Revision Company Law 1928: what impact did the revision had on the financial reporting of the Netherlands?

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Revision Company Law 1928: what impact did the

revision had on the financial reporting of the

Netherlands?

Master Thesis Msc A&C Accountancy

University of Groningen, Faculty of Economics and Business

DENNIS GRISEL Studentnumber: S3275078 1e Daalsedijk 159 3513TD Utrecht Tel. +31641824061 Email: d.m.grisel@student.rug.nl Supervisor University Abe de Jong Co Assessor University Shibashish Mukherjee Word count: 13,035

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ABSTRACT

Despite the developments of the legislation on financial accounting throughout the year, empirical studies focusing on the time frame of the first introduction of disclosure requirements are limited. In this paper we examine to what extent the revision of the company law in 1928 affected the level of disclosed financial information for industrial limited liability firms in the Netherlands. We mean with disclosure to what extent the industrial companies provide information in the financial statement. Overall, the result has shown an increase in level of disclosure in the balance sheet and profit- and lost statement. Nevertheless we found no empirical evidence that the revised company law significantly effects the level of disclosure, comparing the years pre-revision and post-revision. Only the dependent variable of the number of accounts with a value of 1 NLG in the balance sheet has shown a significant association with the revision. It should be considered whether other factors could explain the level of disclosure.

1. INTRODUCTION

Economic scandals, crisis and depression during the past decades have resulted in a constant and increased focus on financial accounting of companies. Reliability and high quality of the financial reporting became well known characteristics in the accounting process of companies. Though the years the demand for financial information increased, expectations changed and the requirements due to regulation constantly developed. Factors like economic structure, interests, stakeholders, social environment and the increased focus on performance of companies had their impact on the financial accounting that we know nowadays. Legislation on financial accounting had to cover a long journey to develop in the standards we use in the present economies. Multiple studies already investigated different time frames in this journey. Looking at the motivations and effects of the introduction of regulation. An interesting question during this journey is: What underlying value had the changes in law on society?

Armstrong et al. (2008) investigated the European Stock Market reaction throughout sixteen events after adoption of the International Financial Reporting Standards (IFRS). In this study they found evidence the IFRS adoption resulted in net benefits for the investors of European firms. This adoption is mainly driven to improve the convergence and comparability of financial reporting in different countries. Using the same accounting standard could simplify

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the understanding of the financial statement for the users. You could question whether the accounting regulation and the IFRS requirements also achieve this objective.

For example Brownlee and Young (1986) question in their paper the need for a Security Act and its disclosure regulation. In their study they discussed three types of critique, starting with examination of the historical process which was the base of the SEC. In their second part they analyzed the effects of the new legislation on the capital market and ultimately several studies had been discussed which questioned the fundamental rationale for financial disclosure regulation. The purpose of this article is to trigger readers to stay critical in the examination of the SEC’s disclosure regulation.

Merino and Neimark (1982) argued that by ignoring the origins of disclosure researchers oversimplified the objective of the introduction of the securities legislation without considering a broad wider view on the fundamental methods of corporate accounting. They showed in their study that both the goals of disclosure and ownership structure had an impact on the discrepancy of economic reality and the public philosophy. They further emphasized the conditions of the starting point of the creation of the Securities and Exchange Commission (SEC). The SEC was introduced in the 1934, quite late in comparison to other countries. The SEC focused on the protection of investors and prescribed a disclosure-based structure for companies within the United States. Companies with a certain size, and companies who traded their securities in more than one country had to deal with the regulation in this Act.

Brownlee’s focus was mainly on the development and introduction of the SEC, but like the study of Armstrong et al (2008). Benston (1973) analyzed to which extent the introduction of the financial disclosure requirements had effected the Stock Market. Starting with an explanation of the disclosure requirements, their main finding was: The Security Act and its disclosure requirements had no impact on the traded securities on the NYSE. The base for the legislation and the study found no evidence that the Security Act was needed. More disclosure requirements have been received with doubt.

In extend to the research which was mainly focused on the introduction of the SEC in later years the focus shifted to a more effect based approach. The regulation was primarily introduced to protect investors and foresee those investors of reliable information. Neel (2017) examines the comparability and firm specific financial reporting quality after adoption of the IFRS standards. Based on the assumption IFRS main objectives where to improve

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comparability and increase the financial accounting quality. This study suggest that the mandatory adoption of IFRS improved the comparability in cross country which been positively related to economic benefits.

Most of the studies concentrated on another part/effect of a more structured financial disclosure. Though the years the structure of companies changed, where ownership and managing of companies where separated the problem of information asymmetry arise. Regulation like IFRS and SEC should control this problem by implementing disclosure requirements. Botosan (1997) examine the effect of the level of financial disclosure in the light of cost of equity. In this study they found evidence that firm’s low analysist following can influence cost of equity capital by providing a greater level of disclosure. For firms with high analyst following they found no association between the level of disclosure and their cost of equity capital. The level of disclosure was for some of the investigated firms voluntary, Beuselinck et al. (2013) further extends this research by looking at the advantages and disadvantages of voluntary disclosure. They made a connection between empirical literature about firm disclosure policies and its corporate governance. Corporate governance became more and more important after the 1990s.

Looking at some examples of previous performed studies we still miss historical studies regarding the starting point for financial disclosure requirements. In this paper we want to look at the starting point of the first regulation regarding financial accounting disclosure. Around the beginning of the twentieth century the first disclose requirements were included in the Company Act. Studies (Aubert and Grudnitski (2011); Kabir (2010)) in a later time slot found emphatical evidence for a positive effect of introduction of legislation. In those studies the introduction of IFRS increased the quality of the financial reporting. We are wondering whether this introduction in the beginning of the twentieth century had the same effect. Did the financial reporting changed after adoption of the first requirements?

We will investigate to which extent the revision of the company law influenced the disclosed financial information of the industrial sector within the Netherlands. Using previous performed studies, including among others the agency theory and the public interest theory, in the analysis of our results. We further look at literature available regarding disclosure regulation, how this relates to the level of disclosure.

Could impact the results or have others effects besides the change in providing financial information. With the presentation of historical revised regulation we aim to explain what

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regulation been changes and how this influenced the financial reporting of firms. It identifies the impact of the revision of the Company Law. We will investigate a multiple dependent variables which should help in the response to the hypothesis. Taking into account other factors besides legislation which could influence the results (f.e. size, leverage, profit (loss), dividend) and may lead to another level of disclosure. The research is carried out by multivariate regression analyses of the data ante (1926) and past (1930) the revised Company law.

