the Voluntary Financial Disclosures

The aim of this paper is to understand the general characteristics of a voluntary disclosure based on its economic position, hypotheses used in the literature to characterize voluntary disclosure, determinants of voluntary disclosure, and large sources for disclosure of optional information. Legitimacy theory, capital need theory, signaling theory, and organization theory are all standard arguments associated with voluntary disclosure in the literature. Voluntary transparency is determined by either contracts or motivations. Finally, various sources of dissemination of optional information are explored, elaborating on whether their annual results are the most trusted source of information. Additionally, the paper offers a short overview of various parties with interest in voluntary disclosure such as Scholars and practitioners. Scholars would benefit from this work while developing studies of voluntary disclosure. Practitioners would possibly get a better understanding of the behavior of companies towards increased or decreased voluntary disclosure of information

Key words: disclosure, voluntary, legitimacy theory, capital need theory, agency theory.

Voluntary Financial Disclosures

Disclosure and transparency constitute the foundations of company governance. Various misconducts have happened globally because of improper or lack of company disclosures. Multiple stakeholders use company disclosure in the process of decision making. Disclosure is described in accounting terms as “revealing financial statements of the company to the public” (Peterson & Fabozzi, 2012). Another definition of disclosure is “the submission of financial or non-financial economy positions, either in quantitative form or otherwise, regarding a firm’s performance and financial position” (Peterson & Fabozzi, 2012). Company disclosure is classified into two broad categories, namely, mandatory, or necessary, and voluntary. On one side, necessary disclosure comprises of information revealed to comply with the rules and regulations of the law. On the other side, voluntary disclosure consists of any information shown further to mandatory disclosure. Furthermore, part of the voluntary disclosure may be the recommendation from an official code or body.

Most of the literature regarding voluntary disclosure in accounts takes into considers the commercial versions of exposure by seeking to match financial information to the results in the economy Debt-collectors, shareholders, and investors are entrepreneurs who want to be careful when making investments. Nevertheless sometimes the asymmetrical nature of information makes linking savings to investment opportunities difficult, when proprietors get better and more information regarding companies than savers. Consequently, the agency problem occurs. When people invest, they delegate their authority to make decisions to business people and do not actively participate in the management of the business. Alleviating the problem of agency can be tried via optimal contracting in domains like agreements of compensation that assist in matching the interests of the entrepreneurs with those of the investor. The existence of company’s board of directors, who ought to be functioning separately from management and also supervise the managers of the company, is a likely solution to the problem of agency (Peterson & Fabozzi, 2012).The problem of agency can also be solved by the available financial analysts who inform of any misappropriation of a company’s resources by supervisors. Rules regarding business disclosure` aim at offering investors with the least amount of details which can allow the efficient making of decisions about investment. Information is conveyed to investors either directly or through financial press releases and reports, or indirectly through intermediaries of details like banks or business analysts. It has been observed that managers ought to voluntarily reveal information, which would fulfill the requirements of certain stakeholders regarding the business’ sustainability over an extended period. The managers should also provide information about agency disputes between investors and mangers as well as reducing data on asymmetry. This paper aims to highlight the theoretical context of voluntary disclosure based on the standard theories, often applied in literature to describe voluntary disclosure, what determines it, and the conventional sources of information of voluntary disclosure.

Literature Review

Specific approaches have been observed via literature to describe practices of voluntary disclosure. These include legitimacy theory, capital need theory, signaling theory, and agency theory (Hung, 2015).

Agency Theory

According to Hung (2015), the relationship of agency is a contract, in which one or more individuals, known as the principal, interact with another individual, identified as an agent, to undertake some work on their behalf. It involves delegating some authority for making decisions to the agents. The principal represents shareholders based on the firm’s perspective, while the agent represents managers. Costs of the agency are derived from the presumption that both the principal and agent have conflicting interests. The expenses of monitoring are provided by shareholders and principals to reduce the agent’s abnormal activities. Cost of bonding is provided by managers and agents to ensure that no destruction of the interests of the principal will come from their actions and decisions. Lingering loss happens when the agent’s decisions differ from decisions aimed at maximizing the welfare of the principal. Therefore, cost of agency is a total of the residual loss, bonding cost, and monitoring cost. The relationship of the body results in the asymmetry problem of information because managers have greater access to information, unlike the shareholders. Hung (2015) suggests that one way of mitigating the question of agency is optimal contract, since it assists in matching the objectives of the shareholders with those of the managers. Additionally, the voluntary disclosure also helps to mitigate the problem of agency, where managers reveal more information voluntarily decreasing the costs of body and even to persuade the outside users that the actions of the manager are optimal. Lastly, regulations can also be used to mitigate the problem of the agency because they need managers to provide private information wholly. Nonetheless, complete disclosure is not always possible even in existence of regulations. The lack of full disclosure id due to the dispute that is present between interests of the shareholders and managers. Also, company reporting rules are aimed to offer investors with the least amount of information that assists in the process of decision making.

