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The supervisor quality and quality of risk

disclosures by European banks

MSc thesis, Accountancy

Rijksuniversiteit Groningen, Faculty of Economics and Business

22nd June, 2018

Marco Holtrop Studentnumber:2028751 E-mail: m.holtrop.1@student.rug.nl

Supervisor: J.G. Huttenhuis MSc. EMA RA Prof. dr. R.L. ter Hoeven RA

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Supervisor quality and quality of risk disclosures by European banks Abstract

Following the 2008 financial crisis many new regulations and laws have been introduced to (re)gain trust in the financial system and prevent future crises. This study aims to investigate the quality of risk disclosure, based on new regulations (like Basel III) integrated in a disclosure index, by 75 European banks and three determinants for it; type of supervisor, audit committee activity and audit firm specialisation. For all three associations a positive relationship is expected. To complete the model ‘supervision quality’ is measured as a proxy of all three determinants and investigated for association with the quality of risk disclosure, using Structural Equation Modelling (SEM). Furthermore, culture, masculinity (negative association expected) and uncertainty avoidance (positive association expected), are tested for their moderating effects. No empirical evidence is found for associations between type of supervisor, audit committee activity and audit firm specialisation and the quality of risk disclosures by European banks. Thus, the underlying value of the Single Supervisory Mechanism (SSM), consistent supervision, is achieved. Furthermore, in the debate of big N dominance and audit firm tenure, the limited influence of an audit firm specialist is a contribution. The estimations for supervision quality and the culture moderators resulted in non-significant results, leaving room for future research. Overall, the disclosure scores are mediocre, implicating there is still room for improvement. Stakeholders, according to agency theory, can convince management to be more transparent leading to better decisions and higher disclosure quality. Banks can benefit from greater legitimacy, trust and more investor attractiveness when the disclosures are of higher quality.

Keywords: Risk disclosure quality, European banks, Corporate governance, Supervision quality, Basel III

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3 Table of contents 1. Introduction 1.1. Study 4 5 2. Theoretical background 8 2.1. Theoretical Foundation 8 2.2. Risk Disclosures 10 2.3. Supervision 10

2.4. Audit Committee Effectiveness 2.5. Audit Firm Specialisation 2.6. Culture 11 12 13 2.7. Hypothesis development 2.8. Conceptual Model 14 17 3. Methodology 18

3.1. Sample and data collection 3.1.1. Dependent Variable 3.1.2. Independent Variables 3.1.3. Control Variables 18 18 19 20 3.2. Supervision Quality 21 3.3. Culture

3.4. Linear Regression Model

21 22 4. Analysis and Results

4.1. Descriptive Analysis 23 23 4.2. Additional Analysis 27 5. Discussion 28 6. Conclusion 30 6.1. Contributions 30

6.2. Limitations and Future Research 31

7. References 32

8. Appendix 39

Appendix A: List of Bank Sample Appendix B: Disclosure Checklist Appendix C: Audit firm specialist

Appendix D: Masculinity and Uncertainty avoidance scores

36 42 44 46

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1. Introduction

Trust in the banking industry was at an all-time low after the 2008 financial crisis (Hurley et al., 2014). Shim (2013) finds that trust plays an important role for the existence of banks and the well-functioning of economies; without trust, economic factors decline and even the richest and most advanced economies come to an halt. The 2008 financial crisis and the fall in trust led to many bankruptcies and nationalisations in the banking industry (e.g. ABN-AMRO, RBS, IKB (Forbes et al., 2015)). The crisis also affected the entire global financial system, showing the importance of trust for the banking industry. Trust was not only lost in the banking industry, but also towards regulators, governments and supervisors (Hurley et al., 2014).

Following the 2008 financial crisis many regulatory adjustments have been made such as Capital Requirement Directive (CRD)/Capital Requirement Regulations (CRR) (2013), Systemically Important Financial Institution (SiFi) (2011) and towards Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Trying to deal with the cause of the crisis, a liquidity shortage sparking a series of events resulting in a dramatic downturn in the key stock markets and the collapse of some large financial institutions (Rossi and Malavasi, 2016). The Basel Committee on Banking Supervision (BCBS) developed a new set of measures, also referred to as Basel III (framework) or CRD/CRR (legislative translation). These measures aim to strengthen the regulation, supervision and risk management of banks and Basel III. Basel III standards are minimum requirements which apply to all active European banks and consist of three sections, also referred to as pillars. The media and most market participants tend to focus primarily on Pillar I, since that is where the capital

ratios and new buffers requirements reside. However, it is Pillar 3 that can shed light on the

opacity of banks' ratios and models (Valladares, 2015), as the Pillar 3 disclosure framework seeks to promote market discipline through regulatory disclosure requirements.

Risk disclosure can increase corporate transparency and information about risk is important for the well-functioning of capital markets (Deumes, 2008). Therefore, studying risk disclosures is important. Investors with this information can make better valuations of a company’s stock, so well-informed investors will lead to well-functioning capital markets (Deumes, 2008). Furthermore, risk disclosures by banks are seen as an effective signal to avoid future financial crises (Financial stability board, 2012). Risk disclosure can be used by management to influence external perceptions about the organisation (Connely, 2011).

The need for risk disclosure can be explained by agency theory (Healy and Pelapu,

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asymmetry and overcomes the agent-principal problem. Legitimacy theory explains that

organisation’ needs to be legitimate towards the opinion of society, or otherwise do not have a

reason to exist. Risk disclosures provides a tool to influence the perception of society and can

show in what way an organisation meets the ‘social contract’ with society, also raising the level of trust. Signalling theory can address the reason why firms can be willing to disclose more and higher quality information (An et al, 2011). For example, signalling superior quality in risk response due to the financial crisis can be a tool for European banks to restore the trust in the system, and regain the trust from stakeholders. It will help to close the information gap, caused due to the information asymmetry. Also signalling sustainable choices for investments can attract more investors. All theories in their own way show how external perceptions can be influenced by risk disclosures and can motivate the utility for quality risk disclosures.

1.1 Study

The supervision of banks is a key measure in Basel III. Quality risk disclosures in banking, as mentioned before, are an effective tool to prevent financial crisis according to the Financial Stability Board (2012) and to close the information gap between organisations and their external stakeholders. Supervision is mostly done by governmental authorities and includes supervision on drivers for trust (e.g. competence, integrity, customer orientation, and transparency) (Van Esterik-Plasmeijer, 2017). The drivers relate to the behaviour of banks and can also be regulatory recorded. However, to what extend is supervisor quality associated with the quality of risk disclosure? Supervisor quality will be defined by combining several measures of supervision; the supervision on banks, audit committee and the specialisation of the audit firm. The institutions charged with supervision of a bank differ between the European Central Bank (ECB) or the National Competent Authorities/equivalent of the ECB (NCA) (Gren et al., 2015). The NCA seems to have more possible issues for supervisory forbearance (Garicano, 2012), “supervisors turning a blind eye to mounting problems within banks” (Gren et al., 2015),

also moral hazard problems arise when a fund is created for national authorities to bail out or resolve banks (Boone and Johnson, 2011). For the quality of risk disclosure this can signify lower quality when a bank is supervised by a NCA. The role of the audit committee is positively associated with voluntary financial disclosure (Karamnou and Vafeas, 2005). However, the results are mixed for other definitions of audit committee such as busyness (Sun and Liu, 2014). Hence more empirical evidence is needed to support an association between audit committee and risk disclosure quality. Also industry-specialisation by audit firms is positively linked to the quality of disclosure in unregulated industries, but not for regulated industries (Dunn and

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Mayhew, 2004). For European banks, as not being one of the most regulated industries (McLaughlin, 2016), this indicates that preferring a specialised firm over a non-specialised firm can raise the disclosure quality.

