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Electronic copy available at: http://ssrn.com/abstract=1930177

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Signalling theory and voluntary disclosure to the financial market.

Evidence from the profitability indicators published in the annual report

Laura Bini

Francesco Dainelli

Francesco Giunta

Department of Business Administration, School of Economics, University of Florence

Paper presented at the 34th EAA Annual Congress,

Rome, 20-22 April, 2011

Abstract

Signalling theory posits that the most profitable companies provide the market with more and

better information. The research, however, reveals disaccording results.

Because the general disclosure level depends on many factors, our paper centres on a focal

point of the signal that companies send to the financial market: the profitability indicators. As

several studies have shown the strong relevance of this type of data, the hypothesis is that the

most profitable companies should disclose more profitability indicators.

A sample of UK and Italian firms has been selected to verify if signalling policies are adopted

in two very different cultural, economic, and legal contexts.

After controlling for size, risk, industry, and country, our results support our hypothesis. We

conclude that the market is capable of controlling the production and use of information,

concentrating it on the focal points of the agency relationship. Moreover, our results seem to

dismiss the relevance of the European Directive 51/2003, which generally requires the

company to communicate performance indicators. In fact, the most profitable companies

communicate such data independent of any legal requirement. Less profitable companies, on

the other hand, might be induced to massage their disclosure, presenting useless or doctored

ratios.

Keywords: signalling theory, voluntary disclosure, profitability indicators

Electronic copy available at: http://ssrn.com/abstract=1930177

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INDEX

1. Introduction 2. Literature review and research hypothesis 3. Dataset 4 Variables and

method 5. Results 6. Sensitivity analysis 7. Conclusions References

1. Introduction

Financial markets are based on contractual relationships that occur under conflicting

conditions where, if one market player benefits, another loses. Contractual relationships

reflect economic decisions which, when approached rationally are based on the quality, the

reliability, and the timeliness of information related to the contract (Grossman and Stiglitz,

1980; Rasmunen, 1987; Laffont, 1989).

In the financial market, there are some players who have both more and better quality

information than other players. As a consequence, the best informed players are able to make

economic decisions which allow them to tease out, from the contractual relationships, greater

benefits than the other players (Grossman and Stiglitz, 1980; Rasmunen, 1987; Laffont,

1989). Contracts entered into when the players do not all possess the same information might

result in capital misallocation. In this way, profitable companies may have more problems

with fund raising or pay a higher cost of capital than less profitable companies (Knight, 1957;

Rothschild, 1976; Radner, 1982; Laffont, 1989). In a market where contracts are constantly

being entered into and renewed, according to signalling theory, lenders and investors

(principals) require companies who are seeking for capital (agents) to provide information

about their performance (Holden and Subrahmanyan, 1992). The management, therefore, is

naturally induced to send signals to the market (Healy and Palepu, 2001; Verrecchia, 2001).

Signalling theory goes so far as to posit that the most profitable companies signal their

competitive strength by communicating more and better information to the market

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(Verrecchia, 1983; Dye, 1985; Trueman, 1986; Jung and Kwon, 1988; Miller, 2002).

However, research that moves from this theoretical premise and relates a companys

profitability to the general level of disclosure in annual reports indicates conflicting results.

All of these independent pieces of research point to the relationship between profitability and

the general level of a companys disclosure; the latter, however, depends on several factors,

making it difficult to isolate the signalling effect. Nevertheless, research development on

signalling theory can be informative and beneficial. In fact, it has been confirmed that the

conflicting nature of the relationships between principal and agent causes the managers to

focus the signal they send to the market on a few focal points (Ross, 1977; Thakor, 1990; Cho

and Sobel, 1990; Kreps and Sobel, 1994).

Based on this concept, the most valuable information for the financial market is the return on

invested capital, for it represents the crux of the relationship between agent and principal.

This information is disclosed by means of specific indicators or ratios which, very often,

measure specific conditions on which to enter into or renew the agency contract, including,

but not limited to covenants, management stock options, and preference shares.

Against this background, our aim is to verify the presence of signalling mechanisms in

voluntary disclosure to the financial market. Specifically, we are expecting that when a

companys profitability increases, the number of profitability indicators being disclosed also

increases.

