ajsr_37_02

American Journal of Scientific Research

ISSN 1450-223X Issue 37(2011), pp.12-19

© EuroJournals Publishing, Inc. 2011

http://www.eurojournals.com/ajsr.htm

The Effect of Corporate Board Characteristics on Information

Asymmetry: Case of the Iranian Listed Firms

Mahdi Safari Gerayli

Department of Accounting, Bandargaz Branch

Islamic Azad University, Bandargaz, Iran

E-mail:[email protected]

Abolfazl Momeni Yanesari

Department of Accounting, Firoozkuh Branch

Islamic Azad University, Firoozkuh, Iran

E-mail:[email protected]

Ali Reza Ma'atoofi

Department of Management, Gorgan Branch

Islamic Azad University, Gorgan, Iran

E-mail: [email protected]

Tel: +98-171-2245961; Fax: +98-171-2247958

Abstract

The purpose of this study is to provide empirical evidence on the impact of

Corporate board Characteristics on bid-ask spread, as a measure of information asymmetry,

in Iranian listed firms. Using three different attributes of corporate board including board

ownership, board independence and CEO duality and based on a sample of 90 non-

financial Iranian listed firms from 2005 to 2010, the results reveal that bid-ask spread is

negatively related to board ownership and the proportion of independent directors on the

board. the paper also finds that the presence of CEO duality on the board is associated with

higher bid-ask spread. Overall, this study provides evidence that firms with effective board

of directors are associated with less information asymmetry between management and

shareholders, a finding which is consistent with prior research.

Keywords: Board Ownership, Board Independence, CEO Duality, Bid-Ask Spread

1. Introduction Agency theory predicts the relationship between the principal and the agent whereby Jensen and

Meckling (1976) defined an agency relationship as “a contract under which one or more persons (the

principals(s)) engage another person (the agent) to perform some service on their behalf which

involves delegating some decision making authority to the agent”. This separation of ownership gives

rise to conflicts between the principal (shareholder) and the agent (board of directors) because their

goals are not in perfect agreement. the agency problems associated with the separation of ownership

and control in turn arise from the asymmetric information in the Principal-agent contracts.

The concept of information asymmetry was well elaborated by Akerlof (1970), who

demonstrated that information differences between sellers and buyers can cause adverse selection, or


Asymmetry: Case of the Iranian Listed Firms 13

the “lemons” problem, which can lead to improper functioning of the market. In the context of capital

markets, corporate insiders generally have superior information about the current condition and future

prospects of the firm, compared to outside investors. the existence of information asymmetries across

investors can lead to adverse private and social consequences including low investor participation, high

transaction costs, thin markets and decreased gains from trade (Lev, 1988). Recognizing the adverse

consequences of information asymmetry and agency problems, researchers have suggested several

solutions, among which corporate governance is an important mechanism (e.g., Jensen and Meckling,

1976; Shleifer and Vishny, 1986). the role of corporate governance is to align the interests of managers

with those of shareholders through appropriate bonding and monitoring. In particular, the board of

directors, elected by the shareholders, is charged with evaluating and disciplining the management

team. Within their fiduciary duty to shareholders, directors have a responsibility to ensure greater

transparency when it is in the shareholders’ interests. Since shareholders, in general, are outsiders who

are at an information disadvantage about the company, an effective and representative board of

directors may be able to move the managers toward disclosing more information to the market

participants. Although prior research has studied the link between corporate governance and disclosure,

and between disclosure and information asymmetry, very few studies have directly examined the

relationship between corporate governance and information asymmetry in the emerging countries

particularly in Iran market.

This was, by itself, a motive for the present study. Therefore, the present study wants to find a

justifiable answer for the empirical question whether the existence of an efficient board, as one of the

elements of firm's corporate governance, can lead to the reduction of information asymmetry in capital

market.

The remainder of this study is organized as follows. the background and hypotheses

development are discussed in Section 2. the research sample and design are discussed in Section 3, and

the results of testing the hypotheses are discussed in Section 4. Section 5 contains the summary and

conclusion that includes identified limitations and suggestions for further research.

2. Literature Review and Hypothesis Development Sound financial disclosure diminishes agency problems by bridging the information asymmetry gap

that exists between management and shareholders. In contrast, poor financial disclosure often misleads

shareholders and has adverse effects on their wealth, as suggested by the wave of recent financial

reporting scandals. In response to recent financial disclosure scandals, the U.S. Congress, the Securities

and Exchange Commission (SEC), and the major stock exchanges focused on corporate boards as

primary vehicles for improving the quality of financial information provided by firms and hence

reducing the information asymmetry. Corporate boards are responsible for monitoring managerial

performance in general, and financial disclosures in particular. the present study concentrates on

discussing and analyzing the effect of corporate board characteristics on information asymmetry.