The findings of this research make the following contributions. First, to our knowledge, there are no published studies which have investigated the impact of the revision of the Company Law in 1928 in the Netherlands. Other studies focused on the introduction of SEC, SOX and the adoption of IFRS but not specifically the Company Law of the Netherlands. Second, by combining modern theories with historical data we can further clarify whether the revision of the company law causes the change in financial reporting or other influences need to be further investigated. The revision and legislation been introduced to set some disclosure requirements all with the protection of the investors in mind. Third, the findings will help explain the change in financial accounting though the first introduction of disclosure legislation by using historical evidence, focused on the Exchange Stock Market in the Netherland in the period 1926 till 1930. This paper is constructed as follow: Section 2 discuss the literature review on disclosure, followed by the Dutch setting, section 4 includes the hypotheses, data and methodology. Section 5 provides the empirical results and we closing with the conclusion and discussion in section 6.

2. LITERATURE REVIEW ON DISCLOSURE

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Throughout the years the financial reporting has constantly been the subject of debate. Financial accounting has a long history, disclosures started with providing financial information in the most simple form. The first forms of a financial statement consisted of a balance sheet and profit- and loss statement. Over the years the financial statement evaluated at an extensive report comprises the accounting information of the company. Still comprised

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of a balance sheet, profit- and loss statement, but extended with a cash flow statement, notes of the financial figures, note with te accounting policies, a board report and further voluntary disclosure. Important in this research is to know what we define with financial disclosure, and how we will use this definition in the rest of this research. We define disclosure as accounting information produced by the company to inform stakeholder, in particular the investors, about the financial result of a company in a given period. This accounting information can be used to evaluated the performance of the company, there management and employees. Helping stakeholders in their decisions due to the company, and further helps attracting potential investors.

After introduction of the financial statement and the definition of disclosure we will further continue this chapter with previous performed studies regarding disclosure of financial information. Starting with empirical studies regarding the adoption of financial legislation. Followed with literature due to more actual disclosure research subject. Helping explain the motivation of companies to disclose information, in particular in the form of a financial statement. The next chapters comprise of two theories linked to financial disclosure. Agency theory explains the information asymmetry between the agent and principal. The base for the need for financial information. Where the public interest theory more focusses on the need an demand for regulation by the public.

2.1 Disclosure

2.1.1 Historical accounting perspective

Legislation regarding financial accounting started in the nineteenth century. Starting with a limited set of rules and requirements. Europe was the founder of the fist regulation Act, started in the UK in 1844 as the Companies Act. In the twentieth century this developments in the financial accounting further expanded and shifted to the United States. The raptly growing economy was the cause of this shift. Those developments were accounted for the introduction of the corporate tax in 1909. The accounting standards took a longer period to settle. The crash of the stock market in 1929 was needed to wake up the Government. US government realized that the crash and the followed depression had a huge impact on whole economy. Investor needed to be better protected against the companies they investing in. They came up with the Security Act in 1934, most important focus of this Act was the protection of the investors. In the Act the government incorporated a disclosed-base structure. The Securities and Exchange

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Commission responsible of the Security Act had to ensure that investors are protected and receive reliable unbiased financial information.

In 1973 the Financial Accounting Standards Board (FASB) reinforced the SEC. First the SEC was the only body which could set new accounting standards, but this was now able for both. The accounting standards where only applicable for the US. Resulting in the US GAAP, Generally Accepted Accounting Principles.

A long period on unchanged settings was abruptly disturbed by a numerous of scandals, for example Enron in 2000 and WorldCom 2001. Having a major impact on the confidence in financial reporting of society. The Congress of the US had to reinforce this trust, the only way they believed would held was to revise the Security Act. In 2002 the US Congress accepted a new law to reestablish confidence notable as the Sarbanes-Oxley Act. In the Act rules getting tight up, the audit function was further elaborated and they improved on corporate governance. Requirements regarding corporate governance were focused on the alignment of the objectives and interest of the investors, society and the firm’s. Further the Public Company Accounting Oversight Board (PCAOB) was created. The PCAOB had the task to set auditing standards, inspect and discipline auditors of public companies.

Beside the local GAAP in a collaboration whit Australia, Canada, Japan, Mexico, the Netherlands, the United Kingdom, Ireland and the United States they created a body first the International Accounting Standards Committee (IASC) in 1973. In 2001 this body was replaced for the International Accounting Standards Board (IASB).The main goal of this body was to develop a single set of global accounting standards. High quality accounting standards, which will be understandable and executable and globally accepted. The global standards called International Financial Reporting Standards (IFRS).

2.1.2 Adoption of financial legislation

The adoption of legislation regarding financial accounting has been subject in several studies. The time of the adoption of the SEC in 1932 financial accounting research was still limited. From half way of 1960s accounting theory began to show up. Most studies are therefore more focused on changed made in a later time period. In regard to the historical perspective described earlier we follow with different studies focusing on journey legislation had made.

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Merino and Neimark (1982) questions the fundamental change the Security Act have started and believe the model was a logical consequence to maintain an ideological, social and economic status quo. In other the words the public policies the US known was comparable with the SEC’s disclosure system. They argued the Security Act was a response to the crisis in the credibility of the system, cause by the stock market crash and followed depression. The antitrust legislation, potential competition, which was the base in the public disclosure policies and on the other hand the two-tiered stock market structure with moral regulation constituted as the base in the pre SEC period. The crash caused disruption and loss of the confidence in both policies. Concluding the design of the Security Act were a result of the lack of confidence in the credibility of the system and institutions.

In a later timeframe Brownlee and Young (1986) criticized the financial disclosure regulation. The foundation of their study is the proposed expansion of the existing disclosure regulation of the SEC. Brownlee and Young questions the need for this regulation, discussing three types of critiques. This article wants to stimulate interest for future research by forming a basis of discussion. Further they presented some alternatives for the disclosure system of the SEC using other countries as a reference. The principle base disclosure requirements of the Netherlands been pointed out and contain aspect worthy to consider. In the UK they focusing on the difficult administer of the SEC compared to the UK, and further arguing that the SEC is a log system where discussing about disclosure requirements will take months. In the UK the system is flexible, a to discuss a requirement or procedure will take approximately three days to get a answer.

