Managerial Auditing JournalEmerald Article: Cultural impact on Chinese corporate disclosure - a corporate governance perspectiveWen Qu, Philomena Leung

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To cite this document: Wen Qu, Philomena Leung, (2006),"Cultural impact on Chinese corporate disclosure - a corporate governance perspective", Managerial Auditing Journal, Vol. 21 Iss: 3 pp. 241 - 264

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Cultural impact on Chinesecorporate disclosure – a

corporate governance perspectiveWen Qu

Department of Accounting and Finance, Monash University,Caulfield, Australia, and

Philomena LeungSchool of Accounting, Economics and Finance, Deakin University,

Burwood, Australia

Abstract

Purpose – The purpose of this preliminary study is to explore the impact of changed culturalenvironment on the voluntary disclosure behaviour of Chinese listed companies.

Design/methodology/approach – A theoretical framework of the relationship between corporatedisclosure and governance forms the basis of the research. A composite checklist of corporatedisclosure was developed using relevant corporate governance indices and analyses were carried outon the 2003 financial reports of 120 Chinese listed companies. Six areas of voluntary disclosure of thesample companies were analysed and reported. These areas are: board structure and functioning,employees related issues, director remuneration, audit committee, related party transactions andstakeholder interest.

Findings – The results suggest that as China’s cultural and social norms change, there waswillingness of Chinese listed companies to provide voluntary information in addition to the disclosurerequirements. Information relating to stakeholder interest and employees issues are found morefrequently disclosed by listed companies than those which were regarded as sensitive. This is anexploratory study which shows that further research may provide more concrete evidence of thechanging corporate disclosure environment in China.

Research limitations/implications – This study based on one year’s results and as such haslimitation in the interpretation of the results. Further research is necessary to demonstrate the impactof culture in corporate disclosure.

Practical implications – The results have practical implications for professional accountants andauditors to understand further the trend of voluntary disclosure in China. The paper provides someevidence of the changing scene of Chinese corporate governance practice.

Originality/value – This study fulfils a gap in prior research by examining the effect of culturalimplications in corporate governance, in an emerging economy. The composite voluntary disclosurechecklist will serve a good basis of measurement in corporate disclosure.

Keywords Corporate governance, Disclosure, Audit committees, Organizational culture, China

Paper type Research paper

IntroductionChina currently is widely regarded as a new growth engine and an indispensableparticipant in global economy. Since Chinese government implemented theeconomic reform and opening door policy 26 years ago, its average annualeconomic growth has been four times that of developed countries in the sameperiod and double that of developing countries (People’s Daily Online, 2005a). As

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Managerial Auditing JournalVol. 21 No. 3, 2006

pp. 241-264q Emerald Group Publishing Limited

0268-6902DOI 10.1108/02686900610652991

one of the fastest-growing economies in the world, China has attracted substantialamount of foreign direct investment (FDI) for years, especially post China’s entryinto World Trade Organization. The FDI into China reached an estimated 60.6billion yuan in 2004, making it the world’s top destination for capital inflows(People’s Daily Online, 2005c). To maintain the confidence of the Chinese capitalmarket and international investors, there is a high demand for transparency ofcorporate disclosure (Groom et al., 2004).

Transparency of corporate disclosure has become one of the essential componentsof corporate governance principles issued by organizations worldwide (OECD, 1999,2003; ASX Recommendation, 2003). High profile corporate collapses such as Enron inthe USA and HIH in Australia have highlighted the significance of corporate disclosurein playing a critical role as one of the external control mechanisms to solve the agencyproblem. Corporate governance, in respect of transparency, is the availability offirm-specific information to those outside publicly traded firms and it should gohand-in-hand with accountability. High level of disclosure transparency contributes tothe establishment of confidence in capital markets and encourages a better flow of FDIinto a country (Bushman and Smith, 2000; Groom et al., 2004).

The transparency of corporate disclosure made by Chinese publicly listedcompanies has always been an issue. Companies are criticised for lack of disclosuretransparency and corporate scandals in recent years further strengthen this point ofview. Falsification and fabrication of financial and governance information in Chinaenable some listed companies to survive or obtain new injection of funds from thecapital market (Shi and Weisert, 2002). International investors eye Chinesecorporate reports with questioning as they experience difficulty in understandingthe way that Chinese companies disclose information and their effectiveness (Leunget al., 2005).

Corporate disclosure is heavily influenced by environmental factors of a nation.Culture, defined by Hofstede (1980) as “a collective mental programming” has beenidentified as an important variable (Jaggi, 1975; Gray, 1988). Likewise, the traditionalChinese culture also has the potential to impact on their corporate disclosureenvironment (Chow et al., 1995; Bloom and Solotko, 2003). Based on an analysis of theauthority for financial accounting systems, the role of accounting profession andaccounting measurement and disclosure in China, Chow et al. conclude that thefinancial disclosure made by Chinese enterprises is secrecy in nature and they arguethat the development of financial accounting would be constrained by the influence ofChinese traditional culture.

During the past 20 years, China has experienced dramatic changes in almost everyaspect of societal life including political regime, legal system, social value and norms asa result of the economic reform implemented by Chinese government since late 1970s.Researchers have highlighted the need for further investigation into the significantchange process that has occurred in Chinese corporate disclosure practices (Chow et al.,1995; Xiao, 1999; Liu, 2001; Leung et al.; 2005). This paper is inspired by the fact thatthe traditional culture in Chinese society has undergone changes. The social norms andbounds are impacted by the surrounding environmental factors such as thetransformation from a central planned to a market orientated economy, the emergenceof the capital market in China, the booming in individual and institutional investments,the establishment of a financial accounting regulatory framework and corporate

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governance mechanism. Being a country that has experienced all these changes, Chinaoffers a unique research opportunity to examine the impact of changed culturalenvironment on the level corporate disclosure.

