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CORPORATE COMMUNICATION OF FINANCIAL RISK
Grantley Taylor, Greg Tower and John NeilsonSchool of Accounting, Curtin Business School
Curtin University of TechnologyGPO Box U1987
Perth, Western Australia, Australia 6845Tel: +61-8-9266-3377Fax: +61-8-9266-7196
Paper submissionAccounting and Finance Association of Australia and New Zealand
Annual ConferenceGold Coast, Queensland, Australia
July, 2007
Topic Area : Financial Reporting
Key Words: financial risk management; IFRS; corporate governance; capital raisings; overseas listings
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CORPORATE COMMUNICATION OF FINANCIAL RISK
ABSTRACT
This paper investigates the communication patterns of Financial Risk Management Disclosures (FRMD) within the annual reports of Australian listed resource companies over a four year longitudinal period (2002 to 2006). This is a crucially important period to investigate FRMD patterns as it encompasses those years leading up to and immediately following formal adoption of the Australian equivalents to the International Financial Reporting Standards (IFRS). The results of regression analysis demonstrate that corporate governance and capital raisings of firms are factors which are significant and positively associated with FRMD patterns. In contrast, overseas stock exchange listing of firms was found to be significantly negatively associated with FRMD patterns. Moreover, the findings clearly show that the introduction of a new regulation changes corporate communication patterns. This paper contributes to an understanding of the extent, trends and rationale behind resource firms’ financial risk management practices in Australia.
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1.0 Introduction
Resource companies are subject to a range of financial risks1 that arise as a result of extensive
exploration, production and financing activities. These financial risks include foreign
exchange risk, commodity price risk, credit risk, liquidity risk and interest rate risk. Financial
risk management is concerned with the identification of these financial risks by both the
management of the firm and the board of directors and the management of exposures to
ensure operations are not jeopardised through financial mismanagement. Effective financial
risk management requires: 1) identification of financial risks and associated costs or potential
costs of exposures, 2) installing internal controls and other mechanisms to mitigate exposures
and 3) adequately communicating exposures or likely exposures to stakeholders. A
conceptualised financial risk management framework is provided as Figure 1. Adoption of the
International Financial Reporting Standards (IFRS) on 1 January 2005 in Australia has had a
profound impact on the recognition, measurement and disclosure of financial instruments
(Honey, 2004; Jubb, 2005) with increased emphasis on communication of financial risks to
stakeholders. Resource firms commonly participate in hedging of commodity prices, interest
rates and foreign exchange rates and often utilise complex financial derivatives to hedge their
exposure to financial risk (PwC, 2005). The introduction of IFRS has placed greater pressure
on these resource firms with far more rigorous accounting and reporting requirements creating
more scrutiny from both capital markets and senior executives and directors. These
observations support the focus of this study on financial risk management disclosures made
by companies within the mining and oil and gas industries.
The next section outlines the research questions and significance of the study, corporate
financial risk management practices and implications of the introduction of IFRS on reporting
of these financial risk management practices. Section 3 covers the theoretical position of the
study and hypotheses development and section 4 discusses the research approach. Section 5
provides the results of the empirical analysis while section 6 concludes the study.
2.0 Research Questions and Significance of the Study
Australian listed resource firms’ management are required to understand and communicate a
complex set of issues with respect to financial risk management including risk identification,
measurement, monitoring and internal control mechanisms, how, why and to whom the
1 Risk can be defined as any event that, if it occurs, will have a material impact on the ability of the company to achieve its objectives. These events can be financial, organisational or operational in nature.
3
Insert Figure 1 here
financial risk management strategy is to be communicated and the accounting and capital
management implications of these risk management arrangements. The communication of
information relating to the hedging of risk exposures, the nature of the entity’s financial risk
exposure, the significant areas of financial risk concentration, the avoidance of undue
concentrations of risks and an entity’s maximum financial risk exposure provides valuable
information to an entity’s stakeholders.
The focus of this paper is to first quantify the extent of financial risk management disclosures
within the annual reports of Australian listed resource companies longitudinally over the
period encompassing the 2002 to 2005 financial years inclusive. The paper then relates
financial risk management disclosures to firm specific variables incorporating corporate
governance and capital management.
This study assists in determining the extent of financial risk management disclosure
communication in annual financial reports. This is important as there are several prominent
Australian cases where mining companies have been placed in administration and/or
liquidation as a direct consequence of financial risk mismanagement particularly with respect
to hedging activities and debt financing. These collapses, to the consternation of shareholders,
often occur very quickly. This raises the question as to whether firm management has
adequately communicated relevant information to their stakeholders, in particular,
shareholders concerning the extent, likelihood of occurrence and potential costs or impacts of
the risks relating to financing arrangements.
Financial derivatives are one avenue by which firms can manage financial risks and are often
used to hedge exposures to foreign currency, commodity price and to a lesser extent, interest
rate movements. Financial instruments are used as a means of increasing certainty with regard
to future cash flows, to manage risks and to lock in a minimum cash flow and income stream
for producers and their lenders (Berkman, Bradbury, Hancock and Innes, 2002; Chalmers and
Godfrey, 2000, 2004; Lopes and Rodrigues, 2006).
