I am a research assistant reporting to a finance director in a public listed company namely VY Sin plc in United Kingdom. The company operates in the manufacturing industry. Previously, my company does not voluntarily disclosure (VD) expansive information to the public. My finance director is concerned about the issue of whether the act of adding on non-mandatory information will increase the transparency of company's annual report and add value to the company and increase the degree of materiality to the shareholders, resulting in an increase in investor confidence.
Hence, my task is to brief them on the issues pertaining to the factors caused the extent of VD of annual report data on mandatory disclosure (MD) by companies and its impacts on transparency, shareholders and companies, along with the benefits and limitations of both MD and VD on company's information, enable the financial director to make an informed decision.
Introduction -66
Reporting and disclosure are the most essential tools that companies use to communicate with their stakeholders. Disclosure is a crucial element in ensuring the effective allocation of resources in society and diminishing the information asymmetry between company and its stakeholders through mandatory and voluntary disclosure. In this recent year, companies have slowly changing and moving toward VD information through management forecasts, internet and other business reports (Popa and PereÅŸ, 2008).
Related issues of mandatory and voluntary disclosure
4.1 The impact of mandatory and voluntary disclosure on transparency. -311
As transparency is a desirable characteristic of financial reporting, the level to which financial reports exhibit a company's underlying economics in a way that is readily understandable and comprehensible by users of financial reports. Barth and Schipper (2008) suggest that increased reporting transparency can reduce the cost of capital provided that transparency reduces information risk. This is supported by Easley and O' Hara (2004) that diminishes information asymmetry among investors, the probability of informed trading is interrelated with a lower cost of capital because private information transfer into public information is essential. [34]
Zarb's (2007) study has concluded the essential of financial accounting disclosure in capital markets where VD will not only reduce information asymmetry, uncertainty and indirect costs, but will increase firm value, transparency and share price. Gray, Meek, and Roberts (1995) put forward that VD will also increase market liquidity and prevent market failure as well. In the assessment of Frost, Gordon, and Pownall (2005) on relationship between disclosure and transparency in capital markets and find that disclosure and transparency are positively associated with companies in emerging capital markets accessing capital markets globally. Besides, Ferreira and Rezende (2005) posit that VD of information about business strategy is found to be credible as managers are concerned about their reputation.
In contrast, Zandi and Shahabi (2012) argue that the companies were appearing to deceive shareholder that there is a sign of strength in their companies through increase in VD but in fact releasing less-relevant information in order to disadvantage competitors. In my opinion, greater transparency or honestly to public about company's forward-looking earning prospect will provide users some idea to predict the company's value creation, may help to enhance companies' reporting quality and credibility. This is supported by Jiang, Habib and Hu (2011) who presumed that VD is indicates more transparency and it would be valuable to any companies that exercise it, especially for companies with management controlled-ownership structures will reduce information asymmetry risk associated with ownership concentration.
4.2 Would the additional disclosure of company information increase materiality to the shareholders and increase more investors? -465
It was reported by Aman Singh (2012) that VD will definitely increase shareholder price and companies' fair value during the managers' course of actions in serving shareholders' best interests and improving the environmental sustainability of the companies. Recently, ACCA (2012) has asserted that the disclosure on covenant for a company's finances will increase materiality to the investors as they are providing with much greater information necessary in decision making and evaluate the effectiveness of companies' corporate governance (CG) system. With this in mind, VD has overcome some of the deficiencies of mandatory reporting that appears to be insufficient to meet user's needs. Besides, if shareholders don't know whether companies actually have information, managers with unfavourable information would not make a disclosure as investors cannot distinguish them from companies that hold no information (Rahman, 2012). Other opponent argues that the managers will disclose information if their intention is to maximise company's share price plus they have private information about firm value, unless it is extraordinarily unfavourable (Scott, 2011; Rahman, 2012) [google 4].
In contrast, cheap-talk models such as Crawford and Sobel in 1982 assume that the manager does not have to accountable for any direct cost for disclosing erroneously. Their findings on manager's disclosure decisions in a situation of various stakeholders with conflicting interests showed that the managers attempt to increase their incentives and reputation by convince their existing shareholders that the firm value is high; meanwhile, they also persuade potential entrants that the company is unprofitable. As managers can only make public disclosures observable by both investors and potential entrants at the same time, they are less likely to expose 'either too optimistically or too pessimistically'. Thus, their disclosure is 'informative'. Additionally, Beyer et al. (2010) also posit that corporate disclosure decisions are influenced by manager's remuneration or reputation in the decision-making labour market.
