Variable definition and measurement .1 Accruals quality

1231 A t-1 - Total assets at t-1 REV t - Change in revenues REC t - Change in receivables PPE t - Plant,property and equipment at t The coefficients ,  and  are estimated from coefficients a, b and c of the following cross-sectional regression by industry : TA t A t-1 = a 1A t-1 + b REV t A t-1 + PPE t A t-1 +  t Then, DA = TA t A t-1 - NDA t A t-1 Where, TA = Total accruals = Change in current assets – Change in current liabilities – Change in cash + Change in short term debt – Depreciation In the following analysis the absolute DA is taken and the acronym ABSDATA absolute discretionary total accruals is assigned to the variable. The following analysis will also use the current accrual variation of the above model as given below. NCA t A t-1 = 1A t-1 +  REV t - REC t A t-1 Where, NCA t - Non-discretionary current accruals at time t The coefficients ,  and  are estimated from coefficients a, b and c of the following cross-sectional regression by industry : TCA t A t-1 = a 1A t-1 + b REV t A t-1 +  t Then discretionary current accruals DCA, DCA t = TCA t A t-1 - NCA t A t-1 Where, TCA t = Total current accruals 1232 = Change in current assets – Change in current liabilities – Change in cash + Change in short term debt In the analysis the acronym ABSDATCA absolute discretionary total current accrual is used. The Bursa Malaysia classification of industry is used for the cross sectional regression. The larger the discretionary accruals whether based on total accruals ABSDATA or total current accruals ABSDATCA the poorer the earnings quality. The second measure of accrual quality is based on Dechow and Dichev 2002 model. It simply measures quality as how well accruals map current cash flows to last and future cash flows. It is the residual from the regression of changes in working capital of past, current and future cash flow. This study will use the cross sectional version operationalized in Aboody et al. as follows. TCA j,t Avasset j,t = a + b CFO t-1 Avasset j,t + c CFO t Avasset j,t + d CFO t+1 Avasset j,t +  t Where, CFO =cash flow = net income before extraordinary item – TA total accruals Avasset - average asset ovet t and t-1 The coefficients a,b,c and d will be applied to individual companies current, past and future cash flows. The difference between the predicted and actual company‘s total current accrual is the residual used as a measure of earnings quality. The acronym ABRES absolute residual is assigned to the variable. The larger the value of ABRES the poorer the quality of earnings as the current accruals do not map well with current, past and future cash flows. If the residuals is small, this means that the total current accruals is largely translated into cash flows. 1233

3.3.2 Times series versus cross section versions of Jones 1991 and Dechow and Dichev 2002

This study uses the cross sectional regressions to obtain the relevant parameters in the respective models as in Aboody et al 2005. Francis et al 2004 uses the time series version to obtain the absolute residuals. The cross sectional version arguably provides ‗noisy measure‘ due to differences across companies in the same industry Francis et al 2004, however the measure would not be bias towards companies that survive longer as would a measure from the time series version. For the purpose of this research, on balance, the cross sectional approach is preferred as the time series approach provides parameters that are a company‘s own benchmark measures.. Previous study, Mohd Salleh 2003, on Malaysian data indicates that the cross sectional approach provides measures that produce significant results.

