the quality analysis of risk...

VALUE RELEVANCE OF RISK DISCLOSURE QUALITY INDEX IN INDONESIA

IRA GERALDINAHILDA ROSSIETA

RATNA WARDHANIFITRYANI AMARULLAH

UNIVERSITAS INDONESIAAbstract

This study is aimed to investigate the value relevance of quality of companies’risk

disclosure, both mandatory and voluntary items, in Indonesia. The quality of risk disclosure

is measured by using four dimensions, namely: (i) relative quantity; (ii) depth; (iii) the scope;

and (iv) outlook profile of companies’ risk management. This study uses sample of 407

companies across the public companies excluding the financial industry in the period 2011

and 2012. Using unbalanced panel data analysis, the results showed that the risk disclosure

quality index (mandatory and voluntary) are not relevant for making investment decisions in

Indonesia stock’s exchange. In addition, the index of the quality of enterprise risk disclosures

are not abble to improve investor’s ability in assessing of the companies' future performance

(earnings).

Keywords: Risk Disclosure Index, Mandatory Risk Disclosure, Voluntary Risk Disclosure,

Value Relevance, FERC.

1. Introduction

After the 2007/2008 financial crisis, demand for risk reporting (risk disclosure) has

been increased. Beattie (2000) conducted a review of the need of future external corporate

reporting model of modern business. The review concluded that, in general, the business

demands a fundamental change in corporate reporting practices by adding forward-looking,

non-financial, and soft information to the financial reporting. One of those kind of information

is risk disclosure that are useful for assessing the risk of the company, especially when

combined with information related to the companies’ threats and opportunities. The

information it is important to answer the challenges of the changing of business environment

in turbulancing’s era.

1

2

The risk information is expected to be relevant information for users of financial

statements, especially investors in the capital market. To be a relevant information, the

information should has ability to make a different in investment decision making. In the

context of the capital market, the relevant information is reflected in the changes of

company's stock price.

The previous study that investigated the value relevance of risk disclosure in the

capital market for investors was conducted by Uddin & Hassan (2011). Uddin and Hassan

(2011) examined the effect of risk disclosure index on stock price volatility and market risk

(beta) in the United Arab Emirates. The result showed that risk disclosure index has

significant positively effect on stock price volatility (contrary to hypothesis) and has

negatively effect on market risk (beta). It has positively effect on market risk if the

relationship is quadratic. This condition is caused by the disclosure of corporate’s risk might

increase the uncertainty of investment, but in the other hand, the information can help

investors to diversify their portfolio and minimize the decreacing tendency of market risk.

Their study did not examine the role of company's risk disclosure information in increasing

the informativeness of future earnings as one of study of value relevance of accounting

information. In this case, if company has a good quality of risk disclosure, the information will

reliable and relevant for investors in making investment decisions. Investors will use the

information to assess company's future cash flow and earnings as a basis for decision-

making for their portfolio of investment. In other words, the reliable and relevant of risk

disclosure can increase the ability of the market to anticipate the compan’ future earnings.

Therefore, this study is aimed to examine the value relevance of index of quality risk

disclosure (mandatory and voluntary) across public companies in Indonesia, excluded

financial institution companies during the period 2of 011 and 2012. To achieve objective

above, the study conducted two investigations by examining the effect of index of quality risk

disclosure on return and the effect of the quality of risk disclosure index on future earnings

informativeness (Future Earning Response coeficient or FERC).

3

2. Review of Literature and Previous Research

2.1 The Quality Analysis of Risk Disclosure

2.1.1 The Items of Risk Disclosure

In this study, the disclosure of risk is defined as a communication tool of information

strategies of company, characteristics, business operation, and external factors of company

that could potentially have impact on company in the future of (Beretta & Bozzolan, 2004).

Disclosure of risk is focused on a number of risk uncertainties which may affect the volatility

and the company's future performance.

Risk is defined as a set of outcomes arising from a decision that takes into account

the probability of outcomes. Outcomes of these risks or uncertainties can be either positive

or negative. Studies on risk analysis emphasizes the impact of uncertainty that can be

managed by companies. Therefore, the study of risk disclosure is to analyze the information

regarding company’s opportunities or prospects, threat (hazard), danger (harm) or the

exposure of the company disclosed that have potential impact on company in the future

(Linsley & Shrives, 2006).

Analysis of risk disclosure in the study are including both items of mandatory and

voluntary risk which are disclosed in the company 's annual report and the quality of

disclosure for both items. The component of risk in this study were adopted from Linsley &

Shrives (2006). The reason in choosing their study is because of their component is based

on ICAEW guidelines risk disclosure framework, enhanced Beretta & Bozzolan framework

(2004), and adopted by many reearchers with few of modification.

Table 1: Items of Risk Disclosure

No. Items of Risk Indicators ReferencesA. Mandatory Discosure Items

1. Financial Risk Credit Liquidity Market (commodity/present value) Interest rate Exchange rate Contigent Risk

BapepamLK No. KEP-347/BL/20121

PSAK No. 60 (Revisi 2010)2.

PSAK 57 (Revisi 2009)3

1 Mandatory risk disclosure regulation issued by Stock Exchange Supervisor Body2 Local accounting standard regarding financial instrument disclosures

4

Linsley & Shrives (2006)

B. Voluntary Discloure Items1. Operations

risk Customer satisfaction Product development Efficiency and performance Sourcing Stock obsolescence and shrinkage Product and service failure Environmental Health and safety Brand name erosion

Linsley & Shrives, (2006)

2 Empowerment risk

Leadership and management Outsourcing Performance incentives Change readiness Communications


3. Information processing and technology risk

Integrity Access Availability Infrastructure


4. Integrity risk Management and employee fraud Illegal acts Reputation


5 Strategic risk Environmental scan Industry Business portfolio Competitors Pricing Valuation Planning Life cycle Performance measurement Regulatory Sovereign and political


2.1.2 Dimension of Quality of Risk Disclosure

In this study, the nature of analysis of quality of risk disclosure is semi-objective by

using two approaches suggested by Beattie, et al., (2004). This approach uses textual and

disclosure index analysis. Textual analysis is done by using content analysis, mostly done in

thematic, readability, and linguistics analysis.

