Voluntary risk reporting to enhance institutional and organizational legitimacy. Evidence from Portuguese banks
| Date | 26 July 2011 |
| Published date | 26 July 2011 |
| DOI | https://doi.org/10.1108/13581981111147892 |
| Pages | 271-289 |
| Author | Jonas Oliveira,Lúcia Lima Rodrigues,Russell Craig |
| Subject Matter | Accounting & finance |
Voluntary risk reporting
to enhance institutional
and organizational legitimacy
Evidence from Portuguese banks
Jonas Oliveira
University of Aveiro, Aveiro, Portugal
Lu
´cia Lima Rodrigues
University of Minho, Braga, Portugal, and
Russell Craig
University of Canterbury, Christchurch, New Zealand
Abstract
Purpose – This paper aims to explore the factors that affected the voluntary risk-related disclosures
(RRD) in the individual annual reports for 2006 of Portuguese banks. It also explores the extent to
which those reports conformed to Basel II requirements in terms of the voluntary disclosure of
operational risk and capital structure and adequacy matters.
Design/methodology/approach – The authors conduct a content analysis of the annual reports of
a sample of 111 banks. Voluntary operational risk and capital structure and adequacy disclosures were
assessed using a list of disclosure categories that were developed from the Third Pillar disclosure
requirements of the Basel II Accord.
Findings – Stakeholder monitoring and corporation reputation are crucial factors that explain the
risk reporting practices observed. Voluntary risk reporting appears to enhance legitimacy for two
major reasons: first, by fulfilling institutional pressures to assure the effectiveness of market
discipline; and second, by managing stakeholder perception of a corporation’s reputation.
Originality/value – The voluntary RRD observed are shown to be explained by legitimacy theory
and resources-based perspectives. This theoretical framework has not been tested hitherto in
explaining the motives for banks to make voluntary RRD.
Keywords Disclosure,Financial risk, Voluntary, Legitimacy,Reputation, Stakeholders,Portugal
Paper type Research paper
1. Introduction
Few studies have explored the motivations of banks to make risk-related disclosures
(RRD). Those to have done so have focused on aggregate concepts of risk or on voluntary
operational risk in non-Latin countries in periods immediately after the Basel I Accord
(Linsley et al., 2006; Helbok and Wagner, 2006). In contrast, the present study focuses on
voluntary RRD of operational risk and capital structure and adequacy that were made in
2006 (the year before the Basel II Accord became mandatory in Portugal).
The aggregated concept of risk used by Linsley et al. (2006) included credit risk,
market risk, interest rate risk, operational risk, and capital structure and adequacy.
Linsley et al. (2006) found a positive association between RRD and size of banks.
However, they did not use a theoreticalframework to explain the motivations for making
RRD. In contrast, Helbok and Wagner (2006) used a framework of agency theory,
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Voluntary risk
reporting
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Journal of Financial Regulation and
Compliance
Vol. 19 No. 3, 2011
pp. 271-288
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DOI 10.1108/13581981111147892
signalling theory, and political costs theory to explain voluntary operational risk
disclosures.Their dependent variable included two categories designatedas “operational
risk in general” and “definitions.”However, prior research has considered disclosures of
information in these two categories to be “boilerplate” disclosures (Abraham and Cox,
2007; Linsley and Shrives, 2005) of limitedusefulness (Linsley and Shrives, 2006, p. 400),
and conducive to adverse capital allocations (Merkl-Davies and Brennan, 2007).
Accordingly, the present study considers a concept of voluntary risk that does not
contemplate such “boilerplate” disclosures.
Helbok and Wagner(2006) concluded that voluntaryoperational risk disclosures were
associated negatively with capital ratio and profitability. They found that the economic
rationalefor RRD was that “outsidersmay perceive the impactof an operational lossevent
to be higher for financial institutions which are lower capitalized and less profitable.”
However,Blum (2008, p. 1700) argued that banks “knowthat reporting a high level of risk
leadsto a higher level of requiredcapital.” For our part,we contend that voluntaryRRD are
made to enhance stakeholders’ confidence in a bank’s reputation.
The Basel II Accord became mandatory for Portuguese banks in 2007 (Decree-Law
103/2007 and Decree-Law 104/2007). However, from 2004, many Portuguese banks
began to prepare internal systems and processes to conform to Basel II requirements in
2007. In doing so, they had an increased need to develop information systems
applications (Flores et al., 2006). According to Boonstra (2003), what motivated banks
to implement information systems to conform to Basel II requirements was the desire
to improve their competitive position, improve the economic allocation of resources,
and be regarded as legitimate by the supervisory entity and the market. For Boonstra
(2003), one of the most important factors was a political one. The influence of the
stakeholders was perceived as crucial to the survival of a bank, especially in settings
where banks are publicly visible to relevant stakeholders and are subject to high levels
of scrutiny by them. Consequently, the Portuguese setting was chosen because
Portugal has shown a higher degree of public visibility since 2006 (assessed by the
number of bank’s branches per 100,000 people) compared to European common law
countries (the UK, Ireland, and The Netherlands) (European Central Bank, 2010).
Linsley and Shrives (2006, p. 400) have appealed for studies to be conducted of
industry-specific risk disclosures in order to understand managers’ RRD motivations.
We respond to this appeal by drawing on the institutional and organizational
perspectives of legitimacy theory and resources-based perspective, to contend that
Portuguese banks were motivated to make voluntary risk disclosures for two major
reasons: first, to conform to institutional pressure from stakeholders to ensure a socially
desirable flow of information and to make market discipline effective (Diamond, 1985;
Frolov, 2007; Bliss and Flannery, 2002; Ferna
´ndez-Alles and Valle-Cabrera, 2006); and
second, to manage stakeholders’ perceptions of the company’s reputation in dealing with
risk exposures. RRD would thereby help to ensure an adequate inflow of resources that
are crucial to the viability of a company (Branco and Rodrigues, 2006b; Bebbington et al.,
2008; Sa
´nchez-Ballesta and Bernal Llo
´rens, 2010).
Our results show that RRD are influenced by the perceived level of stakeholder
monitoring (as assessed by a bank’s public visibility) and by perceptions of a bank’s
reputation (as assessed by company age, depositor confidence level, and the ability
of a bank to manage risk). Our results lend support to arguments that disclosure “can be
conceived as both an outcome of, and part of, reputation risk management processes”
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