They scandals that followed in a later period leaded for a revision of the Security Act. Ball (2009) investigates the cause of the accounting scandals. He used different perspectives in his search for an explanation. Beginning with the political/regulatory process followed by the market for corporate governance and financial reporting. Founding contrasting result depending on the perspective he used. Where the political regulation process had worked in detecting fraud or negligence in reporting, it did not evaluated though time. The regulatory reaction to the scandals was the introduction of Sarbanes-Oxley Act, the most extensive rule base regulation since the Security Act. The market reaction was two-fold: there need to be penalties for management who commit fraud or negligence reporting and the incentive had to be reduced by changing institution arrangements.

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Beattie et al. (2013) investigated the impact of the post-SOX on the audit quality. Different from the study of Ball (2009) they believe the scandals resulted in significantly change in the regulatory regime. In their study they view the impact of 36 economic and regulatory factors on audit quality post-SOX. They found 26 factors are perceived in the results of the survey, it further indicates the relevance on policy makers. Factors like audit committee, big four auditor, client assessed as high risk audit, total fees from listed firm not exceeds 10% of annual fee income of firm been important factors which positively affect the audit quality.

The period before IFRS shown studies with a greater focus on the question whether the disclosure regulation needed, and what caused the adoption in the first place. The period after the introduction orientated more on the effect of the adoption of regulation. Concentrating on the IFRS standards we observe a shift in relation to the subject of investigation. Studies now questioning the impact of the standards, the importance, the effect on earning quality, the accounting comparability and market reaction for continents or countries. The IFRS adoption accompanied with several reporting requirements and standards effecting all kind of factors. The adoption along different countries have different impacts. The European Commission made the adoption for IFRS in 2002 mandatory for all listed firms in European Countries. Aubert and Grudnitski (2011) reported the result on a two stage analysis, impact and importance, of the IFRS adoption for European Countries and their firms. “Disappointingly, confirmatory evidence of the relative value relevance of IFRS information could not be found for any sample”.

One of the requirements of IFRS besides high quality accounting standards, was to improve comparability. By using the same standard in different countries this requirement could be achieved. In a study of Neel (2017) four different economic outcomes where investigated regarding the adoption of IFRS. He found cross country comparability improvements and the economics benefits were both correlating with the adoption. They both played an important role in the mandatory IFRS adoption in 2005. The improvements of the comparability had the first order effect and which effected the information environment of firms. Armstrong et al. (2008) embroider on this changed in environmental information. His findings were consistent with the expectations of the investors, believing IFRS improves the information environment of firms. “Findings indicate that investors expected net benefits associated with increases in information quality, decreases in information asymmetry, more rigorous enforcement of the standards, and convergence”.

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Kabir (2010) examines the impact IFRS adoption on the accounts and the earning quality in New Zealand. Kabir compared the pre IFRS adoption, General Accepted Accounting Standards of New Zealand, with the post IFRS adoption. And found evidence for a significant higher valuation of total assets, total liabilities and net profit under the adopted IFRS standards. Further absolute discretionary accruals were significantly higher which suggest lower earnings quality under IFRS than under NZ GAAP.

Where Owusu-Ansah and Yeoh (2005), used New Zealand in their sample as well, examine the effect of legislation on corporate disclosure practices. Using a compliance disclose module to measure the effects of legislation on the mandatory disclosure related variables, and found improvements of the corporate disclosure practices. In another study Inchausti (1997) investigated two different influences where accounting information is subject of: market pressures and pressure from regulatory bodies. Different from the previous mentioned studies this paper provides an empirical analysis of the influence of both forces, where regulation explains to which extend financial information is disclosed, but also found other characteristics explaining information disclosure by Spanish companies.

2.1.3 Voluntary disclosure

Throughout the years the financial accounting regulation changed enormously. The financial statement evaluated and more financial information was added. A more actual subject connected to disclosing financial information is the disclosure on voluntary base. For decades the most important roll of the financial statement was based on the protection of the investors, subjects like disclosure requirements, legislation and law where much discussed issues. In more recent studies this focused expended in new focus areas, Corporate Social Responsibility (CSR), Social and Environmental reporting (SAR) and internal capital (IC) are two important examples. Those area’s influenced the way companies fulfil their activities and how they reported the result on those areas to their stakeholders and investors. Firm performance, with mostly financial driven performance indicators had a primary focus. Though the years long term objectives obtained increased importance in the evaluation and valuation of company. No longer financial indicators like result, share value, return on assets/investment, dividend rule in the economic businesses, other factors on areas like social and environment performance gain attention.

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Brooke Elliott et al. (2014) investigated the causal relation between CSR performance and investors’ estimates of fundamental value that can be attenuated by investors’ explicit assessment whether CSR performance. They provided evidence of a causal relation between CRS performance and investors’ estimates of fundamental value that reflects and unintended influence of CSR. The study also provide evidence of the affect’s role in subconsciously influencing judgements on accounting settings.

This new focus being applied by the government, professional bodies, industry bodies, and corporations to various related issues (Deegan, 2002). They explain why managers might elect to publicity disclosure information about particular aspects of their social responsibility and SAR performance. In their research they use the legitimacy theory, stakeholder theory and political economy theory to explain why companies are willing to voluntary disclose information (financial or non-financial) which isn’t mandated or required. Deegan and Rankin (1996) investigate, by means of a questionnaire, whether various classes of annual report users consider environmental information to be material to the various decisions they may make. Conformity to this paper there was no formal law or standard where a company should confirm to.

An et al. (2011) further expand previous mentioned legitimacy theory and stakeholder theory with signaling theory and link those with the agency theory to explain why companies are willing to voluntary disclose organization information. In their paper they construct a comprehensive theoretical framework explaining IC disclosure thought integrating four relatively often-used theories in the area. Concluding that the agency theory appointed the problem of “self-interest” among the management of a company and their shareholder. Information asymmetry is the result of those self-interest because management has an information advantage over its shareholders. Firm can provide more information to reduce this information advantage. The stakeholders theory replace the shareholders for a broader context and looks from the stakeholders point of view of the company. So the company not only provide information to fulfill in the needs of the shareholders but also discharge accountability to a variety of stakeholders in the society. In order to highlight the qualities and value of the firm to society a firm can signal the society. Information asymmetry address the problem society do not see the actual firm value. The signaling theory deal with this problem and explaining how voluntary disclosing could help in highlight the firms excellence.