This study uses both the number of risk disclosure and textual analysis to capture the

quality of company risk disclosure. This study uses four dimensions of quality of risk

disclosure, that are: (i) the relative quantity of risk disclosure, (ii) scope (coverage), (iii)

depth, and (iv) the outlook profile of company risk management. The relative quantity of risk 3 Local accounting standard regarding contigent risk

5

disclosure is represent the mechanistic approach of the disclosure or the index number of

company's risk, while the concentration (coverage), depth, and the outlook profile of

company risk management are represent interpretative or textual-semantic analysis

approach (Beattie, et al., 2004; Beretta & Bozzolan, 2004; Miihkinen, 2012).

Dimension of relative quantity of risk disclosure is the actual number of company risk

disclosure adjusted relatively to the size and complexity or the industry where the company

operates (Beattie, et al., 2004; Beretta & Bozzolan, 2004). The greater relative quantity of

risk disclosure of a company, the higher the quality of risk disclosure. Dimension of

concentration (coverage) of risk disclosure captures the coverage of disclosure between risk

categories. The more coverage of disclosure means risk disclosure are not concentrated in a

particular type of risk, then the higher the quality of a company risk disclosure (Beattie, et al.,

2004; Miihkinen, 2012). Dimension of depth of risk disclosure capture the quantitative and

qualitative of economic impact of the risks on a company's future performance (Beretta &

Bozzolan, 2004; Miihkinen, 2012). The economic impact of these risk can be positive or

negative. Dimension of outlook profile of company risk management is used to capture how

management communicates the approach in managing company risk management. This

dimension can be asses from the current management expectations on future performance

and operation of the company regarding the risks are managed by company, the actions or

programs or policy taken to address those risks (Beretta & Bozzolan, 2004; Miihkinen,

2012).

2.1.3 Value Relevance of the Quality of Risk Disclosure Index

According to Kothari (2001), there are five types of studies in the area of capital

markets, namely: (i) capital market research methodology, (ii) evaluation of alternative

measures of accounting performance, (iii) analysis of stock’s valuation, (iv) efficiency of

capital market, and (v) value relevance of accounting disclosure and their economic

consequences. The last areas was explored deeper by Healy and Palepu (2001) and the

focus of this study either.

6

The value relevance is closely related to the concept of earnings quality because it

generally uses changes in stock prices around the earnings announcement to measure how

much information in the financial statements may help investors to predict the future value of

the company (Scott, 2012; page 207). Previous literature conducted research on the

relevance of values based on the assumption that the accounting information is one source

of input in the stock assessment for investors (Holthausen and Watts, 2001).

The study of value relevance generally focused on examining the relationship

between accounting information with the stock price without directly examining definition of

attribute of reliability and relevance of accounting information as described in accounting

standard definition (Holthausen and Watts, 2001). Barth, et al., (2001) further explains that

the definition of the value relevance in academic literature is not as defined in accounting

standards. Accounting standards uses relevance and reliability as ingredient of the quality of

accounting information. The accounting information is relevant if it is able to provide some

alternative information for investment decision making.

Definition of value relevance in the academic literature is a way to operationalize both

relevance and reliability criteria that are stated in the accounting standards. The accounting

information is relevant if the information is relevant for investors in assessing the company,

reliably measured, and then reflected in stock prices. So, examining value relevance is

generally examining both of two critrea simultaneously (Barth, et al., 2001).

Study regarding value relevance is not aimed to estimate the value of the company

(direct equity valuation) as conducted in fundamental analysis research purposes, but to

conduct inputs-to-equity valuation. Although both use the stock price as the benchmark in

the model of study. In the study of fundamental analysis, the equation model are including all

the variables that can explain the value of the company or to predict the future value of the

company. Fundamental analysis does not consider the relevant information that can be used

in assessing companies appear in the financial statements or other information. Study of

inputs-to-equity valuation focus on the value relevance of accounting numbers that are

7

reflected in the components of earnings, not the value of the company as a whole (Barth, et

al., 2001).

Thus, study on value relevance is basically examining the relationship between the

stock price as the dependent variable and a set of accounting variables. The accounting

information (number) has value relevance if the accounting number variables have a

significant effect on stock price. It is supported by argumentation that accounting numbers

are used by investor in assessing company’s equity value that is repflected in sock price

(Beaver, 2002; Barth, et al., 2001). The accounting variables could be both financial and

non-financial information.

According to Beaver (2002), study on the relevance has at least three roles namely:

(1) to articulate an issue and provide paradigm in formulating the role of accounting numbers

in a reaserch framework; (2) to generate a theory as a reference in making a statement of

hypothesis; (3) to providing empirical evidence as a signal from an information system.

The value relevance investigation in this study is aims to provide empirical evidence

of the quality of risk disclosure as a signal of a non-financial information system to the

market. The quality of risk disclosure is relevant for investors if there is a significant

relationship between the variable of quality of risk disclosure and stock price. The significant

relationship between the two variables is conveying the message that company's risk

disclosure information is used by investors in making investment decisions as reflected in

the company's stock price. In addition, this study will examine the ability of quality of risk

disclosure in increasing the ability of investors in assesing future of company’s performance

or earnings (future earnings response coefficient / FERC).

2.2 Development of Hypothesis

Previous studies that examined the value relevance of risk disclosures in the capital

market is quite diverse. The study of Huang (2011) showed that the 25 risk factors disclosed

in the SEC Form 10-K are significantly correlated with the volatility and stock returns. The

more adequate disclosure of risk, the lower the uncertainty and the less of stock price

volatility. In addition, risk of disclosure reduce the information asymmetry in capital market,

8

thus decrease market risk and company’s cost of capital, and in turn increases the stock

return.

Similar finding was found in study of Uddin and Hassan (2011). They found that risk

of disclosure index had a significant positively associated with stock price volatility, but had

not significantly associated with market risk (beta) in the United Arab Emirates. The

implications of their study showed that, the more risk information disclosed in the annual

report, the higher the intensity of the uncertainty in the future performance of the company.