The aim of this paper is to investigate the impact of culture on the transparency ofChinese corporate disclosure. To fulfil the aim, the paper will identify different aspectsof influence in the nature and extent of corporate information disclosed in companies’annual reports. This will be achieved by examining the cultural factors that could leadto changes in corporate disclosure in the Chinese context, from a corporate governanceperspective and by investigating the voluntary corporate governance disclosure madeby Chinese listed companies. Legitimacy theory and stakeholder theory are used toexplore the relationship between the changed cultural environment and level ofChinese corporate disclosure. This study will contribute to the body of knowledge byfilling the literature gap on the understanding of the relationship between modernChinese culture and Chinese corporate disclosure. The output from the research willalso extend the literature by contributing to the development of knowledge regardingthe modern Chinese corporate disclosure environment.

The paper is structured as following: the next section, on culture and corporatedisclosure, details the impact of societal cultural dimension on nations’ disclosurepractices; traditional Chinese culture and Chinese corporate disclosure; changedChinese societal and corporate culture environment; theoretical framework andhypothesis development; the methodology section describes the sample selection anddata used in empirical testing; the results of the tests are discussed in the result section;and the conclusion section concludes the study.

Culture and corporate disclosureEarly studies of the influence of national culture on financial accounting and reportingcould be traced back to mid-1970s. Jaggi (1975) examines the impact of the culturalenvironment and individual value orientations on the reliability of financialinformation disclosures based upon Parsons and Shils’ work, which classified valueorientation of individuals into universalism and particularism. Universalism isfeatured by individual independence and impersonal relationship in respect of workstructure among the most developed countries, and particularism is featured byworshiping family system in most developing countries. Jaggi hypotheses thereliability of financial disclosure is not expected to be high in developing countriesunless legal disclosure standards are set. While this study represents the earlyawareness of the linkage between culture and disclosure practice, it lacks a culturalframework to support the approach to measure culture, also, it has no empirical resultto test the hypothesis established. The literature on societal culture is quite fragmenteduntil 1980, when Hofstede reports his study of work-related cultural values in morethan 40 countries around the world. Based on an extensive empirical researchconducted between 1960s and 1970s on 117,000 non-management IBM employees, heidentifies four dimensions of societal culture (Hofstede, 1980):

(1) large versus small power distance, the extent to which the members of a societyaccept that power in institutions and organisations is distributed unequally;

(2) individualism versus collectivism, which stands for a preference for a looselyknit social framework in society wherein individuals are supposed to take careof themselves and their immediate families only versus a preference for a

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tightly knit social framework in which individuals can expect their relativesclan, or other in-group to look after them in exchange for unquestioning loyalty;

(3) strong avoidance versus weak uncertainty avoidance is related to the degree towhich the members of a society feel uncomfortable with uncertainty andambiguity; and

(4) masculinity versus femininity, which stands for a preference in society forachievement, heroism, assertiveness and material success versus a preferencefor relationships, modesty, caring for the weak and the quality of life.

Hofstede’s cultural framework has been employed to guide the formation of severalaccounting and reporting theories, which significantly enrich the explanations aboutthe different accounting practices and reporting systems among different countries(Gray, 1988; Perera, 1989; Gray and Vint, 1995; Zarsekei, 1996; Chanchani and Willett,2004). Gray (1988) suggests that if Hofstede’s cultural dimensions exist, then a linkbetween societal values and accounting system can be established and the influence ofculture can be assessed. Four sub-cultural accounting values including professionalismversus statutory control, uniformity versus flexibility, conservatism versus optimismand secrecy versus transparency are identified accordingly. Of these values, secrecyrelates to the amount of disclosure. As secrecy increases, the amount of publicdisclosure decreases. Secrecy increases with uncertainty avoidance and powerdistance, and decreases with individualism and masculinity. Several subsequentstudies are conducted to test Gray’s accounting sub-culture model. In respect of thetransparency/secrecy of corporate disclosure, Salter and Niswander (1995) find thatonly individualism is significantly related to secrecy, but not other cultural dimensions.Gray and Vint (1995) conclude that the cultural values most significantly related to theextent of information disclosure in practice are uncertainty avoidance andindividualism. Findings of Zarsekei (1996) show that the secretiveness of a cultureunderlay disclosure practice of its business enterprises. Other studies extend theculture-disclosure research to institutional factors including national systems (politicaland legal systems, press), economic systems (economic development, inflation andcapital markets), corporate systems (financial systems, ownership, exchanges listings,dividends, auditor and leverage) and operation systems (firm size, number of industriesand foreign sales). Empirical evidences not only further strength the relationshipbetween culture and disclosure practice of a nation, but also demonstrate that cultureand other environmental factors which also influence the level of corporate disclosureare interactive with each other (Perera, 1989; Doupnik and Salter, 1993, 1995; Vermaand Gray, 1997; Jaggi and Low, 2000; Hope, 2003; Archambault and Archambault,2003; Chanchani and Willett, 2004).

Corporate disclosure in China – prior researchCorporate disclosure research on China attracted little attention until the end of 1980sowing to political, socio-economic, cultural and linguistic reasons (Zhou, 1988).Adopting Hofstede and Bond’s (1988) cultural dimensions and Gray’s (1988)accounting sub-culture model, Chow et al. (1995) fills the literature gap by exploringthe cultural constraints on the implementation and development of accounting reformsin China. Chinese society, according to the survey conducted by Hofstede and Bond(1988), is featured with large power distance, strong uncertainty avoidance, long-term

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orientation, collectivism and femininity. Based upon the examination of severalimportant phases of China accounting regulation development, some conventions,doctrines adopted by enterprises and the role played by accountants, Chow et al.suggest that China’s accounting practice and disclosure should be classified asstatutory control, uniform practices, a conservative measurement approach andsecrecy in disclosure. Disclosure requirement is totally rely on government’sprescription. Accessing accounting information, particularly in the public ownershipsector is almost impossible. The implication is that transparency of corporatedisclosure could hardly be achieved under the traditional Chinese culturalenvironment. Recent Chinese corporate disclosure researches indicate that there is ahigh level of mandatory disclosure requirement compliance among listed companies(Xiao, 1999). However, companies listed on the domestic stock exchanges are reluctantto disclose sensitive information such as related party transactions and new sharesubscription (Liu, 2001). In contrast, Chinese government owned enterprises listed onStock Exchange of Hong Kong (SEHK) voluntarily disclose more strategic andfinancial information than other companies listed there (Ferguson et al., 2002).