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In an older study combining theories was already done by Morris (1987). In this paper Morris combined the signaling and agency theory to explain the accounting policy choice within companies. In the article the writer explains the relationship between the two theories in a fourfold, it is the same theory under different forms, one theory may imply the other, both consistent and finally they may be contradictory. Main contribution of this article will be that both theories are dealing with the information asymmetry problem companies have with separation of ownership and control. We will use the paper of Morris as a bridge to further discuss voluntary disclosure. In the prior section we already mentioned the effect of the changed of responsibilities and requirements of stakeholders, and what impact they had on the level of disclosure in the financial statement. Prior empirical research investigated the cause why companies consider to provide voluntary financial disclosure. Further they emphasis how voluntary financial disclosure could help in the valuation of a firm. Important factors which could be influenced by providing some extra information, decreasing the information asymmetry between manager or the controlling party and their stakeholder. Choices dealing with financial disclosure could help or could affect the firm value.

Healy and Palepu (1993) further discuss the financial disclosure strategy of companies. They suggest the financial disclosure strategy could affect the stock prices of firms. They start to set out the shortcoming of the financial reporting requirements. Missing important information like benefits of investments of quality improvements, research and development, human research development programs. All due to the conflicting interest of managers and the stakeholders, the reporting requirements of that time would not suffice to mitigate that gap. They argue financial disclosure reporting strategies could help mitigating the information asymmetry. In relation to our research we could seriously question whether reporting

requirements (completely) serve their purpose.

In a later research Healy et al. (1999) investigated to what extend voluntary disclosure could help to effect firm value, or in other words by providing more information to their stakeholder and analyst influence the firm value on the capital market. One of the limitations Healy mentioned about other empirical research papers, that most researcher assume the stock market of equity market is in market efficient. Further they assume investors or the users of the financial statement see through the limitations of accounting. This assumption is misleading, because this does not fit every situation.

In this paper they investigated to what extend companies benefit from expanded voluntary disclosure by examining changes in capital market factors associated with increased analyst

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disclosure ratings. Founding evidence contradicting the efficient market hypotheses. In their research a variety of factors could influence the firm value. Healy et al (1999) found that expanded disclosure leads to revised upward valuation of the firms used in their sample. It positively influenced the stock price, stock liquidity and created additional institutional and analyst interest in the stocks of the firms. The results continued to hold after controlling conflicting variables like earnings performance, size and risk.

Aboody and Kasznik (2000) looked at another factor in the voluntary financial disclosure literature. They suggest timing is also an important factor in providing voluntary financial disclosure. In their paper they investigated the casual relation between the moments of releasing voluntary financial disclosure around stock option award. Their finding suggest that CEOs make opportunistic decision regarding voluntary financial disclosure to maximize their value of stock options. The CEO incentive to rush forward bad news before earning announcement, to influence the price per share to a lower level. The incentive to delay good news to a point after the earning announcement to prevent an increase in share price, their stocks options would be settled at a higher price. In this situation CEOs have an incentive to voluntary disclose information to the outside world.

We discussed different empirical studies focusing on factors which may explain a certain extent of financial disclosure. Through time you see the continually increase and change of the demanded information disclosed in the financial statement. This disclosed information should help resolve the gap between the inside information of controlling management and the owners of the company. Interesting paper of Hooks et al. (2002) where they used an index developed by 15 experts representing broad stakeholders group to compare the extent and quality of each index item with the level of importance of those items as stated in the panel. Founding many items are not adequately disclosed and resulting in an important gap between the expectations

and reality.

In the 19th_{century legislation was among other things introduced to protect stakeholder against}

the controlling management of the company. In our research we want to focus on the impact of the disclosure requirements on the financial statement of the listed companies of the Netherlands. Our contribution will focus on the revision of the company law in 1928 and its primary effect on the financial disclosure. In the timespan around the revision companies where less aware of other factors around disclosing information, factors in empirical studies above could also affect the financial information. In our research we therefore include controls to obviate biased results and conclusion.

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In this study we will use the studies in the examination of our results. The different viewpoint about the adoption of different regulation due to financial accounting could contribute and help explaining our results. In the beginning of the adoption a multiple researchers had questions about the introduction of financial accounting legislation. The voluntary disclosure part show there can be a multiple reasons for voluntary disclose information. We will investigate the revision of a company law, and to what extent this influenced the financial reporting. The requirements where still limited, could the demand for information have a greater influence on the level of disclosure. The Dutch setting and of the literature due to the Netherlands will be further discussed in chapter 3.

2.2 Agency theory

The agency theory rely on the assumption that everybody pursuing his on goals to maximize their own welt far, because the agent and principal in most cases do not have the same goals , they called it the agency problem. The agent, mostly management, have an information advantage on the principal, to mitigate or reduce this information asymmetry the agent need to provide the principal from information. This information asymmetry arose when new firm structures were introduced in the ninetieth century. The separation between ownership and management became more common and resulted in an increased demand for financial information. The founders of this theory Jensen and Meckling (1976) investigated to what extend this ownership structure and separation of control influence the size of the agency costs. Agency costs which a company had to make in order to provide information to their investors of debt and equity. They came up with a new definition of an organization and corresponds to: The management of the company, directors or chief executive officer, owns the money of the people who invested in the company. They should watch over this money with their lives and fulfill their tasks and perceiving in the best interest of the investors. With the risk they consider attention to the small matters compensating themselves because they watch the money. Remiss and plenty, therefore, need to rule in the management of the affairs of such a company. The definition further explains what the new developed structure has created and why (financial) information became more important. Another factor which influenced this need are the financial scandals, this shifted the need for reliable financial information a company was giving to its investors or other parties. Reliance, quality and relevance became important aspects in financial reporting. Financial experts or professional auditors could fulfill this roll by supporting the accounting process, controlling the provided information. Something we also

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founded in the revise Commercial code. Shareholder now could appointment a financial expert which could protect the investors for manipulated information.

One of the first empirical research which further detailed the information asymmetry problem where Watts and Zimmerman (1983). They investigated the monitoring roll of this financial expert (auditor). The paper provide evidence for the importance of the monitoring roll in the theory of the firm analyze, and the threat of opportunistic behavior by its managers. What roll an independent auditor could have to reduce the agency costs of a firm which accompanied the opportunistic behavior. Interesting insides how the separation of ownership effects different parties with interests in a certain company.