However, the risk disclosure helps investors to diversify their investment portfolio in order to

reduce the risk of its portfolio.

Both of the above results confirm the conjucture that a good quality of risk disclosure

can be used as a source of information for investors in investment decisions making that can

affect stock return. This argumentation is in line with capital market transactions hypothesis

(Healy & Palepu, 2001) which states the company has an incentive to disclose relevant

information regarding the company's prospects in the future in order to reduce information

asymmetry between companies with investors and among investors.

Based on the above arguments, the following hypothesis 1a is suggested.

H1a: The mandatory or voluntary of risk disclosure quality index has a significantly positive

effect on company’s stock return.

If the asymmetry of information regarding the company's risk is low, it will make

investors easier to assess and anticipate the future risk and prospects of company for their

investment decision-making. A good quality of risk disclosure can reduce asymmetry of

information regarding the company's risk. A good quality of risk disclosure is relevant for

investors if they use the information to assess company’s future cash flow and earnings

performance, thus encourage them to take investment decisions in current period. In other

words, the risk disclosure is a relevant information for investors in the capital market and

may increase the ability of the market to anticipate the company’s future earnings.

Based on observation on published pervious study were, it was not found any studies

that examined the effect of risk disclosure in increasing the investor's ability to asses and

9

predict the company's future earnings that is reflected in the future earnings response

coefficient (FERC). However, study regarding the effect of a good quality of information

disclosure on FERC had conducted by Ettredge, et al., (2005). Ettredge, et al., (2005)

examined the effect of adoption of SFAS No. 131 regarding disclosure of segment reporting

on investor's ability to predict the company's future earnings that is reflected in the FERC.

The result gave a strong empirical evidence that the companies who had previously

disclosed a multi segment reporting, their FERC were significantly increased after adopting

SFAS No. 131. Similarly, some companies who previously disclosed single segment

reporting and then disclosed multi segment reporting, their FERC were significantly

increased after adopting SFAS No. 131. Other wise, the companies who did not alter the

disclosure of segment reporting, their FERC were not changing after the adoption of SFAS

No. 131.

Study of Ettredge, et al., (2005) supports the argument that a good quality of

disclosure is a relevant information for investors. Relevant information will be used by the

market to assess the company's future risk and performance, thus increase the content of

the company's future earnings. Based on the above arguments, the following hypothesis 1b

is suggested.

H1b: The mandatory or voluntary of risk disclosure quality index has a significantly positive

effect on the informativeness of company’s futute earnings.

3. Research Methodology

3.1 Data and Sample

This study uses all public listed companies in Indonesia Stock Exchange during

2011-2012 period, except for banks and other financial institutions. Banks and other financial

institutions were excluded due to there is a different regulation regarding mandatory risk

disclosure with other industry. The secondary data used in this study were extracted from

Eikon database for annual reports and financial statements data, whereas share price were

obtained from Bloomberg database.

10

A total of 407 firm year observations are used as samples after excluding delisted

companies, public listed consolidated companies, inactive trading shares, some missing

data, and outliers. Public listed subsidiary companies were excluded because their parent

usually disclose its subsidiaries risk on its consolidated annual report. Inactive trading shares

were also excluded in order to accommodate on shares that were actively traded by

investors. These shares usually has a better liquidity due to lower asymmetry information

and better disclosure.The sample selection process is presented in Table 2 below.

Table 2: The Sample Selection Process

DescriptionsNumber of firm

yearsNumber of public listed companies in Indonesia Stock Exchange 882Number of delisted companies in Indonesia Stock Exchange (14)Number of Public Bank & Finance Institutions (132)Number of public listed consolidated subsidiaries (60)Number of inactive trading shares (145)Number of incomplete observation's data (110)Number of Initial Samples (421)Number of Outliers (14)Number of Final Samples 407

3.2 Research Model

Model in Equation (1) below modified from Ettredge, et al., (2005) is used to test the

hypothesis. This model only make an adjustment on the independent variable by replacing

the segment reporting disclosure with risk disclosure quality index (RDQI) variable.

Ri , t=θ0+θ1E i ,t−1+θ2 Ei ,t+θ3 Ei ,t+1+θ4 RDQI i ,t+θ5Ei , t∗RDQI i ,t+θ6E t+1∗RDQI i , t+θ7−13∑n=1

7

( IND )i+εi ,t

(1)

Ri , t : The annual stock return for year t, measured over the

12-month period ending three months after the

company’s fiscal year-end.

Ei , t−1 : Income available to common shareholders before

extraordinary items in year t-1; deflated by market value

of equity three months after the year t-1 fiscal year-end.

11

Ei , t : Income available to common shareholders before

extraordinary items in year t; deflated by market value of

equity three months after the year t-1 fiscal year-end.

Ei , t+1 : Income available to common shareholders before

extraordinary items in year t+1; deflated by market value

of equity three months after the year t-1 fiscal year-end.

RDQI i , t : The risk disclosure quality index of company in year t,

composed from 4 dimensions: (i) relative quantity; (ii)

depth; (iii) the scope; and (iv)outlook profile of

companies’ risk management. RQDI is divided into 2

items, mandatory risk disclosure quality index

(RDQI_MAND) and voluntary risk disclosure quality

index (RDQI_VOL).

INDi ,t : 8 types of industry category based on categorical of

Indonesia Stock Exchange that is excluded financial

institution.

The hypotheses 1a dan 1b can not be rejected if θ4>0 and θ6>0.

Expected sign for each control variables are: θ1≠0; θ2≠0; θ3>0; θ5>0; θ7−13≠0.

3.3 Measurement of Variables

The dependent variable of this study is stock annual return for the periode t (Ri , t).

Ri , t is measured by the annual stock return for year t, measured over the 12-month period

ending three months after the company’s fiscal year-end. The independent variable of this

study is the risk disclosure quality index (RDQI i , t), including mandatory and voluntary items.

The variable of RDQI i , t is the focus of study as well as moderating variable of future

earnings and RDQI (Et+1∗RDQI i ,t). The moderating variable is used to examine the effect of

the risk disclosure quality index in increasing the informativeness of future earnings.