Hancock (1994) notes that the dramatic increase in the use of derivatives had caused growing
concern to corporate regulators and accounting standard-setters around the world. Berkman et
4
al. (2002) observe the influence of firm-specific variables on the likelihood of a firm using
interest rate, foreign currency and commodity derivatives. Nguyan and Faff (2002; 2003)
found that an Australian listed firm’s leverage, size and liquidity were important determinants
of aggregate financial derivative use. Benson and Oliver (2004) conclude that managers’ use
derivative financial instruments to reduce risk and volatility of cash flows and earnings
ultimately leading to an increase in firm value and a reduction in risk faced by management
They then argue that derivative use is the result of complex agency relationships existing
within the firm and is not driven by one particular management objective.
There are capital management implications arising from a firm’s financial risk management
strategy, policies and procedures. Disclosure of the significant financial risks that give rise to
unrealised losses of hedging instruments at fair value forces management to examine this
impact on the achievement of business objectives. Clear communication allows the board of
directors to examine the potential impact of these risks on the ability to raise further capital or
continue as a going concern.
3.0 Research Proposition and Hypotheses Development
The disclosure requirements of resource firms’ financial risk management have changed
significantly with the introduction of IFRS. Both AASB 1033 Presentation and Disclosure of
Financial Instruments and AASB 1322 Financial Instruments: Disclosure and Presentation
require disclosure of information relating to the extent of currency risk, price risk, market risk
(or fair value interest rate risk), credit risk, liquidity risk and cash flow (or cash flow interest
rate) risk (AASB, 1999; AASB, 2004a). Further, AASB 139 Financial Instruments:
Recognition and Measurement requires an entity to document its risk management strategy
for a particular hedging relationship and its effectiveness in offsetting the exposure to changes
in the hedged items fair value or cash flows attributable to the hedged risk (AASB, 2004b).
Both AASB 132 and AASB 139 mandate measurement of derivative and available-for-sale
financial instruments at fair value which could potentially contribute to volatility of current
earnings, retained profits and total equity. The implementation of IFRS requirements creates
additional pressure for resource firms to disclose information relating to their financial risk
management strategies. Thus, the study analyses the following research proposition:
2 Financial instrument disclosures prior to formal IFRS adoption were required under Australian Accounting Standards Board (AASB) 1033 Presentation and Disclosure of Financial Instruments (AASB, 1999). Following formal IFRS adoption, financial instrument disclosures were initially required under AASB 132 Presentation and Disclosure of Financial Instrument
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RP: Financial risk management disclosure levels by Australian resource firms are more extensive in the post-IFRS adoption period than the pre-IFRS period.
The motivation to disclose financial instrument information is explained by using agency
theory arguments whereby many determinants of disclosure patterns are driven by economic
considerations (Watts and Zimmerman, 1990). Agency theory provides a conceptual
framework for examining FRMDs in the annual reports of Australian listed resource firms.
Jensen and Meckling (1976) postulate that the separation of firm ownership and control
provides management with incentives to serve their personal interests at the expense of
shareholder interests. An inevitable consequence of the separation of ownership and control is
that management (agents) acquires information about the performance of the firm that is
superior to that acquired by shareholders (principals). Agents may engage in activities that
enhance their own personal utility or welfare by taking advantage of the fact that the bulk of
their decision making and use of superior knowledge is not observable to principals. Agents
use their discretion regarding when to disclose information depending on how this impacts on
the wealth of not only themselves, but all contracting parties to the firm (Watts and
Zimmerman, 1990). Extant literature (Welker, 1995; Van der Zahn and Brown, 2005) cites
agency theory to explain managerial behaviour in the area of corporate governance and capital
management.
It is postulated that financial risk management disclosures will vary considerably based on
firm specific variables including corporate governance structure and capital management
characteristics such as capital raisings and overseas listings (Mallin, Dunne, Helliar and Ow-
Young, 2004).
Corporate governance is concerned with optimally reducing managerial opportunistic
behaviour. Agency theorists suggest there are internal and external governance mechanisms
designed to limit agency costs arising from the aberrant activities of managers. The corporate
governance principles developed by the ASX Corporate Governance Council constitute a
mechanism to ameliorate agency problems in shareholder-manager relationships.
Transparency relating to corporate governance attributes serves to minimise agency conflicts
between shareholders and managers that are inherent in the separation of ownership and
control of firms (Jensen and Meckling, 1976). The mandatory requirement to disclose this
6
information facilitates a comparison between a firm’s corporate governance characteristics
and financial risk management practices.
An effective financial risk management framework is an integral part of a firms’ governance
structure as it forms the foundation of control of hedging arrangements, capital raisings,
access to domestic and foreign capital markets and control over areas of financial risk
concentration. Controls put in place by management and the board of directors can include
implementation of risk limits, well documented measurement procedures and information
systems, continuous risk monitoring and specialised risk reviews, frequent reporting and
comprehensive internal controls and audit procedures. Firms with an effective corporate
governance structure in place are therefore expected to disclose more information of a
discretionary nature as well as disclose mandatory information in relation to financial risk
management. Enhancement of this relationship is expected post implementation of IFRS. It is
hypothesised that the extent of information disclosed concerning financial risk management is
positively related to the strength of the firms’ corporate governance structure:
H1: There is a positive association between the strength of corporate governance structure and the extent of financial risk management disclosures by Australian resource firms in the pre-IFRS and post-IFRS adoption periods.