The association between supervision quality and the quality of risk disclosure can be influenced by many determinants. In this study the influence of national culture will be researched. The European Union exists of many different countries and all banks have their own national background leading to cultural differences. These cultural differences can influence reporting, (Deegan and Rankin, 1996). However, what do these cultural differences mean for the quality of risk disclosure?

Basel III principles are voluntary disclosures, they can be of great value for analysts (Zhou, 2017), investors and other stakeholders (Francis et al., 2008) and can contribute to the IFRS compliance, as great parts apply to all firms subject reporting under IFRS (Fiechter et al., 2017). Thus, the importance for quality risk disclosures in the context of preventing financial crisis is significant. This study aims to shed more light on the association between supervisor quality and the quality of risk disclosure by European banks and the influence of culture on this risk disclosure quality, leading to the following research question:

To what extent is supervisor quality associated with the quality of risk disclosure by European banks, and to what extend does the culture of the bank influence this relation?

By answering this research question, the contributions of this study are fourfold. First, this study contributes to the governance of banks and finds determinants, such as the supervision on banks, audit committee and the specialisation of the audit firm, that add to the existing literature and can be used to strengthen the regulations and can help banks to raise the quality of their risk disclosures. The insights of this study reveal new relations or support already existing relations in the context of European banking, such as the introduction of the relative new Single Supervisory Mechanism (SSM) model, in 2014, and the associated system of banking supervision by NCA’s and ECB. Furthermore, the influence of audit activity on the quality of risk disclosures, where mixed results are found (Sun and Liu, 2014), can also add to the understanding of proper governance. In addition, the relation between audit firm specialists and the quality of risk disclosure can help banks in their search for an audit firm. Not all audit firms have the same quality (Abbott et al., 2003) and especially in complex industries, such as the banking industry, specialisation is more relevant as higher levels of knowledge are more relevant for the audit (Francis and Seavey 2012) and specialist are better in identifying the audit

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risk and detect more audit failures (Owhoso, 2002). Importantly, most studies focus on broader fields or on industry specific firms.

This study has a unique model with different measures for governance for (European) banks, making the associations, an interesting contribution to the literature. Second, in general this paper can add to the debate and development of governance practices. For example, the recent financial crisis and to a lesser extent frequent accounting scandals cause increased demand for improvement of internal controls and reporting about these controls (Hooghiemstra, 2015). Every contribution in this complex field can add in some way to the (public) debate. Third, many stakeholders can benefit from good quality risk disclosure. The information in risk disclosures is relevant for the decisions being made by stakeholders. Well informed investors are needed for the well-functioning of the capital markets (Deumes, 2008). Also, the valuation of the company and external perceptions are partly based on the information in the risk disclosure. Fourth, for banks itself it is also helpful to acquire high quality risk disclosures as the disclosures can lower the cost of capital (Lambert et al., 2012) and the cost of equity (Eaton et al., 2007) for the organisation. This is important as the requirements are costly to implement and may be a deadweight loss to the organisation. Moreover, quality risk disclosures can be a positive sign towards external parties. Credence qualities are needed to give customers organisational trust, as consumers cannot evaluate the firm objectively due to the agency problem (Alford and Sherrell, 1996). More than half of the US bank customers find trust in the organisation more important than the value they receive for their investments (Nienaber et al., 2014), supporting the vital importance of trust in the banking industry. In contrast, having a low-quality disclosure will reduce the effectiveness of a managers communication effort, and also influences the managerial labour markets reputation (Kothari et al., 2009).

The remainder of this study is organised as follows. Chapter 2 provides the theoretical background, hypothesis development, and conceptual model. Chapter 3 presents the methodology including the sampling and data collection as well as the measures included in the disclosure index. Chapter 4 outlines the analyses performed to test the hypotheses and presents the analyses results. Chapter 5 reviews the results consindering the theory and literature discussed in Chapter 2. Chapter 6 closes this study with concluding remarks together with

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2. Theoretical background

This chapter discusses the main theories used in explaining the research questions. Also it will discuss the theoretical background. Agency, legitimacy and signalling theory will be explained first, including the context with this study. Thereafter, the literature and theoretical background on supervision, audit committee and audit firm specialisation (all together supervision quality) will be explained, together with the moderator culture. Subsequently, hypotheses are developed to outline the relationships this study expects to find. An overview is provided in the concluding conceptual model.

2.1 Theoretical Foundation

Central to agency theory is the conflict between the managers (agent) and the shareholders (principal). Managers have a decision making role, but may have different interests than shareholders, causing a gap between both parties (Fama and Jensen, 1983). Giving principals the task to monitor the agent to keep up with the actions of the agent. Furthermore, managers may have superior (inside) information making it easier to out manoeuvre the shareholders to benefit their own interest.

In context of this study the organisations dealing with disclosures can use the disclosures to decrease the gap between the agent and the principal and lower the agency costs (Watts and

Zimmerman, 1983). In the banking industry there is a high complexity and high information

asymmetry between insiders and outsiders supporting the relevance of agency theory (Ahmed an Khaled, 2013). The demand for financial reporting and disclosures arises from this information asymmetry (Healy and Pelapu, 2001). The managers responsible for the disclosures can be selective in what to disclose and what not (Eng and Mak, 2003), and managers will always face a trade-off between higher agency costs and limiting ‘agency loss’(Gren et al.,

2015). However, requirements, such as in Basel III and IFRS, can set a minimum standard.

Legitimacy theory provides a view of existence for organisations. Legitimacy is defined as “congruence between the social values associated with or implied by activities and the norms of acceptable behaviour in the larger social system’’ (Dowling and Pfeffer, 1975). Acceptable behaviour is also linked to trust, negative perceived behaviour and actions by banks will lower the trust (Järvinen, 2014) and vice versa. However, trust is hard to gain and easy to lose. According to the legitimacy theory organisations face a ‘social contract’ with society. When society perceives the organisation is not following the contract in an acceptable or legitimate way, the society will interrupt the activities of the organisation (Deegan, 2002). In case of a bank, society can cause a bank-run having extreme consequences for the functioning of the

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bank. Risk disclosures provide a tool to influence the perception of society and can show in what way the organisation meets the ‘social contract’ with society. The other way round, society can force institutions like banks to disclose certain information and use it to control the organisation on compliance. The perception of society is not fixed and can change over time or more revolutionary when important events happen, such as a financial crisis. Especially for banks it is important to be legitimate, thus important is to monitor the perceptions in society and signal the right signs at the right moment, to prevent problems.

