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Chapter 2: Voluntary Disclosure and its Determinants

2.1 Corporate Disclosure

During the period 1870 to 1900, a number of American companies needed capital from Europe (Mumford and Peasnell, 1993). Thus, corporate financial reporting was derived from the companies’ need to acquire capital from external sources. Furthermore, it became a significant aspect in the twentieth century, with augmentation of the partition between management and ownership control within firms, thus raising the focus on governance relations within firms. In earlier times, the differentiation of financial reporting practices across two countries fell into two groups. One group was concerned mainly with the safeguarding of shareholders (e.g. in the UK and the USA); while the second group was concerned with defending the interests of creditors as well as establishing the efficacy of taxation (e.g. in France and Germany). The publication by the Accounting Standards Steering Committee (ASSC) in the UK in 1975 of the “Corporate Report” was termed as the best endeavour to develop “Corporate Financial Reporting”. In addition to that, in 1980, the Canadian Institute of Chartered Accountants published another document regarding corporate financial reporting called “Corporate Reporting: Its Future Evolution” (Ibrahim, 2006). Financial statements consist of balance sheet, income statement and statement of cash flow that depict the financial conditions of the company. Different sorts of user use those statements such as creditors, management, investors and government regulatory body (Wolk et al., 1992). The shareholders do not have access to accounting information in the accounting department; hence, they

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depend on published financial statements. At first, the accounting department gathers all the information regarding financial activities of a firm. Then it classifies that financial information and presents the information to the interested parties.

2.1.1 Types of corporate disclosure

More recently, financial reporting has evolved to corporate disclosure. In the accounting literature, disclosure is perceived as the final phase of the accounting process, which means notifying the public via financial statements of the firm (Choi et al., 1999). Corporate disclosure possesses a number of advantages, such as those indicated by Healy and Palepu (2001) who considered corporate disclosure as a significant indicator of a competent capital market, reducing information asymmetry, reducing the cost of capital and mitigating agency cost (Diamond and Verrecchia, 1991; Lev, 1992; Leuz and Wysocki, 2008). Despite the benefits, there are two sorts of costs of corporate disclosure: direct and indirect. Direct cost occurs at the dissemination phase of information to the public, whereas indirect cost occurs when parties other than investors, such as regulators, competitors, tax authorities etc, use listed companies’ information. In this regard, Verrecchia (1983) stated that companies would be discouraged from circulating information whenever other parties, other than investors, take advantages. Thus, corporate financial reporting possesses three salient purposes: assisting the country’s taxation procedure, publishing information for investors, and protection of creditors. Wolk et al.’s (1992) study reveals that the purpose of disclosure of financial information is to assist investors to make profitable investment decisions.

Companies can disseminate their information to users through a number of ways. However, literature regarding disclosure refers to two sorts of disclosure, voluntary disclosure and mandatory disclosure. Ghazali (2008) argued that mandatory disclosure consists of reporting as required by the regulations of a government such as accounting standards, companies act, listing requirements of stock exchanges; whereas voluntary disclosure varies in the form of disclosure. According to Hassan et al. (2009), the mandatory financial disclosures are the income statement, balance sheet, statement of changes in equity, cash flow statement, board of directors’ report, notes to the accounts and external auditor’s report. Mandatory disclosure means

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providing financial information to the users to meet disclosure requirements stipulated in different forms, such as laws, standards and rules of stock exchanges. Mandatory disclosure is needed to fulfil the requirements of a government’s regulations and legislations as well as the listing rules of stock exchanges (Hassan and Marston, 2010).