A firm’s capital management policy is another key factor that can determine financial risk
management disclosure practices. The concept of capital management has several key
elements including the level of debt, dividend policy, capital raising, takeovers and mergers,
listing overseas and extent of international operations. This study focuses on capital raisings
and overseas listings of resource firms as possible determinants of financial risk management
disclosure practices.
Financial institutions often require resource companies to implement sufficient hedging to
cover repayments of project financing with these conditions being stipulated in debt
covenants. Companies that raise capital are likely to be more motivated to disclose
information concerning financial risk management practices. For example, Jenson and
Meckling (1976) propose that more highly leveraged firms incur more monitoring costs and
seek to reduce these costs by disclosing more information within annual reports.
7
It is argued that capital raisings induce the company to disclose more information in relation
to financial risk management particularly since resource firms will regularly seek access to
capital markets and may use or issue financial instruments as a consequence. Provision of
accounting disclosures and reports are identified as an agency cost (Jensen and Meckling,
1976) that managers are willing to accept to enable them to raise capital. Clearly, information
asymmetry between the various stakeholders of the firm can be mitigated by disclosure
strategies linked to the capital structure and strategies of the firm.
A firm’s financial risk management objective may include access to domestic and
international financial markets and managing financial risks relating to multi-jurisdictional
operations. Companies with operations in foreign jurisdictions will have additional policies
and procedures for complying with legal operational requirements of the jurisdiction in which
the firm operates. These operations have associated financial risks. Companies with multi-
jurisdictional listing are expected to have more sophisticated risk management policies and
procedures and to disclose more information concerning these financial risks.
To formally test the association between the extent of financial risk management disclosures
and capital raisings or overseas listing by the firm, the following hypotheses are constructed:
H2: There is a positive association between capital raisings and the extent of financial risk management disclosures by Australian resource firms in the pre-IFRS and post-IFRS adoption periods.
H3: There is a positive association between those firms that are listed in more than one jurisdiction and the extent of financial risk management disclosures by Australian resource firms in the pre-IFRS and post-IFRS adoption periods.
4.0 Research Method
Hypotheses testing uses data from the annual reports of 81 Australian listed resource firms
randomly selected from a population of 130 that were engaged in production or extractive
activities at any time over a four year longitudinal timeframe encompassing the 2002 to 2006
years. Data with respect to financial risk management disclosures are obtained from the
annual reports for the three financial years prior to IFRS adoption and one year post-IFRS
adoption. Tests of means formed the prime technique for evaluating the general research
proposition whilst ordinary least squares regression is employed to test the hypotheses.
8
The extent of financial risk management disclosure (FRMD) is measured using the FRMD
Index (FRMDI) comprising 26 financial risk management disclosure items (11 mandatory and
15 discretionary). For each FRMDI item disclosed by a firm in its annual report a
dichotomous score of one [1] is assigned, otherwise a score of zero [0]. A FRMDI score is
computed for all years by summing all information items disclosed divided by the maximum
number of items that could be disclosed. The FRMDI score is mathematically represented as
follows:
Where:FRMDIj = Financial Risk Management Disclosure Index for firm j
Proxy measures3 are created for corporate governance structure and capital management of
applicable firms. First, thirteen corporate governance variables are derived from the ASX
Council’s corporate governance principles and recommendations to construct a measure of the
corporate governance structure of a firm (ASX Corporate Governance Council, 2003). All 13
items are weighted equally. A firm receives a percentage CGS score depending on the number
of conditions satisfied. Second, capital raisings and overseas listing are the two aspects of a
firm’s capital management structure that are possible determinants of financial risk
management disclosures in this study. Capital raisings and overseas listings are each treated
as a dichotomous variable in the statistical analysis with a score of one allocated to an equity,
debt or hybrid capital raising in that year or listing overseas as well as on the ASX.
5.0 Results
Analysis of the data shows that mandatory financial risk management information typically
disclosed includes a description of the extent of currency, price, credit and interest rate risk
and whether management have policies and procedures in place to deal with financial risk
mitigation (see Table 1). Far less information relating to the financial assets exposed to credit
risk and areas of significant concentration of credit risk is disclosed. The more commonly
disclosed discretionary items include information relating to how interest rate risk and credit
3 Aside from the dependent and independent variables, the study also included the standard control variables of firm size, sub-industry and shareholder concentration in the statistical analysis (Ahmed and Courtis, 1999). The size of the firm is measured as the natural logarithm of total assets to reduce the impact of skewed data in the statistical analysis. Consistent with many past studies, firm leverage or debt to equity ratio is measured as total liabilities divided by total equity. Sub-industry refers to mining or the oil and gas sub-industries. Shareholder concentration is measured by the proportion of the top 20 shareholders of the firm at financial year end.
FRMDIj =Total number of items disclosed
Maximum number of items
9
risk arose. Substantially less information relating to internal controls to mitigate financial
instrument risk, financial risk sensitivity analysis and liquidity risk, and how it arose and is
being managed, is disclosed.