Changed Chinese societal cultural dimensionsThe Chinese cultural environment has undergone some dramatic changes as a result ofthe economic reform and open-door policy, which have fundamentally changed the lifeof Chinese people during the last 20 years. Cultural environment changes, for thepurpose of discussion of this paper, are broken down into Chinese societal culturechanges and Chinese corporate culture changes. The following section will devote thediscussion of Chinese societal culture and culture changes.

China is a country with more than 5,000 years civilization. Chinese sociologistssuggest that the social structure of China was linked with the patriarchal clan systemand blood relationships have intense ethical qualities. The moral standards and socialnorms of Chinese were heavily influenced by a well-known teacher, Confucius, wholived in the sixth and fifth century BC and created a philosophy which the Chinesepeople based their beliefs upon for hundreds of years to come. He took a view thatachieving harmonization was for the best interest of each member lived in a goodsociety. Influenced by Confucius’ philosophy, traditional Chinese culture valued themind more than material things. Although Chinese appreciated wealth, wealth wouldbe meaningless if people could not live harmoniously and happily amongst oneanother. The essential component of Confucianism is that there should be lessemphasis on questions of logic, epistemology and meta-physics than on moralproblems and social philosophy. The traditional ethico-moral ideas of China arefeatured by a strong conservativeness and closed character (Liu, 1997).

The economic reform and the open-door policy have been a major impetus toChinese economic development. Historical experience shows that economicdevelopment leads a transformation in ideology, modes of thinking and sense ofvalue (Fu, 1997). Social scientists believe that there are four chief factors that cause aculture to change: changes in the environment, contact with other cultures, inventionand the future development of the culture itself. The last three have proved to be thekey factors in China’s cultural change from old to new, as China began opening itsdoors to foreign relations and making scientific, technological and economic advances.Chen (1997) contends that collectivism, one ingredient of Chinese traditional values has

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been abandoned and individualism, as an emerging value, is accepted by people. TheChinese Communist Party has especially upheld collectivism for the last severaldecades and the advocacy of communist morality encourages people to devotethemselves to the state and society. However, with the rapid development of Chinesemarket economics, idea of freedom, self-realization, self-determination andself-struggle have replaced collectivism as a result of the movement of liberation inboth business area and social life. For instance, rewarding for loyalty and conformityas well as group performance, one of the ingredients of collectivistic culture, has beenreplaced by performance-based rewarding for personal contributions, the character ofindividualistic culture, among many Chinese corporations these days. Individually,worship of money, wealth, power and individual success gradually become acceptablevalues among Chinese society and Chinese business community is driven byprofitability and productivity, the vocabularies which are consistent with a highlymasculine culture. Security of employment which is highly valued by femininecultures, is not predominate situation in China now.

The evolution of corporate culture in ChinaChina has a relatively short history of corporate culture (Tong, 2003). The evolution ofcorporate culture in China is motivated by the development of corporate governancestructure, the establishment of financial reporting regulatory framework and increasedawareness of corporate social responsibilities.

The development of corporate governance in ChinaAs one of the important participants in the global economy, China has responded to theemphasis of corporate governance worldwide by establishing its own corporategovernance principles for publicly listed companies. There was no notion of corporategovernance in China until Chinese government allowed state-owned enterprises tobecome separate legal entities in 1987. As a consequence of enterprises reform, whichaimed to “save” the heavy losses enterprise and facilitate the modernization of Chineseenterprise management system, some of the state-owned enterprises were transformedinto listed companies via corporatization, raising funds from two stock exchangesofficially opened in China since 1990. The agency relationship emerged in China, so didagency problems which exhibited some distinctive characteristics in the Chinesecontext and the ownership structure was widely regarded as one of the mostsubstantial factors contributed to agency problems (Xu and Wang, 1997; Lu, 2002). Toanalysis the ownership structure of Chinese listed companies, considerations need to begiven to the classification of shares and trading restriction imposed on different classesof shares in China. There is a concentration of ownership with the largest shareholderstake in a listed company averaging 45 per cent. More than 60 per cent of the listedcompanies’ shares are non-tradable. The rationale is to ensure the “control” of thecompany to remain with the state-owned or state-controlled shareholders. Onlyone-third of total shares issued, owned by Chinese individual investors and overseasinvestors could be traded relatively freely on the capital market. There is a perceptionthat some parent companies treat their listed companies as “An ATM” (Groom et al.,2004). The agency problem in the Chinese context is featured by the conflict betweenmajority and minority shareholders (Xu and Wang, 1997).

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To regulate the capital market behaviour and protect the interest of individualshareholders, in 1992 China Securities Regulatory Commission (CSRC) was formedcorrespondently to the opening of Shanghai and Shenzhen Stock Exchanges in 1990and 1991, respectively. The initial function of CSRC was to undertake stock exchangesadministrative examination, approval of listing and share transferring. Nowadays,CSRC has changed its function to regulate the information disclosure, securities fraudand management of the listing process. It formulated a series of regulations oninformation disclosure with reference to international practices. In January 2002,following the footstep of the development of corporate governance worldwide, CSRCissued its own code of corporate governance for listed companies in China to prescribedesired corporate governance structure. Chapter 7 of the code gives special attention toinformation disclosure and transparency by addressing detailed disclosurerequirements to listed companies. In addition to financial information, companiesmust disclose information regarding corporate governance and controllingshareholders’ interest. It is listed companies’ responsibility to provide shareholderstruthful, accurate, complete and timely information as required by laws andregulations (Article 87). The code itself does not give definition of transparency butcompanies are encouraged to voluntarily disclose all other information that may have amaterial effect on the decision so shareholders and ensure equal access to informationfor shareholders (Article 88). In terms of means of information disclosure, CSRC takeson board the fact that the large number of individual investors in China reside indiverse locations, it requires listed companies to make information available not only atthe company’s premise, the stock exchange, the relevant licensed brokers and theirbranches, but also publish the report using specified publication and internetconcurrently.