Signalling theory is based on signalling your qualities to the market to attract more investors or create a positive image for the firm. Signalling is possible towards all stakeholders and can be used for more than just accounting information (An et al, 2011). Signalling is effective when information asymmetry exists, linking it to agency theory. In this case management can choose to signal or not signal true quality to outsiders who are less informed (Kirmani and Rao, 2000). In the light of the 2008 financial crisis, banks are looking to restore the trust in the system and regain trust from their customers. The Basel III standards are also measures to regain confidence and prevent a new financial (banking) crisis (Financial Stability Board, 2012). Signalling theory can address the reason why firms can be willing to disclose more and higher quality information (An et al, 2011). Signalling superior quality can be useful for banks to acquire high quality risk disclosures as the disclosures can lower the cost of capital (Lambert et al., 2012) and the cost of equity (Eaton et al., 2007) for the organisation. This is important as the requirements are costly to implement and maybe a deadweight loss to the organisation. Disclosing more (non-) financial information can make the bank look more transparent and can help to show progress for the ‘social contract’ with society, linking it to legitimacy theory. Banks can benefit from the lower cost of funding when they are trusted making implementation not fully a deadweight loss, however making trust a kind of resource (Barney and Hansen, 1994), when trusted banks will receive more resources from customers. In contrast, having a low quality disclosure will reduce the effectiveness of a managers communication effort, and also influences the managerial labour markets reputation (Kothari et al., 2009). Trust provided by quality disclosures also withholds consumers and investors to doubt the capabilities of the bank functioning, keeping a stable bases in funding (Moriera and Savov, 2017).

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2.2 Risk disclosures

Risk disclosure can be used by management to influence external perceptions about the organisation. Legitimacy theory reasons that organisation use disclosures to improve this perception (Deegan, 2002). Besides legitimacy theory, (voluntary) disclosure theory offers a view that organisations with good performance are incentivised to disclose the information about this performance to increase its market value (Hummel and Schlick, 2016). Well-informed investors are needed for the well-functioning of the capital markets (Deumes, 2008). A lack in disclosure information causes a gap between management, who has superior information, and outside investors (Hutton, 2004), causing imperfections in valuation. Not addressing the risks and uncertainties can be damaging in the long-run for the reputation and stability of the organisation (Fuller and Jensen, 2002). Management therefore is motivated to disclose both favourable and unfavourable information. Risk disclosure research is gaining in popularity and before 2000 only research on other kinds of disclosure has been done (Stanton and Stanton, 2002). The fall of Enron and WorldCom created more awareness for risk disclosures. Improved risk disclosures can lower the cost of capital (Lambert et al., 2012) by taking away uncertainty premiums. Furthermore, forward looking risk information increases the market efficiency, benefiting society (Diettrich et al, 2011). Two hurdles can be described for not disclosing certain risk information by management commercially sensitive information and forward-looking information, not knowing whether it becomes truth (Linsley and Shrives, 2005). For the banking sector the sensitivity of information is a possible reason to not (voluntary) disclose certain information. However, the possibility to change perception on the organisation and attract new possible investors due to trust is key for banks. This perception can also make the bank more legitimate, especially when stakeholders already demanded the disclosure information.

2.3 Supervision

The responsibility for the supervision on a European bank is a task of the European Central Bank (ECB). After the financial crisis and several incidents leading to problems in Cyprus and Spain, a new system of supervision was developed (Tröger, 2014). The Single Supervisory Mechanism (SSM), a mechanism that grants the ECB the supervisory role to monitor banks and declaring the collaborating role with the NCA’s, was implemented in October 2014. The three main goals of this new system are: “to ensure the safety and soundness of the European banking system, to increase financial integration and stability, and to ensure consistent supervision” (ECB, 2014). The ECB will keep direct supervision on the significant

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institutions and indirect supervision by the National Competent Authorities on the less significant institutions, testing among other things compliance with CRD/CRR. The Capital Requirement Directive (CRD)/Capital Requirement Regulations (CRR) IV are a Basel III feature concerning countercyclical provisions, that nowadays are implemented in EU member states banking frameworks (Amorello, 2016). According to the ECB (2014) a bank is significant if: 1) “the total value of its assets exceeds €30 billion or – unless the total value of its assets is below €5 billion – exceeds 20% of national GDP, or 2) it is one of the three most significant credit institutions established in a Member State, or 3) it is a recipient of direct assistance from the European Stability Mechanism and the total value of its assets exceeds €5 billion and the ratio of its cross-border assets/liabilities in more than one other participating Member State to its total assets/liabilities is above 20%”. A total of 128 banks are under direct supervision of the ECB (Gren et al., 2015). With these criteria the ECB has supervision over the most important financial system banks, but also the most important banks in smaller countries. This

should help overcome the issues from NCA for supervisory forbearance (Garicano, 2012). This

is also known as the ‘home bias’ from NCAs’ towards national champion banks (Tröger, 2014). Also moral hazard problems when a fund is created for national authorities to bail out or resolve banks (Boone and Johnson, 2011) can be solved through this set-up of ECB supervision.

Because this is a rather new system not many literature can be found. Therefore, it is more important to add contributions to the literature. Only predictions can be made, as Ferrarini (2015) predicts there will be a great impact on the governance structure, and that it will level the playing field for banks in the European Union. Furthermore, competition can increase together with cross-border integration, and may result in further consolidation in the banking sector. Success for the SSM is expected if the ECB is able to transfer know-how for a ‘supervisory culture’ towards new ECB staff with background as national supervisors, and if there will be clarity in the allocation of liabilities between the ECB and the NCA’s (Gortsos, 2015).

2.4 Audit Committee Effectiveness

The audit committee has at least two ways in which it can influence the financial reporting of the organisation; the internal audit function and the external auditor (Abbott et al., 2000). The controls of an internal audit function supported by the audit committee are more powerful and objective in practice (Alzeban, 2015; Zaman and Sarens, 2013: Scarbrough et al., 1998). With regard to the external auditor the audit committee has a vote in the appointment

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committee often lacks power, effectiveness and acting in a passive way instead of making interaction (Cohen et al, 2002). Literature provides four main determinants for audit committee quality, independence, diversity, size and meeting frequency. First, the percentage of outside directors who are independent from the organisation’ management helps protect the interest of stakeholders (Fama and Jensen, 1983). This is narrowing the agent-principal gap. Furthermore, outside directors are effective monitors for management behaviour (Klein, 2002). Second, diversity of the audit committee helps strengthen the position and effectiveness of the committee. Sultana (2015) investigated the role of financial expertise in the audit committee, finding a link between the effectiveness of the audit committee and a higher level of financial expertise. However, also members with different backgrounds increase the effectiveness of the audit committee (Kalbers and Fogarty, 1993). For more mixed boards (gender, age) there are mixed results in literature (McMullen and Raghunandan, 1996). Third, the size of the committee also raises the effectiveness of the committee. Yang and Krishnan (2005) find that larger audit committees reduce earnings management by management. Adding more members increases the knowledge base of the audit committee, but also makes the board more inefficient and less flexible (Karamanou and Vafeas, 2005). Fourth, the meeting frequency of the audit committee is an important determinant. Vafeas (1999) finds that after a crisis the frequency of meetings increases and the effectiveness also increases. It is recommended that audit committees meet three to four times a year, showing interest in the control-related issues and wanting to keep being informed about them (McMullen and Raghunandan, 1996).