Insert Table 1 here
Descriptive statistics provided as Table 1 indicate that the mean disclosure of mandatory,
discretionary and total financial risk management information for all sample firms is 63.19%,
26.47% and 42.01% respectively. The median scores are very similar and the standard
deviations range from 15% to18%. These data show great diversity of disclosure of financial
risk information. Sample firms generally exhibit a strong corporate governance structure,
based on the CGS, with a mean of 62.10%.
Simple correlations between FRMDI and each of the independent and control variables are
computed using Pearson’s product-moment correlations (see Table 2).
Insert Table 2 here
Table 2 shows that FRMDI is moderately positively correlated with the independent variable -
corporate governance score (CGS) and firm size consistent with the hypotheses. Larger firms
tend to be correlated with better corporate governance structures and higher financial risk
disclosures. Correlation coefficients suggest that multi-collinearity is not a concern in the
multiple regression analysis.
A paired t-test is performed to test for differences between the means of the FRMDI for
consecutive financial years over the study period. The results are shown in Table 3, Panel A.
Insert Table 3 here
The difference in means of FRMDI between the years is statistically significant at the 1%
level with the largest change (21.16%) in mean FRMDI occurring between year 3 (pre-IFRS
adoption period) and year 4 (post-IFRS adoption period). The general research proposition is
supported by the results.
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In Table 3 (Panels B and C), paired t-tests are also performed to test whether the mean of the
distribution of differences in mandatory FRMDI (mandFRMDI) and discretionary FRMDI
(discFRMDI) is zero. The increases in mandatory FRMDI from year 1 to 3 during the pre-
IFRS adoption period, whilst being statistically significant at the 1% level, is not as
pronounced as the 17.98% increase from year 3 (pre-IFRS) to year 4 (post-IFRS). The mean
mandatory FRMDI in year 4 is 73.72% as compared to 62.48% in year 3. There is a marked
increase in discretionary FRMDI with a 26.72% increase from year 3 to year 4 being
statistically significant. Firms disclose far more financial risk management information of
both a mandatory and discretionary nature in the post-IFRS adoption period compared to the
pre-IFRS adoption period, despite the fact that disclosure requirements mandated under
AASB 1033 (pre-IFRS) and AASB 132 (IFRS) are very similar. A notable example is the
disclosure of information relating to liquidity risk. Although disclosure of the extent of
liquidity risk is required under both AASB 1033 and AASB 132, far more extensive
disclosure of this particular risk is evident in the immediately post-IFRS adoption period (year
4).
The rate of change in financial risk management disclosures (FRMDI) and CGS over the
study period is shown as Figure 2.
Insert Figure 2 here
A marked increase in disclosure of financial risk management information is evident in year 4
(post-IFRS) compared to that within the pre-IFRS period (years 1 to 3). Overall, it can be
concluded that the implementation of new rules fundamentally increases financial risk
disclosures; new regulation makes a difference.
A paired t-test is then used to test for differences between the means of the CGS for
consecutive financial years over the study period (Table 4).
Insert Table 4 here
The difference in means of CGS between the years 1 and 2 and years 2 and 3 are statistically
significant at the 1% level with the largest change (33.47%) in mean CGS occurring between
year 1 and year 2 immediately following release of the ASX Council’s best practice corporate
11
governance principles and recommendations on 31 March 2003. Resource firms made
significant additions and adjustments to their corporate governance structure in the 15 month
period following the release of these principles and recommendations as reflected by an
8.46% increase in CGS from year 2 to year 3. Although not statistically significant, a further
increase in CGS from year 3 to year 4 of 2.38% indicates further fine tuning of the corporate
governance structure by firm management.
The multiple regression model in Table 5, Panel A supports the predictions of a positive
association between the corporate governance structure of all sample firms (as measured by
the CGS) and all financial risk management disclosures, as measured by FRMDI. Hypothesis
1 is supported by the results. In addition, a positive and statistically significant association
between capital raisings and FRMDI is achieved supporting hypothesis 2. Contrary to
expectations, there is a significant and negative association between firms with overseas stock
exchange listing or listings and the extent of financial risk management disclosures.
Hypothesis 3 is not supported by the results. Firm size and leverage are the only control
variables consistently positively associated with FRMDI.
Insert Table 5 here
Regression tests4 utilising a financial risk management disclosure index comprising
mandatory (mandDHADI) or discretionary (discDHADI) items are shown in Table 5 Panel B
(for mandDHADI) and Panel C (for discDHADI). The key findings are:
There is a statistically significant and positive association between corporate
governance, capital raisings, firm size and leverage and the extent of total (mandatory
and discretionary) financial risk management disclosures.
There is a statistically significant and negative association between firms with
overseas listing status and financial risk management disclosures.
In respect of mandatory disclosures, the exact same variables are significant.
4 Statistical significant sub-factors issues such as whether the CEO/CFO have stated in writing that the company’s risk management, internal compliance and control systems are operating effectively and efficiently (item 10) are important precursors to financial reporting integrity and the ability of firm management to assert in writing that the financial statements and report represent a true and fair view of the financial position and financial performance of the firm as mandated under CLERP 9 (effective 1 st July 2004). Financial and/or accounting expertise and qualifications of at least one member of the audit committee and the existence of a treasury charter, policy or committee are further potentially important determinants of derivative and hedge accounting disclosures consistent with expectations and extant literature (Mallin et al., 2004).
