding the independent

members involved respectively in more than three boards (INDIR3) and in more

than five boards (INDIR5). Only 83 companies disclosed information about the

number of boards in which each director is involved. Table 7 reports the

results that still confirm the validity our hypothesis.

As a further check, we constructed an alternative variable for independent direc-

tors by excluding both the above-mentioned categories of directors from the defi-

nition of independent directors (INDIRADJ). As reported in Table 7, results from

the regression analysis proved to be robust, confirming that the proportion of inde-

pendent directors is positively correlated to the extent of voluntary disclosure.

As mentioned before, in the accounting literature, the usual threshold used to

identify dominant-shareholder companies is the 10% of the share capital or of

the voting rights. According to this criterion, companies in which one shareholder

owns 10% or more of the share capital or of the voting rights are characterized by

the presence of a dominant shareholder. In our analysis we preferred to consider

voting rights since they are a better indicator of the decision power of the dominant

shareholder. Our empirical sample consists of 175 listed companies that have at

24 L. Patelli & A. Prencipe

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least one shareholder who owns 10% or more of the voting rights. This indicates

that our research setting can be considered extremely adequate to test our hypoth-

esis. However, whether a threshold of 10% appropriately defines the presence of a

dominant shareholder is questionable. Therefore, we established a stricter criterion

in order to conservatively test our hypothesis. More precisely, we tested our empiri-

cal model on a sample including those companies with either one shareholder pos-

sessing more than 50% of the voting rights or more shareholders signing a vote

agreement and controlling more than 50% of the voting rights. The 50% represents

a stricter definition for dominant-shareholder companies. The regression analysis

provides similar results, confirming the support of our hypothesis.11

5. Conclusions

Based on a sample of Italian non-financial listed companies characterized by the

presence of a dominant shareholder, this study shows that there is a positive

Table 7. Robustness checks: MLS regressions (alternative variables of independentdirectors) (white heteroscedasticity – consistent standard errors and covariance)DSCOREi ¼ aþ b1Xi þ b2LSALi þ b3LEVi þ b4ROIi þ b5LABCi þ b6ROWNDIFi þ

1i where X can be:2 INDIR98: proportion of independent directors excluding those who were already part of

the same board in 1998;2 INDIR3: proportion of independent directors excluding those who sit on more than three

boards;2 INDIR5: proportion of independent directors excluding those who sit on more than five

boards;2 INDIRADJ: proportion of independent directors excluding all the cases above

Variable Coeff. Prob. Coeff. Prob. Coeff. Prob. Coeff. Prob.

Intercept 20.167 0.003 20.240 0.005 20.241 0.006 0.163 0.002INDIR98 0.067 0.007INDIR3 0.100 0.087INDIR5 0.100 0.074INDIRADJ 0.303 0.000LSAL 0.020 0.000 0.023 0.000 0.022 0.000 0.019 0.000LEV 0.044 0.158 0.071 0.152 0.078 0.119 0.039 0.188ROI 0.004 0.933 0.078 0.272 0.804 0.273 0.012 0.787LABC 0.022 0.545 0.054 0.183 0.052 0.200 0.012 0.733ROWNDIF 0.001 0.029 0.001 0.065 0.000 0.086 0.001 0.020

Adjusted R2 0.2060 0.3272 0.3264 0.2634F-Statistics 8.3530 7.7267 7.7021 11.1294Prob. 0.0000 0.0000 0.0000 0.0000No. obs. 171 83 83 83

DSCORE: disclosure score as the sum of the six partial disclosure scores related to the different cat-

egories of information divided by the maximum score assigned to each company; LEV: Equity to

Total Assets ratio; ROI: Operating Income divided by Total Assets; LABC: Labour charges on Turn-

over ratio; ROWNDIF: percentage of share capital owned by shareholders who possess less than 2%

of the share capital.

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correlation between the proportion of independent directors on the board and the

amount of voluntary information disclosed by the companies in their annual

reports. The correlation is found through a multivariate analysis controlling for

residual ownership diffusion, size, leverage, profitability and labour pressure. Find-

ings provide support for our expectation that the internal (i.e. independent direc-

tors) and the external (i.e. voluntary disclosure) control mechanisms tend to

coexist. Results are consistent with the agency theory which predicts a positive

relationship between the two control mechanisms under investigation, due to the

fact that the ex ante existence of either of the two reduces the costs for insiders

(in terms of loss of opportunistic benefits) arising from introducing the other.