According to Sobel's cheap-talk model in 1985, he examined the impact of manager's reputation on voluntary strategic disclosure. Due to the investors do not know the type of managers are, hence, if a manager is a strategic type he may disclosure inaccurately to maximise his remunerations earnings whereas a manager who is non-strategic type will always discloses his confidential information truthfully. (Fisher and Stocken, 2001; Sheehan Rahman, 2012). On the other hand, Pingyang's (2010) disclosing-and-then-trading model which allows disclosure to influence the company's investment shows that cost of capital does not outline the impact of disclosure quality on the benefit of either existing investors or potential entrants. Investors are apt to pay a higher price for the shares 'on average' as disclosure reduces their uncertainty about the companies' marginal profitability.[15] In my opinion, given precedence over all others is the maximisation of share prices; companies must increase the extent of VD by releasing more informative contents. As a result of additional disclosure of companies' performance, investors have preempted to a great extent of the news and therefore are attracting to invest in the company.
4.3 Adding on non-mandatory information, does it improve company's financial reporting and add value to the company? -408
Recently, rational shareholders observe that managers disclose voluntarily only provided those information is favorable to them; otherwise, managers would not publicly additional information. Therefore, shareholders will assume the firm value is low and revises their belief on companies' management downwards. Consequently, managers are being harm through lower incentive and reputation as a result in a fall in company's share price, and thus lower value on managerial labour market (Scott, 2011; Rahman, 2012)
Many companies vacillate to publicly expansive information that go beyond regulatory requirements for fear it may help their competitors or increase their revelation to lawsuits (ACCA, 12 October 2012). Managers in United States (U.S.) are more prefer to issue forecasts during interim periods in which earnings decreasing whereas Canadian managers who faced with less litigious environment, they do not follow the tendency but issue more precise and long-term forecasts when earnings are increasing, and their forecasts are of annual rather than interim earnings (Baginski, Hassell and Kimbrough, 2002). [4.3(2)] Healy and Palepu (2001) posit the use of VD by CEOs is to explain away the bad performance of company. (Healy and Palepu, 2001; Villiers and van Staden, 2011). [27] In my opinion, by the act of VD might help the company to avoid shareholders' adverse selection.
According to Veldkamp's (2006) information market model, investors' reliance on inexpensive signals contribute to bigger share price co-movement but would lowers its informativeness. In contrast to Veldkamp's point of view, Jin and Myers' (2006) division of risk model devised that a company-specific information deficiency lets insider capture some portion of the companies' cash flows and well increases the amount of company-specific risk that they fear. However, company opacity forces outside investors rely greater on publicly known industries factors. He suggests that a company whose is lack of firm-specific private information will cause too pessimistic returns. However, both models have outlined a similarity that investors are enable access to company-specific information effortlessly if companies' disclosure is beyond required information. Consequently, the investors will rely less on common information signals. Consistent with both Veldkamp (2006) and Jin and Myers's (2006) models, Haggard, Martin and Pereira(2008) investigated further the variation in companies' VD policies to comprehend its disclosure's impact on share price co-movement and the frequency of share price crash. In my opinion, companies obtain benefits from providing more complementary statements and from changes in share prices in capital market. This is because survival companies that charge from a CG failure usually respond by providing more expansive CG disclosure thereafter.