In Francis and Wang (2017) they found evidence changing from auditor will have a negative effect on the costs of bank debt, this research suggest the monitoring function of an auditor has a cost reducing effect whether they been the auditor for several years. Interesting founding which roll information could have in the outside world but its shareholders as well. Ang et al. (2000) used the case of Jensen and Meckling to provide evidence for the prediction agency costs are higher at firm where ownership and management are not 100 percent the same. Again evidence opportunistic behavior and costs due to information asymmetry was found. Easley and O’Hara (2004) focused on the cost of capital and to what extent information could influence that. They found evidence the quantity and quality of information effect the asset price of an organization. Questions raised by reading those papers about the role of the reporting regulation we nowadays know.

Perhaps regulation could influence the provided information of companies, could partly work as monitor besides the auditor profession. Could it reduce agency costs and affect the previous described important aspects of financial accounting. Whether new accounting law will be introduced will this eventually lead to a change in financial accounting? Also in such way they intended?

Previous research already investigated what impact the IFRS adoption and SOX implementation had on companies and there way of reporting their financial results. In the paper of Brownlee and Young (1986) the writers came with several critical points why the legislation of financial reporting will not result in the same result as expected. In the paper of Merino et al. (1982) they question SEC’s disclosure system because the authors among other things conclude that existence of voluntary disclosure before the implementation proof that the existing mechanism and demand of different parties where enough to inform investors with

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sufficient information. In this paper we are interested whether the revision really resulted in a change in the way limited companies published their financial figures. Thereby, we posit that the revision of the company law resulted in an increase in the disclosures in the financial reporting.

2.3 The Public interest theory2

The financial scandals in all periods of time had their impact on the belief of public around financial accounting. Scandals like Enron, WorldCom and Lehman Brothers are recent examples. Scandals been from all times and already started in 1494 with the double entry bookkeeping of Luca Paciolo. Further economic failure, stock market crashes, crisis, depressions al examples of events during the last decades. The depression of the stock market crash in 1929 in the United States, left their mark on the belief of the public in the financial accounting of firms. How is it possible that companies reported their figures but a crash or scandal was not noticed? How controllable are those financial reporting for third parties in their demand for information the right? The public interest theory explains regulation is a response to public demand for correction of market failures. The regulator is assumed to have the best interest of society of heart. It pursuits to maximize social welfare – that is, to attain a first-best amount of information. Consequently, the tradeoff always will be: regulation should outweigh its costs and its social benefits in the form of improved operation of markets (this should always been considered when a regulator is implementing new standard requirements, to what optimum does this new requirement outweigh its social costs and benefits. Wheater the benefits exceed the costs, the standard will be implemented, and vice versa) (Scott, 1931). This public interest theory helps explain the need for a company laws and to what purpose this law serves. One reason for the introduction of financial reporting requirements is to protect stakeholders from information asymmetry. The increased separation of ownership of a firm and the controlling function of its management is one of the major causers.

Hanke-Domas (2003) rebutted the direct relation between this public interest theory and regulation and speaks of a non-existence theory, they come up with several argues which do not prove or deny this connection. In this research we will focus on the way regulation will

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impact the financial reporting. More financial information could lead to other choices of the public. By using historical data we combine this theory with the results of the revision, to what extent the disclosures changed compared to the period foregoing the revision.

Interesting in this public interest theory it suites the events through time. After an major event, mostly with negative consequences, every time the reaction followed could be found in a change in regulatory bodies, legislation or accounting standards. In the following section we will focus us on our focus area, we are interesting in the Dutch setting.

3. DUTCH SETTING

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In the execution of this historical research the historical background of the Company Law in the Netherlands is an important part. Starting with the introduction of de general stetting of the Netherlands, following with the law and how this developed to the revision in 1928 and a chapter with the major changes in the Company Law. In the final part we included the accompanying literature connected to the Dutch setting.

3.1 General

In the period of 1870 till 1914 the Netherlands had a strong focus on expending their trading area. The Netherlands globalized the trading area to colonies increasing the free trade. In the period following 1914 the Netherlands economy slowly changed in a more industrial country. War and economic depression had a major impact on the economic health of the Netherlands. However the economy increase over the years was mainly due to the upcoming industrial sector. The war ensured that the trading with colonies was almost impossible, therefore the Netherlands was obliged to find substitutes for product which were impossible to secure. Further stimulating the production of product in our own country. The average size of companies increased and with their size also their capital intensity. To finance the increase in

3_{Scott, W.R. (1931). Financial Accounting theory, Seventh edition. Pearson. Toronto.}

4_{Camfferman, K., & Brand, R.C.J. van den (2010). Jaarverslagen van Nederlandse ondernemingen vanaf 1811 tot 2005. Instituut voor}

Nederlandse Geschiedenis.

5_{Westerhuis, G., & Jong, A. de (2015). Over geld en macht: Financiering en Corporate Governance van het Nederlandse bedrijfsleven.}

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capital the demand for investors increased. By using investors to finance their assets most of the companies chose to release shares. Those investor became shareholders, and with those shares they obtained the voting right during the shareholders meeting. In the beginning the group of investors was small and still involved in the daily activities of the organization. Through the years the shareholder group grow and the distance between ownership and management of the company increased. The new structure was already known for a long period time. The limited liability structure started at the beginning of the nineteen century, differently from that period of time the number of new limited liability companies increase exponential around 1920. In 1851 the Netherlands only counted about 137 limited companies, in just sixty

years this grown to 6.874 in 1911.

Beside the developments of the economy, the war and the depression within the Netherlands the roll of the government been changed as well. The change in structure and the capital intensity further encouraged this change. Though this period of time government and business were working more together thinking about the rules and regulation. . Important instigator for this development was the increasing independency of the management of a company. Eventually this ended up in the first reporting requirements.

3.2 Code de Commerce

As a result of the incorporation in 1810 of the Kingdom Netherlands in the French empire the Code de Commerce was born. In this code the first uniform regulation for listed firm with a separation between ownership and management where included. This regulation was minimum and included rules which monitor the formal aspects of a public company. For example about development, dissolution and interpretation of the agreement. Further the first rules regarding the financial statement and the compulsory of a merchant to keep a journal with a record of their daily activities. Further they introduced a time period of ten years to archive this recordings. No formal structure or a prescribed way of recording figures were included.