12
For voluntary disclosures, again corporate governance, firm size and leverage are
significant predictors with sub-industry categories also now significant but overseas
listing now longer a predictor.
The predictive adjusted r-squared range varies between 42% for the total and
voluntary disclosures to 26% for the mandatory disclosures.
A sub-sample of 14 companies5 with an “inherent uncertainty regarding continuation of the
entity as a going concern”6 audit qualification was examined to determine how the financial
risk management disclosures of these companies compared to those companies without that
audit qualification. Comparative descriptive statistics are provided in Table 6.
Insert Table 6 here
Total financial risk management disclosures of audit qualified firms (33.49%) are
fundamentally lower compared to that of non-audit qualified firms (42.72%). As expected,
these audit qualified firms have a weaker corporate governance structure, as measured by the
corporate governance score (CGS) and have considerably more debt in their capital structure
with mean leverage of 72.65% compared to 34.90% for non-audit qualified firms. Clearly,
those firms with an audit qualification regarding continuation of that entity as a going concern
do not have an effective financial risk management framework in place - this is reflected in
less extensive financial risk management disclosures within the annual reports of these firms.
Stakeholders of audit qualified firms are not being provided with complete information
regarding the financial risk exposures and risk mitigation activities of these companies. There
is also some evidence of selective disclosure of financial risk management activities
depending on the particular circumstances of a firm. As an example, one particular gold
mining company disclosed information concerning credit risk in the annual financial report
for all years except in the financial reporting year immediately prior to that company going
into administration.
5 Data were derived from 24 annual reports for 14 companies (i.e. some companies had an audit qualification over consecutive years). 6 The inherent uncertainty regarding going concern audit qualification refers to the significant uncertainty as to whether the consolidated entity will be able to continue as a going concern and therefore, whether the entity will be able to pay its debts as and when they become due and payable, and whether it will realise its assets and extinguish its liabilities in the normal course of business.
13
To enrich the study, an investigation of the extent of disclosure of liquidity risk was made
leading up to and immediately following IFRS adoption. The pattern of liquidity risk
disclosures provides insights on how and why financial risk management disclosures in
general have changed over the four year study period. Figure 3 shows the change in liquidity
risk disclosures over the four year study period.
Insert Figure 3 here
The percentage of firms disclosing information relating to liquidity risk increased marginally
in the pre-IFRS adoption period from 10.12 % in year 1 to 17.72 % in year 3 before
increasing significantly to 57.53% in first year immediately following IFRS adoption. Two
key observations can be made from this trend. First, the 60% increase in firms disclosing
liquidity risk information from year 1 to year 2 is possibly a reflection of the enhancement of
the corporate governance structures of firms over this period. Second, the 225% increase in
firms disclosing liquidity risk information from year 3 to year 4 is a reflection of adoption and
compliance with the international financial reporting standards dealing with financial
instruments. Pre-IFRS adoption, disclosure of liquidity risk information was required in
accordance with AASB 1033, paragraph 5.1.2(c). Post-IFRS adoption, disclosure of liquidity
risk information is required in accordance with AASB 132, paragraph 52(c). The requirement
to disclose liquidity risk information has not changed pre- and post-IFRS adoption yet, there
has been a significant increase in liquidity risk disclosures made by resource firms in the first
year following the introduction of IFRS. It appears that adoption of IFRS itself has forced
managers and boards of directors to review their existing financial risk management policies
and procedures and ensure that adequate disclosures are made. There are significant
governance implications of shifting to IFRS. In the direct sense, accounting and reporting is
far more rigorous creating more scrutiny from the market and more self-scrutiny at a
governance level particularly in relation to disclosure of how IFRS has affected the financial
reports. This is clearly reflected in the increased financial risk information disclosed to the
market in the immediate post-IFRS adoption period.
6.0 Conclusions
Using a sample of 81 Australian listed resource firms, a significant positive association is
found between firm corporate governance structure and capital raisings and financial risk
management disclosures over the period encompassing the 2002 to 2006 financial years.
14
Firms with multiple exchange listings are characterised by less extensive financial risk
management disclosures. Foreign listing is not necessarily an important driver of disclosure
policy as the overall financial risk management program of these resource companies focuses
on the unpredictability of commodity prices and foreign exchanges which can be managed
independently of listing status.
Resource firms with a strong corporate governance structure (as measured by the CGS) have
more extensive processes and systems in place as a catalyst to effectively manage their
derivative and hedge positions. This is reflected as enhanced financial risk management
disclosures. Additionally, resource firms that have raised capital are characterised by more
extensive financial risk management disclosures.
Disclosures of financial risk management information have increased over the period
encompassing the 2002 to 2006 financial years with a significant increase in disclosures of
both a mandatory and discretionary nature recorded in the first full year annual report
prepared following adoption of IFRS. The introduction of AASB 132 and AASB 139 has
resulted in more rigorous and transparent reporting of information with respect to financial
risk management practices. Clearly, changes to accounting policies and associated
documentation requirements in respect of financial risk management practices have changed
the mindset of executives and the board of directors to one of disclosing more with
consequent changes in the recording and reporting of key financial transactions and associated
risks. In particular, senior executives and boards of directors have embraced the adoption of
IFRS ensuring that they adequately deal with and disclose issues concerning financial risk
management.
