Planteamiento del Problema

The current study employs the difference-in-difference (DID) approach in order to examine the impact of the enforcement of the Loss-Making Firms Procedures (LMFPs) on risk disclosure and solve the problem of endogeneity27_.

In mid-2014, the Saudi Capital Market Authority introduces new procedures that apply only to one group of firms. The procedures are called the Loss-Making Firms Procedures (LMFPs). The procedures apply only to firms with cumulative losses. The enforcement of the procedures results in two groups: (i) a treatment group (i.e. loss-making firms), and (ii) a control group (i.e. other firms). The procedures apply to 17 loss-making firms whereas 99 non-loss-making firms are not affected by such enforcement. Most importantly, since the period of this study is 2012-2015, this enables this study to investigate the impact of the new procedures (LMFPs) on risk disclosure two years before the introduction of the procedures and two years afterward.

As discussed in Section 4.4 of Chapter 4, Model 2 explores the impact of the enforcement of the Loss-Making Firms Procedures on risk disclosure. The model is re-stated as:

(equation 2)

LogRDi,t =  0 + β1 LOSSi,t * POSTi,t + β2 LOSSi,t + β3 POSTi,t +



= + n i it it iCONTROLS 1   Where:

LogRD Risk disclosure

LOSS Loss-making firms (i.e. a dummy variable takes 1 if the firm has cumulative losses, and 0 otherwise).

POST The period after the enforcement of Loss-Making Firms Procedures (i.e.

a dummy variable takes 1 if the time is after the enforcement of LMFPs, and 0 otherwise).

LOSSi,t * POSTi,t Loss-making firms after the enforcement of LMFPs.

CONTROLS Control variables for firm size (LogSales), profitability (ROE), liquidity (LIQ), leverage (LVG), and error term.

As can be seen from Figure 6.1 and Table 6.6, the number of risk sentences disclosed by loss-making-firms increased sharply after the introduction of LMFPs. The number of risk sentences disclosed by loss-making-firms increased from 19.18 in 2013 to 22 and 28.12 in 2014 and 2015 respectively. The risk disclosure gap between loss-making and non-loss making firms decreases from 3.52 risk sentences in 2013 to become 1.7 in 2015. This descriptive finding suggests that the introduction of LMFPs has a significant role in enhancing the practices of risk disclosure.

Figure 6.1: Risk disclosure comparison between Loss-making and Non-loss-making firms

Looking at risk disclosure practices for loss-making firms, it can be noticed that risk disclosure was decreasing before the introduction of LMFPs and reversed to be gradually increasing afterward. This finding also supports the robustness of the results where the enforcement of corporate governance mechanisms leads to a higher level of risk disclosure. 15.00 17.00 19.00 21.00 23.00 25.00 27.00 29.00 31.00 2012 2013 2014 2015 Non-loss-making firms Loss-making firms

Table 6.6: Average number of risk sentences

Year Non-loss-making firms Loss-making firms

2012 21.41 19.82

2013 22.70 19.18

2014 24.44 22.00

2015 29.82 28.12

Table 6.7 presents the results of the DID model with a view to confirming the robustness of the impact of corporate governance on risk disclosure. Hypothetically, the variable LOSS*POST has to be significantly positive in order to confirm the robustness of the results of the present study. As defined above, LOSS*POST represents the risk disclosure practices of loss-making firms after the enforcement of LMFPs. Table 6.7 shows that the coefficient of LOSS*POST is positively and significantly related to risk disclosure. This indicates that loss-making firms reveal significantly more risk-related information after the introduction of LMFPs in comparison with non-loss-making firms. The result is statistically significant at the 5% level. Therefore, the thirteenth hypothesis cannot be rejected at the 5% level of significance. Further, this finding supports the robustness of the presents study`s results after solving the problem of endogeneity. Also, the results suggest that the enforcement of Loss-Making Firms Procedures play an important role in enhancing risk disclosure practices for Saudi listed firms. Hence other capital markets regulators are encouraged to apply the same procedures.