4.4 The factors caused the extent of voluntary disclosure of annual report data on mandatory disclosure of financial information by companies in the annual reports in recent years and its impacts. -944
The extent of VD by companies has been increasing due to various factors. A study from Dontoh (1989) stated that the dynamic lead companies to voluntarily disclose private information about future prospect when the disclosure is predictable to have a positive effect on share price. He also demonstrates the manager' disclosure decision is depend upon the conjecture about the viewpoint held by competitors and investors. Another factor caused the companies decide to disclosure more risk and business forecast information is due to the narrative reporting is insufficient to satisfy analysts to play a significant part in the investment decisions. However, they also identify that by doing this will results in more complicated disclosures. (ACCA, 12 October 2012)[ACCA 3] During environment crisis, companies disclose more environmental information on the companies' website with the intention to reduce political costs faced by them. Nevertheless, bad performers disclose more in their annual report when they have a worst environmental reputation with the intention to diminish information asymmetry among shareholders and management as well as to avoid investors' adverse selection (Charl de Villiers, Chris J. van Staden, 2011). [27]
Bayesian equilibrium model has determined the disclosure behaviour of the companies; the results show that the companies may rather not to disclose any private information when the companies' return is below the risk free rate (Suijs, 2007). Additionally, the companies will disclose average information in order to attract investors' capital away from the risk free asset. [25] The incentive to disclose bad news may arise if the companies face a fixed disclosure cost and a variable proprietary cost that is relatively large compared to this fixed disclosure cost, such as a market where the incumbent companies face relatively high proprietary costs. Potential entrants may have positive beliefs about entering this market, so to deter them from entry; the incumbent companies voluntarily disclose bad news.
In the disclosure model of Verrecchia (1983), the company incurs a disclosure cost if, and only if, it discloses its private information. In the partial disclosure equilibrium that arises, bad information is kept private while good information is publicly disclosed. However, as the cost of disclosure increases, more and more information becomes worthless for disclosure, and resulting in full non-disclosure equilibrium ultimately. Wagenhofer (1990) found that the company hold private information that is valuable to the financial market as well as to the opponent. While the market uses any publicly disclosed information to revise the firm value, the opponent may find the disclosed information sufficiently valuable to take an adverse action that imposes a cost on the firm. When determining its disclosure strategy, the company thus weighs out the benefits of a better company value against the possibility of incurring a proprietary cost. In both models, companies always conceal their bad news in partial disclosure equilibrium (Suijs, 2005) [32]
Diamond and Verrecchia (1990) argues that the greater VD should lower information asymmetry and therefore reduce the cost of capital whereas Kim and Verrechia (1994) argues that increasing cost of capital effects may occur if the disclosures themselves lead to a more asymmetric information environment than would exist in their absence. However, Francis, Nanda, and Olsson (2008) research have provided empirical evidence on companies that more VD is related with a lower cost of capital. Moreover there is a negative relationship for VD measures based on management forecasts and conferences calls, and no relations for a press release associated with either earnings quality or cost of capital. They concluded that companies with good (bad) earnings quality have more (less) VD (Francis, Nanda, and Olsson, 2008). [3] The capital structure the company prefers is depends on the company's disclosure policy. Bertomeu, Beyer, and Dye (2011) stated that there is no relations between companies' cost of capital and the amount of information companies disclose, more extensive VD would not result in a reduction in companies' cost of capital whereas MD would alters companies' VD, cost of capital, and the capital structure choices. [7]
On the other hand, Bagnoli and Watts (2007) have an opposite point of view with Bertomeu, Beyer, and Dye (2011) where the content and probability of a VD disclosure decision by the managers are depend on whether the mandatory reports contain good or bad news. Firstly, if the reports contain sufficiently better (worst) news, the managers disclose small (large) amounts of private information and otherwise only provide mandatory required disclosure information to public. Secondly, if the companies' reported performance is close to market expectations, the benefits of increasing or lessening the news are small whereas if the companies beat market expectations by more, the benefits are much greater. Furthermore, their VD model also suggest that the changes in MD regulations can have unintended consequences to their effects on the manager's willingness to voluntarily provide supplemental disclosures. However, Bagnoli and Watts' (2007) findings above seem to be similar to the finding in Fischer and Stocken's (2004) cheap-talk models in disclosure settings where they concluded that the extent to which managers would disclose information truthfully often depends on the manager's aversion to litigation conjunction with the degree to which the investor is indemnify for the managerial misreporting (Bagnoli and Watts, 2007; Rahman, 2012) [google 4].
In my own opinion, the rationale of information asymmetry due to agency problems calls for the need for manager to disclose a firm's financial performance to outsiders. The extent of disclosure are made is depend upon the level of uncertainties faced by the companies. Such as the reputation and incentives of manager is vary from that of investors whose attempt to maximise their share value, thus, they do not always have a motivation to disclose truthfully. This is evidenced by Bujaki and McConomy (2002), the choices of disclosure medium and the degree of VD are made are affected by the consideration of management's strategic. They posit that the degree of disclosure is more likely to be higher for larger companies with high gearing. This is very relevant to VY Sin plc.