15
7.0 ReferencesAASB, 1999. AASB 1033 Presentation and Disclosure of Financial Instruments. AASB,
Melbourne. October 1999. Available from: http://www.aasb.com.au [Accessed April 2005].
AASB, 2004a. AASB 132 Presentation and Disclosure of Financial Instruments. AASB, Melbourne. July 2004. Available from: http://www.aasb.com.au [Accessed April 2005].
AASB, 2004b. AASB 139 Recognition and Measurement of Financial Instruments. AASB, Melbourne. July 2004. Available from: http://www.aasb.com.au [Accessed April 2005].
ASX Corporate Governance Council, 2003. Principles of good corporate governance and best practice recommendations. Australian Stock Exchange, Sydney. Available from: http://www.asx.com.au, [Accessed April 2005].
Benson, K and Oliver, B. 2004. Management motivation for using financial derivatives in Australia. Australian Journal of Management, 29 (2), 225-242.
Berkman, H., Bradbury, M.E., Hancock, P. and Innes, C. 2002. Derivative financial instrument use in Australia. Accounting and Finance, 42, 97-109.
Chalmers, K. and Godfrey, J. 2000. Practice versus prescription in the disclosure and recognition of derivatives. Australian Accounting Review, 10 (2), 40-50.
Chalmers, K and Godfrey, J. M. 2004. Reputation costs: the impetus for discretionary derivative financial instrument reporting. Accounting, Organizations and Society, 29, 95-125.
Hancock, P. 1994. Accounting for financial instruments: an overview. Australian Accounting Review, 4 (2), 3-12.
Honey, M. 2004. IFRS – The key issues for mining. Mining Journal, 17, 20–22.Jensen, M.C. and Meckling, W.H. 1976. Theory of the firm: managerial behaviour, agency
costs and ownership structure. Journal of Financial Economics, 3 (3), 305-360.Jubb, C. 2005. Transition to IFRS: Listed companies’ expected accounting policy impacts as
revealed by AASB 1047 disclosures. AFANE Annual Conference, Melbourne.Lopes, P. T. and Rodrigues, L.L. 2006. Accounting Practices for Financial Instruments. How
far are Portuguese Companies from IFRS? Financial Reporting Regulation and Governance, 5 (1), 1-36.
Mallin, C, Dunne, T, Helliar, C and Ow-Young, K. 2004. FRS 13 and corporate governance - a fund management perspective. Qualitative Research in Accounting and Management, 1 (2), 17-53.
Nguyen, H. and Faff, R. 2002. On the determinants of derivative usage by Australian companies. Australian Journal of Management, 27 (1), 1-24.
Nguyen, H. and Faff, R. 2003. Further evidence on the corporate use of derivatives in Australia: The case of foreign currency and interest rate instruments. Australian Journal of Management, 28 3), 307-317.
PriceWaterhouseCoopers. 2005. Hedging in the Mining Industry: Strategy, Control and Governance. Available from: www.pwc.com/mining. (Accessed April 2005)
Van der Zahn, M. and Brown, A. 2005. Exploratory Analysis of the Association between Remuneration Committee Characteristics and Executive Director Compensation in Singapore. Unpublished Paper, Curtin University of Technology, Western Australia.
Watts, R.L. and Zimmerman, J.L. 1990. Positive Accounting Theory: A ten year perspective. The Accounting Review, 65 (1), 131-156.
Welker, M. 1995. Disclosure policy, information asymmetry and liquidity in equity markets. Contemporary Accounting Research. 11 (2), 801-827.
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Figure 1: Concepualised Financial Risk Management Framework
17
Delegation
Accountability
Board ofDirectors
Treasury Committee
AuditCommittee
Risk Committee
CEO/CFOIndependent Assurance
Key Policies and Procedures: Develop approval and implement risk policies and
guidelines Financial risk identification, measurement and
management Analysis of the likelihood of occurrence and
potential costs Approvals and reporting of derivative and hedge
transactions Reviews of capital management programs to
assess their reasonableness Board and management approvals and monitoring Comprehensive internal controls and audit Strategic risk management decisions (market risk
appetite) Report risk exposures to stakeholders and
measures to mitigate exposures
TABLE 1: Descriptive Statistics for all sample firms for all years
MandFRMDI DiscFRMDI FRMDI CGS Size Total Assets Leverage Top20
Mean 63.196 26.473 42.010 62.109 18.703 1545647118 37.859 62.962Median 63.636 26.667 38.462 69.231 18.583 117571345 34.773 64.900Standard Deviation 17.932 15.887 14.952 23.012 1.908 6984681488 25.662 20.184Kurtosis -0.155 0.154 -0.228 -0.337 1.940 41 6.990 -0.581Skewness -0.128 0.646 0.337 -0.498 0.433 6 1.786 -0.246Minimum 9.1 0 3.8 0 10.1 25244 0.8 12.0Maximum 100 86.7 88.5 100 24.9 64688000000 195.6 99.1Count 310 310 310 310 310 310 310 310Confidence Level(95.0%) 2.004 1.775 1.671 2.572 0.213 780581411 2.868 2.256
Descriptive statistics of sample firms for all years. DHADI = derivative and hedge accounting disclosure index (both mandatory and discretionary; MandDHADI = mandatory derivative and hedge accounting disclosure index and DiscDHADI = discretionary derivative and hedge accounting disclosure index.
