In present business globalization, corporate governance plays an important role in assisting the firm, shareholders and stakeholders in doing the business transactions and investments. Transparency and disclosure is considered as a crucial part of the effective corporate governance. It has developed to essential policy tool in an effort to make the corporations act more ethically, socially, and environmentally responsible way (Hale, 2006). In recent years, partly regarding the corporate scandals, the firms, especially multinational corporations, are demanded to be more transparent and to disclose more information of the firms.
The corporate scandals which were occurred by a fraud could not be happened if the system of transparency was put in place. The transparency allows the financial reports, business transactions, investment of firm�s asset and other firm�s movements to be monitored both by internally and externally, hence, the loopholes to conduct the fraudulent and unethical management are eliminated or at least diminished. The transparency is the tool to enable the detection of either illegal or unethical managements, once such activities are captured, they can be fixed in time before the problems are severely expanded (Veneeva, 2006). Therefore, it is a benefit to shareholders as they obtain greater security on their investments they have made.
Beyond of being an observer tool, improvement of disclosure and being more transparency plausible lead to the reduction in the agency costs. The agency costs incurred from asymmetric information that is managers are having more information about the organization�s activities and financial situation than existed or potential investors which lead to the conflicts of interest (Hermalin, 2007). It is the cost spent in an effort to align the interest between two groups i.e. managers and shareholders (Investopedia, 2011). By enhancing the disclosure of the corporations, the flow of information from the companies to shareholders is improved. The better information flows certainly decrease the information asymmetry (Solomon, 2004). Hence, the agency costs are reduced.
In addition, the transparency also assists the shareholders in their investment decision making processes. In current era, firms are required to disclose not only financial reports but also their environmental and social policies and procedures (GEMI, n.d.). Shareholders are better informed on all business activities, conducted by management, such as the utilization of firm�s assets and other important decisions of management (Flint, 2011). As a result, shareholders will have a confidence and greater ability to assess the risk of the firm, especially financial risk, which might impact their investment. Hence, they can decide whether to commit with their current investment or diversify it to other low risk investments.
As illustrated that transparency reduces the asymmetric information between management and shareholders. It also, in turn, enhances the liquidity of a stock of the firm. The more liquidity of the firm�s stock favorably magnetizes the institutional investors (Madhani, 2007). The more liquidity also leads to greater analyst following. Hence, the firm can improve its access to lower cost of capital (Madhani, 2007). The lower cost capital gives the firm more liquidity and leads to make more investments which could yield substantial profit, consequently, return the financial benefits to shareholders.
Disadvantage of being transparency
Although, transparency is desirable as it creates the various benefits, there also contrarily return the drawbacks if the transparency is set at improper level.
Being transparent involves with the substantial costs to the firm. The costs incurred by collecting, preparing, organizing, and disseminating the information. These costs can be in several forms of resource e.g. effort, time, and also money (Wishvanath, 1999). If the transparency is improperly set at the topmost, the costs of being transparent is possible higher than the in turn benefits. As a result, the firms make a loss economically which may lead to the decrease in its share price and suddenly has negative impact to the shareholders.
Another drawback of being improper transparency is the affect on company freedom. Being too transparency may lead to the conflict with company freedom and other company�s moral principles (Dubbink, 2008). For instance, the right to privacy of workers or other parties might be invaded, as a result, lowers the productivity of the workers and leads to the loss of the firm.
There is also a direct impact to the shareholders and stakeholders in short run. Full transparency tends to transmit the load of information which including both necessary and non-necessary information to the users, shareholders and stakeholders (Dubbink, 2008). The overburden of information might cause the users to overlook the important information or even flee from inspecting information regarding their limited time of absorbing information and cognitive skills.
One major drawback of being too transparent is the availability of the critical information which may cause the benefit to competitors (Madhani, 2007). For instance, the firm thoroughly discloses its critical strategy. Once its competitors perceive the strategy, they try to replicate and improve it. Suddenly, its competitors gain most of the benefit out of critical information that is disclosed and in turn, the firm suffers from a competitive disadvantage and makes a loss economically. Companies need to weight the competitive advantage with the competitive disadvantage from disclosure, if the competitive disadvantage surpasses the competitive advantage, the level of transparency should be lowered (Madhani, 2007).
