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Opening the “black box”: how internal
reporting systems contribute to the quality of
financial disclosure
Florence Cavélius
ESSEC Business School, France
Abstract
Purpose - Institutional investors use the information disclosed by listed companies to
analyze the performance of their investments. This article tries to open the “black box” of
the construction of financial disclosure by analyzing the internal reporting systems of firms
with reference to the information disclosed.
Methodology/approach - Using indexes, the quality of the financial disclosure and the
internal reporting systems are measured, and analyzed with a view to finding some links
between them. It is expected that the quality of disclosure is dependent on the quality of the
internal reporting.
Findings - Complex interactions between internal reporting and financial disclosure are
revealed, which leads to the identification of a typology of practices. The dependence of the
relationship may be troubled by the willingness of the firm to communicate, or by the
internal methods of control. According to the various cases, different levels of usefulness of
the information for the investor are expected.
Originality/value – This paper is a first attempt to analyse information disclosed by firms
with regards to the internal information at their disposal.
Key words - Reporting, financial communication, quality of information, public and private
disclosure, indexes
Paper type - Research paper
Acknowledgements
The author would like to thank the two anonymous reviewers and the participants of the
30th Annual Congress of the “Association Francophone de Comptabilité” (A.F.C) for their
helpful comments on an earlier version of the paper.
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Institutional investors use the information disclosed by listed companies to understand
the strategic and operational key factors explaining their performance (Eccles et al., 2001).
This information has to possess a number of features or qualities that are essential to investors
in order to ensure its usefulness.
Following the accounting harmonization in Europe, in 2005, which requires all EU
listed companies to adopt international accounting standards (IAS/IFRS), commission
regulations must assess whether the application of accounting standards in financial
statements offers a true and fair view of the financial position and performance of a company.
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The commission must check whether the financial information meet the criteria of
“understandability, relevance, reliability and comparability” in order to make economic
decisions and assess the stewardship of management” (Article 3, Regulation No.1606/2002).
In fact, these requirements have been laid out by international regulations (IASB, IAS1) in
terms of the following criteria: representativeness or fair view (the information accurately
reflects the economic reality of the company); substance over form; reliability (the
information is exempt from fault or error); relevance (it allows the investors to make
decisions) including timeliness or accessibility (the information reaches its destination in due
time); intelligibility; comparability.
While many researchers have studied the quality and the value of disclosed information
(Copeland and Fredericks, 1968; Vickrey, 1985; Chow and Wong-Boren, 1987; Cooke, 1989;
Bradbury, 1992; Raffournier, 1995), as far as we are aware, no one has tried to understand
how this information was put together within the company. The information comes from
internal financial and managerial accounting systems, especially from the company’s internal
reporting. To ensure the quality of disclosure, the information should necessarily be part of
the reporting system and include the required qualities. Bushman and Smith (2001) thus point
out:
In spite of distinctions between internal and external reporting, there is likely to be
a positive relation between the managerial accounting information reported
internally and the financial accounting reported externally […]. Hence, managerial
accounting systems are a potentially important omitted correlated variable.
This paper specifically addresses this call. The focus of this article is thus to compare
the quality of the information issued via internal reporting, and the quality of the information
disclosed to investors. We contend that a community of practices should exist according to the
link between these. To investigate this, the article intends to compare and assess, from a
sample of French listed companies, financial communication practices and internal reporting
systems by measuring their quality. The quality measure of both systems will then bring out a
typology of practices, suggesting different possible use of information disclosed.
This paper makes two contributions: theoretical and practical. It first intends to
contribute to both financial and managerial fields of accounting research. Indeed, financial
scholars are more concerned with the reaction of shareholders to the information disclosed,
with no interest in the internal reporting mechanisms of firms. On the contrary, management
accounting research is interested in methods of measuring performance from an internal point
of view, without any consideration for external views or needs, particularly those of investors.
This paper tries to fill this gap.
From a practical point of view, we intend to reach practitioners as well: indeed, we
believe that the more concern the financial controller has in terms of the needs of investors in
matters of information, the more he will try to gather the “right” information from inside the
firm, for the benefit of the internal management. On another hand, the closer the investor is to
the firm, the easier it will be for him to collect the information he needs.
The remainder of the paper is organized as follows: section 2 elaborates the theoretical
context, in particular highlighting the criteria for quality for both internal reporting and
financial communication practices. Section 3 introduces the research’s methodology. Section
4 presents and discusses the results. Section 5 concludes and draws the implications of the
findings for future research.
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Researchers generally agree on three main points in terms of measuring the quality of
information disclosure practices: the information extent, the vectors of disclosure, the
periodicity and deadlines. Following signal theory (Spence, 1974), firms may be interested in
standing out from their competitors by disclosing voluntary information through voluntary
vectors, and according to voluntary deadlines (Verrechia, 1983; Dye, 1986; Darrough and
Stoughton, 1990; Healy and Palepu, 2001).
Regarding extent, institutional investors expect to have access to voluntarily released
information from company managers, including management control information (Cavélius,
2007). Investors can then control their investment results, make decisions and play a cognitive
role in utilizing new knowledge. Company managers must then submit and explain the
information in private: this allows for two-way dynamic exchanges and learning between the
parties, as well as facilitating investors to give their own point of view and perspectives
(Holland, 1998). “This integrated approach to corporate disclosure should end up increasing a
company’s value” (Hutton, 2004). The disclosed information thus includes: segment
information (partially required by IFRS 8 standards), forecast information (the budget
becomes a tool for improving information disclosure, according to Miroir-Lair (2007)) and
non-financial information (Decock-Good et al. (2004) and Cauvin et al.’s (2006) studies have
established a list of the non-financial information generally disclosed). The presence or
absence of this particular information within public disclosure determines the quality of the
extent (Meeks et al., 1995).
Concerning the vectors of disclosure, Holland pointed out, in his 2005 study, the four
options company managers may choose:
• Public disclosure: including mandatory as well as voluntary information; the
company manager shows his willingness to disclose information (Jensen and
Meckling, 1976), thus distinguishing himself from his competitors (Spence, 1974);
• Semi-private disclosure: consisting in private discussions revolving around
publicly disclosed information and interpretation, clarifications and answers to
questions raised;
• Private disclosure: consisting of in-depth discussions on strategy elements or
operational aspects. This type of disclosure is rather informal and not necessarily
supported by figures; yet it is essential to get a good grasp of the strategic and
operational reality of the company.