Development of financial reporting regulationIn line with the development of stock market and corporate governance, Chinesegovernment establishes regulatory framework for financial reporting and disclosure.Several important promulgations are noteworthy. In 1985, the National People’sCongress issued “The Accounting Law” to specify the responsibilities of accountants,measurement processes, principles of accounting transactions. The issuance ofAccounting Regulation for Experimental Listed Companies in 1992 by the Ministry ofFinance (MOF) is seen as a landmark of Chinese accounting system by abandoning the“fund system” adopted from Soviet Union four decades ago. Effective on July 1993, theaccounting standards for business enterprises (ASBE) is regarded as the conceptualframework of financial reporting in China. It firstly identifies the objective and users offinancial reporting, qualitative characteristics of information and definitions of theelements of financial statements. Served as a set of basic accounting standards, ASBErepresented the early effort made by Chinese government to harmonize its accountingpractices with international accounting standards. In 2000, the MOF promulgated theaccounting system for business enterprises (the “system”). All listed companies arerequired to follow one unified new system. To complete the framework, Chineseaccounting standards are developed by the Chinese Accounting Standards Committee.There are 16 accounting standards have been released with reference to theinternational accounting standards issued by the International Accounting StandardsBoard. The fundamental change in Chinese accounting and reporting led by the

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establishment of financial accounting regulatory framework is the switching theemphasis of users of financial accounting information. In the centralized planningeconomy, the government is the user. Accounting is prescribed by the government,consistent with the tax law, using a uniform chart of accounts. In the mixed marketeconomy, external investors and creditors are the primary users of financial accountinginformation (Bloom and Solotko, 2003). The objective of Chinese financial accountingand reporting is to satisfy external users’ information needs which enable them tomake efficient decision marking in relation to their investment (Davidson et al., 1996).

Corporate social responsibility and accountabilityThere is a view that corporations are working in a social system, which affects andmeanwhile is affected by the achievement of corporations (Freeman, 1984). Previously,Chinese state-owned enterprises (SOEs) only needed to be accountable to governmentauthorities. Since the separation of management from the private ownership, publiclylisted companies should be accountable to external investors. Under the normativeperspective of accountability model, information disclosure is responsibility driveninstead of demand driven; it is corporations’ obligation to provide information tostakeholders who have direct or indirect stake with corporations (Gray et al., 1996).This viewpoint has been adopted by CSRC when it establishes the corporategovernance principle for listed companies in China as Chinese authority acknowledgesthat the unprecedented economic growth of China has brought consequentenvironmental and social issues (CSRC, 2002). In addition to financial information,Chinese investors and financial analysts need environmental information to evaluateoverall corporation performance and estimate environmental and social risks (Guo,2005). The promotional campaign of sustainable reports has begun in China (People’sDaily Online, 2004a, b).

Above analysis have highlighted a fact that the relationship between changedcultural environment and the transparency of Chinese corporate disclosure needs to bere-defined as the finding of China culture-disclosure research, conducted a decade ago,does not possess the validity these days.

Theoretical framework and hypotheses developmentTo investigate the impact of culture on the transparency of Chinese corporatedisclosure, voluntary disclosure made by Chinese listed companies in their annualreports is chosen as the area of interest. Voluntary disclosure is the disclosure in excessof requirements and they represent free choices on the part of company management toprovide information deemed relevant to meet the needs of users of their annual reports(Meek et al., 1995). Listed companies are selected as they are more likely to attract theattention of investors who are interested and rely upon the quality of corporatedisclosure to make investment decisions in China (Liu, 2005). The annual report is asignificant element in the disclosure process (Todd and Sherman, 1991; Gray et al.,1995). Furthermore, the level of voluntary disclosure of annual reports is positivelylinked to the voluntary disclosure of quarterly and other published information. Also,companies would like to incorporate the information disclosed voluntarily beforehandthrough other sources into audited annual reports to increase its credibility (Lang andLundholm, 1993). Therefore, in certain degree, the level of voluntary disclosure in

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annual reports mirrors a company’s overall attitude towards information disclosure tothe public.

This paper adopts legitimacy theory and stakeholder theory to explain thevoluntary disclosure behaviour of listed companies, seeking to explore the impact ofchanged cultural environment on this process. Legitimacy theory asserts thatorganisations continually seek to ensure that they operate within the bounds andnorms of their respective societies and they attempt to ensure that their activities areperceived by outside parties as being “legitimate” (Deegan, 2000). Since mid-1990s’legitimacy theory has been frequently used to explain voluntary social andenvironmental disclosure made by corporations (Campbell et al., 2003; Deegan, 2002;Deegan et al., 2002; O’Donovan, 2002; O’Dwyer, 2003). Legitimacy theory is derivedfrom the concept of organisational legitimacy, a condition or status which exists whenan entity’s value system is congruent with the value system of the large social systemof which the entity is a part. When a disparity, actual or potential, exists between thetwo value systems, there is a threat to the entity’s legitimacy (O’Donovan, 2002).Legitimacy threatening issues can be created by the media, regulatory or institutionalpressures, evolving social awareness and or corporate/industry crises (Chalmers andGodfrey, 2004). Management must be cognisant of legitimacy threatening issuesand manage legitimacy. Voluntarily disclosing information related to their social andenvironmental performance and contribution has been seen as a means utilized bycorporations to gain, maintain and repair legitimacy and legitimate their ongoingexistence. To change corporation’s activities or attempts to alter other’s perceptions ofits activities, there must be accompanied by disclosures. Otherwise, the intendedaudience will be unaware of what it is the corporation is doing or trying to achieve(O’Donovan, 2002).