4.6 The apparent benefits and limitations of mandatory information disclosure on company's information. -101
Suijs's (2007) empirical studies showed that MD regulations improve the allocation efficiency of the investor's capital as they will enable to distinguish favourable investment opportunities from bad ones. In contrast, it was reported (Financial Times (London, England), 2002) that MD requirements would not help, especially if they were highly prescriptive. In the case of requirement were too rigid, the result would be a bureaucratic compliance culture, where disclosure would irrelevant to any real commitment to good behavior and result in spurious information. [FT2] In my view, historical information provided by conventional financial reporting might not be sufficient to satisfy users need in some certain extent.
4.5 The apparent benefits and limitations of voluntarily information disclosure on company's information. -362
Bujaki and McConomy (2011) claimed that the companies prompt to disclose extensive information including the disclosure decision of legal environment that support or discourage disclosure; investors would assume the company is going worst if the companies fail to disclose what they expected and information uncertainty. They stated the dilemma faced by managers when consider the disclosure of all the information that might be material to investors against disclose only what are mandate by regulation. If managers disclose excessive information, the introduction of proprietary or disclosure costs may incur significantly, rivalry among business firms grew more intense and impact on the company's future business prospects. In contrast, if managers decide not to publish any information, the degree of information asymmetry between manager and potential shareholders is to be relatively high and cause for rise of cost of capital.
PwC's Alison Thomas perceives that companies can improve their probabilities of securing the capital at the right price towards VD during a slump badly (ACCA, 26 October 2012) while it was clarified (Financial Times (London, England), 6 October) that VD by some companies have found to improve considerably. In the interim disclosure, companies are strongly encouraged to follow regulations when they publish their forward-looking earnings. [FT3] In this connection, it was reported (Financial Times (London, England), 2012) that it is the time for Europe to mandate that companies disclose details of payments they make to foreign governments. However, Browne (2012) argued that it is infrequent for a company to damage competiveness and lose business by being too transparent. [FT1]
Holland (1998) comparing the benefits to the costs of VD and posits that companies will publicly expansive information until they perceive that the capital agency costs decreasing has equaled the increase disclosure costs for users (Holland, 1998; Popa and PereÅŸ, 2008). Besides, Popa and PereÅŸ (2008) argued that VD is much constrained by the disclosure costs which meant that company will put their position in danger by supplying information which can be used by their competitors virtually. In my own opinion, smaller companies are lead to a competitive position in danger if they disclosure only within required information. In my opinion, companies publicly only mandatory required information would influence their competitive position or disclose additional information to facilitate the capital market to accomplish an efficient evaluation of the companies' shares.
Assessment of Relevant and Reliability
5.1 Academic Journals
Where firms choose to disclose voluntary environmental information by Charl de Villiers and Chris J. van Staden (2011)
Journal of Accounting and Public Policy has a quality ranking at three in the field of Accounting by Association of Business Schools (ABS, 2011). This article can be considered reliable to the topic as the authors' research motivations are mainly focus in the area of disclosure of financial information, especially environmental and social disclosures and social responsibility.
In this research paper, the authors gather the evidence to support their hypotheses that different levels of environmental disclosure are made in annual reports and on websites under different conditions. I assume this article is highly relevant to my report as it identified the companies' disclosure decision and the way they do. Methods they used are KLD Research and Analytics, Inc. (KLD) database to provide the long-term environmental performance or reputational measure to distinguish between companies with a bad environment reputation and other companies. They also used the Toxics Release Inventory (TRI) provided by the short term environmental performance measure to identify companies with an environmental crisis. However, the reliability of KLD measure for long-term environmental performance or reputation can be questioned.
Regarding to the methods used, there are 31 of the top 50 institutional money managers worldwide use KLD's social research to integrate environmental, social and governance factors into their investment decisions. Entine (2003) refers to the KLD ratings as a commonly used screening aid and Harrison and Freeman (1999) regard the fact that the KLD ratings are based on the extensive research of independent analysts employed by KLD, and that KLD uses these ratings as a basis for investment decisions and guidance, as their main strength. In contrast, the Commercial Energy Profile Database (CEPD) contains essential details on major types of commercial facilities under the ultimate holding firm listed on a US stock exchange, allowing companies prompt to identify new customers and their energy needs quickly and accurately. CEPD provides powerful resource for anyone involved in energy services and TRI data contained therein benefits many academic papers in their sample selection process. However, both measures have already been used extensively in academic research, ensuring that their research is reliable and valid.