2.5 Audit Firm Specialisation

The audit committee tends to select the audit firm, however the independence of the

audit committee influences this process (Abbott and Parker, 2000).The choice of the audit firm

can influence the quality of financial reporting, because not all firms have the same qualities in every field (Abbott et al., 2003). The profession of auditor is mainly driven by experience (Waller and Felix, 1984), and therefore for many years now there is a recommendation for audit firms to pursue specialisation to lower audit failures (Muczyk, 1986). Experience can be divided in generic experience and sector experience (Reheul et al., 2017). For firms, specialisation can be beneficial as they can charge larger audit fees (DeFond et al., 2000). Firms that are specialised in an industry often possess more knowledge in the industry (Cahan, 2015), are better in identifying audit risk, and detect more audit failures (Owhoso, 2002). Especially in complex industries, such as the banking industry, specialisation is more relevant as higher levels of knowledge are more relevant for the audit (Francis and Seavey 2012). Rose-Green et al.

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(2011) find that organisations audited by an industry-specialist more likely report about internal control defects than organisations audited by non-industry-specialist. This implies a higher level of reporting.

2.6 Culture

Social values of a firm will differ between firms, and it influences the way in which a firm operates and reports (Deegan and Rankin, 1996). Values can differ between countries, but also within countries different values can exist (Specter and Solomon, 1990). Managers’ and stakeholders’ will therefore form different perceptions, also concerning the agency problem (Fidrmuc and Jacob, 2010). What is seen as legitimate can differ between cultural settings giving different preferences for the behaviour of management. Consequently, how to assess agency problems will differ across countries (Fidrmuc and Jacob, 2010). The supervision on the banks differs between two parties, ECB or NCA, however the ECB in the end is always responsible. This approach can lead to isomorphism, modifying organisational characteristics towards comparability with environmental characteristics (Dimaggio and Powell, 1983), leaving no difference between the cultures within banks. However, the different banks have a strong connection with their home market, despite the international character of the sector. The majority of employees are based in the home country and still propagate and act on their own values and beliefs. That is why cultural differences are still worthwhile in research. Furthermore, the trade-off between the costs and benefits of disclosures may also depend on cultural values (Hooghiemstra, 2015), thus affecting disclosure choices. Archambault (2003) shows that many national and corporate factors influence disclosure decisions. The basis for his model is the cultural dimensions developed by Hofstede (1980). Hofstede (1980) identified nine dimensions for cultural distinctions. Consistent with prior research (Salter and Niswander, 1995; Kanagaretnam et al., 2014; Hooghiemstra, 2015) two dimensions have the clearest implications for manager’s choice behaviours: individualism and uncertainty avoidance. ‘’Individualism indicates a preferences for a loosely knit social framework in a society. And uncertainty avoidance is the degree to which members of a society feel uncomfortable with uncertainty and ambiguity’’ (Hofstede, 2001). Gray (1988) developed four accounting values from the Hofstede (1980) dimensions; professionalism, uniformity, conservatism, and secrecy. Secrecy is the value linked to disclosures, and increases with uncertainty avoidance and power distance. Secrecy will decrease with masculinity and individualism, increasing disclosures (Archambault, 2003). There seems to be consensus between uncertainty avoidance,

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individualism and disclosures. For power distance and masculinity the results are mixed (Zarzeski, 1996; Han et al., 2010)

2.7 Hypotheses Development

This study will focus on risk disclosures by European banks, looking for determinants effecting the quality of risk disclosures. This could be useful for future regulations and standards because risk disclosure information can avoid future crisis (Financial stability board, 2012), close the information gap between insiders and outsiders (Hutton, 2004) and is needed for well-functioning markets (Deumes, 2008). Not addressing risk information can be damaging for existence of organisations in the long-run (Fuller and Jensen, 2002). A closer look from a corporate governance point of view seems to be justified, making sure that the quality of risk

disclosures by European banks can be safeguarded and maybe improved. Barakat and

Hussainey (2013) find enhanced risk reporting by European banks for; “sustaining board independence, enhancing audit committee activity, easing entry to banking requirements, and promoting a more proactive role for bank supervisors”. Karamanou and Vafeas (2005) find voluntary disclosure enhancement for corporate board effectiveness and audit committee structures. Taking this into account a positive association between supervisor quality and the quality of risk disclosures by European banks is expected in this study.

H1: Supervisor quality is positively associated with the quality of risk disclosures by European banks.

Supervisor quality in this study will be proxied by the type of supervison on a bank, the audit committee effectiveness and the specialisation level of the audit firm.

Under the Basel III regulations the supervision on European Banks has been divided between the ECB and the National Competent Authority (NCA). This structure is also referred to as the Single Supervisory Mechanism (SSM). Based on certain criteria, significant banks are under direct supervision of the ECB and other banks of the NCA, but in the end the ECB is always responsible for the supervision of all European banks. The NCA may be affected by the

‘home bias’, and therefore the quality of supervision can be afflicted (Tröger, 2014). Does it

matter if there is direct ECB supervision on European banks or indirect supervision through the NCA? The NCA is closer related to the banks and its culture and it may bias the supervision, however it can also strengthen the supervision as they are more related. Contrary, financial integration as conditioned by the Basel III standards and the EU guidelines should make this

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less important. The ECB can been seen as a “effective outside monitor and influential outside stakeholder” in comparison with NCA’s and therefore higher risk disclosures are expected (Barakat and Hussainey, 2013). Therefore, in this study a greater positive association is expected between the supervision done by the ECB (instead of the NCA) to the quality of risk disclosures by European banks.

H2: The supervision done by the ECB is positively associated with the quality of risk disclosures by European banks.

Audit committee effectiveness can be measured by different determinants. In this study the effectiveness will be measured by the meeting frequency of the audit committee, naming this construct audit committee activity. Vafeas (1999) suggest that time spend on meetings is an indication for time spend on monitoring management. He finds that after a crisis more meetings are held ‘waking up’ the audit committee. This raises the effectiveness. The level of activity can therefore been seen as a determinant for supervisor quality.

McMullen and Raghunandan, (1996); find a similar relation for the effectiveness of the audit committee and recommends that committees meet three to four times a year at a minimum. Kalbers and Fogarty (1993) suggest that “audit committee effectiveness is a function of audit committee members’ desire to carry out their duties”, and that the frequency of meeting underlines this effectiveness. Drawing from the previous studies, the expectation is that audit committee activity will be positive associated with the quality of risk disclosures by European banks.

H3: Audit committee activity is positively associated with the quality of risk disclosures by European banks.