Stakeholder theory defines stakeholder is any group or individual who can affect, oris affected by the achievement of the corporation’s objectives (Freeman, 1984). Theconcept of stakeholder implies that in addition to shareholders, who have directfinancial transactions with a corporation, parties such as creditors, suppliers,customers, government and local community also can have interest in a corporation’sactivities and behaviours. Gray et al. (1996) recommend that information (disclosure) isa major element that can be employed by the organisation to manage or manipulate thestakeholder in order to gain their support and approval, or to distract their oppositionand disapproval. Therefore, voluntary disclosure has been seen as a mean ofcorporations to meet the stakeholder demands, especially in respect of the demandrelated to the provision of information about the social and environmental activities ofthe corporation.

Both legitimacy theory and stakeholder theory predict that organizations react todemands of diverse groups with responses aiming to legitimise their actions.Therefore, if voluntary disclosure behaviour of listed companies in China could beobserved, then legitimacy theory could be used to explain why and stakeholder theorycould be used to explain how as companies are anticipated to pay most attention tothose legitimate stakeholder groups who have power and urgency. It is reasonableto assume that Chinese publicly listed companies will adopt voluntary disclosure tolegitimate their behaviour and public investors’ expectation has impact on thevoluntary disclosure behaviour of Chinese listed companies (Figure 1).

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Regulatory agencies can be seen as corporate disclosure interest groups. Theylegitimise their existence by developing and enforcing corporate disclosure rules andregulations that satisfy community information demands (Chalmers and Godfrey,2004). In China, corporate disclosure environment has changed from one which thedisclosures were completely not required to one where pressure was exerted on Chineseenterprises, especially on publicly listed companies. In order to maintain the confidenceof capital market and continuously attract more FDI, the Chinese Security RegulatoryCommission (CSRC) and the MOF, working as Chinese government regulatoryagencies, devote to improve the transparency of overall capital market by graduallyestablishing a comprehensive disclosure framework for listed companies. To protectthe interests of public investors, CSRC introduces average 20 major policies each yearto address the stock issue system, trading and supervision on listed companies(People’s Daily Online, 2005b). CSRC also publicly vows to improve the transparency ofits own work to ensure the efficiency of capital market reforms and to curb corruption.

Figure 1.Theoretical framework

Collectivism- individualism Femininity – masculinity

Corporate governanceDisclosure regulatory framework

Corporate social responsibility andaccountability

Societal culturechanges

Corporate culture changes

Chinese culture changes

Transparency of

corporate disclosure

Investigated by voluntarydisclosure made by Chinese listed companies

How Why

Stakeholder Theory Legitimacy Theory

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It acknowledges that investors are expecting more disclosure on the policy-makingprocess of regulators and stronger supervision on the transparency of the operation oflisted companies. These regulators’ self-promotional behaviour not only legitimisestheir own existence from domestic and international investors’ perception, but alsoexerts pressure on “regulatees”, listed companies in this context, to legitimate theirbehaviour as well. Companies that failed to provide the capital market with timely,adequate and transparent information will face the severe consequence.

Individual investors emerged in Chinese society as a group in the beginning of1990s when two stock exchanges were opened in Shanghai and Shenzhen. In only 14years, China’s capital market has developed into Asia’s third biggest market, withmore than 1,300 listed companies, 4 trillion yuan (US$483 billion) of marketcapitalization and more than 70 million individual personal share trading accounts(People’s Daily Online, 2004a, b). Investors are certainly more concerned about thereturn of their investments to fill the dream of getting rich, although listed companieshave been the biggest beneficiaries from the fast growth capital market. Previously,traders in Chinese stock exchanges had reputation of speculation, after a decade,traders are reported become more rational and mature investors. Quite a few financialscandals teach them lessons that the stock exchanges are not only a place where theycan only make profit but also where they have to sustain the loss as well.Value-oriented investment ideology is more acceptable also due to the increasingnumber of institutional investors, which has changed the structure of investors inChinese capital market. More and more shareholders start to use lawsuit mechanism toseek compensation from companies for their financial losses due to misleadingfinancial disclosure (People’s Daily Online, 2002). The overall investor communitycreate a demand for transparency of corporate disclosure. It is predictable thatindividual shareholders will participate into the construction of corporate governancemore actively.

The research evidence strongly indicates that the societal background of employeesis very evident in the work environment: workers do not abandon their societal valuesand attitudes upon entering a working place (Hofstede, 1980). As part of Chinesesociety, the mindset of senior executives of Chinese enterprises would be impacted bythe societal culture as well. Ralston et al. (1999) compare values held by old generationmanager group in China who experienced the communist consolidation (1949-1965)and current generation manager group whose adolescence occurred during the greatcultural revolution (1966-1976) to the new generation manager group who grew upmostly during the era of social reform (1977-present). The research findings suggestthat the new generation managers scored much higher on values that are consistentwith individualism, while scored lower on traditional Chinese values such ascollectivism and Confucianism. One implication of the increased individualistictendencies of these younger Chinese managers is that they are more likely to actindependently, openly and take risks in the pursuit of profit even when these actionsare in conflict with traditional ways. Authors recommend that the values of the newgeneration managers appear to be reflecting the consequence of government’s“open-door” policy, the relative freedom Chinese people have and the greater exposureto western society and culture. Confronted with the societal pressure for transparentcorporate disclosure, listed companies will have incentive to legitimise theirbehaviours in order to survive and be competitive in the capital market. Chinese