• Secrecy: no information that could lead to competitive or managerial
disadvantage is disclosed; a reluctance to disclose uncertain events can also be added
to this.
The quality of disclosure vectors can be measured thanks to the number of different
channels of communication used: the Internet, conference calls, investor and analyst
meetings, as well as one-to-one meetings with company managers, etc. (Depoers, 1999).
As far as deadlines are concerned, the French stock market Authorities, AMF,
established compulsory disclosure deadlines in January 2007 (Transparency Directive): half-
yearly full financial reports have to be disclosed within 60 days following the end of the
period, and a quarterly financial disclosure (general description of the financial situation and
segment turnover) must be provided within 45 days of the end of the quarter. The company
can decide to willingly release quarterly financial reports in a shorter time period. A study by
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PricewaterhouseCoopers in 2005 highlighted that the average time limit for quarterly
publication is 29 days for SBF 120 listed companies (stock exchange index including the 120
most capitalized firms on the Paris Stock Exchange). We will consider this as the time limit
for voluntary publication. Indeed, the more frequently a company releases information in
short time periods, the more valuable its disclosure is. Investors need to be informed
regularly, and in a timely manner in relation to the events mentioned. For example, in the case
of EADS, its shareholders were informed too late that the company’s subsidiary, Airbus, was
facing huge delays in the production, and this made the unexpected losses worse.
The previously specified requirements allow for the assessment of the quality of
information disclosure in terms of extension, but not in terms of reliability or relevance. We
may consider these aspects from an internal perspective through a close examination of the
way the information is brought together in the company’s internal reporting.
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In order to meet the quality requirements of information disclosure, all company players
must participate in the reporting. Beau and Pigé (2007) point out that “the financial
information has gone beyond its original sphere of activity to reach and involve the
operational managers as well”.
Firstly, the financial and management accounting consolidation systems must be
merged to ensure the reliability of the information. “The processes of systems merging tend to
provide the whole company with single, formalised and controlled information,” (Beau and
Pigé, 2007). The segment information obtained, along with the accounting information, is
made accurate thanks to the international standards (Sunder, 2002), and the fact that the
information is audited (Hope, 2003; Richard, 2003). Consequently, potential risks may be
identified. However, this information remains past-oriented, urging investors to pay more
attention to the forecast information included in the company’s budget.
To ensure the reliability of the forecast information, strategic targets must be the result
of exchanges between operational entities and the head office. This idea echoes Goold and
Campbell’s strategic control model (1987), as well as Simons’s vision (1987). The head office
becomes involved both in the budget process and budget control, thus reducing the budget
slack of the operational managers (Antle and Fellingham, 1997). This model also helps to
identify the strategic control indicators to include in the reporting. Operational managers must
become familiar with these indicators in order to drive strategy into operations. This is the
balanced scorecard concept (Kaplan and Norton, 1996), whose importance has been stressed
by Malina and Selto (2001) in the implementation of a strategic control. The non-financial
indicators resulting from the driving of operations must be added to the strategic indicators.
According to Ittner and Larcker (1998), accounting-based indicators cannot measure
performance alone. In 1996, researchers began to study the contribution of non-financial
indicators, or key performance indicators (KPIs), which were usually identified as more
representative of economic reality than financial information (Hemmer, 1996). Their presence
within the company’s reporting is questioned since, according to Arya et al. (2005), managers
will prefer standardized measures which are much simpler and focused on comparability.
These non-financial indicators are by definition linked to the company’s activities and cannot
always be standardized, especially in the case of a particularly diversified company. However,
Bollecker (2003) has pointed out that the non-financial information within the management
control systems improves the power control of the line authority. These results can be
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compared to the presence of non-financial information in the reporting, which helps the head
office to better understand and control the performance of the entities. In the case of a
company with diversified activities, the designing of the reporting systems is more
complicated because the selected non-financial data differs from one activity to another.
Along with the requirements for the reporting extent, financial markets push for shorter
deadlines with regards to the release of companies’ results (Mottis and Zarlowski, 2003). This
also affects the internal reporting deadlines. According to Pigé (2005), the new technologies
(ERP, and reporting and consolidation tools) enhance gathering and data processing
capacities. Apparently, the systems no longer slow down the availability of the reporting
information. Reducing the time limits and the periodicity of account closure is nonetheless
essential for quick publication of the results. According to management control professionals
referred to here, in order to meet external deadlines firms generally close their accounts
monthly, within 15 days after the end of the month. We will consider this deadline as the
quality criterion.
Having defined the essential requirements for meeting financial disclosure demands, the
following table summarizes the criteria by type and nature of the information inside the
reporting.
Table 1: Quality requirements of the reporting information
Reliability criteria Representativeness
criteria
Relevance criteria Accessibility
criteria
Financial
information
including
management
control
accounting
Unique information
system – information
established in
accordance with
international
standards and audited
by an external
independent audit
firm.
Management
accounting
information linked to
key success factors.
Non-financial
indicators
(KPIs)
Written calculation
rules – indicators
followed at the
executive level and
internally controlled.
Non-financial
indicators included
inside the head office
reporting – the right
number of indicators
must be selected.
Selected by the head
office in relation
with the operational
managers, they are
locally-used
indicators, each
measuring a strategic
or operational target
in association with
traditional financial
measures.
Forecast
information
Captured in pre-
established forms and
obtained thanks to a
top-down process,
plus internal control
of the estimations.
Set by taking
strategy into account
– in consultation
with the operational
managers, a re-
estimate is also
included.
An ERP that
facilitates
information
accessibility – this
is a single concept
for the entire firm
except when the
activities differ
from one branch
to the other;
time limit and
periodicity of
information:
monthly reporting
within 15 days
after the end of
the period.
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The previous review allows us to distinguish quality criteria for both disclosure
practices and internal reporting systems. We can say that the quality of the disclosure depends
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on the presence or absence of selected items in a general set of information, including
voluntary information. But, according to the extant literature, we can say nothing regarding
the qualities of reliability, relevance or representativeness, except if we have access to the
internal reporting of the firm, and may measure the quality as mentioned before. Besides this,
we are currently not able to find a link between both: do firms having “good” communication
practices have a high level of internal reporting quality? May some firms disclose quality
information without high levels of internal reporting quality? Do some firms have quality
internal reporting systems whilst not disclosing the information? Our purpose is to answer
these questions. We now present the methodology used in the current study.