Their research method is sample and data collection. Although this article was published in 2011, but the database used was 2004 information for sample selection and in all analyses for the TRI on the CEPD database. Database used was relative out-to-date and lack of recent up-to-date data to support their conclusion. Moreover, the sample size is relatively small (30 firms selected from 3000 largest US publicly trade firms). Furthermore, their research did not take the factor such as disclosure quality into consideration, without this, they were unable to distinguish information based on specificity or using a quality index to evaluate the reporting quality. Subsequently they examined only two hypotheses concerning the volume of environmental disclosure by bad environmental performing firms experiencing environmental crises or not, are simplifications and additional factors may have been overlooked. As a result, this article is researched based on U.S companies which might not very relevant and applicable in today UK business environment.
5.2 Academic Journals
Voluntary disclosure, earnings quality, and cost of capital by Jennifer Francis, Dhananjay Nanda and Per Olsson (2008)
Journal of Accounting Research is ranked at 4th place in the field of accounting by ABS (2011). Due to the examination of these alternative forms of disclosure are conducted on a relatively large sample of companies whose composition does not vary across tests, their design mitigates the possibility that these results are due to differences in sample size, composition, or duration.
Looking at the prior empirical research that examines the disclosure-cost of capital link is primarily based on theoretical research that treats disclosure as exogenous; such Botosan's (1997) tests of the Diamond and Verrecchia (1991) model. In contrast, they only focus on research that VD models as an endogenous choice that is affected by company fundamentals. Specifically, there are many models of VD, but the reliability of this article is very low as their research has limited to the model used and does not provide evidence of real life companies that have used.
Despite the sample size is on average and relatively large (a total of 677 firms with data on all variables), however the requirement that a company has at least 11 years (from 1991 to 2001) of financial data to estimate earnings quality metrics likely results in a bias. The sample has over represents successful companies where normal operating companies are being ignore and did not take into consideration in their research. Although this article is being received in 2004 and published in 2008, but the authors read the public listed companies' performance in Form 10-K (an annual report required by the U.S. Securities and Exchange Commission) for financial year 2001, where it can be bias due to the lack of timeliness. Hence, the findings from this article are indirectly relevant to the topic and the research was conducted at U.S. which is not suitable to apply in VY Sin plc.
5.3 Academic Journals
The Effect of Legal Environment on Voluntary Disclosure: Evidence from Management Earnings Forecasts Issued in U.S. and Canadian Markets by Stephen P. Baginski, John M. Hassell, and Michael D. Kimbrough (2002)
This article is published in The Accounting Review in 2002 as a premier journal and ranked at 4th by ABS (2011) in the field of accounting, therefore, this increase the reliability of the article. This article is relevant to my topic as authors have provided evidence on the influence of legal environment on VD from management earnings forecast disclosure differs between the U.S. and Canada where both countries have diverse legal regulations.
Besides, it can be argue that the sample size used in this empirical research is not on average between both countries. In this research paper, the authors only take 64 Canadian listed companies compare with 687 U.S. listed companies. Apart from this, despite the data used on this article was based Canadian companies, but the reliability of hypothesis test is low because the authors did not discriminate locally listed from cross-listed Canadian companies. In some certain extent, cross-listed Canadian companies came across some legal revelation in U.S., for that reason, the reliability of their finding is impaired by combining both cross-listed and listed Canadian companies.
Additionally, their findings from hypothesis tests might not be universal present U.S. VD policy which is developing constantly. Even though this article was published in 2002, but their research was based on data from period of 1993 to 1996. Hence, this article is considered relatively out-to-date as it was published more than 10 years and reduces its reliability. Overall, it can be polemical that this article is intimately reliable and relevant to my topic in some extent.
5.4 Professional Accountancy Bodies Publications
Capital Competition by Association of Chartered Certified Accountants (ACCA) (26 Oct 2012)
This paper was first published in the International edition of Accounting and Business magazine before published by ACCA in the website in 2012 which is the premium article related to the topic as it highlighted the current financial reporting issue in public listed company. It is considered up-to-date and relevant to my scenario where it has demonstrated some guidelines for decision-making.