12

The hypotheses of 1a can not be rejected if the coefficient of RDQI i , t is significantly

positive and the value of coefficient of θ4>0. In addition, The hypotheses of 1b can not be

rejected if the coefficient of Et+1 and Et+1∗RDQI i ,t are significantly positive and the value of

coefficient θ3−θ6>0.

The variable of RDQI i , t is composed from 4 dimension of disclosure quality which is

analyzed by using semi-objectively approach with considering the mechanistic aspects

(form-oriented) and textual semantics (interpretative). The four dimensions of disclosure

quality, namely: (i) relative quantity (RQT); (ii) depth (DPT); (iii) the scope (COVERAGE);

and (iv) the outlook profile of companies’ risk management (OPR).

The dimension of relative quantity of disclosure (RQT i ,t) is the actual quantity of risk

disclosure sentences that are adjusted relatively to the size of the company and the industry

where the company operates (Bozzolan, 2004). RQT i ,t is measured by residual value after

estimating the number of companies that are in lie the same subindustry ( IND j) and the

natural logarithm of the total assets of the company (LnSIZEi , t) to the actual number of

sentences of the company's risk sdisclosure as shown in equation 2 below.

Dij ,t=β0+β j IND j+βk+1 LnSIZEi ,t+εij ,t (2)

Dimension of coverage of disclosure captures concentration or distribution between

each categories of risk disclosure. The more spread means risk disclosure is not

concentrated in a particular type of risk, the higher quality of companies risk disclosure

(Beattie, et al., 2004; Miihkinen, 2012). The dimension is measured by Herfindahl index as

shown in equation 3 below (Miihkinen, 2012).

Coveragei , t=[ (1/H )Total numbers of risk items ] (3)

H is an Herfindahl index obtained from equation 4 as follows

H=∑i=1

n

P i2 (4)

13

Pi is the proportion of the number of sentences on topic of risk disclosures i to the

total number of sentences of risk disclosure. 1/H is used to demonstrate the greater number

of the Herfindahl index, the more extensive the distribution of risk disclosure among topics.

This study adjusted the formula of Miihkinen (2012 ) on by sorting the value of Herfindahl

index into percentile values, so-called Coverage Rank. This procedure is done in order to

create the output value of coverage-dimension is identical to the three other dimensions

which are expressed in the form of number of sentences. So the value would be in the

range of 1-10.

Dimension of depth DPT i ,t captures the economic impact of the risk which are

disclosed by a company on the future performance of a company, both quantitatively and

qualitatively (Beretta & Bozzolan, 2004; Miihkinen, 2012). The dimension is measured by the

natural logarithm of the total number of sentences that reveal the expected economic impact

which are affecting the future performance of the company as shown in equation 5 as

follows:

DPT i ,t=∑j=1

k j

IMPACT ij ,t (5)

DPT i ,t is the depth of risk disclosure index for firm i in year t; k j is the number of

sentences of risk disclosure in the company's annual report j; IMPACT ij ,t is given value of 2

if the sentence of j is expressed quantitatively in the annual report the company i in the year t

and contains the impact of risk to the future company’s performance, given the value of 1 if

the risk disclosure is expressed qualitatively, and the value of 0 if the sentence of j is not

expressed either quantitatively or qualitatively.

The dimension of outlook profile (OPR i ,t) is used to capture the way of manager

communicates the approach which is adopted in managing company’s risk. The dimension

appears from the manager’s expectation regarding current risk exposure on future operation

and performance of a company, the actions or policies or programs are taken to address the

risks (Beretta & Bozzolan, 2004; Miihkinen, 2012).

14

OPR i ,t=1rfl i

∑j=1

k j

ACPij (6)

OPR i ,t is outlook profile index of company i; rfl i is the number of sentences of risk are

disclosed by the company i; kj is number of sentences of risk disclosure in the company's

annual report j; ACPij is given value of 1 if the sentence of j in the annual report of company j

is containing with information relating to the actions or policies or programs are taken to

address the risk, and given value of 0 if otherwise.

The four dimensions of risk disclosure quality above are composed to create a risk

disclosure index (RDQI i , t). The indexes are analyzed separately either for mandatory risk

disclosure (RDQIMANDi , t) or voluntary risk disclosure (RDQIVOLi , t).

RDQI i , t=14 (RQT i , t+COVERAGERANK i ,t+DPT i ,t+OPRi , t ) (7)

The sentence risk disclosure is identify by using a few key words, namely: risk, uncertainty,

impact, opportunity, challenge, threats, hazards, prospect, etc.

The another four variables, namely earnings of peiod t-1 (E¿¿ i , t−1)¿; earnings of

peiod t (Ei , t); earnings of peiod t+1 (Ei , t+ 1); and industry (INDi ,t) are used to control the

possibility of the effect of previous earnings, current earnings, future earnings and the types

of industry on stock return.

Ei , t−1 is measured by income available to common shareholders before extraordinary

items in year t; deflated by market value of equity three months after the year t-1 fiscal year-

end. Ei , t is measured by income available to common shareholders before extraordinary

items in year t-1; deflated by market value of equity three months after the year t-1 fiscal

year-end. It is difficult to determine the direction of the effect of those two variables on stock

return of the company.

Ei , t+1 is measured by income available to common shareholders before extraordinary

items in year t+1; deflated by market value of equity three months after the year t-1 fiscal

year-end. The coefficient value of Ei , t+ 1 is expected to be significantly positive to show that

15

the increase in company earnings performance of future periods reflected on the increase in

stock returns in the current period.

INDi ,t is measured by using a dummy variable of 8 industry sectors based

clasification of Indonesia Stock Exchange, excluding financial institution industry. They are:

agriculture; mining; basic chemical industry; consumer goods; property, real estate, and

construction; infrastructure, utilities, and transportation; trade, services, and investments;

and other industry. Other industry is used as a benchmark for other industries (Syabani &

Siregar, 2013).