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companies’ legitimacy behaviour can be evidenced by the study conducted byFerguson et al. (2002). Owing to different political regime, legal and economic system,Hong Kong capital market is thought to be more mature than the capital market inMainland China. Companies listed on the Hong Kong Stock Exchange are subject to amore comprehensive reporting regulatory framework. Chinese SOEs listed on theSEHK, interestingly, are found voluntarily and significantly disclose more strategicand financial information than other SEHK firms. Despite their status as relatively newentrants to competitive capital markets, the disclosure practices of the former SOEsappear quite sensitive to external investor’s information demands and voluntarydisclosure behaviour of SEHK listed SOEs is the effect of “showcasing” – to signal tointernational investing communities that mainland China firms are willing to increasetransparency and act as a good corporate citizens among worldwide capital market(Ferguson et al., 2002). Presumably, in line of more disclosure regulations implementedin Chinese capital market and pressure from both domestic and international investors,listed companies in China will exhibit similar behaviour as they behave in Hong KongStock Exchange.

Above discussion and anecdotal literature form the foundation of followingresearch question:

RQ1. Could voluntary disclosure regarding to corporate governance be found fromChinese listed companies’ annual reports as a result of changed culturalenvironment?

Sampling and data collectionTo investigate culture impact on corporate disclosure, a pilot research has beenconducted by collecting and examining 2003 financial year annual reports of 120Chinese listed companies. The sample consists companies only issue A-shares,companies issue both A and B shares and companies issue A, B and H shares. A-sharescould be only sold to Chinese investors, traded on Chinese stock exchanges in Chinesecurrency and financial reporting is under Chinese GAAP. B shares could be only soldto foreign investors, starting April 2001, to Chinese investors as well. This type ofshares is tradeable on Chinese stock exchanges but in US dollars and financialreporting is subject to international accounting standards. Companies that issue Hshares are listed on SEHK and this type of shares could be only traded in HK dollars.According to 2003 Chinese Annual Report Handbook, there are 1,243 companies listedon Shanghai and Shenzhen Stock Exchanges. All 1,243 companies are classified into 20industries including miscellaneous. The percentage occupied in two stock exchangesby each industry is calculated by using the number of listed companies in eachindustry divided by the total number of companies listed. After excluding 41companies which are classified as miscellaneous, the population of this study is 1,202companies listed in two stock exchanges. Ten per cent of the population is chosen to bethe sample, which covers 19 industries. The allocation of the number of samplecompanies for each industry is based on the proportion of each industry on stockexchanges. The general principle followed by sample selection is that the higher thepercentage of an industry, the more companies are selected from this industry,however, subject to the availability of annual reports downloaded from CSRC’s website (for instance, if the annual report could not be downloaded from CSRC’s web sitedue to technical difficulty, the annual report of the second largest company will be

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used). Once the total number of companies of each industry decided, the largest,medium and smallest companies are selected from each industry. The value of asset isused as the proxy of the size of the company. Table I displays the industryclassification and component of sample.

Corporate governance disclosure indexAmong corporate disclosure which is constituted by financial information disclosureand corporate governance information disclosure, corporate governance disclosure ischosen as the area of investigation. A voluntary corporate governance disclosurechecklist has been developed in order to compare with the mandatory disclosurerequirements to identify the voluntary disclosure items. The checklist is developed byreference to several important corporate governance principles and recommendationsestablished by organizations including OECD, Australian Stock Exchange (ASX),HKSE in Hong Kong and CSRC in China. This checklist consists of 120 items ofcorporate governance related information which could be categorised into eightcategories including: board structure and functioning; employees related issues;director remuneration; audit committee; related party transactions; controllingshareholder’s interests; stakeholder interest; and, compliance with relevant corporategovernance principles. It is believed that above corporate disclosure items havecaptured a significant corporate governance disclosure that corporate management areexpected to disclose in their annual reports in order to meet the information needs ofdifferent stakeholders. The items on the checklist are checked against the mandatorycorporate disclosure requirements including the Code of corporate governance forlisted companies in China (2002) (CSRC, 2002) and the format and content of publicly

Sample selectionIndustry classification Percentage of stock exchanges Large Medium Small Total

Equipment 15.9 8 6 8 22Petroleum and chemical 13.2 5 5 5 15Metal 9.1 4 3 5 12Medicine and biology medicine 6.6 4 1 3 8Wholesale and retail 6.9 3 2 2 7IT and telecom 6.8 3 2 1 6Food and beverage 4.3 3 3 6Power and raw material 4.2 3 3 6Textile 4.6 3 3 6Transport and storage 4.3 3 3 6Real estate 3.6 2 2 4Electronic 3.3 2 2 4Service 3 2 1 3Agriculture and pastoral 2.7 2 1 3Paper and printing 2.3 2 1 3Construction 1.9 1 2 3Mining 1.7 1 1 2Other manufacturer 1.4 1 1 2Finance and insurance 0.7 1 1 2Miscellaneous 3.5Total 100 53 19 48 120

Table I.Industry classification

and component of sample

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listed companies, No. 2 (2001) released by CSRC, in order to arrive at the voluntarydisclosure index applicable to the sample companies. Among eight sections of thevoluntary corporate governance information disclosure checklist, controllingshareholder’s interests and compliance with relevant corporate governanceprinciples are covered by the mandatory disclosure requirement, which leaves sixsections constituting the content of the voluntary disclosure index. The voluntarydisclosure index identified for this study could be found from the Appendix.

The content related to corporate governance disclosure of annual reports has beenentirely examined. To carry out data analysis, the content of annual reports iscompared with the voluntary disclosure index and coded in order to find whetherparticular voluntary disclosure item has been disclosed by certain companies. A scoreof 1 (0) is assigned to each item of information disclosed (not disclosed). The voluntarydisclosure index is complied based on the addition, and unweighted scoring approachof the disclosure items. Such an approach is based on the assumption that each item ofinformation disclosure is equally important to users of annual reports in theirdecision-making process. This method is in line with the method adopted by Chau andGray (2002) and Meek et al. (1995).