Signaling Theory

The first aim of developing signaling theory was to shed light on the asymmetry of information within the labor market. However, it has been useful in explaining voluntary disclosure in company reporting. Due to the problem of information asymmetry, some information to investors to indicate that their performance beats other firms in the market with the aim of improving a favorable status and attracting investors. Voluntary disclosure constitutes one of the ways of signaling, where corporates would reveal further information besides the mandatory ones needed by rules and regulations to prove their worthiness (El-Bannany, 2013).

Capital Need Theory

Firms purpose to attract finance from outside to add onto their capital, either through equity or debt. The theory of capital needed states that voluntary disclosure assists in getting the firm’s need to increase wealth at an affordable cost (Hung, 2015). In 2001, reports published by the Financial Accounting Standards Board by the ”Improved Business Reporting” research body indicated that competition for capital is responsible for higher voluntary disclosure (El-Bannany, 2013). This assertion implies that a firm’s cost of capital is assumed to add a surcharge for investors’ doubt regarding the accuracy and adequacy of the existing information about the firm. Hence, the company achieves a reduction in the cost of capital when investors can interpret the firm’s economic potential via voluntary disclosure. The association between the cost of capital and voluntary disclosure was believed to be a positive one based on the fact that a higher information disclosure leads to lower prices for money. Nevertheless, other studies suggest that some forms of exposure might produce the opposite impact.

Legitimacy Theory

The legitimacy theory presumes that a firm should not exist except if its benefits are seen as corresponding to the society it serves (Hung, 2015). Therefore, the concept of legitimacy theory is similar to a social agreement between the firm and the community. Because accounting aims to offer users with information to assist in making decisions, accounting studies have incorporated the theory as a way of answering how, when, why questions on some items that are handled by company management within their interaction with outsiders. Because the theory of legitimacy is founded on the perception of society, the administration is compelled to reveal information that would transform the opinion of external users regarding the firm. The annual report has been identified as a significant source of being lawful.

Determinants of Voluntary Disclosure

Earlier research classifies the aspects influencing the decisions of managers to perform voluntary disclosure among constraints and motivations (Jones & Ratnatunga, 2012). Restraints of mandatory disclosure motivate voluntary disclosure, management talent signaling, increased analyst coverage stock compensation, and corporate control asset as well as asymmetry information in capital markets. Voluntary disclosure is constrained by political costs, agency costs, proprietary costs and disclosure precedent.

Motivations to Voluntary Disclosure

Transaction of capital market motivates voluntary disclosure. When the manager of a company plans to give new capital via debt or equity, the investor’s perception towards the asymmetry of information between outside investors and the manager requires being minimized. Voluntary disclosure of information assists to reach this goal, where a decrease in the asymmetry of information may happen, when there is an increase in voluntary disclosure to external investors.

Another motivation is corporate control contest. The likelihood of a company’s investment below intrinsic value is an additional motive for leaders increase voluntary disclosure to decrease such a possibility, mainly when stock performance and poor earnings might result into the risk of losing employment (El-Bannany, 2013). Consequently, leaders enhance the disclosure of information with the aim of preserving control of the company, to clarify the causes of poor performance and decrease reducing the likelihood of stock undervaluation of the company.

Remunerating leaders with compensation plans like stock option rights and capital appreciation is also a motive for higher voluntary disclosure of information. Two reasons justify this motivation. First, leaders will own incentives to limit costs of contracting related with compensation of stock for new workers when they perform in favor of the interests of the current shareholders. Second, when leaders have interest in selling their shares, they will be inspired to reveal private information to fulfill the restrictions of rules of insider trading and rectify any perceptions of undervaluation before the deadline of awards of the stock option (Jones & Ratnatunga, 2012).

A higher voluntary release of information reduces the costs of acquiring information by analysts because private information of the management is not thoroughly needed by mandatory disclosure. More analysts would want to follow the firm due to the additional information provided voluntarily.

Talent signaling in management is another motivation for voluntary disclosure.

The investors would wish to not only observe the manager’s ability to foretell the future changes in the economic world, but also his readiness to respond to the factors influencing the market value of a firm. Hence, managers who are talented freely provide information regarding earnings predictions to disclose their talent. Hung, (2015) argues that leaders restrict information disclosures which regulators may use against them.