3.3 Dutch Company Law – Commercial Code

The Code de Commerce was replaced 1838 by the Commercial Code (Wetboek van Koophandel) and was the first Dutch Company Law. This commercial code contained rules for limited liability firms. Most of the regulation was nothing more than a copy of the Code de Commerce, the main difference was the degree of detail. Further they obligated the Merchants

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to “draft an inventory and balance sheet” on a yearly base, they had to appoint directors (appointment of the supervisory board was voluntary), but again no formal requirements about the structure or transparency of the reporting where included in de Commercial Code. This was mainly due to the fact that the group of public listed firm was still small.

3.4 Period 1838 – 1928

For a long period of time the Commercial Code stands, during a period of almost thirty years the code was not touched or changed. Eventually in 1871 the first formal plans and ideas for a revision where introduced. A proposal of J.A. Jolles was presented in 1871, but ended up in a rejecting by the Parliament. The main object of this draft was to change the principle of control of limited companies by Royal Consent for a control by publicity. This first move was followed by a lengthy and arduous period, they believes in this period the first foundations of the revision started. In 1879 the government appointed a commission called “The Kist Commission”. The Kist Commission were appointed to come with a proposal for a complete revision of the Commercial Code. It took them eleven years to propose a draft version in 1890, consisting of multiply reports of law dealings for limited companies. The draft never made it to the Parliament or left the Ministry, until present day no further explanation was given. Again another period of twenty years was needed to come up with a new draft. This time, in 1910, the draft was developed by a minister Mr. A.P.L. Nelissen. The most important renewal was the obligation all limited companies had to publish a financial report. The increased urgency of this mandatory publish was due to several financial scandals in the beginning of the twentieth century. A new element compared to the draft of the Kist Commission was the provision of an auditor. The general shareholders meeting could appoint an auditor which, but this was only a right, could support companies in their accounting process. Again the obsolete Commercial Code became a discussion point in the Netherlands, but again the new proposal did not end up in a revised law. It might have been the base for the approved revision in 1928.

In the period between 1910 and 1925 the Minister Mr. Th. Heemskerk blown new live in the draft revision of Nelissen. He raise new awareness to this draft and emphasized the tasks of the Parliament in the reforming of the legislation for limited companies. Heemskerk used Nelissen draft version, with a little help op Mr. L.E Visser, for a new foundation and all proposed changes made by the committee where processed in a new. A new version, which was called

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the Nelissen-Heemskerk draft, made it to the Parliament. Round 1925 the draft law was summited to the Parliament. A number of company embarrassments where a reason to put some provisions regarding disclosure requirements in the draft: drafting the balance sheet, appointment of a financial expert supporting and overlook the accounting process. In the draft they further develop requirements with respect to the period a limited company could publish his financials, the financial reporting contains at least a balance sheet, a profit and loss statement and all accompanied with notes regarding the used accounting principles. This all had to be presented and confirmed by the general shareholders meeting. Again no conclusive success which resulted in renewed law.

A new wave of financial scandals resulted in refocused attention on the company law, but reaction of the business community and the audit profession driving new delays. Eventually in February 1927 the Nelissen-Heemskerk draft resulted in a Memorandum of Alterations. In this memorandum they made several changes in the Commercial Code, but just one with an important impact on the financial reporting of limited firms. The Justice Ministry could exempt companies from their requirement to publish.

3.5 Revision of the Commercial Code 1928/1929

After a period of ninety years the need for a revised Commercial Code was inevitable. The separation of ownership and management had grown constantly, the demand for transparency increased, investors need information due to the financial positions and results of their investment. The ongoing financial scandals in all the years kept the discussion going. The memorandum in 1927 made that first important the starting point, resulting in a revision of the Commercial Code in 1928, the First Camber finally accepted the changes. After changing one Novelle in the whole code the Second Camber accepted the revision with no further amendment in 1929.

3.6 Content of the renewed Commercial Code6

The most important changes which directly affected the financial accounting of companies within the Netherlands can be found in follow listing, as referred to the articles 42 and 42c of the Commercial Code July 2, 1928:

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 All limited companies had to publish at least a balance sheet, a profit and loss statement and notes regarding the used accounting principles. The financial statement needs to be presented to and confirmed by the General Meeting of Shareholders;

 The management is compulsory within eight days, after determination of the financial statement, to fill the financial statement and other information at the office of the companies register

 Mandatory release of the financial figures for limited companies with a total of 100.000 NLG of issued shares, debt securities, certificates either firms listed at the Exchange Stock Market;

 General Shareholders meeting had the power to appoint an expert to control, support and review the accounting process of the company;

 Publication requirements, as referred to Article 42c, the following items are to be listed separately:

o The asset side of the balance need to be disclosed with at least ten accounts:  The cash, cash equivalents and immediately enforceable claims on

banks, clearing houses and giro institutions;

 The participations in other enterprises and the amounts receivable from participations;

 Securities listed on an exchange, if it does not qualify of participation in other enterprises;

 Securities not listed on an exchange, if it does not qualify of participation in other enterprises;

 The receivables, other than the receivables previous mentioned;  The movable assets, inventory and work in progress;

 The immovable assets, property, machinery and business equipment;  The intangible assets;

 The balance of revenues becoming due in future years;

 The costs and losses, which been held accountable to the next fiscal year;  The unpaid part of the issued share capital.

o The passive side of the balance: no specific requirements with respect to the liability were made;

o The profit- and loss statement: no specific requirements with respect to the profit- and loss statement were made;

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 Two limitation in drafting the financial statement to protect shareholders, investors or other third parties. The first limitation was the right of litigation for shareholder and stakeholders against the decision of the General Meeting of Shareholders. The second limitation was the sharpen of civil law regarding management, whether they presenting misleading financial figures.

3.7 Supervision

With the introduction of the first Commercial Code in 1838 supervision was one of the subjects which passed the discussion. In the past decades the only form of control of limited liability firms was at the start and allocated to the Royal Consent. In the new Commercial Code this principle need to be update to a more modern standard. Publicity and providing information about the performance of limited liability firms should made it possible for stakeholders to control the company. Throughout the journey this form of supervision was part of several proposals and discussions, but had formally wait till the revision of 1928. Some other form of supervision came at an earlier point of time. The draft in 1910 gave shareholder the right to appoint a professional or expert to control, support and review their financial statement process and audit the accounts. Another form of supervision which was formally settled in 1928. The biggest problem in accepting those types of supervision could be found in the general feeling of accepting regulation and preventive supervision. Trade and industry were believed in general to be honest and trustworthy, believing legislation might produce unforeseen problems. We can conclude the supervision on limited liability firms in the period of 1811 till 1928 were minimal.