Another institution related to corporate governance and risk disclosures is the audit firm. There is an association between having an audit committee and going for an industry-specialised audit firm (Chen et al., 2005). This can be explained by the fact that audit committees tend to help select an audit firm, and by the fact that bigger companies more often have an audit committee and the need for an industry-specialised audit firm. The banking industry is a complex industry, and therefore specialisation seems to be preferable; also because the audit profession requires experience (Waller and Felix, 1984) and more knowledge (Cahan, 2015). The same studies find that experience and knowledge lower audit failures. Francis and

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Seavey (2012) find that in complex industries, specialisation is more relevant. And internal control defects are more likely to be found when industry-specialists audit the organisation (Rose-Green et al., 2011). Altogether, this leads to the expectation that audit firm specialisation is positively associated with the quality of risk disclosures by European banks.

H4: Audit firm specialisation is positively associated with the quality of risk disclosures by European banks

Lastly, managers’ and stakeholders’ across countries will form different perceptions (Fidrmuc and Jacob, 2010) as social values will differ between firms, in turn influencing the way in which an firm operates and reports (Deegan and Rankin, 1996). Archambault (2003) makes a clear link, based on Hofstede’s dimensions (1980), between national and corporate factors and disclosure information. Furthermore, Gray (1988) finds value secrecy as an important cultural measure linked to disclosures. These three studies imply that cultural aspects should be taken into account when researching disclosure quality between organisations in different countries. There seems to be consensus between uncertainty avoidance, individualism and disclosures (Salter and Niswander, 1995; Kanagaretnam et al., 2014; Hooghiemstra, 2015), but mixed results are found for power distance and masculinity (Gray 1988). None of these determinants of culture were tested in the banking sector towards risk disclosure quality. In this study masculinity and uncertainty avoidance will be measured, because these determinants seem, based on previous research, to be the most relevant for risk disclosures and are linked with risks. Masculinity is associated with assertiveness, material success, power and individual achievements. In the light of banking, the hypothesis is that masculinity lowers the quality of risk disclosures (Hofstede, 1980), because masculine cultures will face opacity due to less openness and more self-centred views. Uncertainty avoidance is connected to “society’s tolerance for uncertainty” (Hofstede 1980). To avoid uncertainty, regulations and structure are needed. (Voluntary) Disclosures can be seen as a way to avoid uncertainty. Therefore the expectation is that cultures with a high level of uncertainty avoidance will have greater quality risk disclosures

H5: The level of masculinity across the European nations influences the association between supervisor quality and quality of risk disclosures by Europe banks in a negative manner.

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H6: The level of uncertainty avoidance across the European nations influences the association between supervisor quality and quality of risk disclosures by Europe banks in a positive manner.

2.8 Conceptual Model

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3. Methodology

This chapter discusses the methodology of this study. First, the sampling and data collection procedure is presented. Thereafter, the measures for the independent and dependent variables are discussed and the equation for this study is presented.

3.1. Sample and data collection

The research sample existed of 75 European banks selected out of the entire population of European Banks. The selection was based on the amount of total assets, supported by EBA, and a correction has been made so that banks that are under NCA supervision are also represented in the sample. This to ensure the supervisor determinant can be researched. Total assets are an indicator for the importance of the bank in both the EU and home country. Also, some geographical spread was a criterion for the sample selection. This was needed to examine the influence of cultural differences. A list including the sample, based on previous criteria, is included in appendix A. European banks all have to follow the same regulations like the CRD/CRR and IFRS, that causes a workable population were comparisons can be made.

3.1.1 Dependent Variable

The quality of risk disclosures was researched by collecting archival data from annual reports of the year 2017 for the entire sample. Only the annual report was taken into account, all additional forms of reporting that banks may offer are not included for rating the disclosures, because the annual report is the main report for investors (Lang and Lundholm, 1993) and the most important information needs to be included. 2017 was chosen as it is the most recent available year, and banks that did not published online before May, where replaced by other banks. The qualitative and quantitative risk disclosures were identified with a disclosure index based on CRD/CRR, ECB/NCA and European Securities and Markets Authority (ESMA) guidance. The index was divided in four sections of items: general information, credit risk, solvency/financial strength, and liquidity. Disclosure indexes are commonly based on a text analysis conducted through an a priori defined list of items. They can include voluntary and/or mandatory information, and the items included in the index can be weighted differently (Pivac et al., 2017). An outline of the disclosure index is included in the appendix B. The combined scores on the different topics result in a rating for the quality of the risk disclosure. All items have been weighted equally (0,1 or 2), a total score of 60 can be reached. The risk disclosure reflects existence of various items rather than importance, as all items contribute to greater

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transparency (Hassan, 2009). Further, this research does not focus on specific users of the disclosure information making it hard to differentiate in what is important and maybe less important (Oliveira et al., 2016). Hence, not much differentiation is possible in the answers, and slight differences in reporting cannot be measured in this way. When more options were available, the comparison between the disclosers will be too complicated and not generalizable. The disclosure index has been composed by five different reviewers. Beforehand, every reviewer prepared a review of one bank and the results were discussed, arguing the rating of the different topics and making agreements about the scoring. Further, all items that had to be scored where explained in the index together with the possible score and the requirements for a certain score. In the reviewing trajectory the reviewers were able to contact each other and discuss new difficulties. To ensure homogeneity in the reviewing process 40 banks are double rated, controlling for a similar method and opinion between the different reviewers. No big changes in the total score were necessary after evaluation, implicating agreement between the reviewers.

3.1.2 Independent Variables

The independent variables are type of supervisor, audit committee activity and audit firm specialisation. Together they form the construct supervision quality. All dependent variables have been tested in isolation for an association with risk disclosure quality. Tests have been done using regression analysis. In a subsequent analysis, as described in section 3.2, the supervision quality as a whole has been measured in relation with risk disclosure quality using structural equation modelling.

The type of supervisor has two options of occurrence according to the SSM model: either the bank is under direct supervision of the ECB, or the bank is under indirect supervision of the NCA. The ECB keeps a public record containing the supervisor of each bank, so the entire sample was covered. On a nation level the supervisor (ECB/NCA) can differ depending on size, however some countries do not fall under the ECB supervision regardless as they are not part of the Euro (Bulgaria, Croatia, Czech Republic, Denmark, Norway, Poland, Romania, Sweden and United Kingdom). The ECB still is concerned with the supervision when the NCA has the direct supervision, but mentioned earlier ‘home bias’ for example may influence the quality of risk disclosure, even though the regulations in both situations are the same.

Audit committee activity will be measured by the meeting frequency of the audit committee. The frequency of the meetings has been obtained from the annual reports and is in line with previous research methods, for example Archambeault and de Zoort (2001). The

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complete sample of 75 banks was included. The activity level of the audit committee does not necessarily have to come forward in the frequency of meetings. The amount of time can still vary, however meetings also can be seen as the willingness of the audit committee to work together and achieve a higher level in their performance. That is why the meeting frequency can be seen as a reliable measure for the audit committee activity level.