Our attention is focused on the profitability indicators that are published in annual reports.

This is because the annual report, even if non timely, is considered by the shareholder to be

the most reliable tool used by companies to communicate the core of their performance (Lang

and Lundholm, 1993; Botosan, 1997; Coleman and Eccles, 1998; Francis and Schipper, 1999;

Botosan and Plumlee, 2002; Watts, 2006).

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To increase the generalisability of our research, we analyzed two countries. Italy and the UK

have been chosen to verify if, and to what extent, signalling policies are adopted in these two

very different cultural, economic, and legal contexts. The sample companies are

representative of the two countries financial markets.

After controlling for size, risk, industry and general environment, our results support our

hypothesis. According to the literature, firms size appears also influential. This brings us to

conclude that the market, as it was theorised since the beginning of the 1970, seems capable

of controlling the production and the use of information, concentrating the flow of

information on the focal points of the agency relationship.

This result empirically confirms the signalling theory focusing, as recent research

developments suggest, on the core of the companys communication: profitability. Very often,

indeed, the background noise that many factors produce in the general level of company

disclosure has prevented research from buttressing the signalling theory with unambiguous

evidence.

From a practical point of view, our results are conducive to signposting the future guidelines

of IASB and other national standard-setters regarding the key performance indicator

disclosure in the management commentary. In fact, our results seem to dismiss the relevance

of the European Directive 51/2003, which states to the extent necessary for an understanding

of the company's development, performance or position, the analysis shall include both

financial and, where appropriate, non-financial key performance indicators relevant to the

particular business. In this way, the Directive provides a generic obligation to disclose a few

indicators. However, the companies that are profitable, as research based on signalling theory

shows, do so independent of any legal requirement. On the other hand, also following the

signalling theory, those companies that cannot produce positive economic performances are

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inclined to massage their disclosures, presenting useless or doctored indicators. It implies the

need for a standard-setter intervention to prescribe more specific and convincing rules.

The remainder of this paper is organised as follows: section two analyses the literature

concerning signalling theory upon which our research hypothesis is predicated. Our sample

and research method are presented in section three and four. After that, we will present and

discuss our results. The concluding section summarises our conclusions and opportunities for

future research.

2. Literature review and research hypothesis

The signalling theory was borne at the beginning of the 1970 and is based on two main

research contributions: Arrow (1972) and Spence (1973).

To overcome the classic theory limitations, above all, the hypothesis of perfect competition,

Spence (1973) analyses the workforce market with the aim of drawing some general

conclusions about information economics. The authors reasoning is simple: seeking for a job,

an unemployed person has something to gain from sending signals to the market, thus keeping

his talents in the public eye in order to prevail over other unemployed persons.

According to this reasoning, research on disclosure to financial markets posits that the most

profitable companies have something to gain from signalling their competitive advantage

through more and better communications (Verrecchia, 1983; Dye, 1985; Trueman, 1986; Jung

and Kwon, 1988; Miller, 2002). Empirical data, however, are inconclusive and, in some cases,

contradictory: few studies confirm the above mentioned hypothesis (Singhvi, 1968; Singhvi

and Desai, 1971; Lang and Lundholm, 1993; Wallace et al., 1994); other studies find no

correlation between the disclosure level and a companys profitability (McNally et al., 1982;

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Lau, 1992; Raffournier, 1995); or, even more telling are those studies that show the

correlation to be inverse (Belkaoui and Kahl, 1978; Wallace and Naser, 1995).

All of these studies relate profitability to the global level of disclosure. The general level of

disclosure, however, depends on several factors (see the meta-analysis run by Ahmed and

Courtis, 1999) making it difficult to isolate a single signalling effect1.

Subsequent research on signalling mechanism (Ross, 1977; Cho and Sobel, 1990; Thakor,

1990) shows that the conflicting nature of the relationships between principal and agent

causes the management to focus the signal they send to the market on a few focal points

(Ross, 1977; Cho and Sobel, 1990; Thakor, 1990; Kreps and Sobel, 1994), which satisfy the

users primary information needs. This is referred to as the decision usefulness approach.

In the financial market, the crux of the relationship between agent and principal is represented

by the return on invested capital, providing the increasing capital is the object of the contract.

