Market Risk Disclosures, Corporate Governance Structure and Political Connections: Evidence from GCC Firms

The aim of this study is to examine the association between market risk disclosures and the strength of the corporate governance structure of Gulf Cooperation Council (GCC) countries? financial firms. In addition, we will investigate the joint effects of political connection, in the form of royal family membership on the board of directors, and corporate governance structure on market risk disclosures. The GCC provides an interesting and natural context for studying market risk disclosure. Many of the GCC listed firms have at least one ruling family member on the board of directors (TNI Survey 2008). For instance, in the United Arab Emirates (UAE), 56 directors from 101 listed firms in 2008 are ruling family members (TNI Survey 2008). Furthermore, in Qatar, 78 (24%) of all listed companies have ruling family members on their boards in 2008. Similarly, in Kuwait and Oman, there are 45 (21%) and 31 (26%) listed firms with ruling family members on their boards in 2008, respectively. In addition, the GCC has a different institutional environment from developed countries, in terms of ownership structure, market development, and regulations. There is an increasing desire in the GCC to improve corporate governance regimes in line with the rapid economic growth of the region, and from the increasing demand of regulators and international institutional investors for greater transparency and accountability. In response, the GCC has strengthened its regulatory and financial institutions and adopted more business environment reforms. These features of the GCC are expected to bring new and valuable insights to the association between market risk disclosure and corporate governance structure.

The aim of this study is to examine the association between market risk disclosures and the strength of the corporate governance structure of Gulf Cooperation Council (GCC) countries? financial firms. In addition, we will investigate the joint effects of political connection, in the form of royal family membership on the board of directors, and corporate governance structure on market risk disclosures. The GCC provides an interesting and natural context for studying market risk disclosure. Many of the GCC listed firms have at least one ruling family member on the board of directors (TNI Survey 2008). For instance, in the United Arab Emirates (UAE), 56 directors from 101 listed firms in 2008 are ruling family members (TNI Survey 2008). Furthermore, in Qatar, 78 (24%) of all listed companies have ruling family members on their boards in 2008. Similarly, in Kuwait and Oman, there are 45 (21%) and 31 (26%) listed firms with ruling family members on their boards in 2008, respectively. In addition, the GCC has a different institutional environment from developed countries, in terms of ownership structure, market development, and regulations. There is an increasing desire in the GCC to improve corporate governance regimes in line with the rapid economic growth of the region, and from the increasing demand of regulators and international institutional investors for greater transparency and accountability. In response, the GCC has strengthened its regulatory and financial institutions and adopted more business environment reforms. These features of the GCC are expected to bring new and valuable insights to the association between market risk disclosure and corporate governance structure.