Results and discussionA company is classified as a disclosing company if any voluntary corporategovernance disclosure item in the voluntary disclosure index is found disclosed in itsannual report. Although Chalmers (2001) argues that the potential bias introducedwhen dealing with voluntary disclosures is that of classifying a firm as non-disclosingwhen in fact it has nothing to disclose, the bias has minimal potential impact on the testresult of this study as the items included in voluntary disclosure index are all directlyor indirectly related to the “code of corporate governance for listed companies inChina”, issued by CSRC. Some CSRC desired behaviour becomes explicit andmandatory disclosure items required; others are implicit and depending uponmanagers’ discretion. For financial period ended 31 December 2003, of the 120 samplecompanies, 104 are identified as disclosing companies, representing 85 per cent ofsample selected.

Given that there are significant portion of sample companies making voluntarydisclosure, it is worth to examine the area of the disclosures and the quantity ofthe disclosure being made. Table II displays the average of the areas ofvoluntary disclosure made by sample companies. Average is calculated by usingtotal voluntary disclosure item of each voluntary disclosure section to divide totaldisclosure made by disclosing companies for each section.

Voluntary disclosure - corporate governance relatedinformation Average

Stakeholder interest 10.70Director remuneration 7.92Employees related issues 6.87Board structure and functioning 3.54Audit committee 2.17Related party transactions 0.00

Table II.Areas of voluntarydisclosure made bysample companies

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Among six sections which including board structure and functioning, employeesrelated issues, director remunerations, audit committee, related party transaction andstakeholder interest, The most frequently disclosed area is stakeholder interest. Asdemonstrated by Table III, nearly 30 per cent of disclosing companies voluntarilydisclosed the information regarding to their human resource policies, internalmanagement structure and workplace development initiatives. Of disclosingcompanies, 26 per cent disclosed their qualitative environmental protectionprograms. The finding is consistent to the conclusion made by Guo (2005). Althoughthere is no formal standard or rule, listed companies in China would like to disclosesome information regarding to their social and environmental performance. However,the content of disclosure is diverse and the information is featured by all positiveactions or news.

Director remuneration, by all means, is an essential component of corporategovernance information. Half of disclosing companies elaborated how and by whomthe fees and other benefits of non-executive directors are determined. Of disclosingcompanies, 25 per cent mentioned to what extent director remuneration is related todirector’s performance, but the description in annual reports are found very general. Afact noteworthy is that establishing a remuneration committee is required by CSRC,however, only 24 per cent of disclosing companies briefly mentioned the roleundertaken by their remuneration committee in the process of determining directorremuneration. Some companies mentioned in annual reports that there was a plan toestablish such committee during the next financial period.

By examining the breakdown of the disclosure frequency of specific items in thevoluntary disclosure index, it is not difficult to find that the propensity of companiesvoluntarily to disclose broad structure and functioning and issues related to auditcommittee is low. Only two of 104 disclosing companies clearly indicated that the nameof the directors considered by the board to constitute independent directors and thecompany’s materiality thresholds. Audit committee, which is required by CSRC, hasnot been widely set up among sample companies. This could be one of the reasons ledto the low-level audit committee disclosure.

There is no voluntary disclosure related to the related party transaction could befound from sample companies. The result supports the research finding of Liu (2002)which suggests that companies listed on the domestic stock exchanges are reluctant todisclose sensitive information such as related party transactions.

Conclusion and limitationEmpirical result shows that voluntary disclosure regarding to corporate governancecould be found from Chinese listed companies’ annual reports. Although this studyonly focuses on one-year data, the result does indicate the willingness of Chinese listedcompanies to provide information in addition to the disclosure items compulsorilyrequired by Chinese governmental agencies. Information could assist listed companiesto legitimate their social status such as information related stakeholder interestinformation and employees related issues are found more frequently disclosed bycompanies than sensitive information such as the related party transactions. Limitedby the size of the empirical research, this study could not firmly demonstrate theimpact of changed cultural environment on the level of Chinese corporate disclosure asthe impact could be only investigated by a longitudinal study and qualitative research

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Disclosure itemTotal number of

disclosurePercentage of total

disclosing companies

Board structure and functioning N ¼ 104The skills and expertise relevant to the position ofdirectors held by each director in office at the date ofthe annual report 12 11.54Commercial experience of the non-executivedirectors 9 8.65Commercial experience of the executive directors 9 8.65Educational qualifications (academic andprofessional) 6 5.77A statement indicating whether the companyviolated any laws during the previous ten years forwhich the company was found liable in an actionbefore a court or regulatory agency 3 2.88The name of the directors considered by the board toconstitute independent directors and the company’smateriality thresholds 2 1.92Directors’ interest in competing business 1 0.96Statement of directors’ responsibilities for thefinancial statements 1 0.96A statement indicating whether any member of theboard of directors or executive officer of thecompany was convicted of fraud during the previousten years 1 0.96The qualification of company secretary 1 0.96The qualification of accountant 1 0.96A statement indicating whether any bankruptcy wasfiled by the company, its executive officers, ormembers of the board of directors within theprevious ten years 0 0.00The full name and qualification of the complianceofficer appointed 0 0.00Employees related issuesPolicy on training 26 25.00Corporate culture development 25 24.04Safety policy 17 16.35Welfare information (general) 11 10.58Recruitment problems and related policy 7 6.73Nature of training 6 5.77Redundancy information (general) 4 3.85Categories of employees trained 3 2.88Number of employees trained 3 2.88Amount spent in training 1 0.96Details of the number of remuneration of employees,remuneration policies, bonus and share optionschemes 0 0.00Data on accidents 0 0.00Cost of safety measures 0 0.00Policy on communication 0 0.00Equal opportunity policy statement 0 0.00