Some of the literature suggests that investors (users) make their economic decisions based on

the profitability indicators. A first line of research observes the analysts behaviour. The

results clearly show that the main tool analysts use to evaluate the economic performance of a

company is represented by a set of ratios which are based on financial statement figures or

market values (Barnes, 1987; Bouwman et al., 1987; Gibson, 1987; Matsumoto et al., 1995;

Weetman and Beattie, 1999; AIMR, 2000; Gomes et al., 2004; Gomes et al., 2007). Working

on a list of sixty ratios, Gibson (1987) asks a group of analysts to gauge the importance of

each of those indicators. As a result, profitability indicators are believed to be the most

important. Return on equity, in particular, is considered the most relevant ratio followed by

the price/earnings ratio. The other four, in order of importance, are all profitability indicators:

earnings per share, net profit margin after tax, return on equity before tax, and net profit

margin before tax. Similar research was conducted by Matsumoto et al. (1995). They

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achieved the same results: market and profitability indicators are the most important followed

by other growth indicators.

In addition, some studies indicated that some profitability indicators are highly correlated

with stock market return, confirming the strong informative power of these measures (e.g.

Beaver et al., 1970; OConnor, 1973; Beaver and Manegold, 1975; Peterson, 1975; Roenfeldt

and Cooley, 1978; Bowman, 1979; Hill and Stone, 1980; Elgers and Murray, 1982;

Martikainen, 1989; Salmi et al., 1997; Lewellen, 2004). At the same time, profitability

indicators are used to measure the operating and financial risk of a company (Elgers and

Murray, 1982).

Over the last fifty years, another line of research has been developed that uses financial

statement ratios to predict a companys probability of failure. In regards to this field of

research, the profitability indicators stand out for their importance (e.g., Altman 1968; Beaver,

1968; Deakin, 1972; Edmister, 1972; Libby 1975; Ohlson, 1980; Neophytou and Mar

Molinero, 2004; Hillegeist et al., 2004; Beaver et al., 2005). Moore and Atkinson (1961) and

Jen (1963) show that the probability of a company to obtain a loan is closely related to the

level of its profitability ratios. Furthermore, in merger and acquisition operations, profitability

indicators are considered key measures (e.g., Stevens, 1973; Belkaoui, 1978; Dietrich and

Sorensen, 1984; Rege, 1984; Palepu, 1986; Barnes, 1990; Zanakis and Zopounidis, 1997;

Sorensen, 2000).

In conclusion, the signalling theory, on the one hand, and the central role that profitability

indicators play in the relationships between principal and agent, on the other hand, bring us to

advance this research hypothesis:

HP: The most profitable companies communicate a greater number of profitability indicators

in their annual reports.

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As regards this hypothesis, empirical evidence of the key role of profitability indicators in a

companys voluntary disclosure comes from Gibson (1982). This study offers a list of the

indicators that were the most frequently published in 1979 annual reports of Fortune 500

companies. Gibson concludes that profitability ratios are the most popular and, among them,

earning per share, return on equity and profit margin are those most often published by more

than fifty percent of the firms. Other surveys carried out by consulting companies support

Gibsons results (PwC, 2007; Deloitte, 2007; Deloitte, 2009). However, these reports do not

examine the relationship between disclosure and profitability. Watson et al. (2002), who

investigate disclosure practices of ratios among UK firms, is the only study which focuses on

the core of our research hypothesis. Their results show that the number of indicators published

in annual reports grows when companies profitability increases. Nevertheless, this study

suffers from some limitations: it examines the only British context and, above all, it does not

distinguish among the profitability ratios.

3. Dataset

Italy and the UK were selected as countries of interest because they represent two opposing

models of the European cultural, economic and regulatory environments (Cooke and Wallace,

1990; Nobes, 1998; La Porta et al., 1998; Leuz et al., 2003). The UK is an Anglo-Saxon

country, with a common-law orientation; it has an outsider economy with a large stock

market, dispersed ownership, strong investor rights and strong legal enforcement (Leuz et al.,

2003). Italy, on the other hand, has a civil-law tradition with an insider economy based on a

credit system, ownership concentration, a low level of investor protection and weak legal

enforcement (La Porta et al., 1998). Moreover, financial reporting in Italy is strongly

influenced by corporate law and taxation (Nobes, 1998).