The reputation and domino effect contribute to explaining the relationship

between the two control mechanisms. Looking at the individual categories of infor-

mation, the presence of independent directors seems to be particularly correlated to

information related to the current performance more than to those concerning the

past or future expected results. The empirical evidence is consistent with our

expectation that insiders are more willing to disclose information that allows a

better understanding of their current performance when, ex ante, their opportunistic

behaviour is limited by the monitoring activities carried out by the independent

directors.

We test our hypothesis in a setting characterized by companies with a domi-

nant shareholder. Empirical results are robust with respect to three different

sets of voluntary items used to assess the level of voluntary disclosure and five

different ways to operationalize independent directors. Moreover, robustness

checks reveal that our results are not affected by the different thresholds used

to identify the presence of a dominant shareholder.

This study has both theoretical and practical implications. From a theoretical

standpoint, our analysis reveals a positive relationship between the two control

mechanisms in coping with the agency costs. From a practical standpoint, the

study offers insights to policy makers and regulators in order to evaluate the effec-

tiveness of corporate governance rules and the interaction between control systems.

The lack of publicly available information on Italian listed companies limited

to some extent our empirical research. First, we relied on an ad hoc instrument

constructed by researchers to assess voluntary disclosure and based exclusively

on the information reported in the annual report. This might lead to a partial rep-

resentation of the disclosure level. Second, we focused on one single year.12

Finally, we considered only two control mechanisms. Further research can

devote attention to other relevant control mechanisms (for example, executive

compensation) employed by listed companies to cope with the agency problem.

Acknowledgements

We thank the participants at the 27th EAA Annual Conference Meeting in Prague,

at the 6th Emerging Issues in International Accounting and Business Conference

Meeting in Padua, and at the seminar at Erasmus University Rotterdam for their

26 L. Patelli & A. Prencipe

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helpful comments. Special thanks to Wim Van der Stede for his suggestions. We

gratefully acknowledge Professor Botosan for providing us with all the details

necessary to use her instrument to measure voluntary disclosure.

Notes

1All that we affirm in the paper can also be referred to the case in which there is a dominant

‘group of shareholders’, that is, the case in which a group of shareholders agreed to vote and

behave like a single shareholder.2For a more complete literature review on these topics, see Hermalin and Weisbach (2003).3For a wider review of such studies, see Anderson and Reeb (2004).4The professional press provides many articles, suggesting that the outsiders are aware of the risk

of collusion and are able to distinguish formal from real monitoring. See, for example, Plutino

(2002), Il Mondo (2003, 2004), De Rosa (2004), Incorvati (2004) and Sabbatini (2004).5In most cases, this was due to the fact that these companies were no longer listed when we

carried out the data collection.6Commented description of the five categories of information can be found in the article written

by Botosan and published in The Accounting Review in 1997.7Neither Italian law nor Italian accounting standards specifically deal with segment information,

apart from sale revenues. The only reference to segment data is stated in Communication No.

DAC/98084143, a document issued in October 1998 by the Commissione Nazionale per le

Societa e la Borsa (CONSOB, the Italian Stock Exchange Commission). This document

consists of an invitation to all listed companies to disclose segment information according to

IAS 14-revised, but since no clear sanction is stated for the failure to meet this request, it is

not considered mandatory. Earlier studies showed that there is high variety in the segment infor-

mation disclosed by Italian companies (Prencipe, 2004).8In particular, the variable measuring the company’s leverage (LEV) shows two outliers. These

are companies reporting a negative value for equity, resulting in leverage with no clear

meaning. Two other outliers were found in relation to the other variables. The inclusion of

these values in the empirical multivariate model does not change our results.9A recent study on voluntary disclosure conducted on a European country (Depoers, 2000) pro-

poses foreign activity (measured as exports on sales ratio) and barriers to entry (measured as

gross fixed assets) as two determinants of the level of discretionary information disclosed by

the companies in their annual reports. This information is not always disclosed by Italian

listed companies. For companies with available data, we ran our main regression model includ-

ing these additional control variables. Regression results still strongly support our hypothesis.10We still eliminated those items which are mandatory according to Italian regulation.11In addition to 50%, of voting rights, we considered several other thresholds to identify the

presence of a dominant shareholder, that is, 20, 30 and 40%. Moreover, we considered not

only the voting rights but also the shares owned by the shareholders. All the different proxies

provide similar and consistent results.12Similarly, previous studies focused on relatively small samples. For example, Botosan (1997)

analysed 122 reports and Depoers (2000) analysed 102 reports.