4. Data Analysis and Discussion

4.1 Descriptive Statistics

Table 3 below presents the descriptive statistics of the variables in this study. The

mean of risk disclosure quality index for voluntary items (RDQIVOLi , t) is higher than

mandatory ones (RDQIMANDi , t), respectively 7 and 4 sentences. However, on the other hand,

the standard deviation of RDQIVOLi , t is higher than RDQIMANDi , t variable. The minimum value

of RDQIVOLi , t is 0, while the maximum value is 19.76, but the minimum value of RDQIMANDi , t

is 0.94, while the maximum value is 9:42. It indicates that companies disclose voluntary

items of risk is more varied than the mandatory items. This finding indicates the tendency of

companies effort to comply with the regulations when disclose their mandatory items rather

than voluntary items.

Table 3 Descriptive Statistic

Variables Obs Mean Std. Dev. Min MaxRi , t 407 0.019484 0.038198 -0.1 0.1Ei , t−1 407 0.045995 0.086175 -0.2 0.29Ei , t 407 0.05774 0.115308 -0.27 0.38Ei , t+1 407 0.066953 0.146249 -0.36 0.49RDQIMANDi , t 407 4.355774 2.039032 0.94 9.42RDQIVOLi , t 407 7.038894 4.783564 0 19.76Ei , t∗RDQIMANDi ,t 407 0.259951 0.491465 -1.02 1.7Ei , t+1∗RDQIMANDi , t 407 0.261892 0.560342 -1.27 1.84Ei , t∗RDQI VOLi ,t 407 0.448722 0.915078 -2.04 3.18Ei , t+1∗RDQIVOLi ,t 407 0.474816 1.079349 -2.54 3.66

16

Ri , t (return) is dependent variable, measured by the annual stock return for year t, measured over the 12-month period ending three months after the company’s fiscal year-end. The independent variables: (i) Ei , t−1 (Earnings for period t-1), measured by income available to common shareholders before extraordinary items in year t-1; deflated by market value of equity three months after the year t-1 fiscal year-end; (ii) Ei , t (Earnings for period t), measured by income available to common shareholders before extraordinary items in year t; deflated by market value of equity three months after the year t-1 fiscal year-end; (iii) Ei , t+1 (Earnings for period t+1), measured by income available to common shareholders before extraordinary items in year t+1; deflated by market value of equity three months after the year t-1 fiscal year-end; (iv) RDQIMANDi , t(mandatory risk disclosurequality index ), measured by analyzing identified risk sentences, composed from 4 dimensions: (i) relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk management; (v) RDQIVOLi , t(voluntary risk disclosure quality index), measured by analyzing identified risk sentences, composed from 4 dimensions: (i) relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk management.

Table 4 below presents the correlation between variables in this study. Based on

table 4, all independent variables are significantly correlated with dependent variable

(return). Both variables of RDQIMANDi , tand RDQIVOLi , tthat are expected to be positively

correlated with return, they become negatively correlated with return. However, the

interaction variable of Ei , t+1∗RDQIMANDi , t and Ei , t+1∗RDQIVOLi ,t are positively correlated with

return (as expected). These findings are an early indication that a good quality of risk

disclosure is used by investors in assessing the company's future earnings for investment

decision making, thus affecting the company's return. Some variables have high significant

correlation value that are above 0.8, including current earnings (Ei , t) is correlated with

Ei , t∗RDQIMANDi ,t dan Ei , t∗RDQ IVOLi ,tamount is 0.8985 dan 0.8058. Similarly, future

earnings Ei , t+1 is correlated with Ei , t∗RDQIMANDi ,t and Ei , t∗RDQ IVOLi ,t, respectively amount

is 0.9237 and 0.8460. These findings indicate there is a multicollinearity problem on these

variables that might be resulting on inefficiency of coeffcient of regression estimation result.

Table 4 Correlation between Variables

Variables Ri , ti Ei , t−1 Ei , t Ei , t+1 RDQIMANDi , t RDQIVOLi , t Ei , t∗RDQIMANDi ,tEi , t+1∗RDQIMANDi , tEi , t∗RDQI VOLi ,tEi , t+1∗RDQIVOLi ,tRi , t 1Ei , t−1 0.1030* 1Ei , t 0.3448* 0.5182* 1Ei , t+1 0.3659* 0.2911* 0.5686* 1RDQIMANDi , t -0.1139* 0.0051 -0.0014 -0.1499RDQIVOLi , t -0.1063* 0.0258 0.0029 -0.0902 0.3818* 1Ei , t∗RDQIMANDi ,t 0.2934* 0.4416* 0.8985* 0.4699* 0.2734* 0.1050* 1Ei , t+1∗RDQIMANDi , t 0.3727* 0.2756* 0.5520* 0.9237* 0.0313 -0.0402 0.5747* 1Ei , t∗RDQI VOLi ,t 0.2260* 0.4009* 0.8058* 0.4383* 0.1398* 0.4472* 0.7985* 0.4679* 1Ei , t+1∗RDQIVOLi ,t 0.3201* 0.2376* 0.5085* 0.8460* -0.0625 0.2317* 0.4611* 0.8514* 0.6438* 1Ri , t (return) is dependent variable, measured by the annual stock return for year t, measured over the 12-month period ending three months after the company’s fiscal year-end.The independent

variables: (i) Ei , t−1 (Earnings for period t-1), measured by income available to common shareholders before extraordinary items in year t-1; deflated by market value of equity three months after the

year t-1 fiscal year-end; (ii) Ei , t (Earnings for period t), measured by income available to common shareholders before extraordinary items in year t; deflated by market value of equity three months after

the year t-1 fiscal year-end; (iii) Ei , t+ 1 (Earnings for period t+1), measured by income available to common shareholders before extraordinary items in year t+1; deflated by market value of equity three

months after the year t-1 fiscal year-end; (iv) RDQIMANDi , t(mandatory risk disclosurequality index), measured by analyzing identified risk sentences, composed from 4 dimensions: (i)

relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk management; (v) RDQIVOLi , t(voluntary risk disclosure quality index), measured by analyzing identified risk sentences, composed from 4 dimensions: (i) relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk management.