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The study includes a 155-company sample of Italian and UK listed companies from the

manufacturing and service industries. Banks, insurance companies, and holding and real

estate companies were excluded because they have different reporting and legal requirements

as well as different disclosure practices (Hossain et al., 1994).

The world-wide financial crisis started in 2008 has widen the performance gap among firms.

As a consequence, it is reasonable to presume that the identification of signaling policies is

easier in this year. Since the financial crisis has started in the last quarter, only annual reports

ending at 31 December 2009 have been examined, assuring comparability within the sample.

The sample of companies was randomly extracted from the population of the listed companies

included in the Amadeus databank. The sample size was defined to be statistically

representative of the countrys population with respect to the variables employed as disclosure

measures.2 The final sample consists of 73 Italian and 82 UK companies (Table 1). It is noted

that the Italian sample includes a larger portion of the population than the British one. This is

due to the higher variability found in disclosure practices in Italy. Sample composition by

industry is reported in Table 1.

[Insert Table 1 about here]

4. Variables and method

The narrative section of the 2008 annual report is analysed. In particular, the entire annual

report document is scrutinised, with the exception of the Financial statements and the Notes.

The number of profitability indicators (PIs) disclosed is gathered in each annual report. PIs

include both indicators based on accounting data (e.g., ROE, ROI, ROCE) and market values

(e.g., EPS, EBITDA per share, cash flow per share).

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Many empirical findings in disclosure literature testify to a positive relation between the

amount of disclosure and firm profitability. Some of these studies are reported in Table 2

along with the list of profitability measures employed by the authors.


Following this literature, two profitability measures are selected: net profit to net worth

(NP/NW) and operative profit to total assets (OP/TA). Table 3 presents the descriptive

statistics for these two variables. The R2 index shows that both measures are positively

correlated with the variable PIs (Table 3). OP/TA is used in the regression model because its

R2 is higher.


Some control variables are included in the model, referring to the main literature. Those

variables are: firm size, degree of risk, industry, and country.

Firm size (SIZE)

There is general agreement concerning the existence of a positive relationship between the

size of a company and the extent of its disclosure. Firm size is considered to affect voluntary

financial disclosure by influencing the magnitude of agency costs (Leftwich et al., 1981;

Holthausen and Leftwich, 1983; Kelly, 1983). Moreover, larger firms are better able than

smaller firms to afford both direct and indirect costs related to disclosure. The larger firms are

also more likely to take advantage of both economies of scales and their leadership in the

market. Lastly, larger firms tend to employ sophisticated management reporting systems that

can provide a wider variety of corporate information.

The influence of size has been well documented in several studies in several countries: in the

US (Cerf, 1961; Singhvi and Desai, 1971; Buzby, 1975; Salamon and Dhaliwal, 1980; Lang

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and Lundholm, 1993); in the UK (Firth, 1979); in Canada (Kahl and Belkaoui, 1981); in

Mexico (Chow and Wong-Boren, 1987); in Nigeria (Wallace, 1988); in Sweden (Cooke,

1989); in Austria (Wagenhofer, 1990); in Spain (Wallace et al,. 1994; Inchausti, 1997); in

Italy (Prencipe, 2004); and in the New Zeeland (Hossain et al., 1995).

Furthermore, Watson et al. (2002) confirm the positive relation between company size and

disclosure of financial ratios. In their study on UK listed firms, they find that larger

companies are more likely to publish a higher number of indicators in the annual report.

Risk (RISK)

Following agency theory, a positive relation between the level of risk and the extent of firm

disclosure may be expected: higher risk firms should be likely to disclose more than lower

risk firms due to their higher proprietary costs. The few empirical evidences in disclosure

literature show conflicting results about this relation. Garsombke (1979) and Firth (1984) do

not find any correlation between a firms level of risk, measured by the beta index, and the

amount of voluntary communication in the annual report. Patton and Zelenka (1997) include

risk in their regression model which investigates the determinants of disclosure in annual

reports in the Czech Republic. They divide the level of risk into two components: the

operational risk, measured by the percentage of intangible assets, and the financial risk,

measured by the leverage ratio. Their results document that neither of the two risk proxies are

significantly related to the disclosure practises of Czech companies.