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Finance researchers have often used the indexes (or scores) method to measure the
presence of items in a system (Raffournier, 1995; Meeks et al., 1995; Botosan, 1997; Ahmed
and Courtis, 1999; Prencipe, 2004). This method is therefore considered as a valid measuring
tool. It consists of a definition of a list of items selected according to their representativeness
of the system to be measured. The grade “1’”is attributed in the case that the item is relevant,
and “0” is attributed if not. After the systems have been assigned a grade, they can be
compared to one another. This also allows for the creation of groups and the testing of
variables in accordance with the grades received. In order to compare information disclosure
practices and internal reporting systems, both aspects have to be measured.
Concerning information disclosure practices, we will use the indexes suggested by
Meeks et al. (1995), Michaïlesco (1998) and Depoers (1999, 2000) by adapting them to our
context and to the new standards. We have identified a list of 65 items to measure the quality
of these practices. The items measure the previously mentioned main themes for quality
(extent, vectors and periodicity) and are selected according to the required qualities (see
section 2.1). The final number of items is not fixed a priori, and depends on the required
elements. For instance, to measure the type of disclosure, we have set up a list of six possible
vectors, each of which is an item.
To our knowledge, the indexes method has never been used to qualify internal reporting
systems. Thus, we would like to suggest a measure for the reporting system based on items
selected in accordance with the quality requirements mentioned above (see section 2.2). The
55 finally selected items measure reliability, representativeness, relevance and accessibility.
They are being selected in accordance with Table 1, which specifies the expected features for
each type of information. Considering the experimental aspect of the tool, this list of items has
been finalized in collaboration with management control and reporting
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professionals. The list
of items was presented to a sample of professionals, who amended the list by suppressing
irrelevant items or adding missing items according to their view.
These two indexes will now permit the measurement of the quality of reporting systems
and financial disclosure practices with regards to a sample of listed companies.
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The full list of items for each index is available upon request to the author.
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The adopted methodology is quantitative. It leads to the constitution of a sample of
contacts to whom the two questionnaires will be sent: one questionnaire concerns financial
disclosure practices and the other focuses on the characteristics of internal reporting systems
(refer to Appendix B and C).
To minimize the variances linked to different practices, and to ensure reliable data, we
have limited the population studied to the 250 largest French firms (except for the banking
and insurance sectors, which have different practices in terms of internal reporting) listed on
the 2005 Paris Stock Market (SBF 250 index). Previous studies have collected between 50
and 75 useful questionnaires, and thus we sent the two questionnaires to 150 randomly
selected firms, expecting a minimum of a one-third return rate.
In the end, 55 firms returned both questionnaires. The sample distribution by index and
branch of industry can be found in Appendix A, along with a list of participating firms. The
questionnaires were used to grade each criterion according to the answer received. In fact,
each question was specifically related to one item. According to the answer, the criterion on a
specific item was considered to be valid or not. The general method is as follows: for each
criterion, an answer is expected, and is attributed the grade “1” if the system or the practices
are in accordance with the criterion, or “0” if not. The grading is the result of a rigorous
process with few errors of judgement since only one person deals with all the questionnaires.
Furthermore, the highest grade possible varies between the firms: some criteria do not
apply to certain firms and are therefore removed from the maximum grade. This is in
accordance with Meeks et al.’s (1995) method.
We obtain the N grade with the following formula:
N =
NT
Ni
T
i
∑
=1
Where:
Ni = grade obtained by criterion i,
equal to 1 or 0
i = number of the item assigned with a
grade 1 to T value
T = number of the last item after
removal of criteria irrelevant to the firm
NT = amount of items assigned with a
grade
The grade obtained is a ratio value between 0 and 1. This grade has no value in itself; it
merely helps to differentiate the selected firms from one another in order to establish a sub-
category of samples whose main features will highlight the typologies.
However, the dichotomy of the system (0 or 1) makes significant the number of firms
conforming to the expected quality. For instance, a grade of 77.3% (or 0.773) obtained from
criterion number two indicates that 77.3% of the firms in the sample explain their
management methods in writing.
Considering the targets of the present study, we decided not to weigh this list of items.
Indeed, the list has to adapt to every firm and not to a particular user, and each criterion
participates equally in the definition of quality here. In addition, it has been suggested in
Meeks et al.’s work (1995) that companies who are better at disclosing “important” items are
also better at disclosing “less important” items. Moreover, the study by Chow and Wong-
Boren (1987) proved that the results vary slightly between lists of weighted or unweighted
items.
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To analyze the two sets of measures, we use some descriptive statistics to analyze each
of them separately. In order to highlight possible links between the variables, we use the
Pearson correlation test. Before any calculation, we systematically check with a scatter plot
whether or not a linear relationship exists between the two variables. The correlation
coefficient, r, is a scalar quantity in the interval [-1.0, 1.0], and is defined as the ratio of the
covariance of the sample populations to the product of their standard deviations. The
correlation coefficient is a direct measure of how well two sample populations vary jointly.
A value of r = +1 or r = –1 indicates a perfect fit to a positive or negative linear model,
respectively, such that if one variable is known, the second can be accurately predicted. It
consequently indicates a high degree of correlation.
A positive coefficient indicates that if one variable increases, the other increases also. A
negative coefficient indicates that, if one variable increases, the other decreases.
A value of r close to 0 indicates a poor fit to a linear model, and no relationship between
the two variables.
By using this test, we expect to answer our research question regarding the possible link
between a high level of internal reporting quality, and good communication practices.
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The firms can be ranked with the grade they have obtained for quality. The sample can
now be cut by the median, thus supplying two sub-categories of firms: the group of firms who
score above the median is considered to be in possession of quality management control
information (or quality financial disclosure practices); in comparison, the other firms possess
management control systems (or financial disclosure practices) of the lowest quality. By cross
checking both grading systems, we get four firm sub-groups: quality disclosure and quality
reporting, quality disclosure and poor reporting, poor disclosure and quality reporting, poor
disclosure and poor reporting.
