Why Do Firms Voluntarily Disclosure Information - Essay Example

?Why do Firms Voluntarily Disclose Information? Introduction Since modern corporate governance principles give first priority to shareholder values, today firms tend to disclose their financial as well as other information in annual report. An annual report exhibits current state of affairs of a company and it is prepared to serve the interest of shareholders and stakeholders including banks, employees, and general public better way. Economic theories propose that it is better for firms to provide additional information to investors and financial analysts, because the voluntary disclosure assists investors and shareholders to analyse the firm and thereby to estimate future rate of returns on their investment. This paper will discuss why modern firms voluntarily disclose their information. Voluntary disclosure of information While analysing modern corporate culture, it seems that organisations voluntarily disclose more information in their annual reports than what is actually required to comply with the basic financial and accounting regulations. Firms voluntarily disclose three types of information such as strategic, non-financial, and financial information. As per the logical conclusions made by Kim, better informed shareholders were satisfied with less disclosure whereas uninformed shareholders preferred more disclosure (as cited in Cataldo, 2003, p.68). Thus, Kim linked voluntarily disclosure of information with shareholder interests. According to Williams (2008), nowadays firms engage in operations that are not captured by accounting process but have an impact on the firm’s profitability; therefore, such activities of firms have considerable significance in the sense that they may cause changes to investment decisions. Hence, firms make voluntary disclosures so as to overcome these troubles. It is relevant to use normative and positive accounting theories to explain the reasons for firms’ voluntary disclosure of information. The normative accounting theory justifies the feasibility of an accounting treatment whereas the positive accounting theory scientifically shows the truth of an accounting phenomenon. More simply, the former approach illustrates accounting taxonomies as an art while the latter represents accounting as a science of economy. The normative theories deal with intangibles and corporate, social, and environmental reporting while the positive theories represent social and environmental disclosures. Normative theories The normative approaches reflect the direct economic benefits of information disclosures. Economists identify that the major portion of the real value of a company is based on intangibles assets including goodwill and brand loyalty; a firm’s value of intangible assets is represented by the difference between market value and book value of the firm (Lecture 4, slide 7). In addition, the real value of a firm also embraces the intellectual capital of the firm including patents, computer programs, customer relationship, and trademarks (Lecture 4, slide 11). Traditional accounting systems do not provide investors with adequate information about intangible assets and intellectual capital. Hence, investors find difficulty in estimating the real value of the company. This is one of the main reasons why firms voluntarily disclose their information. Since modern societies give great emphasis on environment safety and public welfare, organisations cannot vie with the market competition unless they maintain effective corporate responsibility policies. As Deegan (2002) reports, nowadays majority of the multinational corporations prepare an annual sustainability report in order to promote their social responsibility policies. Even though firms set different goals while initiating corporate sustainability reporting, their main focus is to enhance the firms’ international operations and to convince investors. Healy and Palepu (2001) argue that corporate disclosure is essential for the effective functioning of capital market. In total, normative theories indicate that information disclosure practices assist investors to evaluate the real value of the firm and thereby to assess the feasibility of their investment decisions. These approaches also hold the view that information disclosure policy would reduce the operational costs of firms by passing necessary information to concerned parties on time. Positive theories Positive theories propose economic as well as sociological explanations for firms’ information disclosure. Economic explanations are given using rational choice theory and positive accounting theory; whereas accountability theory, stakeholder theory, legitimacy theory, and institutional theory are employed to explain sociological aspects of information disclosure. The rational choice theory argues that effective information disclosures will assist firms to reduce cost of capital as well as cost of debt. The positive accounting theory has three key hypotheses such as bonus plan hypothesis, debt hypothesis, and political cost hypothesis. The bonus plan hypothesis envisages that mangers that are provided with bonus plans are more likely to employ accounting practices which would inflate the current period reported income in order to take unfair advantages of bonus plans. In contrast, the debt hypothesis indicates that when a firm’s debt/equity ratio is higher, its managers may use accounting practices that increase income with intent to conceal the firm’s adverse condition. Political cost hypothesis is practiced by large firms to deflate their reported profits; and through this approach, organisations intend to prevent people from thinking that the firm is exploiting other parties (Lecture 5, slide 28). In short, positive accounting theory tells that managements’ unfair use of accounting practices can inflate or deflate reported income of the current time. According to Milne (2002), the positive accounting theory claims that the practice of information disclosure will assist shareholders to ensure that the organisation has not used inappropriate accounting practices to manipulate its profitability. As Islam and Deegan (2010) claim, increasing media pressure also has been compelling organisations to disclose their corporate information. In sum, economic theories indicate that information disclosures facilitate effective information flow between a company management and its shareholders, and this practice adds value to shareholder interests. Finally, some system-oriented theories point out different sociological elements behind information disclosure. Evidently, today organisations disclose their environmental and social activities including workplace diversity programmes and community projects sponsorships. According to accountability theory, the disclosure of information will greatly aid firms to ensure that it reacts to the concerns of shareholders, debt holders, employees, and customers. The stakeholder theory has been proposed to meet the needs of stakeholders; and this theory states that a company has to build shareholder value by addressing various issues that are of specific importance to stakeholder groups (Lecture 6, slide 30). As per the terms of this concept, an organisation is considered as a part of community and hence all shareholders have an ethical right to be treated fairly by a firm. In other words, a business venture must revolve around its stakeholders as they are the actual beneficiaries of that firm’s operations. Likewise, the legitimacy theory recommends organisations to comply with community expectations by paying specific focus on the norms and values of the society in which they operate. Obviously, according to these two theories, stakeholder satisfaction is the primary objective of every business organisation; and stakeholders would not be satisfied unless they are better informed on organisational matters. Finally, the institutional theory also suggests that information disclosure will help firms to increase their market repute. This approach highlights two elements such as isomorphism and decoupling, which strongly point to the need of information disclosure (Lecture 6, slides 43-45). Conclusion From the above discussion, it is clear that firms voluntarily disclose their information mainly in order to serve stakeholder interests by keeping them better informed. The normative theories say that information disclosure will assist investors to estimate the real value of the firm. The economic theories focus on the financial aspects of the disclosure. The positive accounting theory purports that information disclosure will help shareholders to ensure that the management has employed proper accounting tactics. Finally, system-oriented theories point out the significance of information disclosure to all stakeholders or to the society as a whole. References Cataldo, AJ (Ed.) 2003, Information asymmetry: a unifying concept for financial and managerial accounting theories, Emerald Group Publishing, US. Deegan, C 2002, ‘The legitimising effect of social and environmental disclosures: a theoretical foundation’. Accounting, Auditing, and Accountability Journal, volume, 15, No. 3, pp. 282-312.  Healy, PM & Palepu, KG 2001, ‘Information Asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature’. Journal of Accounting and Economics, Volume, 31, pp.405-440.  Islam, MA & Deegan, C 2010, ‘Media pressures and corporate disclosure of social responsibility performance information: a study of two global clothing and sports retail companies.’ Accounting and Business Research, Volume, 40, No. 2, pp. 131-148.  Milne, M 2002, ‘Positive Accounting theory, political costs, and social disclosure analyses: A critical look’. Critical Perspectives on Accounting, volume, 13, pp.369-395.  Williams, C 2008, ‘Towards a taxonomy of corporate reporting strategies’. Journal of Business Communication, Volume 45, No. 232, p. 264.  Lecture Notes. Read More