Hence, several hypotheses are developed that identify and link some specific attributes of board of

directors to information asymmetry.

2.1. Board Ownership and Information Asymmetry

It has long been recognized that greater managerial ownership generates greater alignment of the

interests of shareholders and managers, and mitigates the agency problems between the two parties

(Jensen and Meckling, 1976; Demsetz, 1983). Agency theory predicts that there is a positive

association between management interests and the level of voluntary disclosure. Warfield et al (1995)

provide evidence supporting this contention in their findings that the extent of shareholding by

management is positively associated with the amount of information disclosed about earnings. the

14 Mahdi Safari Gerayli, Abolfazl Momeni Yanesari and Ali Reza Ma'atoofi

above reasoning suggests that firms with higher Board ownership will be associated with greater levels

of disclosures and hence lower degree of information asymmetry. the hypothesis is thus:

H1: There is a significantly negative association between Board ownership and information

asymmetry.

2.2. Board Independence and Information Asymmetry

Drawing from Fama and Jensen (1983), a large body of empirical evidence finds that outside directors

who are independent of management’s influence help enhance shareholder value by protecting

shareholder interests against managerial opportunism (Hermalin and Weisbach ,2001). Focusing on

financial reporting issues in particular, Dechow et al (1996), Beasley (1996), and Klein (2002) find that

outside directors are effective monitors of managerial actions. ). Beasley (1996) argues and provides

evidence that the proportion of outside directors is positively related to the board’s ability to influence

disclosure decisions. Chen and Jaggi (2000) find empirical evidence of a positive relationship between

Board independence and disclosure (including mandatory disclosure). Foo and Zain (2010) examine

the association between bids-ask spread, a market-based measure of information asymmetry, and board

characteristics among 227 firms listed on the Main Board of Bursa Malaysia. the results reveal that

board independence is negatively related to the level of information asymmetry. Based on the

foregoing discussion, it can be inferred that the proportion of outside directors in the board might have

a positive impact on disclosure practices, thus leading to lower degree of information asymmetry. It is

therefore hypothesized that:

H2: There is a significantly negative association between Board independence and information

asymmetry.

2.3. CEO Duality and Information Asymmetry

Fama and Jensen (1983) point out that CEO duality signals the absence of separation of decision

control and decision management. the result of CEO duality is the concentration of decision-making

power, which could constrain board independence and reduce its ability to execute its oversight and

governance roles (Gul and Leung, 2004), and prove detrimental to disclosure levels and quality,

especially voluntary disclosure (Ho and Wong, 2001). Huafang and Jianguo (2007) provide evidence

that An increase in independent directors increases corporate disclosure and CEO duality is associated

with lower disclosure. Byard et al (2006) report that CEO duality is negatively associated with

analysts’ forecast accuracy. the authors conclude that CEO duality increases information asymmetry.

To further examine the relationship between CEO duality and information asymmetry, this study tests

the H3 (stated in the alternative form):

H3: There is a significantly positive association between CEO duality and information

asymmetry.

3. Research Method 3.1. Sample

We select all publicly- listed companies in Tehran Stock Exchange (TSE) over the entire duration of

the estimation time period (2005–2010) as initial samples. Of these initial 840 firm- year observations,

companies whose stock trading days are less than 25 in a quarter and firms that are either missing

financial variables or that have insufficient data are eliminated. Financial institutions, banking, finance

and investment firms are also eliminated, since their accounting and reporting environments differ

from those in other industries. This gives a final sample of 630 firm-year observations from the fiscal

years 2005 to 2010.



3.2. Measurement of Variables

3.2.1. Dependent Variable

The proxy we use to measure information asymmetry, as the dependent variable, is the bid-ask spread

(SPREAD) .the relation between the extent of informed trading and bid-ask spreads was first discussed

in Bagehot (1971). Bagehot (1971) argues that market makers trade with two kinds of traders—

informed and uninformed. While the market maker loses to informed traders, he recoups these losses

from uninformed traders by increasing the bid-ask spread. Thus, a high level of informed trading leads

to higher bid-ask spreads. Bagehot’s (1971) intuition was subsequently modeled by Kyle (1985), and

Glosten and Milgrom (1985).There are many measures of bid-ask spreads commonly used in the

literature. However, Hasbrouck (2005) finds a high degree of correlation (above 0.9) among these

alternate measures. Following Amihud and Mendelson (1986) and Jayaraman (2008), we define

SPREAD as the annual relative bid-ask spread using daily closing bids and asks. Specifically,

( ),

,

1,

1

( ) / 2

i t

i i

i t

i t i i

DASK BID

SPREADD ASK BID

−=

+∑

Where: Di,t is the number of days in year t for firm i for which closing daily bids (BIDi) and

closing daily asks (ASKi) are available.