For the rest, the majority of the studies investigated the financial risk dimension and found

divergent results. Salomon and Dhaliwal (1980), Bradbury (1992), Mitchell et al. (1995), and

Inchausti (1997) reference evidence of a positive relation while Chow and Wong-Boren

(1987), Hossain et al. (1994, 1995), Meek et al. (1995), and Raffournier (1995) find no

significant relation.

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Industry (IND)

Because proprietary costs vary by industry, voluntary disclosure practices are likely to differ

among industries (Wallace et al., 1994). Moreover, Cooke (1992) affirms that levels of

disclosure in corporate annual reports differ by industry for several reasons. In his study on

Swedish firms, Cooke (1989) suggests that historical factors may have been important in the

financial reporting of different sectors. Cooke segregates his company sample into:

manufacturing, trading, conglomerate, and services and finds that the level of

voluntary disclosure is lower in those companies classified as trading.

Nevertheless, Watts and Zimmerman (1986) consider that the effect of industry on disclosure

can be obfuscated by firm size. Companies operating in the same industry, in fact, are usually

characterised by similar size. Divergent empirical findings document the difficulties in

separating industry-effect from other variables. For example, Amernic and Maiocco (1981),

Wagenhofer (1990), Cooke (1992), and Camffermann and Cooke (2002) point out the

presence of an industry-effect while Wallace et al. (1994) and Chavent et al. (2006) do not

find any significant relation.

Institutional environment (COUNTRY)

Environmental factors are considered to play a relevant role in influencing firm disclosure

practices. Many studies investigate how institutional variables, such as culture, legal

orientation, and economic structure, affect firm activity, and its communications (La Porta et

al., 1998; Jaggi and Low, 2000; Hope, 2003; Vanstraelen et al. 2003; Bushman et al., 2004).

La Porta et al. (1998) give evidence that the legal origin is the more representative proxy

for certain environmental variables such as economic structure, legal enforcement, investor

protection and accounting rules. They maintain that common-law oriented countries are more

inclined to provide the market with voluntary disclosure than civil-law oriented countries.

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Moreover, Francis et al. (2005) affirm that economies based on the credit system are

characterised by a lower level of voluntary disclosure than economies based on financial

markets because credit-system oriented economies mainly recur to private information.

The variables described above are included in the following multiple regression model:

PIs = 0 + 1 PROF + 2COUNTRYi + 3SIZE + 4RISK + 5IND + i [1]

where:

PROF = OP/TA for the fiscal year 2008.

COUNTRY = dummy variable, identifying the country origin of the firm (Italy/UK).

SIZE = natural logarithm of sales for the fiscal year 2008.

RISK = firms beta index at the end of the fiscal year 2008.

IND = dummy variable, indentifying the industry (manufacturing/service).

The descriptive statistics for the quantitative variables employed in the model are reported in

Table 4. UK companies are bigger and more profitable, on average, than Italian companies.

Looking at the standard deviation, the value for the PROF is similar for the two countries. It

means that the higher profitability of UK firms is not related to the outstanding performance

of a few outliers, rather it is a generalised condition.

The beta index is noted to be lower in Italian firms. This fact partially contradicts the

evidence of more leveraged and thus, higher firms level of risk, Italian firms. Nevertheless,

the beta index is a proxy of the whole firms level of risk, including financial risk.

Considering that the sample is not stratified for control variables, the higher level of risk for

UK companies should not invalidate the results.


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5. Results

The correlation matrix is reported in Table 5. As expected, there exists a positive relation

between profitability and total sales (SIZE). At the same time, the risk (RISK) is negatively

correlated to profitability. However, the risk of multi-collinearity is maintained (Hossain,

1995).3


The results of regression tests are shown in Table 6. The F statistic confirms that the

regression model is significant (p-value

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6. Sensitivity analysis

Regression tests are repeated with a different measure of profitability, net profit to net worth

(NP/NW). The results confirm those presented above (Table 7).


