The predictive ability of “conservatism” and “governance” variables in corporate financial disclosures

Abstract

Purpose

The purpose of this paper is to examine the extent to which “corporate governance” and “conservatism” variables can contribute to the predictive ability of corporate financial disclosures.

Design/methodology/approach

Multiple discriminant analysis is used to differentiate between good and poor companies in Australian manufacturing industry on the basis of their 2009 performance. A classification model including size, governance and conservatism variables, together with financial ratio data is constructed based on 2008 data, and used to predict 2009 performance.

Findings

A model with conservatism, total debt/total assets, company size, and “percentage of shareholdings held by non‐executive directors” (representing corporate governance) as its independent variables, has a classification accuracy of 80.6 percent, and a predictive accuracy of 62.2 percent.

Research limitations/implications

The relatively small sample size, for Australian manufacturing companies, limits both the predictive ability of the model and its generalisability elsewhere.

Practical implications

The findings of the paper demonstrate the importance of both “conservatism” and “corporate governance” measures in determining corporate financial performance.

Originality/value

The paper uses familiar discriminant methods in an unfamiliar context – focusing on surviving companies exhibiting extremes of financial performance.

Citation

Smith, M., Ren, Y. and Dong, Y. (2011), "The predictive ability of “conservatism” and “governance” variables in corporate financial disclosures", Asian Review of Accounting, Vol. 19 No. 2, pp. 171-185. https://doi.org/10.1108/13217341111181096