As a means of control with regards to the obtained results, we decide to proceed to a
statistical cluster analysis. This procedure attempts to identify relatively homogeneous groups
of cases based on selected characteristics. In hierarchical clustering, an algorithm is used that
starts with each case in a separate cluster and combines clusters until only one is left. The
variables to be used for cluster formation here are the disclosure quality index, and the
internal reporting quality index. The variables are ordinal numbers between 0 and 1, with six
decimals. The cases are the 55 firms. The cluster method chosen is the between-group
linkage. Using the smallest average distance (measured here by the squared Euclidean
distance) between all group pairs, the two groups that are closest are combined. The process
continues until all cases are grouped into a large cluster.
The output of running hierarchical cluster analysis gives results very near to the ones
obtained by the use of the median cut, as we can see in the following section. Indeed, it
appears from Graph 1 that seven firms are not included in the same group, using either the
median or the cluster method.
From here, we can analyze in a descriptive manner the main features of each sub-group.
We can expect each sub-group to have different approaches to disclosure practices, and that
investors will, accordingly, be in a situation where they are more or less able to control and
manage their investment.
9
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The following graph shows the position of the cases according to the two axes quality of
reporting, and quality of disclosure. Each firm is placed according to its obtained scores. The
lines of both medians are indicated, constituting four sub-groups. On the same graph, the
curves show the four clusters obtained through the cluster analysis (dendogram shown in
Appendix D).
It is noticeable from the graph that only a few firms are placed differently, due to the
fact they are very near the median score. We can say that some of them are probably in a
hybrid position, either because their scores are near the median, or because they are on the
way to changing their practices.
Graph 1: Clusters overview
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The firms’ average IRS (internal reporting system) grade is 67.5% (ranging from 40.8%
to 88.2%).
Graph 2: Reporting system quality overview
0,687
0,594
0,656
0,715
0
0,5
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Reliability
Representativeness
Relevance
Accessibility
IRS general grade
0,675
0,30
0,40
0,50
0,60
0,70
0,80
0,40 0,50 0,60 0,70 0,80 0,90
0.6981
0.49230
8
A2
B1
B2
A1
10
The top priority for the firms in the sample is to ensure a good periodicity concerning
the local units’ information feedback to the head office, through integrated and interfaced
tools. They can then make sure that the information is reliable thanks to the implementation of
internal control procedures.
Firms are able to link strategy and control during the finalization stage (for instance
Strategy and Control Departments work in common, formulating an integrated plan and
budget, using indicators selected by the head office). But they find it hard to implement
strategic controls because they mostly choose financial indicators which do not allow them to
secure the parameters linked to the activity, and so the supervision of strategic control.
Finally, the differences between financial accounting and management accounting still exist
in many firms, so that the internal information is not sufficiently oriented on external needs.
Each firm is assigned with a grade, which allows us to classify them by the median of
the sample: above the median, they are assigned to group 1, named IRS+; below the median
they are group 2, named IRS-. We can comment on the analysis of the differences in the
firms’ characteristics as follows:
• The distribution by branch of industry does not highlight any fundamental
difference between the sub-groups. Unsurprisingly, the sectors are equally represented
on the whole, and there is apparently no reason that the industry branch affects the
quality of the internal management accounting system.
• Size variables, however, indicate that internal information of better quality
predominates for big companies (Student Test’s comparison of averages for both
groups 1 and 2 are significant at the level of 6%): 12 out of 14 firms from the CAC40
Index (the forty most capitalized firms) belong to group 1, whose average turnover is
9,452 million euros compared to 3,545 millions euros for group 2.
• The “floating” variable, representing the shareholder percentage belonging to
the public (including institutional investors to the exception of those possessing a
capital percentage above 5%), indicates that the percentage of public shares are more
important for group 1. The T test confirms these observations at the level of 1%.
• Consequently, the grades assigned to group 1 are on average higher for each
quality criterion, with the highest grade having been assigned to reliability, which is
significantly higher than the grade given to group 2.
These last observations enable us to more closely analyze the differences that exist
between both groups regarding the grading assigned, in order to highlight certain
characteristics relative to each sub-group.
Graph 3: Comparison of reporting system quality between IRS+ and IRS-
0,000
0,200
0,400
0,600
0,800
1,000
Reliability Representativeness Relevance
A
ccessibilit
y
IRS+
IRS-
11
Two types of reporting can be identified:
The reporting system of the firms belonging to group 1 can be defined as dynamic:
the system facilitates interactions between the head office and the operational levels; it is a
communication tool made to convince; it is a management tool as it comprises specific
indicators, linking strategy and operations together, and is defined in association with the
operational managers. This reporting is considered as being more relevant because it includes
information giving a representative and relevant view of the activity. Furthermore, emphasis
is put on reliability (development of written procedures, implementation of internal control
processes and uniqueness of information). Finally, periodicity and information reporting
deadlines concerning the firms in this sub-group are much shorter.
The reporting system of the firms belonging to group 2 can be defined as static: this
suggests a weaker interaction between the head office and the operational levels, with
reporting being perceived as a performance check tool, including a majority of classic
financial indicators that are mostly managed and calculated by management controllers. The
periodicity and information reporting deadlines are a matter of control rather than
management.
The better the internal reporting quality is, the better the quality of the disclosure should
be. The analysis will continue by focusing on the grading of financial disclosure practices.
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The firms from the selected sample have been assigned with the average grade D
(disclosure) of 49.8% (ranging from 30.6% to 76.9%).
With regards to Graph 4, the firms in the sample generally use the vectors at their
disposal. If they comply with international standards by actively disclosing the usual financial
and strategic information, they are much more reluctant to release voluntary information such
as segment information (which international standards made mandatory), forecast information
or non-financial information, as shown by the grades obtained for these criteria. The
periodicity and disclosure deadlines do not meet the investors’ expectations, even though
these deadlines remain shorter than the legal ones. This shows that the public disclosure’s
orientation is mainly conformist.
However, the firms are willing to provide complementary information in private, as well
as any other element that could help to explain the publicly disclosed figures. This suggests
that management control information is more likely to be exchanged in private, even if private
and public communication work together, as Holland’s (1998) study results showed.