3.3.3 Ownership structure

Ownership structure refers to the distribution of control measured by the voting rights and ownership measured by cash flow rights or rights to benefitscash. A controlling party holds more than 20 of shares. A controlling party can be an individual or a group of related individuals. A group of individuals are related if they are of the same family or hold the shares through a single common entity such as a company or a partnership. The relationship between individuals is analyzed from disclosure of analysis of shareholders‘ in the financial reports. For this purpose companies are divided between those with pyramidal structure PYS and those without pyramidal structure NPYS. For PYS companies both cash 1234 flow and voting rights of companies are collected and for NPYS the cash flow and voting rights are equal. Further, for PYS the ownership structure measure is the cash flow to voting rights ratio. The lower the ratio, the larger the disparity between cash flow and voting rights and the wider is the separation between ownership and control. 3.3.3.1. Calculation of the ownership structure variable PYS companies. The calculation of cash flow and voting rights is based on the method used in Claessens et. al. 2000, and in other researches Fan Wong 2002. Voting rights is taken as the ‗weakest link‘ in the chain of voting rights. The main weakness in this method is that it does not take into account the existence of other controlling shareholders. The inclusion of the other substantial shareholder addresses this weakness. For the sampled companies in Malaysia the cash flow and voting rights chain will be extracted and analyzed from the shareholder‘s statistics pages of the annual report. It is also necessary to use information on the company profile, such as structure of the whole group of companies in which the company belongs, which is sourced from annual reports or the official website of the company. The following shows such calculations for ACP Industries Berhad. The structure of ACP could be understood by also looking at Metacorp Berhad and εTD Capital Bhd shareholder‘s statistics. The group refer to figure γ.1 could be traced to Dato‘ Dr Nik Hussain Abdul Rahman NHAR, although there are other substantial shareholders. NHAR and family members are substantial shareholders of Nikvest Sdn Bhd and Alloy Consolidated Sdn Bhd. Figure 3.1 1235 Cash flow rights = 21.18x74.17x29.02 + 15x74.17x29.02 = 7.78 Voting rights = 21.18 + 15 = 36.18 NPYS companies. NPYS companies will be analyzed into widely held or manager control, and not widely held. Widely held is the situation where none of the shareholders have more than 20 shareholdings. In other words no shareholder has gained effective control and therefore control is in the hands of manager. For these manager controlled companies, the voting rights equals the cash flow rights which is simply the percentage holdings of shares by the manager if any. This is consistent with Jensen and Meckling 1976 analysis, although they begin from 100 owner controlled situation without outside shareholdings. The agency related problems begins as outside shareholdings exist. Thus manager controlled situation is the agency problem at its worst. Consider for the moment the interest alignment theory, the lower the voting rights held by the controlling manager the higher is the expectation of inappropriate behavior. Thus this is consistent with the reading of cash flow to voting rights ratio of PYS Nikvest Sdn Bhd Alloy Consolidated Sdn Bhd 21.18 15 MTD Captial Berhad 100 Lambang Simfoni Sdn Bhd 74.17 Metacorp Berhad 29.02 ACP Industries Berhad 1236 companies and expectation of inappropriate behavior by the controlling party of the PYS companies. For non-widely held companies, the cash flow voting rights of the shareholders with the highest shareholdings will be documented. Even though there is no disparity between cash flow and voting rights and considering the interest alignment theory, the lower the voting rights held by the controlling shareholder the higher is the expectation of inappropriate behavior. Thus this is consistent with the reading of cash flow to voting rights ratio of PYS companies and widely held companies described earlier, and expectation of inappropriate behavior by the controlling party of the PYS companies and widely held companies.

3.3.3.2 Substantial shareholders

Substantial shareholders are those with shareholdings of more than 5 and listed as such in the analysis of shareholde rs‘ statistics in the financial reports. Having identified the ultimate controlling party, the shareholder with the next highest shareholding is identified as the substantial shareholder. This substantial shareholder is therefore not related to the ultimate controlling party and expected to have a monitoring role. Referring to MTD Capital Bhd example earlier the substantial shareholder is the Employees‘ Provident Fund with voting rights of 9.11. For this purpose Ruslan Sulaiman and Mohd Dom Ahmad, though appear not to have any family connections with Dato‘ Nik Hussain are deemed to be related as they all have interest in various companies. The truly unrelated is the Employees‘ Provident Fund.

3.3.4 Cost of equity

1237 The measure of COE is estimated based on Ohlson and Juettner-Nauroth 2000 OJN and as operationalized in Chen et al 2003 as follows. P t = FEPS t+1 + FEPS t+2 –FEPS t+1 – COExFEPS t+1 1-POUT COE COECOE- g Which then rearrange to find COE and where POUT- Dividend pay out ratio COE = A + A 2 + FEPS t+1 FEPS t+2 –FEPS t+1 - g 0.5 P t FEPS t+1 Where, A = ½ g + POUT x FEPS t+1 P t P t - Share price at time t FEPS - Forecasted earnings per share POUT - Dividend payout ratio g - estimated long term growth The long term growth in this estimation is proxied by the inflation rate of 1.4 for year 2004 and that is the company wide economic growth. 4. Results 4.1 General descriptive statistics Table 4.1 shows the proportion of companies that are with ultimate controlling party having controlling rights through layers of companies pyramidal ownership and those that are with ultimate controlling party having direct controlling rights non-pyramidal. Table 4.1 Breakdown of companies with pyramidalPYS and non-pyramidal ownershipNON-PYS Sample PYS NON-PYS ABRES 141 40 101 1238 28 72 ABSDATCA ABSDATA 151 46 30 105 70 Table 4.2 and table 4.3 show the descriptive statistics for each variable in each of the two samples. The values of each variable used in the regressions are as estimated or calculated. Only for both the discretionary accruals variables ABSDATCA and ABSDATA the logged form is used as the calculated form is highly skewed as shown in table 4.3. As given in table 4.4 the skewness and kurtosis problems of the logged form LABSCA and LABSTA is much lesser than the original form of the variable. Even though some of the other variables are skewed and peaked, they are not transformed as the transformed variables are not much improved and to prevent further reduction of sample size. Besides as discussed in Tabachnik. and Fidell 2001 transformation poses interpretation problem and not widely recommended. Further, with the given sample sizes Central Limit Theorem is relied on to predict normality. Market values MV and book to market BTMV are transformed LGMV and LBTMV as MV are large and transformation of BTMV achieved univariate normality.