Audit firm specialisation needs to point out when an audit firm is a specialist in the banking industry or not. There is no general accepted method to get this data, and differences can be expected between countries and even between cities (Francis et al, 2005; Reichelt and Wang 2010). Due to the size of the banks and the size of the audit teams, a city level view is less important. Differences can be expected between different audit teams within the same firm, however the firm itself has an incentive to deliver similar quality to all of their (banking) clients. Therefore, the method used to measure the audit firm specialist will be on a national level. The specialist will be determined with help of data concerning all the listed banks in a country and their audit firms. This data has been recovered from the Orbis bank database. From this data the audit firm specialist for each country was determined by selecting the firm with the most banks in their portfolio. All other audit firms are classified as non-specialist. When an equal score is achieved between two audit firms both are designated as specialist. Arthur et al. (2017) use a similar method, however they use the total sum of audit fees in an industry to determine the specialist instead of the count of the banks audited. In this way larger banks are of greater influence on the determination of the specialist, as they pay larger audit fees. To not rule out the smaller audits, where similar specialisation skills can be developed and used to enhance the quality in other audits, the current method was chosen. Following from this, all 75 banks in the sample have been classified for audited by a specialist audit firm or a non-specialist audit firm, see Appendix C.

3.1.3 Control variables

The relation between corporate governance variables and voluntary disclosures can be influenced by various firm characteristics, therefore it is good to control for several of these characteristics (Barros et al., 2013). Literature provides dozens of control variables, in this study board size, audit committee size and firm size are used, as the board size and audit committee sizes are related to the monitoring of banks and firm size, measured by total assets, is also used in the sample selection, making it a wise control variable. The size of the management board, “the number of directors serving in the board” (Archambeault et al, 2008) can influence the performance of the board. When the management board is larger, more knowledge is available,

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however larger boards are also less flexible (Karamanou and Vafeas, 2005). Enhanced performance by the board can influence the quality of the risk disclosure, because management is responsible for the preparations of reports. Therefore, management board size is used for control. The same goes for the size of the audit committee. A larger audit committee has more knowledge available, but can also face difficulties in the working process due to its size. However, performance increases in most cases (Karamanou and Vafeas, 2005). A smaller audit committee meeting frequent can also achieve similar effectiveness as a larger audit committee meeting less frequently. The size of the audit committee was measured by counting the number of members. Lastly, the firm size, expressed in total assets, of the client has also been controlled for. The total assets were taking as a logarithm to mitigate big differences in total assets. Furthermore, all assets were converted in euro’s using the exchange rates at 31 december 2017, the end of the financial year. Bigger clients report more financial and non-financial risk disclosures (Linsley and Shrives, 2005). The more is reported concerning the risk disclosures, the higher the results in the risk disclosure may be.

3.2 Supervision Quality

The supervision quality exists of the previous independent variables; type of supervisor, audit committee activity and audit firm specialisation. Because the supervision quality cannot be measured directly, it is a latent variable. The structural equation modelling (SEM) technique was used to measure the influence of supervision quality on the quality of risk disclosure. SEM is a combination of factor analysis and regression analysis (Reisinger and Mavondo, 2007). The regressions are also done separately to uncover the different associations with the quality of risk disclosures. The model and analyses were done with the help of AMOS. The first part was the estimation of the latent variable of supervision quality. The second step was to estimate the association with the quality of risk disclosures. Finally, culture was tested as a moderator (see 3.3).

3.3 Culture

Culture has been used as a moderator in this study. The influence of uncertainty avoidance and masculinity on the association between supervision quality and the quality of risk disclosure is tested. The country measures for uncertainty avoidance and masculinity are widely available (Hofstede, 2001) and these Hofstede dimensions were used to measure the cultural differences. Hofstede’s dimensions are developed in a business setting and therefore are suitable for this research. Many previous studies used the Hofstede dimensions in a

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cultural comparison (Hooghiemstra et al., 2015; Han et al. 2010; Zarzeski et al, 1996). All countries in the sample were already scored by the Hofstede Insights institute and these scores have been used to determine the level of uncertainty avoidance and masculinity for the countries in the sample, see Appendix D.

3.4 Linear Regression Model

The following equation is used for the linear regressions:

𝐷𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒𝑄𝑖 = 𝑎 + 𝛽1𝑆𝑢𝑝𝑒𝑟𝑣𝑖𝑠𝑖𝑜𝑛𝑖 + 𝛽2𝐴𝐶𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦𝑖 + 𝛽3𝑆𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑠𝑡𝑖 + 𝛽4𝑀𝑎𝑠𝑐𝑢𝑙𝑖𝑛𝑖𝑡𝑦𝑖 + 𝛽5𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦𝐴𝑣𝑜𝑖𝑑𝑎𝑛𝑐𝑒𝑖 + 𝛽6𝑆𝑢𝑝𝑒𝑟𝑣𝑖𝑠𝑜𝑛𝑖 ∗ 𝑀𝑎𝑠𝑐𝑢𝑙𝑖𝑛𝑖𝑡𝑦𝑖 + 𝛽7𝑆𝑢𝑝𝑒𝑟𝑣𝑖𝑠𝑖𝑜𝑛𝑖 ∗ 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦𝐴𝑣𝑜𝑖𝑑𝑎𝑛𝑐𝑒𝑖 + 𝛽8𝐴𝐶𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦𝑖∗ 𝑀𝑎𝑠𝑐𝑢𝑙𝑖𝑛𝑖𝑡𝑦𝑖+ 𝛽9𝐴𝐶𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦𝑖 ∗ 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦𝐴𝑣𝑜𝑖𝑑𝑎𝑛𝑐𝑒𝑖 + 𝛽10𝑆𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑠𝑡𝑖 ∗ 𝑀𝑎𝑠𝑐𝑢𝑙𝑖𝑛𝑖𝑡𝑦𝑖 + 𝛽11𝑆𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑠𝑡𝑖 ∗ 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦𝐴𝑣𝑜𝑖𝑑𝑎𝑛𝑐𝑒𝑖 + 𝛽12𝐵𝑜𝑎𝑟𝑑𝑆𝑖𝑧𝑒𝑖 + 𝛽13𝐴𝐶𝑠𝑖𝑧𝑒𝑖+ 𝛽14𝐹𝑖𝑟𝑚𝑆𝑖𝑧𝑒𝑖 + 𝑒𝑖

Where Supervision, ACactivity and Specialist are the independent variables. Masculinity and

UncertaintyAvoidance are the measures for the moderator culture. Followed by the different

interaction variables between the independent variables and moderator measures. Finally, the control variables BoardSize, ACsize and FirmSize are included. Endogeneity concerns hereby are addressed, however not entirely excluded.

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4. Analyses and Results

This chapter discusses the analyses and results of this study. First some descriptive statistics are presented. Thereafter, the results for the hypothesis 2-6 are discussed. Subsequently, an additional analysis is described to examine hypothesis 1.

4.1 Descriptive analysis

The sample for most variables consisted of 75 observations, except for the size of the audit committee and the activity of the audit committee. The missing observations could not be retrieved using the annual reports or other open resources like a website or database. As can been seen in Table 1, the minimum and maximum values are in line with the underlying meaning of the values. Hence, a committee or board have several members and meet at least two times a year. Furthermore, the disclosure scores do not exceed the maximum score of 60, and the Hofstede dimensions do not exceed 100. The firms score on average 26,51 for their disclosure quality out of 60. The supervision and specialist variable only have a value of 0 or 1, where ECB and specialist are 1 and NCA and non-specialist are 0.