Regardless of absolute value of profitability, a firm can be more inclined to communicate

because of an increase in its profitability. To take this phenomenon into account, regression

tests are repeated assuming the variation of operating profitability between 2007 and 2008

(OP/TA_VAR) as an independent variable. The results, as reported in Table 8, are not

significant.


A possible explanation for this is that signaling strategies operate on a time horizon wider

than a year, and they are not functions of conjuncture factors. Thus, year by year, signaling

policies, in our case the number of indicators published in the annual report, are likely not to

be reformulated when considering firm performance, rather they probably depend on the

competitive strength historically affirmed in the market and gradually transmitted to it.

Conversely, the communication action of management would lose credibility, due to its high

variability year by year.

7. Conclusions

Decisions that move financial markets are based on the quantity, the reliability and the

timeliness of information. If that information is not equally distributed among operators,

informative asymmetries are created which generate capital allocation inefficiencies.

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To remain on the market, a firm needs to inform operators, launching signals that will be

beneficial during the capital allocation process. Studies on signaling theory have

demonstrated that the most valuable messages, those which demonstrate the credibility of the

agent is judged, centre on the focal points of the relationship.

Because the general level of disclosure depends on multiple factors, this work concentrates on

one of the focal signal in the market to verify the existence of signaling mechanisms. It has

been shown that the information about the return of capital is the most significant for

principals and agents, thus suggesting that the more credible firms would communicate the

relative indicators.

To this end, the annual reports of a representative sample of listed companies are examined.

Italy and the UK are chosen to verify if, and to what extent, signaling policies operate in very

different cultural, economic, and regulatory environments.

A multiple regression model has verified the existence of a relationship between the number

of profitability indicators, meant as both accounting and market values, and the firm

profitability, measured as operative profit divided by total assets. Dimension, risk, industry,

and country are assumed control variables.

Results highlight the presence of signaling mechanisms in the voluntary annual report

communication: the most profitable firms communicate a higher number of profitability

indicators in the narrative section of their annual report. Very often, indeed, the background

noise that many factors produce in the general level of company disclosure has prevented

research from buttressing the signaling theory with unambiguous evidence. Moreover,

according to much of the literature, the dimension seems to be influential.

Although we cannot know the quality of this communication, the market, as theorised from

the beginning of the 1970, has been found capable of controlling the production and the use of

17

information, concentrating that information on the focal points of the agency relationship.

This fact supports the empirical evidences of a stream of literature that maintains the market is

able to produce relevant information without legislative intervention (see the studies

developed on Verrecchia, 1983).

From a practical point of view, our results are conducive to signposting the future guidelines

of IASB and other national standard-setters concerning the key performance indicator

disclosure in the management commentary. In fact, our results seem to dismiss the relevance

of the European Directive 51/2003, which states: to the extent necessary for an

understanding of the company's development, performance or position, the analysis shall

include both financial and, where appropriate, non-financial key performance indicators

relevant to the particular business. In this way, the Directive provides a generic obligation to

disclose some indicators. However, the companies that are profitable, as research based on

signaling theory shows, do so independent of any legal requirement; on the other hand,

always following the signaling theory, those companies that cannot produce a positive

economic performance are induced to massage their disclosure. This would be a

manipulation of the signal induced by external sources according to Kreps and Sobel (1994),

thereby presenting useless or doctored indicators. As a consequence, the information

asymmetry that the rule aims to reduce, paradoxically would increase.

In this framework, the intervention of a standard setter that defines principles and rules about

the communication of indicators in annual reports appears to be opportune in order to avoid

the adoption of the recalled directive which generates counterproductive effects. Moreover,

the fact that signalling phenomena are found both in market-oriented countries, such as the

UK, and in credit-oriented countries, such as Italy (results that are in line with Francis, 2005),

calls the need for standardized intervention at the European level.

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Some limitations affect this study. A first limitation concerns our independent variable

(profitability). We use two of the main measures utilized in literature, but other proxies can be

taken. Moreover, we analyze only one year and it could reduce the reliability of our results,

even if Gray et al. (2001) testify to a substantial static nature in the relation between the

amount of voluntary disclosure and firm performance over time. In any case, it could be

interesting to observe the firms behaviors and the related signaling policies across the crisis

period.