However, the few studies that focus on market risk disclosures (Ahmed et al., 2004 and Elshandidy and Neri, 2015) appear to suffer from a number of limitations. First, they mainly analyze how general characteristics, such as firm size, liquidity, industry, and board size drive market risk disclosures (Lajili and Zeghal, 2005). Despite suggestions that corporate disclosure decisions, including market risk disclosures, are largely at the discretion of shareholders and corporate board of directors (Michelon and Parbonetti, 2012), few studies examine the relationship between market risk disclosures and the strength of corporate governance (Oliveira et al., 2011), particularly in developing countries (Amran et al., 2009). We therefore do not have a full comprehension of why and how corporate governance practices can promote or impede market risk disclosures. Most importantly, previous studies have mainly investigated how general characteristics drive market risk behavior, without attempting to either examine the association between market risk disclosure and the strength of corporate governance, or to develop market risk and corporate governance indexes, which are critically important in our understanding of the effect of market risk disclosures on the strength of corporate governance. Second, existing studies on market risk disclosures mainly use one year cross-sectional data (Linsley and Shrives, 2006 and Oliveira et al., 2011), which limits our understanding of market risk disclosure behavior over longer periods of time. Inadequate empirical evidence and a general lack of critical academic reflection on the association between market risk disclosures and the strength of corporate governance over long periods has prompted growing criticism. Third, despite increasing evidence that using a multiple theoretical framework provides a richer basis for understanding and explaining market risk disclosures (Oliveira et al., 2011), previous studies ex-ante rely primarily on a single theoretical viewpoint (Dobbler et al., 2008).We will attempt to overcome the limitations of previous corporate governance studies in a number of ways, extending them and making new and important contributions. First, we will examine the association between market risk disclosures and corporate governance, based on previous literature (P?rignon and Smith, 2010) and accounting regulations. We will use a comprehensive self-constructed (qualitative and quantitative) market risk index and a firm corporate governance index. Ours will be the first study to investigate the association between market risk disclosures and strength of corporate governance in emerging markets and in the GCC. Most previous studies focus mainly on how general features, such as firm size, industrial sector, liquidity, and board size affect market risk disclosures without either examining the association between market risk disclosure and the strength of corporate governance or using a market risk index and a firm corporate governance index. Second, unlike existing one-year cross-sectional studies, we will explore market risk disclosures over a relatively long and recent period. This will enables us to gain new, valuable, and timely empirical insights into the patterns and practices of firms? market risk disclosures over a relatively longer period of time. Third, we will examine the market risk disclosures from multiple theoretical perspectives. There are different motivations behind market risk disclosures and unlike previous studies ours will include an ex-ante exploration of a number of theoretical perspectives, including agency, institutional, political connections, and board-gender diversity, and therefore will provide a likely basis for understanding and explaining market risk disclosures in the particular context of the GCC. Finally, this will be the first study to analyze the relationship between royal family membership, strength of governance structure, and market risk disclosure practices. Several recent developments in the GCC region are likely to see an increase in demand for market risk disclosure, particularly with respect to risk reporting. Corporate governance codes and regulations are now well established in all GCC countries, with firms held accountable for breaches or non-compliance with regulations in some GCC members (Al-Shammari et al. 2008). Some GCC countries have established corporate governance task forces to monitor the adherence of firms to governance codes of conduct (Al-Hadi et al., 2015; Hawkamah 2008). Recent regulation of GCC firms has made significant progress toward the establishment of more independent boards of directors in those firms. In all of the GCC countries, the corporate governance code requires the audit committee to review firms? risk management systems and policies, including disclosure practices. Adoption of International Accounting Standards (IAS) or International Financial Reporting Standards (IFRS) is mandatory for all listed financial companies throughout the GCC (Al-Shammari et al. 2008; IFC/Hawkamah 2008). All GCC central banks have adopted Basel II including Pillar III: Disclosure. Finally, although board risk management is voluntary in practices, about 39% of the GCC financial firms have adopted board risk management to oversight firm?s risk management and disclosures (Al-Hadi et al., 2015). The GCC region has seen a marked increase in foreign direct investment (Mina 2007). The GCC as a whole has experienced unprecedented growth rates, and many companies trade with offshore partners and have subsidiaries incorporated in countries outside of the GCC (Lagoarde-Segot and Lucey 2007). The internationalization of GCC listed firms then makes them subject to greater scrutiny from stakeholders, regulators and international institutional investors, who have recently demanded greater transparency and accountability from those firms (Abu-Nassar and Rutherford 1996). Market risk exposures are considered to be particularly important for GCC financial firms (Al-Hadi, Taylor, Hossain 2015) given the recent emphasis of regulatory bodies on strengthening risk management and risk reporting systems in the GCC (Al-Shammari et al. 2008). Firms belonging to the financial sector are generally more prone to issues relating to risk disclosure as these firms are subject to greater regulatory constraints (e.g., Central Bank regulation, Basel, and IFRS). Prior research on the financial industry and market risk reporting show that financial firms disclose more risk related information compared to that of other industries (e.g., Perignon and Smith 2010). Overall, risk disclosure patterns of GCC financial firms is impacted by the existence of ruling family directors on the board, as well as recent developments in governance codes, adoption of IAS/IFRS, the increased importance of regulatory bodies, and internationalization of these firms.