Table 1

Descriptive statistics and correlations

N Minimum Maximum Mean Std. Deviation

Disclosure 75 11 42 26,51 7,533 Supervision 75 0 1 0,64 0,483 Specialist 75 0 1 0,45 0,501 AC activity 67 2 69 8,97 9,344 Board Size 75 2 23 7,59 4,278 AC Size 69 3 10 4,71 1,783 Firm Size 75 3,24 6,32 5,15 0,689 Cult_MSC 75 5 100 46,16 23,392 Cult_UV 75 23 100 64,88 22,518 Valid N 64

A linear regression is performed to examine the hypothesised effects of supervision, audit committee activity and audit firm specialisation on the quality of risk disclosure (model 2). In model 1 the control variables are tested and in the models 3-8 the moderator culture, defined as masculinity and uncertainty avoidance, is examined on interaction each time combined with another variable. To perform these analysis the three independent variables are multiplied with the two cultural variables, leading to six variables to test the interaction. Model 3 and 4 includes the type of supervisor with the culture variables, model 5 and 6 the audit committee activity together with the culture variables, and model 7 and 8 include the audit firm specialist with the cultural variables, all tested for their influence on the quality of risk disclosures by European banks. A summary of the linear regression results can be found in table

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3. To test for multicollinearity all variables are included in the Pearson correlation matrix (Table 2). All correlations are below 0,8, which is good (Hair, 2010), except for the interactions, what is in line with what you would expect. To further test for multicollinearity all VIF values of the different models were determined (untabled) , finding all values lower than 10, except for the interactions, which is good (Hair, 2010).

Hypothesis 2 predicted that supervisor quality is positively related with the quality of risk disclosures. Although a positive association is found in the models 3-8, no significant evidence is found to support this association. Besides, in model 2, regression, and in table 2, correlation, negative values are found, not significant for the regression, for the direct association for type of supervisor and risk disclosure quality, leading to opposite results than expected. Therefore, there is no evidence for an association between supervisor quality and the quality of risk disclosures by European banks.

Hypothesis 3 predicted a positive association between audit committee activity and the quality of risk disclosures. In table 3 some (interaction) models show a significant result for audit committee activity and the quality of risk disclosures including the interaction. However, in these models the direct effect of audit committee activity on risk disclosures is interpreted differently due to the culture variables. The direct association, in model 2, between audit committee activity and risk disclosure quality does not provide evidence for any association. Thus, in general there is no evidence for an association between audit committee activity and the quality of risk disclosures by European banks.

Hypothesis 4 predicted that audit firm specialisation is positively associated with the quality of risk disclosures. Audit firm specialisation is negatively correlated with risk disclosure quality, see table 2. The regression results, table 3, show a negative association, but yet again no significant result is found. So, there is no evidence for an association between audit firm specialisation and the quality of risk disclosures by European banks, and the direction may be the opposite way.

Hypothesis 5 predicted that the level of masculinity across the European nations influences the association between supervisor quality and the quality of risk disclosures in a negative manner. For all three independent variables this hypothesis was tested, leading to no significant results. Therefore, in general there is no evidence that masculinity negatively influences the association between supervisor quality and the quality of risk disclosures by European banks.

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Hypothesis 6 predicted that the level of uncertainty avoidance across the European nations influences the association between supervisor quality and the quality of risk disclosures in a positive manner. First of all, although not hypothesised in this study, uncertainty avoidance seems to have a negative association with the quality of risk disclosures by European banks, see table 3. This contradicts the underlying thought of the hypothesis. However, in model 6 a positive non-significant result is found, but in the other models a significant negative result is shown. Furthermore, once again for every independent variable this hypothesis was tested. Model 8 results show a significant influence by uncertainty avoidance on the association between firm specialisation and the quality of risk disclosure. However, this is not enough to state that the level of uncertainty avoidance across the European nations influences the association between supervisor quality and the quality of risk disclosures by European banks in a positive manner.

Some concluding remarks; the control variable ‘firm size’ shows a highly significant positive result, proving a useful control variable. The amount of total assets apparently is an

positive indicator for the quality of risk disclosures by European banks. Furthermore, the R

-squaredfor all models is high, given the ‘raw data’. The variance in the dependent variable

explained by the independent variables in these models therefore is high, indicating a proper fit for the model. The adjusted R-squared increases when adding the different variables to the model, indicating that these new terms improve the model.

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Disclos ure Supervis ion AC activity Speciali st Cult_ MSC Cult_ UV Mod_ Sup_ MSC Mod_Sup _UV Mod_ACA_ MSC Mod_ACA_ UV Mod_SPEC_ MSC Mod_SPEC _UV Board Size AC Size Frim Size Disclosure 1 Supervision -0,038 1 AC acitivity 0,112 0,165 1 Specialist -0,083 0,069 -0,007 1 Cult_MSC -0,023 0,218 0,186 0,003 1 Cult_UV -,275* ,501** 0,154 -0,044 ,280* 1 Mod_Sup_ MSC -0,062 ,825** ,245* 0,016 ,578** ,417** 1 Mod_Sup_ UV -0,075 ,937** 0,196 0,054 0,206 ,675** ,775** 1 Mod_ACA_ MSC 0,166 0,175 ,961** -0,022 ,340** 0,150 ,303** 0,190 1 Mod_ACA_ UV 0,093 ,256* ,968** 0,004 0,160 ,331** ,271* ,329** ,931** 1 Mod_SPEC_ MSC -0,076 0,097 0,043 ,821** ,395** 0,073 ,229* 0,089 0,092 0,046 1 Mod_SPEC_ UV -0,072 0,224 0,070 ,907** 0,087 ,237* 0,150 ,249* 0,040 0,120 ,815** 1 Board Size 0,159 -0,079 ,390** -0,033 0,002 -0,133 -0,008 -0,083 ,418** ,325** 0,028 -0,027 1 AC Size 0,150 ,380** 0,059 0,000 ,365** 0,190 ,475** ,357** 0,169 0,078 0,160 0,072 ,281* 1 Firm Size ,515** 0,167 0,060 -0,103 0,052 -0,140 0,124 0,189 0,137 0,090 -0,068 -0,102 0,226 ,410** 1

*. Correlation is significant at the 0.05 level (2-tailed). **. Correlation is significant at the 0.01 level (2-tailed). Table 2

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4.2 Additional Analyses

Hypothesis 1 predicted that supervisor quality is positively associated with the quality of risk disclosures. To test this hypothesis an additional analysis is done in the form of a structural equation model (SEM). Supervisor quality is the latent variable in this model, with

the supervision, audit committee activity and audit firm specialisation as independent variables

and the quality of risk disclosures as dependent variable. This model was tested in Amos and the results are not recorded, as the results found were not significant. Hence, supervisor quality is not associated with the quality of risk disclosures. This is in line with the results of the linear regression.