12
Graph 4: Overview of the quality of financial disclosure practices
The results are nonetheless contrasted when we look closely at both group practices
provided by the sample median: the ones that score above the median are classified in group
A, entitled D+; the ones below the median of the sample in group B are entitled D-.
The characteristics of the classifications can be explained as follows:
• Just as before, the distribution by branch of industry does not highlight any
fundamental difference between the sub-groups. Again, unsurprisingly, the sectors are
equally represented on the whole and there is apparently no reason for industry branch
to be considered a key variable with regards to the quality of information disclosure.
• Size variables, however, indicate that publicly disclosed information of better
quality predominates for big companies, (Student’s test of comparison of average for
both groups A and B is significant at the level of 3%).
• Contrary to the results regarding the internal information, the “floating”
variable is not significant at the usual level of the Student’s test, although it is higher
on average for sample A firms.
• Consequently, the grades assigned to group A are on average higher for each
quality criterion, yet we can notice that the highest quality grade concerns non-
mandatory information.
Graph 5: Comparison of financial disclosure practices between group D+ group and D-
The groups cannot be differentiated through general and financial information, or with
reference to public disclosure vectors: the firms, even those who communicate the least, use
new media.
Both new sub-groups can be defined as follows:
0,000
0,100
0,200
0,300
0,400
0,500
0,600
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Vectors
General
information
and
procedures
Financial
information
Non
Financial
information
Forecast
information
Segment
information
General
and Strategic
information
Explanation
of the results
Periodicity
and deadlines
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D-
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Vectors
General
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and procedures
Financial
information
Non-financial
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Forecast
information
Segment
information
General and
strategic
information
Explanation
of the results
Periodicity and
deadlines
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Reluctance to
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and especially
forecast
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13
The financial disclosure practices of group A firms can be defined as voluntary
and active. The nature of the publicly-disclosed information indicates that the firms are
willing to keep their shareholders well informed: they disclose non-financial information
(59%), forecast information (15%) and segment information (40%). They use diversified
vectors of disclosure, including private ones. Firms express a desire to explain information,
help interpret the results, and share a common vision by holding private or one-to-one
meetings and site visits. Lastly, firms following these practices accept voluntary disclosure
(within 30 days) along with frequent meetings. In addition, 26% of firms disclose quarterly
results. Communication is perceived as an exchange between investors and general managers.
The second type (group B) of public disclosure can be defined as conformist and
goes along with private communication practices, which at best can be considered
passive, and at worst secretive. This group is characterized by permanent secrecy regarding
the extent of information disclosed (this is mostly mandatory information; 35% disclose non-
financial information, only 7% disclose forecast information and 16% disclose segment
information). The public means of disclosure are limited and the deadlines for results
availability are usual (60 days).
In the case of passive and private communication, the results are reluctantly explained
and questions barely answered: the attitude is more in line with conforming to best practices.
Firms regard communication as a compulsory step to winning the market’s favour. Private
and secret disclosure reflects a withdrawn attitude characterized by the release of minimum
information, and fear of competitors: indeed, minimum compulsory meetings are being
organized. In other words, communication is perceived as a constraint.
We can draw a parallel between this typology and Gibbins et al.’s, (1990), which
opposes opportunistic disclosure (taking into consideration the advantages that disclosure can
bring) and ritualistic disclosure (wishing to meet the standards). The results are also similar to
those identified by Holland (2005).
Active and voluntary communication happens to be the qualities required by
shareholders regarding disclosed information. This explains why the firms included in this
sub-sample are likely to publicly disclose information of a better quality, management
information in particular, considering the previously selected criteria.
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Graph 1 showed that the two sets of variables do not seem to be correlated. The
calculation of the correlation coefficient is 0.38, with a significance level at 0.32, which
indicates a very low correlation. This is the first important result: an internal reporting of
quality does not necessarily enhance good communication practices. Similarly, a reporting of
poor quality does not necessarily mean bad communication practices.
If we consider each sub-group separately, we can expect better correlations between the
two variables. The calculation of the correlation coefficient for each sub-group brings the
following results:
Table 2: correlation between A1/A2/B1/B2
A1 : IRS+ / D+ A2 IRS- / D+ B1 IRS+ / D- B2 IRS- / D-
R 0.13 0.47 -0.08 0.37
Degrees of
freedom
13 10 10 14
Significance 0.32 0.6581 0.6581 0.5742
Probability 0.01 0.01 0.01 0.01
14
The two sets of variables appear to be uncorrelated in the four sub-groups. This may
indicate that the sub-groups are too small for the results to be significant. It can also be noted
that the indexes are complex, and have to be analyzed more deeply.
As we assume an internal reporting of quality should lead to good communication
practices, and vice versa, we should be able to find correlations between the variables of A1
and B2 when put together. Similarly, the variables of A2 and B1 together should be
negatively correlated. From the calculation, we obtain the following results:
Table 3: correlation between A1B2/A2B1
A1 : IRS+ / D+
B2 IRS- / D-
A2 IRS- / D+
B1 IRS+ / D-
R 0.83 -0.57
Degrees of
freedom
29 22
Significance 0.4093 0.4921
Probability 0.01 0.01
This is the second important result. In the first sample, the better the quality of the
internal reporting is, the better the communication practices firms have. On the contrary,
reporting of poor quality is associated with limited communication practices.
In the second sample, on the contrary, a reporting of quality does not mean that firms
communicate this information externally – in this instance, firms provide poor-quality
disclosure. Similarly, firms may have good communication practices despite poor internal
reporting quality. The two variables are negatively correlated.
The relationships seem to be more complex than expected; this suggests a need to
follow the analysis a little further. Thus, the constitutive elements of each score are analyzed
more deeply as follows.