3.2.2. Independent Variables

Corporate board characteristics: the Variables that represent corporate board characteristics are board

ownership, board independence and CEO duality. Board ownership is computed as the proportion of

executive share ownership to total shares of the firm. Board independence (BIND) is measured as the

proportion of non-executive (independent) directors on board. CEO duality (CEO) is measured as a

dummy variable, assigned 1 if the chief executive officer (or managing director) additionally occupies

the position of the chairman of the board, or 0 if otherwise.

3.2.3. Control Variables

To test the main hypotheses, we selected several factors that had been identified by the extant literature

as relevant to bid-ask spread as control variables in multiple-regression models. Among of these

factors are firm size, Stock return volatility, ROE and growth opportunity.

Large firms may face less information asymmetry because they tend to be more mature firms,

have established and time-tested disclosure policies and practices, and receive more attention from the

market and regulators (Diamond and Verrecchia (1991) and Harris (1994)). We also included Stock

return volatility, because market makers increase the spread to make up for the uncertainty associated

with volatile stocks. ROE is included on the expectation that income-generating firms disclose more

information to communicate investors of their good performance (Wallace et al, 1994; Owusu-Ansah,

1998). Therefore we expect a negative relationship between firm Profitability and information

asymmetry. Another important control variable is growth opportunity(GWTH), High-growth firms

have greater information asymmetry because Firms with favorable future prospects are less likely to

provide sensitive operating information in order to protect their competitive advantages and avoid

attracting new entrants or increased competition from existing competitors (Liao ,2009). We use the

ratio of market-to-book value of equity to proxy for growth opportunities.

3.3. Regression Model

To investigate the association between Corporate Board Characteristics and information asymmetry,

the authors estimate the following ordinary least squares (OLS) regression:

SPREADi,t = β0+ β1 BOWNi,t+ β2 BINDi,t+ β3DUALi,t +β4 FSIZEi,t + β5 VOLi,t + β6 ROEi,t + β7

GWTHi,t + εi,t

Where, for firm i at the end of year t:


SPREAD = defined as annual relative bid-ask spread using daily closing bids and asks.

BOWN= board ownership defined as proportion of executive share ownership to Total shares

of the firm.

BIND = percentage of independent non-executive directors on board.

DUAL = dummy variable, 1 if chief executive officer is also chairman of the board, 0

otherwise.

FSIZE = firm size defined as natural log of firm’s total assets.

VOL = Volatility defined as the standard deviation of daily security returns.

ROE = return on equity defined as income before tax and interest to total equity.

GWTH = growth prospect defined as the market value of equity divided by book value of

equity.

ε = the error term.

4. The Results of Hypotheses Testing 4.1. Descriptive Statistics

Table 1 contains descriptive statistics for the dependent and explanatory variables. As shown in this

Table, bid-ask spread vary from 0.0032 to 1.087 with a mean of 0.1145. the mean score for the

proportion of shares held by the board is 24.36 percent, which is comparatively high. the average

proportion of outside directors on the board is 32.56 percent. In the test sample, slightly more than 12

percent of companies have CEO duality, indicating that the phenomenon of CEO duality has improved

gradually. the mean (median) log of firm’s total assets is 5.3665 (5.0121) and the average market-to-

book ratio is 1.7016. As presented in Table I, the mean (median) of ROE, is 0.1533 (0.1321)

respectively, these results suggest that Iranian listed firms have relatively poor profitability during the

test period (2005-2010) with respect to ROE.

Table 1: Descriptive Statistics for All Variables

Variables N Mean Median Minimum Maximum Std. Deviation

SPREAD 630 0.1145 0.0767 0.0032 1.087 0.1314

BOWN 630 0.2436 0.2094 0.0000 0.4112 0.6124

BIND 630 0.3256 0.3005 0.0000 1.0000 0.1244

DUAL 630 0.1267 0.1117 0.0000 1.0000 0.2015

FSIZE 630 5.3665 5.0121 2.8419 7.4683 0.6273

VOL 630 22.4131 18.8436 0.9152 36.3172 4.4566

ROE 630 0.1533 0.1321 -0.1886 0.4342 0.7381

GWTH 630 1.7016 1.6777 0.5941 2.350 0.5615

Notes: SPREAD - annual relative bid-ask spread using daily closing bids and asks; BOWN - board ownership defined as

proportion of executive share ownership to total shares of the firm; BIND - percentage of independent non-

executive directors on board; DUAL -dummy variable, 1 if chief executive officer is also chairman of the board, 0

otherwise; F-SIZE-firm size defined as natural log of firm’s total assets; VOL- Volatility defined as the standard

deviation of daily security returns; ROE- return on equity defined as income before tax and interest to total equity;

GWTH-growth prospect defined as the market value of equity divided by book value of equity.