Restrictions on the mandatory disclosure have a positive effect on the motive towards voluntary disclosure. Laws and regulations do not often fulfill the requirement of data by investors via required disclosure since most of the time laws and regulations offer investors with the least amount of information which assist in the process of decision making; there arises the need for voluntary disclosure. Therefore, voluntary disclosure is seen as bridging the gaps left by mandatory disclosure.

Constraints of Voluntary Disclosure

Certain elements limit or discourage managers from voluntarily providing company information. Setting a precedent of disclosure constitutes one aspect that decreases voluntary revelation of information because it implies that leaders need to preserve the same trend in the future, although it may be challenging to maintain (Jones & Ratnatunga, 2012). Furthermore, the market would anticipate the firm to devote to the submission of additional and preserve them whether it is good or bad news. It offers motivation for leaders to decrease voluntary exposures.

Proprietary costs are constraints to voluntary submission of financial information. Proprietary information is any information whose revelation is likely to change a firm’s earnings in the future gross of the compensation of senior management inclusive of information that is likely to reduce client’s demand for firm’s products (Jones & Ratnatunga, 2012). Therefore, managers prefer to hide information that may influence the competitive state of their business in the market despite its contribution to increased capital costs. Proprietary costs act as the competitive advantage. The management can be anticipated to reveal aggregate information on performance when the performance of the company differs across its sectors. However, companies with such reducing profitability across its segments will provide more sector information.

Issues of the agency regarding costs are a source of constraints of voluntary disclosure. Managers’ wish to avoid likely follow up and attention from bondholders and stakeholders regarding less essential items like external reputation and career concerns because these aspects discourage voluntary disclosure.

In general terms, managers would rather not disclose voluntary information, which the law may apply to them. Economists point out that the company’s size determines political costs. Big companies with huge profits have a higher potential of reducing the level of voluntary information disclosure, to prevent being subjected to political attacks as a threat of nationalism. Political costs also include taxes.

Sources of Voluntary Information Disclosure

Company information can be obtained from various communication sources, such as annual reports, interim reports, employee reports, analyst presentations, management forecasts, letters to shareholders, stockbrokers advise press reports, newspapers and magazines (Jones & Ratnatunga, 2012). Nonetheless, to several users in less developed and developed nations, the yearly report is seen as the most significant, comment and the critical source of information out of all others. Furthermore, the yearly report acts as a considerable source of disclosure information for the public, although company websites and other reports may offer more details. The yearly reports are regarded the only official source of information in the majority of developing nations, even though shareholders can access data directly from the company’s management. The annual reports are also compiled on a regular basis and cab obtained by the public for investigation. Lastly, it is believed that disclosure of annual reports is positively related to the level of exposure offered by other media. Hence, although there are ways of company reporting besides the yearly reports, they still act as good agent for the level of disclosure given by companies. Information found in annual reports can be subdivided into two segments. The first section provides financial details, such as auditor’s report and the financial statement. The second segment concerns information on non-financial matters, such as management discussion, director’s reports, chairman’s report and the section of the analysis. Even though discussions by management and the analysis part constitute the category of non-financial, it is considered as a source of helpful information, which may be utilized for financial analysis (Hung, 2015). Last, worth to note is that those who oppose annual reports believe that they fail to offer coherent vision regarding the future of a company. They would instead use it for public relations and advertising and not for making decisions.

Summary and Conclusion

This paper offered a review of the theoretical perspective of voluntary disclosure of information. Theories associated with voluntary exposure and are commonly applied in the literature include legitimacy theory, capital need theory, signaling theory, and agency theory. Constraints and motivations determine voluntary disclosure. Six motives discussed were restrictions on mandatory disclosure, management talent signaling, increased analyst coverage, stock compensation, corporate control contest and capital information asymmetry. Constraints discussed included political costs, agency costs, proprietary cost and disclosure precedent. Lastly, various sources of disclosure of voluntary information were discussed explaining the reason for the annual report being the most trusted source of information. Further studies need to be done by scholars because no agreement has been found concerning some factors of voluntary disclosure like its association with capital cost. Practitioners should consider the partisanship of the revealed information, which is difficult to eliminate regarding voluntary disclosure.

References

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Hung, A. (2015). Effective disclosures in financial decision making. Santa Monica: Rand Corporation.

Jones, S., & Ratnatunga, J. (2012). Contemporary issues in sustainability accounting, assurance and reporting. Bingley, UK: Emerald Insight.

Peterson Drake, P., & Fabozzi, F. (2012). Analysis of financial statements. Hoboken, NJ: Wiley.

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