Table 3

Results of linear regression Model 1 control Model 2 control+vari able Model 3 Interact Sup_MSC Model 4 Interact SUP_UV Model 5 Interact ACA_MSC Model 6 Interact ACA_UV Model 7 Interact SPEC_MSC Model 8 Interact SPEC_UV Supervision -0,92 (1,947) 0,170 (3,912) 0,238 (5,741) 0,056 (2,082) 0,065 (2,048) 0,062 (2,101) 0,025 (2,023) AC activity 0,154 (0,99) 0,211 (0,098)* 0,216 (0,099)* 0,534 (0,529) 1,715 (0,789)* 0,209 (0,099)* 0,195 (0,095) Specialist -0,38 (1,634) -0,74 (1,603) -0,61 (1,598) -0,71 (1,596) -0,20 (1,627) -0,126 (3,519) -0,686 (4,610)** Cult_MSC 0,050 (0,052) -0,023 (0,038) 0,074 (0,065) -0,40 (0,037) -0,040 (0,049) -0,013 (0,036) Cult_UV -0,342 (0,043)** -0,262 (0,060) -0,341 (0,043)** 0,040 (0,037) -0,331 (0,043)** -0,513 (0,050)*** Mod_SUP_ MSC -0,148 (0,072) Mod_SUP_U V -0,231 (0,088) Mod_ACA_ MSC -0,358 (0,008) Mod_ACA_ UV -1,610 (0,010) Mod_SPEC_ MSC 0,072 (0,067) Mod_SPEC_ UV 0,682 (0,069)** Board Size 0,060 (0,188) -0,25 (0,219) -0,82 (0,217) -0,89 (0,218) -0,067 (0,224) -0,97 (0,214) -0,90 (0,221) -0,111 (0,211) AC Size -0,036 (0.495) 0,011 (0,557) 0,050 (0,585) 0,037 0,576) 0,045 (0,579) 0,015 (0,570) 0,037 (0,577) 0,053 (0,557) Firm Size 0,513 (1,311)*** 0,535 (1,343)*** 0,453 (1,369)*** 0,510 (1,556)*** 0,460 (1,349)*** 0,463 (1,348)*** 0,476 (1,350)*** 0,463 (1,291)*** R2 (adj R2) 0,252 (0,217) 0,284 (0,209) 0,358 (0,251) 0,353 (0,245) 0,360 (0,253) 0,359 (0,252) 0,350 (0,242) 0,405 (0,305) N 75 75 75 75 75 75 75 75 Notes: *** p < .01; ** p < .05; * p < .10

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5. Discussion

This study examines the influences of the type of supervisor, audit committee activity and audit firm specialisation on the quality of risk disclosure. Positive associations were expected for these three independent variables. Furthermore, an attempt has been done to estimate the influence of these three variables as a whole on the quality of risk disclosure by using a latent variable named ‘supervision quality’, expecting also a positive association. And lastly, the moderator culture, with the measures masculinity and uncertainty avoidance, is used to measure the influences of cultural differences, expecting a negative association for masculinity and a positive association for uncertainty avoidance. The empirical results indicate that none of these hypotheses can be supported and therefore no associations between the different variables seem to exist. The contribution to literature and theory of this study, is set out below.

First, based on this study no association exists between the quality of risk disclosures by European banks and the type of supervisor, audit committee activity or the audit firm specialisation. Besides adding this conclusion to the literature, it also has implications for the governance of banks. Not finding an association between the type of supervisor and the quality of risk disclosure can be seen as evidence for the working of SSM. Partly, SSM was introduced to ensure “strong and consistent supervision across the participating member states” (Wissink, 2017). Finding no difference between ECB or NCA supervision for the quality of risk disclosures can be an indicator that the supervision is consistent. Also no evidence is found for the existence of the ‘home bias’ for NCA’s as described by Tröger (2014). Vice versa no evidence is found for Barakat’s and Hussainey’s (2013) view for higher disclosure scores when the ECB is the supervisor. A possible reason for this result is that the ECB admittedly is not always directly responsible for the supervision however otherwise always is indirectly responsible. Either way, the results from a governance perspective are positive, not contradicting with the underlying values of SSM. However, supervision includes more points for attention than only quality of risk disclosure. The result for the audit committee activity, where no association is found, is in line with the mixed results already found in the literature (Sun and Liu, 2014). Further research is needed to investigate the influence (if any) of this variable. However, not all banks meet the minimum requirement as mentioned by McMullen and Raghunandan (1996) of three to four times a year. Although, no scientific evidence is found in this study, it can be of no harm for banks to critically review the process of the audit committee to optimize their value to the bank. There is no evidence for an association between audit firm specialisation and the quality of risk disclosures by European banks. There is no

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quality difference between the designated ‘banking’ specialist and all other audit firms, indicating equal quality among the audit firms. In the sample used in this study only one bank was audited by a non-big N audit firm. So, a difference in quality between non-big N and big N companies is still possible, but there is no evidence for differences by specialised audit firms and non-specialised audit firms for the quality of risk disclosures by European banks according to this study. Most studies focused on broader fields, general differences between audit firms or on one country specific. The method used in this study to designate the audit firm with the most tenders as the specialist in a country and making cross-country comparisons has not been used before. So, whether this is a correct measurement for audit firm specialisation has to be tested further. Also, it is possible that not the entire firm has influence on the quality of the audit but only the audit partner, however this method can only be used on a national level, like Ittonen et al. (2015) did. Maybe, in some way this can be transferred to a more nation-wide method. This result can also add to the debate of audit market concentration as outlined in Francis et al. (2013) and to the effects of audit firm tenure e.g. (Fitzgerald et al., 2018). The cultural effects, masculinity and uncertainty avoidance, did not lead to significant results. However, a direct negative significant result has been found for uncertainty avoidance and the quality of risk disclosure by European banks, this in line with e.g. Hooghiemstra et al. (2015) and Gray (1988). Second, this study also sheds light on the quality of risk disclosures by European banks. The disclosure scores have a minimum of 11, maximum of 42 and a mean of 26,5. No individual scores are published in this study. In general the scores are mediocre, recall this study only investigates voluntary disclosures, so everything extra can been seen as good. But not addressing the risks can be damaging in the long-run (Fuller and Jensen, 2002). Reporting incentives play a great role for the value of voluntary disclosures and IFRS not per se leads to higher quality (Christensen et al., 2015), thus to improve disclosure scores incentives should be changed instead of making it mandatory disclosure standards. Clear differences can be found between the different European banks. Thus, there is still room for improvement and the maximum score of 60 has not been reached by any bank. Hence, stakeholders can address the management of European banks, in line with agency theory, to try to include more relevant information in the disclosures, as not all relevant criteria are met. A higher disclosure score not necessarily has to influence the decisions made by various stakeholders, however in general transparency is not a bad thing and might help to regain trust and to be more legitimate. For banks, this can mean a greater ability to attract investors, also keeping the effectiveness in the communication and the ability to signal their qualities. When banks pay attention to what to disclose and what not, maybe triggered by the general discussion, the concept of isomorphism

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