First, the internal quality of relevance and representativeness is compared to the
disclosure of voluntary information (non-financial information, forecast information and
segment information). This leads to new scores, to which the correlation test is applied. From
the calculation, the following results are seen:
Table 4: correlation between relevance of the reporting and voluntary disclosure
A1: relev. + / vol. discl. +
A2: relev. - / vol. discl. -
B2: relev.- / vol. discl. -
A1: relev. + / vol. discl. +
B2: relev.- / vol. discl. -
A2: relev. - / vol. discl. -
B1 relev.+ /vol. discl.-
R 0.69 0.70 0.08
Degrees of
freedom
31 29 22
Significance 0.4093 0.4093 0.4921
Probability 0.01 0.01 0.01
It appears that, despite good results in communication practices, due to good scores in
terms of vectors used and deadlines, A2 firms may be compared to B2 firms in terms of poor
quality in voluntary disclosure. Indeed, A2 firms provide poor internal reporting information
in terms of relevance, and do not allow for the disclosure of voluntary information. This is the
third important result. In contrast, it appears here that good communication in terms of
content (presence of voluntary information) is possible if the internal reporting is of a good
quality in terms of relevance (group A1).
15
The A2B1 firms both exhibit poor quality of voluntary information disclosure.
However, A2 firms do not provide relevant information in their reporting, while B1 firms
have this information but do not disclose it. This is why the variables of relevance and
voluntary information disclosure are independent in A2B1.
We then try to find links between internal quality of relevance and private disclosure
quality. This score includes vectors of communication, content and periodicity and deadlines.
Proceeding to the calculation, the following results are obtained:
Table 5: correlation between relevance of the reporting and private disclosure
A1: relev. + / private discl. +
B2: relev.- / private discl. -
A2: relev. - / private discl.+
B1 relev.+ / private discl.-
R 0.62 -0.71
Degrees of
freedom
29 22
Significance 0.4093 0.4921
Probability 0.01 0.01
Analysing A1 and B2 together confirms the former results: the quality of private
communication increases with the quality of reporting.
For the second sub-sample, a negative correlation is found, meaning that relevant
information may not be disclosed even in private meetings, while a good score in private
disclosure is possible even with poor internal reporting quality.
Finally, we compare the quality of accessibility of the internal reporting, and the
deadlines of the external communication. The correlation test gives a 0.57 score on the sample
as a whole, which indicates that the better accessibility score is, the shorter the deadlines will
be for the external communication.
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By intersecting both typologies, we formed a matrix and created four sub-groups. From
the correlation analysis, some links between variables – or lack thereof – have been
highlighted. Our findings are synthesized in Table 6. The existence of distinct groups formed
by measuring the quality of practices suggests different potential uses for the information.
16
Table 6: Typology of practices from the investor’s perspective
Analyses and interpretations
A1: Voluntary (0.59) and
active (0.64), dynamic (0.77):
the “virtuous”
Large firms with majority
scattered shareholding
Thanks to the relevance and reliability of the reporting
information, the financial communication is of high quality, either
in terms of content or vectors.
There is a willingness to communicate and/or the investor is
influential; the external orientation of the internal reporting
system enables the investor to have the expected information
at his disposal: numerous vectors of disclosure are used, and
voluntary extent is supported by information coming from internal
reporting whose information is reliable and relevant. The
deadlines are voluntarily established. We can expect the
information quality to positively influence the decision-making
process.
B1: Passive (0.47) and
conformist (0.45), dynamic
(0.75): the “secretive”
Medium-sized firms with
majority scattered shareholding
The reporting information is relevant and reliable, yet the
unwillingness to disclose management control information and the
restrictions on exchange periods illustrate the low quality of the
financial communication.
There is a culture of secrecy; willingness to communicate is
obviously nonexistent. The information exists internally but is
not disclosed. The determinants for non-disclosure are still to
be found out.
A2: Voluntary (0.54) and
active (0.60), static (0.60):
The “illusionists”
Medium-sized firms with
minority scattered shareholding
The reporting information is less relevant, yet this does not
discourage the firms from willingly communicating, as shown by
the use of many private and public vectors of disclosure, even
though the extent is of lower quality. The results in terms of
deadlines and periodicity are generally good.
The firms are ready to communicate, or wish to be conformist,
but danger lies in the potential for incorrect interpretation or
incomplete analyses, since the internal reporting lacks
relevance. Communication is constrained by the internal
system, probably by internal management (unwillingness to set
up strategic controls for the whole company).
B2: Conformist (0.42) and
passives (0.42), static (0.58):
The “indifferents”
Small firms with minority
scattered shareholding
Public disclosure of mandatory information is prevalent and
communication is perceived as a constraint: the results are bad in
terms of deadlines, poor voluntary information, few private
exchanges, and poor content, frequency and means of exchange.
It is likely that the prevalence of concentrated shareholding
does not urge external communication or influence the
reporting system to that end.
17
Figure 1: Typology of disclosure and reporting practices
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This study is a first step towards opening the “black box” of the construction of
financial disclosure. It shows the complexity of interactions between internal reporting
systems and financial communication practices.
By measuring the quality of internal reporting and communication practices, we
expected to uncover a link between them: a firm disclosing information of quality should
necessarily issue it from an internal reporting system of quality. In the end, however, this is
true for only some firms and we highlighted four different cases. To be in the situation
whereby quality disclosure and quality internal reporting systems are both present, it is
necessary for managers to intend to produce a disclosure of quality, urging them to improve
their internal reporting systems. Managers may find external disclosure too costly, however,
even when the information is in place internally. The explanatory factors for such an attitude
were not revealed by the present study. For the third category of firms, the disclosure seems to
be of a high quality, when in fact this is the case only for the large vectors used, either public
or private; the content remains very poor, due to a poor level of internal reporting. The fourth
group of firms seems to be indifferent to producing a disclosure of quality, and therefore do
not feel a need to improve the quality of their internal reporting. This study increases our
understanding of the way firms manage to deal with disclosure of information to investors,
with regards to the internal information at their disposal.
This research makes a contribution to the academic fields of finance and management
control. First, it allows us to confront two pieces of information that are generally dealt with
in a dichotomous manner by researchers – internal information on one hand, and disclosed
information on another hand; second, the method used comes from the field of finance, but it
Static
reporting
Conformist
and passive
disclosure
Voluntary
and active
disclosure
“Virtuous” firms
“Illusionist” firms
“Secretive” firms “Indifferent” firms
Dynamic
reporting
18
is used here to grade an internal management tool, which has never been done before. This
method could be reproduced by control researchers for other purposes.
This research contributes to the visions of practitioners as well. It shows that the
information has to exist within the internal reporting system if the manager wants to disclose
it. This urges the financial controller to pay close attention to the needs of the financial
markets, and be able to answer the specific requirements. On the other hand, large firms,
generally with a majority of floating shareholders, are urged to improve their financial
communication in order for their investors to understand them better and not be unpleasantly
surprised by the emergence of previously undisclosed information.