4.2. Multivariate Hypothesis Test

Table 2 displays the result of the OLS regression model used to test H1-H3. the use of Multivariate

hypothesis test is based on the assumption of no significant multicollinearity between the explanatory

variables.

To investigate the existence of multicollinearity, the variance inflation factors (VIFs) for each

of the explanatory variables are computed. as reported in column 5 of Table 2, the maximum VIF is

1.454, which is lower than ten, a number that is used as a rule of thumb as an indicator of

multicollinearity problems (Belsely, 1991). Thus, these results support the lack of presence of



multicollinearity in the research model. the results of the regression analysis can, therefore, be

interpreted with a greater degree of confidence. As shown in this table, the Adjusted R2 of 58.75

percent gives confidence in the explanatory power of the model.

The H1 states that there is a significantly negative association between board ownership and

level of information asymmetry. As presented in Table 2, the BOWN coefficient is negative, as

predicted, and statistically significant at the 0.01 level, which indicates a significant negative

relationship between Board ownership and bid-ask spread; the analysis thus supports H1. H2 predicts

that board independence has a significantly negative association with level of information asymmetry.

As reported in this table, the coefficient of BIND in the Model is negative, as expected, and is

significant at the 0.05 level. This result indicates a significant negative relationship between board

independence and bid-ask spread; which support H2. Finally, the H3 proposes that the CEO- duality is

significantly positively associated with level of information asymmetry. Consistent with H3, the results

in column 3 indicate that there is a positive association between the CEO- duality and bid-ask spread.

Table 2: Multiple Regression Results

Explanatory Variable Expected Sign Coefficients t-Statics Collinearity Statistics

VIF

Intercept ? 0.0654** 3.1782 -

BOWN - -0.2694** -5.2014 1.312

BIND - -0.3140* -2.1044 1.212

DUAL + 0.2318* 2.0159 1.113

FSIZE - -0.6147** -4.0512 1.366

VOL + 0.1674 1.0057 1.025

ROE - -0.4291** -4.2315 1.454

GWTH + 0.3291** 3.5636 1.098

Adjusted R2 58.75 F-value 28.316

Durbin Watson 1.895 P-value of F-test 0.000

Notes: * Statistically significant at the <5 percent level, one-tailed test;** statistically significant at the <1 percent level,

one-tailed test; BOWN - board ownership defined as proportion of executive share ownership to total shares of the

firm; BIND - percentage of independent non-executive directors on board; DUAL -dummy variable, 1 if chief

executive officer is also chairman of the board, 0 otherwise; F-SIZE-firm size defined as natural log of firm’s total

assets; VOL- Volatility defined as the standard deviation of daily security returns; ROE- return on equity defined

as income before tax and interest to total equity; GWTH-growth prospect defined as the market value of equity

divided by book value of equity.

The control variables, SIZE and ROE are negatively and significantly associated with bid-ask

spread that was expected and is in line with prior research. the growth prospect (GWTH) was

significantly positive, again as expected, implying that High-growth firms have greater information

asymmetry.

5. Conclusion A vast literature investigates the implications of information asymmetry since the seminal work of

Akerlof (1970). Most of these studies investigate these implications in the developed countries, very

little is empirically known about such implications in emerging economies like Iranian market.

The study investigates the impact of corporate board characteristics on information asymmetry

in Iran, as one of emerging or transition economies. Based on a sample of 630 firm-year observations

from the TSE for fiscal years 2005 to 2010, and using three attributes of the board of directors

including board ownership, board independence and CEO duality, the empirical tests indicate that

board ownership impacts negatively the level of information asymmetry measured by bid-ask spread.

Our results support the notion that firms with higher board shareholding are associated with lower

degrees of information asymmetry. We also find that the bid-ask spread is negatively associated with


board independence. This finding is in line with Foo and Zain (2010) who report that board

independence enhances monitoring quality and hence reduces the information asymmetry, thereby

improving the quality of disclosures. the results from testing the association between the CEO- duality

and bid-ask spread suggest that the presence of CEO duality on the board is associated with higher bid-

ask spread. This is consistent with the findings of Byard et al (2006) that the presence of CEO duality

increases the level of information asymmetry.

Overall, this evidence is consistent with the notion that governance matters and that better

governance in public corporations is associated with less information asymmetry between management

and shareholders. There are two main limitations identified in this study. Firstly, the sample only

covers six years of Iranian data and an external validity problem exists that the results may not be

transportable over different time periods and locations. Secondly, only three corporate governance

variables were considered. Many more variables could be considered. Future research should include

the examination of the association that block holder ownership may have on information asymmetry.

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