(continued )

Table III.Disclosure frequencies oftimes in the voluntarydisclosure index

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Disclosure itemTotal number of

disclosurePercentage of total

disclosing companies

Director remunerationHow and by whom the fees and other benefits ofnon-executive directors are determined 50 48.08Analysis of directors remuneration – performancebased compensation 26 25.00The role and functioning of the remunerationcommittee 25 24.04The name of the members of the remunerationcommittee 1 0.96Work undertaken by the remuneration committeeduring the year 1 0.96The aggregate of amounts paid during the financialyear or receivable by directors as an inducement tojoin or upon joining the company 0 0.00The aggregate of compensation paid during thefinancial year or receivable by directors or pastdirectors for the loss of office as a director of anymember of the group or of any other office inconnection with the management of the affairs of anymember of the group distinguishing betweencontractual and other payments 0 0.00Analysis of directors remuneration –non-performance based compensation 0 0.00Individual director of the aggregate value realized onthe exercise of options during the year together withan indication of the closing market price of theshares at the balance sheet date 0 0.00Number of meetings during the year 0 0.00Attendance of committee members at meetings ofcommittee 0 0.00Significant issues addressed during the year 0 0.00The existence and terms of any schemes forretirement benefits, other than statutorysuperannuation, for non-executive directors 0 0.00Audit committeeThe role and function of the audit committee 12 11.54Details of the names and qualifications of thoseappointed to the audit committee 1 0.96Number of committee meetings 0 0.00Attendance at committee meetings 0 0.00Statement on independence 0 0.00Report of work done 0 0.00Related party transactionsDirectors current accounts/loans to officers 0 0.00Directors’ interest in significant contracts 0 0.00A statement of the interests (class and number ofsuch securities) of each director and CEO of thecompany in the equity or debt securities of thecompany or any associated corporation 0 0.00

(continued ) Table III.

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such as in-depth interview. Nevertheless, this study attempts to theoretically establishthe relationship between changed Chinese cultural environment and Chinese corporatedisclosure and voluntary corporate disclosure made in annual reports could be seen asthe outcome of this relationship.

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Yakhou, M. and Dorweiler, V.P. (2005), “Corporate governance reform: impact on accounting andauditing”, Corporate Governance, Vol. 5 No. 1, pp. 39-44.

Appendix

Score

Board structure and functioningEducational qualifications (academic and professional) 1Commercial experience of the non-executive directors 1Commercial experience of the executive directors 1The skills and expertise relevant to the position of directors held by eachdirector in office at the date of the annual report 1The name of the directors considered by the board to constituteindependent directors and the company’s materiality thresholds 1Directors’ interest in competing business 1Statement of directors’ responsibilities for the financial statements 1A statement indicating whether any bankruptcy was filed by thecompany, its executive officers, or members of the board of directorswithin the previous ten years 1A statement indicating whether any member of the board of directors orexecutive officer of the company was convicted of fraud during theprevious ten years 1A statement indicating whether the company violated any laws during theprevious ten years for which the company was found liable in an actionbefore a court or regulatory agency 1The qualification of company secretary 1The qualification of accountant 1The full name and qualification of the compliance officer appointed 1EmployeesDetails of the number of remuneration of employees, remunerationpolicies, bonus and share option schemes 1Amount spent in training 1Nature of training 1Policy on training 1Categories of employees trained 1Number of employees trained 1Welfare information (general) 1

(continued )

Table AI.Components of thevoluntary disclosureindex for corporategovernance information

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Score

Safety policy 1Data on accidents 1Cost of safety measures 1Policy on communication 1Redundancy information (general) 1Equal opportunity policy statement 1Recruitment problems and related policy 1Corporate culture development 1Director remunerationThe aggregate of amounts paid during the financial year or receivable bydirectors as an inducement to join or upon joining the company 1The aggregate of compensation paid during the financial year orreceivable by directors or past directors for the loss of office as a directorof any member of the group or of any other office in connection with themanagement of the affairs of any member of the group distinguishingbetween contractual and other payments 1How and by whom the fees and other benefits of non-executive directorsare determined 1Analysis of directors remuneration – performance based compensation 1Analysis of directors remuneration – non-performance basedcompensation 1Individual director of the aggregate value realized on the exercise ofoptions during the year together with an indication of the closing marketprice of the shares at the balance sheet date 1The role and functioning of the remuneration committee 1Number of meetings during the year 1The name of the members of the remuneration committee 1Attendance of committee members at meetings of committee 1Work undertaken by the remuneration committee during the year 1Significant issues addressed during the year 1The existence and terms of any schemes for retirement benefits, other thanstatutory superannuation, for non-executive directors 1Audit committeeDetails of the names and qualifications of those appointed to the auditcommittee 1The role and function of the audit committee 1Number of committee meetings 1Attendance at committee meetings 1Statement on independence 1Report of work done 1Related party transactionsDirectors current accounts/loans to officers 1Directors’ interest in significant contracts 1A statement of the interests (class and number of such securities) of eachdirector and CEO of the company in the equity or debt securities of thecompany or any associated corporation 1The details of any right to subscribe for equity or debt securities of thecompany granted to any director or CEO of the company or to the spouseor children under age 18 of any such director or chief executive and of theexercise of any such right 1

(continued ) Table AI.

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Corresponding authorPhilomena Leung can be contacted at: philomena.leung@deakin.edu.au

Score

Stakeholder interestCompany’s acknowledgement of its wider social responsibility includingenvironmental protection 1Company’s human resource policies, internal management structure andworkplace development initiatives 1Commentary on the quality of the company’s key relationships withinvestors, employees, customers, creditors, suppliers and other significantparties 1Company’s contribution to the community 1Social policy and value added information 1Safety of products (general) 1Environmental protection programs – qualitative 1Environmental protection programs – quantitative 1Charitable donations and activities 1Community programs (general) 1Total score 61Table AI.

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