These findings raise questions for future researchers. First of all, we only establish links
between variables, and the present work did not allow for any investigation relating to
causality. A reporting of good quality seems to facilitate good communication practices, but
we could say that good communication practices develop the quality of reporting. Secondly,
we were not able to confirm the reactions of investors according to the quality of the
combined reporting and disclosure. This could be done by testing the investors’ expected
reactions with relation to each sub-group. When the information is of quality, the market is
expected to react positively, thus proving that the information is understood and integrated.
As a third point, the methodology did not allow for a deep exploration of how the voluntary
information, such as non-financial indicators, is used in private exchanges between investors
and managers. Finally, it would be interesting to bring to light the determinants of the non-
disclosure of quality internal information.
19
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22
APPENDIX A: Data on the sample
Table A1: Distribution of the sample by index
Classification by
index
% in relation
to the total
number of
SBF 250 firms
Number of firms
of the sample to
contact
Number of firms
that replied
(useful sample)
% in
relation
to the
total
number
of the
sample
Reply rate
CAC 40 index 15.6% 23 firms 11 firms 20% 47.8%
CAC Next 20 index 7.3% 11 firms 3 firms 5.5% 27.3%
MID100 index 40.0% 60 firms 24 firms 43.6% 40%
SMA 90 index 37.1% 56 firms 17 firms 30.9% 30.4%
Total 100.0% 150 firms 55 firms 100% 36.7%
Table A2: Distribution of the useful sample by branch of industry
Classification by branch
of industry
Number of firms in
the useful sample
% in relation
to the total
number in the
useful sample
% of the total
number of the
sample to contact
% in relation to
the total number
of the population
Energy 3 firms 5.5% 2.0% 1.%
Chemicals 2 firms 3.6% 2.0% 2.6%
Construction and
building materials
6 firms 10.9% 6.0% 5.3%
Wood, paper, Steel 0 firm 0% 2.0% 1.8%
Industrial equipment 6 firms 10.9% 8.0% 6.4%
Engineering 1 firm 1.8% 1.3% 4.6%
Aeronautics,
automotive
4 firms 7.3% 6.7% 4.8%
Textile, clothing,
leather
0 firm 0% 2.% 4.2%
Mass market and small
Equipment
1 firm 1.8% 3.3% 6.2%
Food-processing 3 firms 5.5% 6.7% 7.9%
Healthcare and
pharmaceuticals
2 firms 3.6% 11.3% 7.7%
Retail and business 4 firms 7.3% 7.3% 6.8%
Hotel, catering, leisure 3 firms 5.5% 3.3% 3.5%
Publishing, press,
communications
2 firms 3.6% 6.0% 5.9%
Business and
individuals services
6 firms 10.9% 11.3% 6.4%
Transport 2 firms 3.6% 3.3% 3.7%
IT and
telecommunications
10 firms 18.2% 16.7% 20.7%
23
Table A3: List of firms in the useful sample
Name Index Branch of industry
Air Liquide
CAC 40 Chemicals
Bouygues
CAC 40 Construction and building materials
Danone
CAC 40 Food processing
Eads
CAC 40 Aeronautics, automotive
Essilor Intl.
CAC 40 Healthcare, pharmaceuticals
Peugeot
CAC 40 Aeronautics, automotive
Renault
CAC 40 Aeronautics, automotive
Saint Gobain
CAC 40 Construction and building materials
Schneider Electric
CAC 40 Industrial equipment
Stmicroelectronics
CAC 40 IT and telecommunications
Vivendi Universal
CAC 40 Publishing, press and communications
Business Objects
CAC next 20 IT and telecommunications
Sodexho Alliance
CAC next 20 Business and people services
Technip
CAC next 20 Energy
Alstom
Mid 100 Industrial equipment
Altran Techn.
Mid 100 IT and telecommunications
Areva Ci
Mid 100 Business and individuals services
Bonduelle
Mid 100 Food processing
Ciments Francais
Mid 100 Construction and building materials
Club Mediterranee
Mid 100 Hotel, catering, leisure
Eurazeo
Mid 100 Industrial equipment
Eurotunnel Unit
Mid 100 Transport
Faurecia
Mid 100 Aeronautics, automotive
Fimalac
Mid 100 Business and people services
Galeries Lafayettes
Mid 100 Retail, business
Remy Cointreau
Mid 100 Food processing
Sopra Group
Mid 100 IT and telecommunications
Alain Afflelou
Mid 100 Retail, business
Alpes
Mid 100 Hotel, catering, leisure
Bollore Invest.
Mid 100 Transport
Bull
Mid 100 IT and telecommunications
Esso
Mid 100 Energy
Gl Trade
Mid 100 IT and telecommunications
Groupe Bourbon
Mid 100 Energy
Kaufman And Broad
Mid 100 Construction and building materials
Manitou Bf
Mid 100 Industrial equipment
Manutan Intl.
Mid 100 Business and people services
Toupargel-Agrigel
Mid 100 Retail, business
Apem
Sma 90 Industrial equipment
24
Name Index Branch of industry
Buffalo Grill
Sma 90 Hotel, catering, leisure
Cegid S.A.
Sma 90 IT and telecommunications
Delachaux
Sma 90 Engineering
Exel Industries A
Sma 90 Industrial equipment
Groupe Guillin
Sma 90 Chemicals
High Co.
Sma 90 Publishing, press and communications
Mr Bricolage
Sma 90 Retail, business
Neurones
Sma 90 IT and telecommunications
Prosodie
Sma 90 Business and people services
Radiall
Sma 90 IT and telecommunications
Sii
Sma 90 IT and telecommunications
Skis Rossignol
Sma 90 Mass market small equipment
Stallergenes
Sma 90 Healthcare, pharmaceuticals
Synergie
Sma 90 Business and people services
Thermador Groupe
Sma 90 Construction and building materials
Vm Materiaux
Sma 90 Construction and building materials
25
APPENDIX B: List of themes addressed in the questionnaires
Characteristics of the internal reporting systems
• The relationship management control/strategy in terms of planning and budget
construction, indicators selection and strategic control.