As future development, less profitable firms can be an interesting field of analysis in order to

verify if and to what extent they tend to manipulate profitability indicator disclosure and, as a

consequence, to express a judgment about the effectiveness of certain rules.

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Notes

1 Interpretation of findings in favour of a relation - between disclosure and performance is confounded by a general failure to control for events that are likely to influence disclosure, Miller, 2002, p. 175. 2 To reach a statistically representative sample, iterative procedures were applied. They are based on the variance of the dependent variable, the number of profitability indicators communicated by the company. Starting with a pilot sample of ten firms for each country, new companies were added until the samples variance estimated the population variance with a significance level of 0.05 and a confidence level of 95%. 3 The homoscedasticity and the normal distribution of errors are controlled before running regression tests.

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TABLES

Table 1 Sample size by country and industry

Italy UK Total Manufacturing 53 45 98 Services 20 37 57 Total 73 82 155

Table 2 Profitability measures in disclosure literature

Sinvhi and Desay (1971) Net Profit/Net Worth Net Profit/Total Sales

Wallace et al. (1994) Net Profit Before Taxes/Total Sales

Belkaoui e Kahl (1978) Net Profit/Total Assets

Courtis (1979) Net Profit/Total Sales; Net Profit

McNally et al. (1982) Net Profit/Net Worth Net Profit/Total Assets

Malone et al. (1993) Net Profit/Net Worth

Wallace e Naser (1995) Net Profit Before Taxes/Net Worth Net Profit Before Taxes/Total Sales

Raffournier (1995) Net Profit /Net Worth

Inchausti (1997) Operative Profit/Total Assets Net Profit /Net Worth

Ahmed and Courtis (1999) Net Profit /Net Worth Net Profit /Total Assets

Prencipe (2004) Operative Profit/Total Assets

Chavent et al. (2006) Net Profit /Total Sales

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Table 3 Descriptive statistics and the R2 index for profitability measures

Mean Median Dev.St. R2 NP/NW 4.40% 4.30% 0.066 0.0798 OP/TA 3.91% 4.48% 0.090 0.2266

Table 4 Descriptive statistics of quantitative variables by country

Mean Median Dev.St. Italy UK Italy UK Italy UK

SIZE (mgl ) 1,716 8,677 317 1,390 5,247 37,159PROF (%) 3.91 10.80 4.48 9.17 0.095 0.090RISK 0.97 1.06 0.94 1.04 0.38 0.38

Table 5 Pearson correlation matrix

PIs RISK SIZE PROFPIs 1 RISK -0.00844 1 SIZE 0.39955 0.26230 1PROF 0.47291 -0.12211 0.42162 1

Table 6 Regression results

Variable Expected Sign Coeff p-value

(Intercept) -0.25962 0.7589PROF(OP/TA) + 5.20407 6.24E-05**RISK + -0.09738 0.7392COUNTRY[T.UK] -0.04757 0.8369IND[T.SERVICE] -0.23872 0.2748SIZE + 0.19153 0.0056**Adjusted R-squared: 0.2529 F-Statistic: 9.868 P-value: 5.58E-08 * p-value < 0.05 ** p-value < 0.01

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Table 7 Regression results (NP/NW as independent variable)


(Intercept) -1.09969 0.1957PROF(NP/NW) + 4.30961 0.0224*RISK + -0.28251 0.3477COUNTRY[T.UK] 0.10454 0.6626IND[T.SERVICE] -0.32763 0.1491SIZE + 0.27859 3.62E-05**Adjusted R-squared: 0.1947 F-Statistic: 7.143 P-value: 6.81E-06 * p-value < 0.05 ** p-value < 0.01

Table 8 Regression results (OP/TA_VAR as independent variable)


(Intercept) -0.73642 0.422329PROF(OP/TA_VAR) + -2.21456 0.243413RISK + -0.36144 0.210426COUNTRY[T.UK] 0.24788 0.290979IND[T.SERVICE] -0.23839 0.294362SIZE + 0.26947 1.21E-5**Adjusted R-squared: 0.2245 F-Statistic: 4.712 P-value: 0.0005453 * p-value < 0.05 ** p-value < 0.01

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