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Appendix. Composition of the DSCORE and Weighting System

Summary of the Weighting System

Background information

One point is awarded for each piece of information reported. One additional point

is awarded if the information is reported in quantitative terms (when applicable).

Summary of historical results

For the ratios and EPS, one point is awarded if the information is reported with

reference to the last accounting period (period X ); one additional point is

awarded if it is reported with reference to the previous accounting period

(X 2 1); one additional point is awarded if it is reported with reference to two

periods earlier (X 2 2).

For the evolution of sales, operating income and net income, one point is

awarded if each piece of information is reported with reference to two periods

earlier (period X 2 2).

Segment information

One point is awarded for each item reported.

Key non-financial statistics

Two points are awarded for each piece of information reported.

Projected information

For items from a. to b., one point is awarded for each of them if the information is

reported in qualitative terms. For items from c. to j., two points are awarded for

each of them if the information is reported in qualitative terms. One additional

point is awarded for each item reported in quantitative terms. One additional

point is awarded for items from i. to j. if the information is reported with refer-

ence to the main segments.

Management discussion and analysis

For items from a. to n.: one point is awarded for each item reported. One additional

point is given to each item if quantitative data are provided. The procedure is the

same except for sales and operating income. For these two items a firm is given half

of the points otherwise available if the item is reported only on a consolidated basis

and is not provided with reference at least to its major segments.

For items from o. to s.: one point is awarded if comments are provided on the

last period ratios. One additional point is awarded if comments are provided on

the evolution of the ratios.

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Table A1. List of items included in the DSCORE

Background information:a. A brief history of the companyb. A statement of corporate goals or objectivesc. A general statement of corporate strategyd. Actions taken during the year to achieve the corporate goalse. Planned actions to be taken in future yearsf. A timeframe for achieving corporate goalsg. Barriers to entryh. Impact of barriers to entry on current profiti. Impact of barriers to entry on future profitj. The competitive environmentk. The impact of competition on current profitsl. The impact of competition on future profitsm. A general description of the businessn. The principal products/services producedo. Specific characteristics of these products/servicesp. The principal marketsq. Specific characteristics of these marketsr. A description of the major plants/warehousess. The organizational structure of the companyt. The management organization chart

Summary of historical results:a. Profitability ratiosb. Financial structure ratiosc. Liquidity ratiosd. Other ratiose. EPSf. Evolution of salesg. Evolution of operating incomeh. Evolution of net income

Segment information:a. Description of segmentsb. Assets by segmentc. Liabilities or internal financing by segmentd. Depreciation by segmente. Operating income by segmentf. Investments by segmentg. Research and development spending by segment

Key non-financial statistics:a. Average compensation per employeeb. Average age of key employeesc. Market share for the main products/servicesd. Units sold for the main products/servicese. Unit selling price for the main products/servicesf. Growth in units sold for the main products/servicesg. Break-even sales for the main products/services

(Table continued)

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Table A1. Continued

h. Production/delivery lead timei. Description of production methods/know-howj. Distribution of customers (e.g. private/public, large/small sized, etc.)

Projected information:a. A comparison of previous earnings projections to actual earningsb. A comparison of previous sales projections to actual salesc. The impact of opportunities available to the firm on future sales or profitsd. The impact of risks facing the firm on future sales or profitse. A forecast of market sharef. A cash-flow projectiong. A projection of capital expenditureh. A projection of R&D expendituresi. A projection of future earningsj. A projection of future sales

Management discussion and analysis:a. Explanations for change in salesb. Explanations for change in operating incomec. Explanations for change in cost of goods soldd. Explanations for change in cost of goods sold as a percentage of salese. Explanations for change in gross profitf. Explanations for change in gross profit as a percentage of salesg. Explanations for change in selling and administrative expensesh. Explanations for change in interest expense or interest incomei. Explanations for change in net incomej. Explanations for change in inventoryk. Explanations for change in accounts receivablel. Explanations for change in capital expendituresm. Explanations for change in R&D expendituresn. Explanations for change in market shareo. Comments on profitability ratiosp. Comments on financial structure ratiosq. Comments on liquidity ratiosr. Comments on other ratioss. Comments on EPS

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