TABLE 2:Pearson Correlation Matrix for all sample firms for all years MandFRMDI DiscFRMDI FRMDI CGS Size Leverage Top20
MandFRMDI 1DiscFRMDI 0.590* 1FRMDI 0.869* 0.912* 1CGS 0.400** 0.480* 0.497 1Size 0.418** 0.590* 0.574* 0.597* 1Leverage 0.248 0.329 0.328 0.095 0.162 1Top20 0.125 0.229 0.204 0.154 0.343 0.222 1
Pearson correlation matrix for all sample firms and for all years. Associations * and ** are statistically significant at the 1% and 5% levels respectively.
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TABLE 3: Paired t tests for mean financial risk management disclosures
Panel A Year 1 Year 2 Year 3 Year 4Mean FRMDI 37.390 39.873 41.529 50.316Variance 206.697 185.547 180.693 253.433Observations 79 79 79 73Hypothesised Mean Difference 0 0 0
% change FRMDIt - FRMDIt-1 6.641 4.151 21.160t Stat -2.572 -2.448 -6.401P(T<=t) one-tail 0.006 0.008 0.000t Critical one-tail 1.665 1.665 1.666P(T<=t) two-tail 0.012 0.017 0.000t Critical two-tail 1.991 1.991 1.993
Panel B Year 1 Year 2 Year 3 Year 4Mean mandFRMDI 56.617 60.529 62.486 73.724Variance 271.137 234.978 261.426 384.669Observations 79 79 79 73Hypothesised Mean Difference 0 0 0% change mandFRMDIt-mandFRMDIt-1 6.911 3.232 17.985t Stat -2.764 -2.266 -6.366P(T<=t) one-tail 0.004 0.013 0.000t Critical one-tail 1.665 1.665 1.666P(T<=t) two-tail 0.007 0.026 0.000t Critical two-tail 1.991 1.991 1.993
Panel C Year 1 Year 2 Year 3 Year 4Mean discFRMDI 23.291 24.810 26.160 33.151Variance 241.451 221.010 203.729 309.843Observations 79 79 79 73Hypothesised Mean Difference 0 0 0% change discFRMDIt - discFRMDIt-1 6.522 5.442 26.721t Stat -1.284 -1.791 -4.224P(T<=t) one-tail 0.101 0.039 0.000t Critical one-tail 1.665 1.665 1.666P(T<=t) two-tail 0.203 0.077 0.000t Critical two-tail 1.991 1.991 1.993
Paired t-test results for mean financial risk management disclosures for all sample firms: both mandatory and discretionary disclosures (Panel A); mandatory disclosures (Panel B) and discretionary disclosures (Panel C). For companies with a 30 June year end, year 1 is the 2003 financial year and year 4 is the 2006 financial year. For companies with a 31 December year end, year 1 is the 2002 financial year and year 4 is the 2006 financial year. For both June and December balancing companies, years 1 to 3 are pre-IFRS and year 4 is post-IFRS.
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TABLE 4: Paired t tests for mean corporate governance score
Year 1 Year 2 Year 3 Year 4
Mean CGS 47.420 63.291 68.647 70.285Variance 530.163 486.951 421.442 345.686Observations 79 79 79 73Hypothesised Mean Difference 0 0 0
% change CGSt-CGSt-1 33.470 8.462 2.386t Stat -7.954 -3.546 -1.442P(T<=t) one-tail 0.000 0.000 0.077t Critical one-tail 1.665 1.665 1.666P(T<=t) two-tail 0.000 0.001 0.154t Critical two-tail 1.991 1.991 1.993
Paired t-test results for mean corporate governance score (CGS) for all sample firms. For companies with a 30 June year end, year 1 is the 2003 financial year and year 4 is the 2006 financial year. For companies with a 31 December year end, year 1 is the 2002 financial year and year 4 is the 2006 financial year. For both June and December balancing companies, years 1 to 3 are pre-IFRS and year 4 is post-IFRS.7
7 In order to avoid a natural bias in calculating the CGS, two of the corporate governance its CG9 and CG10 were omitted from the CGS (maximum number of items of 11) for the 2002 financial year of December balancing companies. The same results were obtained for paired t-tests and multiple regression that incorporated CGS in the calculation.
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FIGURE 2: Change in mean disclosure index and corporate governance score
0
10
20
30
40
50
60
70
80
1 2 3 4
Period 2002/2003 (year 1) to 2005/2006 (year 4)
Mea
n d
iscl
osu
re i
nd
ex a
nd
CG
S
Mean FRMDI Mean mandFRMDI Mean discFRMDI Mean CGS
The rate of change in mean financial risk management disclosure index (FRMDI), mandatory FRMDII, discretionary FRMDI and corporate governance score (CGS) from year 1 to year 4. Years 1 to 3 are pre-IFRS and year 4 is post-IFRS adoption.