*), **), ***) significant at alpha 10%, 5%, and 1%

1

4.2 Estimation Result

4.2.1 Value Relevance of Mandatory Risk Disclosure Quality Index

This study uses unbalanced panel approach in analyzing the data. There are three

columns (columns 1-3) presented in Table 5 presents. The column 1 is the estimation of the

main models that are including all the variables of the model 4.1, but specifically for the

mandatory items of risk disclosure. The column 2 is the estimation of model 1 by without

interaction variables of Ei , t∗RDQIMANDi ,t and Ei , t+ 1∗RDQIMANDi , t variable. The column 3 is

the estimation of model 1 without RDQIMANDi , t, Ei , t∗RDQIMANDi ,t, and Ei , t+1∗RDQIMANDi , t

variables. The purpose of those three estimations of the models is to analyze the

incremental explanatory power of RDQIMANDi , t, Ei , t∗RDQIMANDi ,t and Ei , t+1∗RDQIMANDi , t

variables in explaining the return’s behavior.

In the column 1 of table 5 indicates that the variable of RDQIMANDi , t does not

significantly effect returns. Thus, the hypothesis 1a, stating that the mandatory of risk

disclosure quality index has a significantly positive effect on company’s stock return is

rejected. This finding is consistent with the result in column 2, which are excluded

interaction variables of Ei , t∗RDQIMANDi ,t and Ei , t+ 1∗RDQIMANDi , t. In addition, there is a

decreasing in Adj.R2 of 0.0015 (DIFF 2-3) when we are including RDQIMANDi , tvariable into

the research model. In other words, it can be concluded that the explanatory power of

RDQIMANDi , tvariable has been lowering the effect of earnings information to return. It makes

the finding clearer that the mandatory risk disclosure quality or the financial risk disclosure is

not relevant for investors in making investment decisions. Investors still rely on earnings

informastion (either past, current or future earnings) in making investment decisions in

Indonesia Stock Exchange. Those three earnings variables (Ei , t−1, Ei , t, Ei , t+ 1) are significant

as shown in column 2 and 3. Hence, the result of this study has not been able to add

empirical evidence to support capital market transactions hypothesis (Healy & Palepu,

2001). Mandatory risk disclosure quality is not a relevant information about the company's

1

19

prospects in the future in order to reduce information asymmetry between companies with

investors or among investors.

The interaction variable of Ei , t+1∗RDQIMANDi , t in column 1 has a significantly positive

effect on return. However, the variable of Ei , t+1 in column 1 has not, although it has a

significantly positive effect on return in columns 2 and 3 (Table 5). Thus, the hypothesis 1b,

stating that the mandatory of risk disclosure quality index has a positive effect on the

company's future earnings informativeness is rejected. Although there is an increasing in

Adj.R2 of 0.0136 (DIFF 1-2) when we are adding variables of Ei , t∗RDQIMANDi ,t and

Ei , t+1∗RDQIMANDi , tinto research model, but the increasing of Adj.R2 is not too large. In

addition, the variable RDQIMANDi , tis not significant as shown in column 1 and 2. These

findings indicate that the risk disclosures quality index is not a relevant for investors to

increase the ability of investors in assessing the future company’sperformance (earnings)

that are reflected in the investment decisions of investors in the current period.

Table 6 presents the estimation’s result of the value relevance of the voluntary of risk

disclosure quality index model. The result is identical to the result of the mandatory’s model

that has been explained above. The variable of RDQIVOLi , t in column 1 and 2 (Table 6) is

not significant. Thus, the hypothesis 1a, stating that the voluntary of risk disclosure quality

index has a significantly positive effect on company’s stock return is rejected. This finding is

consistent with the result in column 2, which are excluded interaction variables: Ei , t*

RDQIVOLi , t and Ei , t+1*RDQIVOLi , t . In addition, there is a decreasing in Adj.R2 of 0.0018

(DIFF 2-3) when we are including RDQIVOLi , t variable into the research model. In other

words, it can be concluded that the explanatory power of RDQIVOLi , t variable has been

lowering the effect of earnings information to return. It makes the finding clearer that the

voluntary risk disclosure quality or the non-financial risk disclosure is not relevant for

investors in making investment decisions. Investors still rely on earnings informastion (either

past, current or future earnings) in making investment decisions in Indonesia Stock

20

Exchange. Those three earnings variables ¿¿, Ei , t, Ei , t+1) are significant as shown in column

2 and 3. Hence, the result of this study has not been able to add empirical evidence to

support capital market transactions hypothesis (Healy & Palepu, 2001). Even voluntary risk

disclosure quality is not a relevant information about the company's prospects in the future in

order to reduce information asymmetry between companies with investors or among

investors.

Table 6 Estimation Result of Value Relevance of Risk Disclosures of Mandatory Model

1 2 3

Variables Coef. t P>t Coef. t P>t Coef. t P>t

_cons 0.0125 1.51 0.132 0.009968 1.25 0.213 0.007611 1.16 0.246Ei , t−1 -0.04091 -1.8 0.073* -0.04027 -1.77 0.078* -0.04065 -1.79 0.075*Ei , t 0.130628 2.54 0.011*** 0.086871 4.4 0*** 0.086017 4.37 0***Ei , t+1 -0.05311 -1.28 0.2 0.04804 3.37 0.001*** 0.049156 3.49 0.001***RDQIMANDi , t -0.00099 -0.88 0.1895 -0.00047 -0.52 0.3035Ei , t∗RDQIMANDi ,t -0.01212 -0.98 0.164Ei , t+1∗RDQIMANDi , t 0.028221 2.6 0.005***