On the other hand, voluntary disclosure means disseminating financial information in excess of mandatory disclosure (Hassan and Marston, 2010). That is why voluntary disclosure is termed as willingly disclosures of financial information as a part of company management, which may assist the users of annual reports to take prudential decisions regarding investment (Meek et al., 1995). The forms of voluntary disclosure are conference calls, annual reports, and discussions with financial analysts, presentations, newspapers, booklets, press releases and different sorts of letter to shareholders. Given the unavailability of a definition of voluntary disclosure, Debreceny and Rahman (2005) observed that it seems difficult to provide a specific and generally accepted definition of voluntary disclosure. If disclosure of financial information remains within the identified minimum limits of the management of a firm then it is called mandatory disclosure. On the other hand, if disclosures surpass the limits then it is called voluntary disclosure (Lang and Lundholm, 1996). From the viewpoint of Lang and Lundholm (1996), voluntary disclosures assist the financial analysts by depicting the better scenario of companies’ performance, which enable them to provide reliable forecasts. Voluntary disclosure is perceived as a buzzword nowadays, which attracts the interest of accounting literature (Inyang, 2009). It investigates the aspects that influence voluntary disclosure of information with a view to notifying decision makers and users regarding financial information. Different researchers have identified a number of aspects regarding voluntary disclosure. For example, Meek et al. (1995) identified aspects that affect voluntary disclosure in German, English and French firms. Williams (1999) investigated the environmental and societal aspects of voluntary disclosure that affect it within the Asian pacific countries (Australia, Singapore, Hong Kong, the Philippines, Thailand, Indonesia and Malaysia). Ho and Wong (2001) assessed the degree of voluntary disclosure of firms that are registered with the institutional management of the Stock Exchange of Hong Kong Limited (SEHK). The influencing factors of registered firms of Toronto Stock Exchange (TSX, until

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2001, TSE), Canada, have been examined by Bujaki and McConomy (2002). Chau and Gray (2002) investigated the affiliation between voluntary disclosure and ownership structure of Hong Kong and Singaporean firms; Eng and Mak’s (2003) findings were similar to these. The above studies investigate the features of firms that deliberately disseminate information and the influencing aspects of voluntary disclosure. A review of the literature reveals that the majority of the studies are completed in developed, western countries, whereas less concentration is given to countries in Asia and the Middle East (Ding et al., 2004).

2.1.2 Evaluation of voluntary disclosure

According to Choi and Meek (2008), disclosure is the mechanism by which accounting information is communicated to the user who needs it; Researchers have tried to answer the question by evaluating disclosure. They have also tried to find out if there is any linkage between measured disclosure and explanatory variables. The studies on voluntary disclosure have tried to depict disclosures, which were published through annual reports, though it should be mentioned that other disclosures have been studied too, such as press releases. Disclosure can be measured through studying reports, which will provide a list of potential voluntary disclosures. The annual report can be ranked based on potential voluntary disclosure. Voluntary disclosure can be elaborated as disclosure in addition to mandatory disclosure. Company law or an accounting standard does not support voluntary disclosure. These disclosures include new information, not available in some other source. Though some scholars have attached value to this information, it is worth nothing. After consulting with financial and academic analysts, different weights have been given to different disclosures based on their relative importance. The accuracy of issuing weights is subject to the user (Marston and Shrives, 1991). Thus, giving weights to any disclosure will be subjective in nature. It should be noted that companies, which disclose important information, would disclose a very limited amount of irrelevant information. Thus, it can be concluded that there is very limited scope for weighting. However, it matters little to assign a weight or not. The major consideration of the report has been given on discussing different level of disclosure. It is not mandatory to evaluate the appropriateness of each disclosure. To explain various levels of disclosures, accounting theories have been implemented such as

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agency and signalling theories. From this theoretical background, hypotheses have been developed and tested to find out whether there is any relationship or not. In the research paper, the researchers did not mention what sort of information the company should disclose, but they said why the company discloses information by implementing an appropriate accounting theory. It is found that these studies have implemented a positivist methodology. This thesis follows the same methodology. It is appropriate to justify accounting theories, which are supported by the literature of voluntary disclosure. The accounting theories must be evaluated based on their appropriateness in explaining related disclosure (ibid.).