• The general types of information included within the reporting.
• The local/central relationship, in terms of indicators used on both sides in order
to communicate strategically and operationally between both levels.
• Differences between general accounting and management control accounting.
• Differences between internal information and the information intended to be
disclosed, or external information.
• Methods and internal control procedures
• Quality of forecasts.
• Periodicity of the information reporting from base to summit.
Regarding the public and private disclosure practices
• The means used to communicate.
• The nature of the disclosed information.
• Explanation of the results.
• Completeness and clarity of the disclosed information.
26
APPENDIX C: Extracts of some of the questions addressed in
the questionnaires
Part 1: Questionnaire regarding the quality of internal reporting
Q1.2 Internal reporting information system: links between Strategy
and Management Control departments
1.2.1 Strategy and Management Control departments work together to formulate
strategic plans and budgets.
True ○ False ○
1.2.2 When formulating strategic plans, each business unit within the firm
elaborates its own strategy with input from all of the actors in the business unit.
True ○ False ○
1.2.3 In budget meetings, the business units’ point of view prevails over the general
management’s.
True ○ False ○
1.2.4 Long-term objectives are not converted into medium and short term
objectives.
True ○ False ○
1.2.5 The first year of the strategic plan is budget year.
True ○ False ○
1.2.6 No general objectives are given to any business unit during the budget-
formulation process; each business unit gives its own forecasts independently of the
group’s objectives.
True ○ False ○
1.2.7 Qualitative and quantitative indicators are in place within the group reports,
and this allows for management of the strategy adopted by the group.
True ○ False ○
1.2.8 The indicators existing in the reports are chosen by the general management.
True ○ False ○
1.2.9 Strategic control is formalized: each objective is managed with an indicator,
and this indicator is regularly checked.
True ○ False ○
1.2.10 Each report is followed by meetings wherein the results are discussed.
True ○ False ○
27
Part 2: Questionnaire regarding the quality of communication practices
Q2 Public voluntary disclosure to shareholders.
Q2.1 Public disclosure vectors.
Among the following disclosure vectors, please tick the ones you use to communicate
with your shareholders
2.1.1.4 Internet
Please specify:
Q2.2 Items listed in quaterly or bi-annual disclosures
Among the following items, please tick the ones you disclose via any of the
previous vectors
2.2.1 General information on methods and procedures
2.1.1.1 Mention of the referentials used
2.1.1.2 Mention of the principles and procedures used
2.1.1. 3 Explanations linked to the consolidation perimeter
2.2.2 Financial and accounting information disclosed
2.2.2.1 Profit and loss account
2.2.2.2 Details of operating expenses
2.2.2.3 Details of R&D expenses
2.2.2.4 Cash position
2.2.2.5 Cash flows
2.2.2.6 Balance sheet or balance sheet elements (for example investments)
2.1.1.1 Compulsory legal announcements
2.1.1.5 Financial advertising
2.1.1.6 Other
2.1.1.2 General shareholders’assembly
2.1.1.3 Press communications
28
APPENDIX D: Results of the cluster analysis
Rescaled Distance Cluster Combine
C A S E 0 5 10 15 20 25
Label Num +---------+---------+---------+---------+---------+
CIMENTS FRANCAIS 19 ─┐
STALLERGENES 52 ─┤
BUSINESS OBJECTS 12 ─┤
BULL 31 ─┤
APEM 39 ─┼───┐
BONDUELLE 18 ─┤ ├─┐
GALERIES LAFAYETTE 25 ─┘ │ │
CLUB MEDITERRANEE 20 ─────┘ │
AIR LIQUIDE 1 ─┐ ├─────────────────────┐
REMY COINTREAU 26 ─┼─┐ │ │
SCHNEIDER 9 ─┘ │ │ │
EUROTUNNEL UNITS 22 ─┐ ├───┘ │
THERMADOR GROUPE 54 ─┤ │ │
FAURECIA 23 ─┼─┘ │
MANUTAN INTL 37 ─┤ │
ALTRAN TECHN. 16 ─┤ │
EXEL INDUSTRIES A 43 ─┘ │
SOPRA GROUP 27 ─┐ │
ALAIN AFFLELOU 28 ─┤ ├───────────────────┐
CEGID S.A. 41 ─┤
│ │
BOLLORE INVEST. 30 ─┼───┐ │ │
EURAZEO 21 ─┤ │ │ │
RADIALL 49 ─┤ │ │ │
MANITOU BF 36 ─┤ │ │ │
GROUPE GUILLIN 44 ─┘ ├───────────┐ │ │
BOUYGUES 2 ─┐ │ │ │ │
SYNERGIE 53 ─┼─┐ │ │ │ │
SKIS ROSSIGNOL 51 ─┘ ├─┤ │ │ │
FIMALAC 24 ─┐ │ │ │ │ │
PROSODIE 48 ─┼─┘ │ ├───────────┘ │
BUFFALO GRILL 40 ─┘ │ │ │
ESSO 32 ─────┘ │ │
STGOBAIN 8 ─┐ │ │
VM MATERIAUX 55 ─┼───┐ │ │
DELACHAUX 42 ─┘ │ │ │
HIGH CO 45 ─┐ ├───────────┘ │
NEURONES 47 ─┤ │ │
ALPES 29 ─┼───┘ │
GROUPE BOURBON 34 ─┤ │
SII 50 ─┤ │
GL TRADE 33 ─┘ │
STMICROELECTRONICS 10 ─┐ │
TOUPARGEL-AGRIGEL 38 ─┼─┐ │
VIVENDI 11 ─┘ ├─┐ │
DANONE 3 ───┘ ├───────┐ │
TECHNIP 14 ─────┘
│ │
ESSILOR 5 ─┐ │ │
PEUGEOT 6 ─┼─┐ │ │
ALSTOM 15 ─┘ ├─┐ ├───────────────────────────────────┘
SODEXHO ALLIANCE 13 ─┬─┘ │ │
AREVA CI 17 ─┘ ├─┐ │
EADS 4 ─┬─┐ │ │ │
RENAULT 7 ─┘ ├─┘ ├─────┘
MR BRICOLAGE 46 ───┘ │
KAUFMAN ET BROAD 35 ───────┘
A1
B1
A2
B2