D11 -0.0124 -1.26 0.207 -0.01134 -1.15 0.251 -0.01106 -1.12 0.262

D12 0.000587 0.08 0.935 0.000872 0.12 0.904 0.001199 0.17 0.868

D13 0.009622 1.18 0.239 0.009148 1.12 0.265 0.009378 1.15 0.253

D14 -0.00469 -0.59 0.554 -0.00459 -0.58 0.565 -0.00495 -0.62 0.533

D15 -0.01051 -1.3 0.194 -0.00993 -1.22 0.221 -0.01043 -1.3 0.195

D16 0.025544 3.37 0.001*** 0.027028 3.56 0*** 0.027279 3.6 0***

D17 0.007233 1.03 0.303 0.007145 1.01 0.311 0.007299 1.04 0.3

DYEAR 0.001829 0.53 0.599 0.001609 0.46 0.645 0.002125 0.64 0.525

F 10.25 11.19 12.21

Prob > F 0*** 0*** 0***

R-squared 0.2679 0.2543 0.2537

Adj R-squared 0.2418 0.2315 0.233

Number of obs 407 407 407Difference in Adj. R2:

a. DIFF 2-3 -0.0015

b. DIFF 1-2 0.0136

c. DIFF 1-3 0.0142Ri , t (return) is dependent variable, measured by the annual stock return for year t, measured over the 12-month period ending three months

after the company’s fiscal year-end. The independent variables: (i) Ei , t−1 (Earnings for period t-1), measured by income available to common shareholders before extraordinary items in year t-1; deflated by market value of equity three months after the year t-1 fiscal year-end; (ii) Ei , t (Earnings for period t), measured by income available to common shareholders before extraordinary items in year t; deflated by

market value of equity three months after the year t-1 fiscal year-end; (iii) Ei , t+1 (Earnings for period t+1), measured by income available to common shareholders before extraordinary items in year t+1; deflated by market value of equity three months after the year t-1 fiscal year-end; (iv) RDQIMANDi , t(mandatory risk disclosurequality index), measured by analyzing identified risk sentences, composed from 4 dimensions: (i) relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk management; (v) D11=17 is dummy variables for 8 industry types.


21

The interaction variable of Ei , t+ 1*RDQIVOLi , t in column 1 has a significantly positive

effect on return. However, the variable of Ei , t+1 in column 1 has not, although it has a

significantly positive effect on return in columns 2 and 3 (Table 6). Thus, the hypothesis 1b,

stating that the voluntary of risk disclosure quality index has a positive effect on the

company's future earnings informativeness is rejected. Although there is an increasing in

Adj.R2 of 0.0111 (DIFF 1-2) when we are adding variables of Ei , t*RDQIVOLi , t and Ei , t+1*

RDQIVOLi , t into research model, but the increasing of Adj.R2 is not too large. In addition,

the variable RDQIVOLi , t is not significant as shown in column 1 and 2. These findings

indicate that the voluntary risk disclosures quality index (non-financial disclosure) is not a

relevant for investors to increase the ability of investors in assessing the future

company’sperformance (earnings) that are reflected in the investment decisions of investors

in the current period.

There are some possible explations regarding those both findings of this study that

are not supporting the conjecture of the study. It is likely there is multicollinierity problem,

either in variables of Ei , t+1 with Ei , t+1*RDQIMANDi , t or variablef of Ei , t+1and Ei , t+1*RDQIVOLi , t

. The multicollinierity problem may be causing the estimated coefficients of both variables

become inefficient. We had try to solve the problem by centering the data, but the results

remain the same.

Another possible explanation that may be causing the result is companies are more

focus on quantity of sentences, rather than another dimensions disclosure’s quality in the

narrative of their risk’s disclosure (financial or non-financial). Companies less disclose the

dimensions of depth, scope (coverage), and the outlook for the company's risk management

profile. The number of sentences itself is not a sufficient risk information, yet, for investors.

The risk disclosure do not much disclose the information that are conveying the massage of

the impact of those risks on company’ future performance, neither quantitatively or

qualitatively impact. So are the two other dimensions of quality of risk disclosure, namely: (i)

22

the scope (coverage) of risk and the outlook profile of company's risk management. It can be

concluded that the risk’disclosure is insufficient for investors to assess company’s future

performance that might be used in investment making decisions process in capital market.

As presented in table 3, the mean value of risk disclosure quality index for mandatory and

voluntary items are not too high, repectively are 4.355774 and 7.038894 sentences. Risk

disclosure quality index is derived from the average of the four dimensions of quality for risk

disclosures as presented in equation 7.

Table 7 Estimation Result of Value Relevance of Risk Disclosures of Voluntary Model

1 2 3

Variable Coef. t P>t Coef. t P>t Coef. t P>t

_cons 0.006384 0.88 0.382 0.008287 1.2 0.23 0.007611 1.16 0.246Ei , t−1 -0.04012 -1.76 0.079* -0.04023 -1.76 0.079* -0.04065 -1.79 0.075*Ei , t 0.178804 4.1 0*** 0.086445 4.38 0*** 0.086017 4.37 0***Ei , t+1 -0.02894 -0.88 0.378 0.048766 3.45 0.001*** 0.049156 3.49 0.001***RDQIVOLi , t 0.000314 0.55 0.291 -0.00013 -0.32 0.3745Ei , t∗RDQI VOLi ,t -0.01516 -2.42 0.008***Ei , t+1RDQIVOLi ,t 0.012647 2.65 0.004***

D11 -0.01241 -1.27 0.206 -0.01092 -1.11 0.269 -0.01106 -1.12 0.262

D12 0.000788 0.11 0.913 0.001217 0.17 0.866 0.001199 0.17 0.868

D13 0.009308 1.14 0.254 0.009543 1.16 0.246 0.009378 1.15 0.253

D14 -0.00501 -0.62 0.538 -0.00431 -0.53 0.598 -0.00495 -0.62 0.533

D15 -0.01123 -1.34 0.181 -0.00964 -1.14 0.253 -0.01043 -1.3 0.195

D16 0.026238 3.48 0.001*** 0.027372 3.61 0*** 0.027279 3.6 0***

D17 0.006769 0.97 0.334 0.007264 1.03 0.303 0.007299 1.04 0.3

DYEAR 0.002501 0.75 0.452 0.002152 0.64 0.52 0.002125 0.64 0.525

F 10.28 11.18 12.21

Prob > F 0*** 0*** 0***

R-squared 0.2685 0.2539 0.2537

Adj R-squared 0.2423 0.2312 0.233

Number of obs 407 407 407Difference in Adj. R2:

a. DIFF 2-3 -0,0018

b. DIFF 1-2 0,0111

c. DIFF 1-3 0,0093Ri , t (return) is dependent variable, measured by the annual stock return for year t, measured over the 12-month period ending

three months after the company’s fiscal year-end. The independent variables: (i) Ei , t−1 (Earnings for period t-1), measured by income available to common shareholders before extraordinary items in year t-1; deflated by market value of equity three months after the year t-1 fiscal year-end; (ii) Ei , t (Earnings for period t), measured by income available to common shareholders before extraordinary items in year t; deflated by market value of equity three months after the year t-1 fiscal year-end; (iii) Ei , t+1 (Earnings for period t+1), measured by income available to common shareholders before extraordinary items in year t+1; deflated by market value of equity three months after the year t-1 fiscal year-end; (iv)