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TABLE 5: Multiple regression results for all sample firms and all yearsPanel A Coefficients Standard Error t Stat P-value
Intercept -35.875 7.172 -5.002 0.000CGS 0.158 0.035 4.483 0.000*Capital Raisings 2.293 1.333 1.720 0.086***Overseas Listings -3.350 1.520 -2.203 0.028**Size 3.463 0.471 7.354 0.000*Leverage 0.128 0.027 4.819 0.000*Sub-Industry 1.650 1.745 0.946 0.345Top20 -0.051 0.039 -1.297 0.196
Model SummaryAdjusted R Square 0.426F Statistic 33.820Observations 310
Panel B Coefficients Standard Error t Stat P-valueIntercept -4.164 9.782 -0.426 0.671CGS 0.176 0.048 3.641 0.000*Capital Raisings 3.097 1.818 1.704 0.089***Overseas Listing -6.416 2.074 -3.094 0.002*Size 3.036 0.642 4.726 0.000*Leverage 0.120 0.036 3.312 0.001*Sub-Industry -1.079 2.379 -0.453 0.651Top20 -0.062 0.053 -1.169 0.243
Regression StatisticsAdjusted R Square 0.258F Statistic 16.362Observations 310
Panel C Coefficients Standard Error t Stat P-valueIntercept -59.129 7.616 -7.764 0.000CGS 0.146 0.038 3.889 0.000*Capital Raisings 1.703 1.415 1.203 0.230Overseas Listings -1.102 1.614 -0.683 0.495Size 3.777 0.500 7.553 0.000*Leverage 0.134 0.028 4.747 0.000*Sub-Industry 3.650 1.852 1.971 0.050**Top20 -0.042 0.041 -1.016 0.310
Regression StatisticsAdjusted R Square 0.427F Statistic 12.024Observations 310
The regression equation tested the association between financial risk management disclosures for all sample firms over all four years and the independent variables corporate governance (CGS), capital raisings and overseas listing. The results for total (mandatory and discretionary) disclosures are shown in Panel A; mandatory disclosures in panel B and discretionary disclosures in Panel C. Associations *, ** and *** are statistically significant at the 1%, 5% and 10% levels.
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TABLE 6: Descriptive statistics of audit qualified versus non-audit qualified firms
Panel A MandFRMDI DiscFRMDI FRMDI ROA Top20 Size Leverage CGS
Mean 51.515 20.278 33.494 -3309.334 59.808 17.207 72.658 50.641Standard Error 2.772 2.907 2.541 3249.473 4.314 0.381 10.046 3.493Median 50.000 13.333 30.769 -30.864 56.770 17.417 62.520 53.846Standard Deviation 13.581 14.241 12.449 15919.101 21.133 1.869 49.216 17.113Kurtosis 0.809 -0.656 0.182 23.998 -1.230 8.677 0.514 -0.134Skewness -0.054 0.788 0.848 -4.899 0.201 -2.298 0.969 -0.482Range 63.636 46.667 50.000 78048.799 69.550 10.049 181.828 69.231
Minimum 18.182 0.000 11.538-
78045.999 23.780 10.136 13.778 15.385Maximum 81.818 46.667 61.538 2.800 93.330 20.185 195.606 84.615Count 24 24 24 24 24 24 24 24Confidence Level(95.0%) 5.735 6.014 5.257 6722.047 8.924 0.789 20.782 7.226
Panel B MandFRMDI DiscFRMDI FRMDI ROA Top20 Size Leverage CGS
Mean 64.177 26.993 42.725 -122.757 63.226 18.829 34.905 63.072Standard Error 1.060 0.942 0.884 120.857 1.190 0.110 1.193 1.372Median 63.636 26.667 42.308 4.316 65.285 18.651 33.609 69.231Standard Deviation 17.925 15.930 14.942 2043.884 20.118 1.861 20.174 23.205Kurtosis -0.111 0.189 -0.199 285.859 -0.497 0.999 -0.143 -0.282Skewness -0.188 0.635 0.298 -16.905 -0.284 0.717 0.444 -0.562
Minimum 9.091 0.000 3.846-
34562.916 12.040 14.674 0.771 0.000Maximum 100.000 86.667 88.462 83.798 99.100 24.893 99.007 100.000Count 286 286 286 286 286 286 286 286Confidence Level(95.0%) 2.086 1.854 1.739 237.886 2.342 0.217 2.348 2.701
Financial risk management characteristics of firms with an “inherent uncertainty regarding continuation of the entity as a going concern” (Panel A) compared to firms without a going concern audit qualification (Panel B). MandFRMDI, DiscFRMDI and FRMDI refer to mandatory, discretionary and total financial risk management disclosures respectively. Also shown for each sub-sample is return on assets (ROA) measured as pretax profits divided by total assets, firm size measured as the natural log of total assets, leverage measured as total liabilities divided by total liabilities plus total equity and shareholder concentration (equity interest of the Top 20 shareholders).
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FIGURE 3: Liquidity risk disclosures
0
10
20
30
40
50
60
Percentage of firms with liquidity
risk disclosures
year 1 year 2 year 3 year 4
Period 2002/2003 (year 1) to 2005/2006 (year 4)
Percentage of firms that disclosed information in respect of liquidity risk. Years 1 to 3 are pre-IFRS and year 4 is post-IFRS adoption.
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