As refer to the statement made by PwC's Alison Thomas in 2012 that companies can securing their capital with some simple VD (Alison Thomas, 2012). The word of 'simple' is questionable as he did not outline the guidance on what method is considered simple. In return, it might make the companies who intended to VD particle doubtful. The reliability of this paper is difficult to justify without supportive evidence. Indeed, personal opinion given by Alison Thomas without empirical research may affect the public's reliance on his judgements. Moreover, the reliability of this paper is also questionable as this statement was made by a corporate reporting specialist at PwC although he has reasonable well explained the issues related to VD and relevant to the topic. He may represents professional accountancy bodies attempted to develop and write well of his point of view in this paper, therefore it may be biased in some extent.
5.5 Magazine
Corporate disclosures. CA Magazine by Merridee Bujaki and Bruce J. McConomy (2011)
This paper was published in 2011 which is up-to-date. It is applicable for managerial in current UK business environment as it investigates the VD of forward-looking performance in Canadian companies' management discussion and analysis along with the factors affecting the managers' disclosure decision in their annual report and its impact on investors and companies as a whole. I assume this paper is to be relevant to the topic as CA Magazine is published in English and French by the Canadian Institute of Chartered Accountants (Anon, http://www.camagazine.com). Canadian public listed companies were used as sample in research which is consistent with VY Sin plc, hence, this contributed to the relevance and reliability of article.
5.6 Newspaper
Europe must make the oil industry disclose its foreign deals. Financial Times (London, England) 25 April, p.9. by John Browne (2012)
This paper was published in the online newspapers namely Financial Times (London, England), the relevancy of this paper is high by the use of supportive evidence in relation to current business financial reporting environment through this U.K. based online newspaper as VY Sin plc in this case has a same region with it as well. And I also assume this paper is highly relevant to my topic as it giving the example of manufacturing (i.e. oil industry in Europe) with adequacy supportive evidences from research conduct reflect in real world companies. Therefore, the reliability of information is considered relatively high to this topic.
Lord John Browne was former CEO of Britain's biggest company- BP. The possible reason why the author presents this paper would have been his sufficient experience in the real world company with the establishing of voluntary Extractive Industry Transparency Initiative. Generally, he opposed the idea of Europe energy companies should command voluntary disclose the information of disbursements they make to foreign governments and believe it's in the best interest of companies, shareholders, stakeholders as a whole. Although there is no research conducted and no methods used in this paper, but the author's experience can make the reliability of the article convinces.
5.7 Website
Aman Singh (2012) CSR + Transparency: Can Voluntary Disclosure Increase Shareholder Value? Available from: http://www.forbes.com/sites/csr/2012/02/14/csr-transparency-can-voluntary-disclosure-increase-shareholder-value/
This paper was published on the website in 2012 which is considered to be highly up-to-date. Besides, the objective of the website is clear where I was able to determine the objective of the site is. This site is relatively relevant to my topic where it has demonstrated some strange formatting issues, for instance, whether there is a obvious relationship between VD and shareholder value. By few clicks, this page ease me get to the desired information that I am looking for and I can effortlessly to determine whether shareholder price will increase by an act of VD. Although there is purely illustrative and no research have been done to back up the facts, but a range of external links and cross-checking to the content has been available to evidence for and support their conclusion, it enhanced the credibility of the content and I assume the reliability of information contained in this site is relatively high and convert me to particular point of view.
With regard to the reliability of this site, some people advocate that 'Forbes.com' is a reliable source that contributes information about businesses and has an excellent credibility core in Web of Trust (http://www.mywot.com) reputation. Despite it is considered as a safe website to visit but noted that the information provided by analyst is based on their prediction without insider information such as figures in income statement.
Conclusion
In summary, from the company perspective, I believe the VD is important implications for companies, regulators, and investors as it is an important part of the present corporate reporting practice to cover some of the deficiencies in content of mandatory financial reporting. Companies must take into consideration into how VD will achieve transparency, add value to the company and meet users need. Therefore, manager's corrective action is vital in maintaining corporate governance environment
Although most of the authors posit/ agree………………
Conclude R&R
Overall, different information sources are reliable and relevant to my topic in some certain extent.