RDQIVOLi , t(voluntaryrisk disclosure quality index), measured by analyzing identified risk sentences, composed from 4 dimensions: (i) relative quantity; (ii) depth; (iii) the scope; and (iv)outlook profile of companies’ risk

23

management; (v) D11=17 is dummy variables for 8 industry types.


5. The Conclussion, Implication, and Sugesstion of Study for Further Reseach

This study is aimed to examine the value relevance of the mandatory and voluntary

risk disclosure quality index for investors in investment decission making in Indonesia Stock

Exchange. The result shows, neither mandatory (financial) nor voluntary (non-financial) risk

disclosure quality index, are not a relevant, yet, for investors in Indonesia Stock Exchange.

Investors do not use the risk information to assess the future company’s performance

(earnings) in their investment decision making, so the risk disclosure does not increase the

company's future earnings informativeness.

The unsupporting result on the conjucture of the study can be caused by: (i) there

is a potential multicollinearity problem in the model; (ii) the company is still focus on

dimension of quantity of sentences rather than the three other dimensions, namely: the

depth, scope (coverage), and the outlook profile of company's risk management in their risk

disclosure narrative; and (iii) The mean value of index for risk disclosure quality is relatively

poor. Hence, this study suggest companies to improve the quality of risk disclosure,

especially the depth (the impact of risk information on company’s future earnings),

scope/coverage, and the outlook profile of the company's risk management. This study also

encourages related regulator to educate companies for improving the need of a good quality

of risk disclosures, particularly mandatory risk disclosure. The further research should

address the issue of multicollinearity problem of the model. In addition, further research may

explore the value relevance of each item of mandatory or voluntary risk disclosure.

24

REFERENCES

Akerlof, G. A. (1970). The Market for "Lemons": Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, Vol. 84, No. 3 , 488-500.

Asteriou, D., & Hall, S. G. (2007). Applied Econometrics: A Modern Approach Using Eviews

and Microfit (Revised Edition ed.). New York: Palgrave MacMillan.

Ball, R., & Brown, P. (1968). An Empirical Evaluation of Accounting Income Numbers.

Journal of Accounting Reserach , 159-177.

Barth, M. E., Beaver, W. H., & Landsman, W. R. (2001). The relevance of the value

relevance literature for financial accounting standard setting:another view. Journal of

Accounting and Economics, 31, 77–104.

Beattie, V. (2000). The future of corporate reporting: a review article. Irish Accounting

Review 7 (1) , 1-36.

Beattie, V., McInnes, B., & Fearnley, S. (2004). A methodology for analysing and evaluating

narratives in annual reports: a comprehensive descriptive profile and metrics for

disclosure quality attributes. Accounting Forum , 205–236.

Beaver, W. H. (2002). Perspectives on recent capital market research. The Accounting

Review , 453-474.

Beck, A. C., Campbell, D., & Shrives, P. J. (2010). Content analysis in environmental

reporting research: Enrichment and rehearsal of the method in a British–German

context. The British Accounting Review , 207–222.

Beretta, S., & Bozzolan, S. (2004). A framework for the analysis of firm risk communication.

The International Journal of Accounting, 39, 265–288.

Ettredge, M. L., Kwon, S. Y., Smith, D. B., & Zarowin, P. A. (2005). The impact of SFAS No.

131 business segment data on the market's ability to anticipate future earnings. The

Accounting Review Vol. 80 , 773-804.

Gujarati, D. N. (2003). Basic Econometric (4th, International Edition ed.). New York:

McGraw-Hill.

25

Holthausen, R. W., & Watts, R. L. (2001). The relevance of the value-relevance literature for

financial accounting standard setting. Journal of Accounting and Economics, 31, 3–

75.

Hung, M. (2001). Accounting standards and value relevance of financial statements: An

international analysis. Journal of Accounting and Economic 30 , 401-420.

ICAEW. (2011). Reporting business risks: Meeting expectations. Information for better

market initiative. UK: Financial Reporting Faculty of ICAEW.

Linsley, P. M., & Shrives, P. J. (2006). Risk reporting: A study of risk disclosures in the

annual reports of UK companies. The British Accounting Review, 38,

Miihkinen, A. (2012). What Drives Quality of Firm Risk Disclosure? The Impact of a National

Disclosure Standard and Reporting Incentives under IFRS. The International Journal

of Accounting, 47, 437–468.

Miller, B. P. (2010). The effect of reporting complexity on small and large investor trading.

The Accounting Review, 85, No.6, 2107-2143.

PSAK 60 Instrumen Keuangan: Pengungkapan (Revisi 2010). Standar Akuntansi Keuangan.

(2012). Jakarta: Dewan Standar Akuntansi Keuangan Ikatan Akuntan Indonesia.

Scott, W. R. (2012). Financial Accounting Theory. United States of America: Pearson

Prentice Hall.

Shrives, P. J., & Abraham, S. (2013). Improving the relevance of risk factor disclosure in

corporate annual reports. The British Accounting Review , 1-17.

Uddin, M. H., & Hassan, M. K. (2011). Corporate risk information in annual reports and stock

price behavior in the United Arab Emirates. Academy of Accounting and Financial

Studies Journal, 15 (No. 1), 59-84.

the quality analysis of risk...

Documents