3.8 Literature review on the Dutch setting

The literature around the time slot 1926 and 1930 we use in this study is limited, mostly focusing on the development of financial reporting in the Netherlands. Camfferman and van den Brand (2010) , Zeff and van der Well (1992) & Westerhuis and de Jong (2015) investigated the developments in the financial reporting. They all describe the Dutch Regulatory Process which been previously set out in detail.

Westerhuis et al. (2015) have that linked to the developments in the business, within a time period they discussed the development in regulation, business and financing. The main finding in the period of 1914 till 1945 is the increase of limited liability firms and listed companies. At

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that time limited liability firms were more financed with equity than debt. A combination of issuing shares and retained earnings caused this ratio. The loans of banks increased but this was only for a short period of time. The upcoming industrial sector with increasingly capital requirement was depending on the shareholders of the Netherlands. The separation of leadership and ownership were the founders of the changed regulation.

Zeff et al. (1992) & Camfferman (2010) described the historical time path of the Dutch Reporting Regulation. Interesting in this development is the years needed to revise the first introduced Company Law in 1838. After many attempts and a number of proposals in 1928 a new revised Company Law was accepted by the first & second camber of the Netherlands. Where the development were well described the explanation for the long time path was limited. In previous work of Camfferman (1993) this was discussed this reason more in detail. The careful approach for acceptance of the changes in the law could be found in the overall believe trade and industry companies were trustworthy. The government were reserved to rashness in legislation because of the possible negative consequences it could have on the limited liability companies. At the time the revision finally been accepted the Netherlands felt the need for a limited form of preventive supervision. In practice this preventive supervision was already been developed and seen to be neither harmful. The act further included the right for shareholder to appoint an expert to supervise the accounting process following the draft of 1910.

The importance of supervision and the occupation of accountant growth. The discussion with regard to the accountant as an expert started at the first decennium of the twentieth century. In an article Poluk (1924) building on this discussion by raising concerns about the characteristics of the audit report of the accountant. Mainly focusing on the question “Do we need higher demands on the audit report?”. In this article Poluk introduced the Dutch professor Theodor Limperg Junior. Limperg (1932) developed the theory of “vertrouwensleer” in the period of 1920s. This “vertrouwensleer” eventually named after the founder and became the Limperg Theory. The theory was the first which connected the needs of the public for reliable financial information with the a control body. This control body was set up to protect stakeholders against the business operation of management which are not in the best interest of those stakeholders. First this tasks been performed by a Board of Director, but in a short period of time this body was supplemented with a professional the public accountant.

The Limperg theory is a founder for the audit Profession in the Netherlands more recent studies still use the theory. Wallage (1993) examine the differences in audit approach of fifteen Dutch

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Auditing Firms. Starting with the background of the Dutch Audit profession. The most important changes in the auditors function been:

- The accountant is obliged to carry out his work in such a way he will meet the expectations which he evokes in the sensible layman;

- The accountant may not arouse greater expectations than can be justified by the work done.

It was this stakeholders-oriented and more business-science-based approach to auditing that set the Dutch profession somewhat apart from the historically more client-oriented Anglo-Saxon practice.

The reason we discussed the Limperg theory in detail is because of fact this theory was actual in time path we investigate. More importantly it has a multiple intersections with the Agency Theory discussed in the previous chapter. Dassen (1989) his study compares both theories and show the intersections both theories have. Both appointing the need for information of the investor, stakeholders or even public of the company. Protecting stakeholders for dysfunction behavior by the agent, focusing on the information asymmetry within businesses. The accountant as monitor could give more value to the information the public receives from the business. Reducing agency costs the public need to make to reduce this information asymmetry. The development of the Company Law and the Limperg Theory both suggest that the public recognized the importance of reliable financial information. The demand for any protection resulted in new discussions regarding the financial reporting in that time. We investigated the extent and impact off those discussions in the next chapter.

4. HYPOTHESES, DATA & METHODOLOGY

4.1 Hypotheses development

In the literature review we discussed different viewpoints which help explain our development of the hypothesis used in this research. We will use those viewpoints to evaluate the findings/results in our research. Focusing on the revised Company Law in 1928, further specified to which extent the revision effected the financial statement of listed industrial companies within the Netherlands. New company structures and the increased information asymmetry between owner and stakeholder resulted in the grown demand for legislation. As

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seen in the studies (Merino and Neimark (1982); Bownlee and Young (1986); Beattie et al. (2013)) the introduction of the Security Act and Sarbanes-Oxley Act there were some serious doubts whether this regulation will make any difference. Ball (2009) even questioned whether the demand for financial information caused the introduction of regulation, or was it just a trick to reassurance society.

Legislation was introduced to protect stakeholders for fraud and unfavorable behavior of the management. Both factors causing an increase of the demand for regulation, which could be linked to public interest theory (Scott (1931)). Could legislation solve or partly solve this problem, and change the level of financial disclosure? Or does the company have other interests which could lead to voluntary disclosure of financial information? In the chapter voluntary disclosure several studies shown a multiple variety of factors which could explain companies are willing to voluntary disclose financial information. In this study we are interested how the revision influenced the level of disclosure in that time of period. Did the legislation had any impact on the design of the financial statement? Or do we need further research to determine other influencing factors?

A greater number of studies concentrating on periods more close to the present. Focusing on effects of new legislation on local, continental of worldwide level. Previous studies regarding the legislation in the Netherlands where limited around that period of time. No specific study investigated the impact of the revision during 1928. Or even in some way examine the impact of the law on the financial reporting of that period. In this paper we want to found answers at what level the legislation achieves its objectives, the reason why the government eventually accepted the revision. Or did the revision failed in its task?

Based upon the preceding arguments, hypotheses to be tested are:

H1: The improvements/revisions of the Company Law in 1928 positively affected the disclosed financial information by industrial limited liability firms within the Netherlands.