Table 6.7: Difference-in-difference model

Notes: The table shows the results of the difference-in-difference model. The dependent variable for all models is LogRD which represents risk disclosure calculated as a log of the number of risk sentences. The independent variables are as follows: LOSS*POST represents the loss-making firms after the introduction of the LMFPs, LOSS represents the loss-making firms, POST represents the period after the introduction of the LMFPs, LogSALES denotes firm size measured as log of sales, ROE denotes profitability measured as return on equity, LVG represents leverage calculated as total debt to total assets, LIQ represents liquidity measured as current ratio, and LogPAGES represents the log of the annual reports` number of pages. The asterisks *, ** and *** denote the 10%, 5% and 1% level of significance respectively.

Dependent variable: LogRD

1 2 3

Variable expected sign Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic

LOSS*POST + 0.052** 2.016 LOSS - -0.003 -0.147 -0.030* -1.707 POST + 0.084*** 2.660 0.108*** 22.285 Control variables: LogSALES 0.041*** 2.983 0.046*** 3.874 0.045*** 3.640 ROE 0.058*** 8.061 0.053*** 7.008 0.053*** 8.520 LVG -0.002** -2.146 -0.002*** -4.217 -0.002** -1.987 LIQ 0.012*** 3.543 0.011*** 3.279 0.010** 2.331 LogPAGES 0.695*** 10.106 0.662*** 11.981 0.671*** 17.876 C 0.002 0.019 -0.022 -0.297 -0.014** -0.203

Industry fixed effect Yes Yes Yes

Year fixed effect Yes Yes Yes

Adjusted R-squared 0.446 0.461 0.49

N 463 463 463

Possible explanations of this finding could also be derived from pecking order and capital need theories. Pecking order theory states that firms prefer to finance their operations by retained profits, debts, and lastly by issuing equity (Donaldson, 1961; Myers & Majluf, 1984). This implies that loss-making firms are in need to issue debt and/or equity due to the scarce internal financing. Hence, loss-making firms` managers may have incentives to disclose more risk-related information in order to raise capital. Similarly, capital need theory states that firms are motivated to disclose voluntarily since they need to raise capital at a lower cost (Abd-Elsalam & Weetman, 2003; Craven & Marston, 1999; Rajab, 2009). Hence, when a firm is committing losses, the firm might need to issue debt and/or equity in order to finance the operations. As a result, the firm`s directors would have the incentive to disclose more risk-related information with a view to attracting investors and raise capital at the lowest possible cost. Another possible explanation the positive impact of LMFPs on risk disclosure can be derived from the political cost theory. Once the procedures are enforced, managers of loss-making firms might disclose more

risk-related information in order to deflect the undesirable attention after the introduction of the LMFPs. As pointed out in section 3.6, there were higher attentions paid to loss- making firms after the introduction of the LMFPs measured by the level of interest of the phrase “Loss-Making Firms” generated by Google Trends as can be seen in Figure 3.1. Cooke (1989) argues that firms` managers tend to disclose more information in order to mitigate the political cost. Managers of such firms would like to reveal voluntary information with a view to deflecting the unfavorable attention (Linsley & Shrives, 2000). Hence, managers of loss-making firms might have the incentive to disclose more risk- related information in order to deflect the unfavourable attention.

The present study expects that loss-making firms (LOSS) reveal a lower level of risk disclosure since they are expected to have poor corporate governance practices. Hence, this variable is expected to be negatively related to risk reporting. As can be seen from Column 3 of Table 6.7, the variable (LOSS) has a negative relationship with risk disclosure. This negative relationship is significant at the 10% level. The variable (POST) is expected to have a positive relationship with risk disclosure since there was a gradual uptrend of risk disclosure in Saudi Arabia as previously discussed in section 5.3. Consistent with this expectation, the coefficient on POST is positive and statistically significant at 1% level. The results of control variables are similar with the results of the main model except that the firm risk variable (LVG) is found to be significant at the 5% level whereas it was insignificant in the main model.