4.2 Sample selection

We obtain data concerning the financial reporting’s of listed companies in the Netherlands Stock Exchange Market from the “van Oss Effectenboek”. In the “van Oss Effectenboek” all financial statements of listed firms within the Netherlands for the period 1903 till 1978 where

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gathered and put together in one book. Every year they presented a book recording multiple fiscal years, this book was primary set up to fulfill the needs of the stakeholders. The book was introduced to make comparison of financial results between different fiscal years, industries or companies easier. We used the books in order to compare a timeslot period including statistics/financial figures before and after the revision of the Company law. In this research we chose to focus on one sector, the industrial sector, which best represented the economy of the Netherlands in the time path of the revision. After the war in 1913 the industrial sector increased from 13 percent of the listed companies to 30 percent in the thirties. In that period of time most of the listed companies where culture firms. Culture firms operation in colonial settings. Thereby we chose for a sector within the Netherlands with a good size, and main focus

on the economy of the Netherlands.

We identify a total of 210 listed companies within the Netherlands who were operating in the industrial sector at 1926. This research design focuses on the extent of disclosure in the period before revision and the period after revision of the Company law. We started our sample period in 1926, this is one extra year before the revision of 1928. To mitigate any possible effect of the pre announcement of the revision and avoid biased results. We used 1926 as base for the comparison between the level of disclosure before and after the change in regulation. To be sure the effect of the revision was measurable, all listed firms where well informed about requirements and adopted the revision in their financial reporting process, we took one extra year into account to measure the effect. To measure to which extent the depended variable been effected due to the revision both years had to be comparable. We choose to use paired groups, which means the financial figures had to be available in 1926 and 1930. We thereby had to exclude 94 companies from our initial sample. Survivor bias could lead the result of studies skew higher. In this research we will look at the level of disclosure without measuring the performance of the companies. We believe this survivor bias would not impact the results we

found in the level of disclosure of listed firms.

The total sample consist of 116 observable financial reporting’s of listed companies who are operation within the industrial sector of the Netherlands in 1926 and 1930.

4.3 Measuring the change in disclosure level

To quantify the effect of the revised company law we investigated several variables within the financial statement. The financial statements used in our research presenting industrial

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companies in the timeslot 1926 and 1930 where limited in their disclosure. The financial statement only comprises of:

- Balance sheet, including the assets and liabilities (equity and long- and short-term liabilities) of the company;

- Profit and loss statement, including the costs and income of the company - Certain cases explanatory appropriation of the result;

Below an example of the recorded financial information in the “Van Oss Effectenboek”. In this example the financial information is concentrated on two pages, but dependent on the size of the company this could cover multiple pages.

Example of the recorded financial information: Information of the “Machinefabriek Breda” in the “Van Oss Effectenboek 1926”.

Using those components to measure the change in disclosed financial information, concentrating on dependent factors which could help measuring this changes. Because of the limited information we determined the following dependent variables to measure any potential impact:

- Number of disclosed asset side items in the balance sheet of the financial statement of the industrial company;

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- Number of disclosed passive side items in the balance sheet of the financial statement of the industrial company;

- Number of disclosed costs on the debit side of the profit- and loss Statement of the financial statement of the industrial company;

- Number of disclosed earnings on the credit side of the profit- and loss Statement of the financial statement of the industrial company;

Further we investigated whether there were other factors which could be effected by the revised Company Law. Difference were noted in the presentation of the balance before and after appropriation of the result. Further some industrial company included an extra explanatory about the appropriation of the result, this could be valuable for the stakeholders of the company. One of the requirements included in the Revised Company Law set out a minimal for the presentation of the assets in the balance sheet. We noticed in the balance sheet companies also included accountants with value of one Dutch guilder (NLG). Companies could use this presentation method to fulfill the requirements of a minimal of ten accounts. The information

usefulness could be arguable.

To measure those three events we further extended the dependent variables with the following measures:

- 1 if the company reported before appropriation of result, and 0 otherwise;

- 1 if the company reported extra explanatory disclosure about the appropriation of the profits, and 0 otherwise;

- Number of accounts on the balance sheet with a total value less than10 NLG;

In total we use seven dependent variables to investigate whether there is any causality between the revision and the disclosed extent in the financial statement within listed industrial companies in the Netherlands.

4.4 Control variables

While the level of disclosure due to the revised Company Law can be influenced by several other factors, we control only for the effects of four company-specific characteristics due to measurement problems and lack of reliable data. Those measurement problem are mainly causes by the availability of the specific data. We already mitigated industry specific characteristics by focusing on one industry. For example common used control variables as turnover, operating cash flows, big four auditor where not available in the financial statements

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in the period 1926 till 1930. Control variables which been used in several studies measuring the impact of IFRS adoption are (Neel 2017; Kabir et al. 2010; Aubert et al. 2011; Armstrong et al. 2008): company size (SIZE), expressed in total assets, profitability (PROFIT), leverage (LEVERAGE), dividend (DIVIDEND). The data on these variables were obtained from the annual reports of the companies. We scale the dependent variables PROFIT, return on assets, Leverage, liabilities divided by the total assets, and dividend, yield. In the variable leverage we used a gap of 1 because a leverage of which exceeds 100 percent will not have the same effect in this research compared to the range of 0 - 100 percent.

4.5 The Model

In this research design I utilize a multivariate regression analyzes that intercept differences in the extent of disclosure of the financial reporting before and after the revised Company Law of 1928. To test the hypothesis that the intercept of the level of disclosure difference between the pre- and post-revision periods, we introduce a dummy variable, POST28, which assume the value of 0 for the pre revision of the Company Law and 1 for the period 1930 post revision of the Company Law.

My main model takes the following form:

DISCLOSURE(1+X) = α + β1POST28 + β2SIZE + β3PROFIT + β4LEVERAGE + β5DIVIDEND

+

ε

Where:

DISCLOSURE = Dependent variable, see chapter dependent variables for further explanation; β1POST28 = Is a dummy variable, 1 for the post-revision of the company law, and 0

otherwise;

β2SIZE = Natural logarithm of the company’s total assets;

β3PROFIT = Return of assets, total profit divided by the total asset at year-end;

β4LEVERAGE = Liabilities divided by the total assets at year-end;

β5DIVIDEND = Yield, total distributed dividend of the company divided by the total equity at

year-end;

ε =

Error term; β = Parameters.

Revision Company Law 1928: what impact did the revision had on the financial reporting of the Netherlands?