Voluntary Disclosure of Accounting Information: Motivations and Agency Costs

Introduction

Many studies have examined the voluntary disclosure of accounting information and its association with accounting practice in the capital market. The voluntary disclosure of accounting information is argued to reduce information asymmetry while also reducing agency costs. By reviewing the available literature on this concept, one can clearly identify the motivations firms have to disclose such information to the public, as well as gain a clear understanding of the empirical methods researchers use to examine and measure these accounting disclosures. Furthermore, one can understand the relationship between voluntary disclosure and agency costs in order to more fully appreciate the reasoning behind accounting entities' decisions to disclose such information.

In recent years, the decision for corporations and firms to disclose information about their financial positions and performance has risen to the forefront of the finance field. Such disclosure has long been presented to the public in the form of mandated annual reports, but as time progresses, more firms are choosing to support voluntary disclosure of company positions, performance, and assets — both physical and intangible — to enhance transparency within the market for stakeholders and competitors alike.

Voluntary Disclosure in Accounting

In order to more accurately gauge the impact of voluntary disclosure on a company, one must first understand the difference between tangible and intangible assets and the accounting that has historically been completed for each. Companies have long released financial statements, which are technically historical documents showing what a company was worth at a particular point in time. These statements have long disclosed companies' tangible assets — those that have a physical or financial embodiment — such as buildings, equipment, stocks, and bonds (Garger 2010, pp. 28). In essence, a tangible asset is a clearly accounted-for entity within a company whose status is reported in company financial statements and can be viewed as having a discernible profit and value projection in the future. Because tangible assets must be recorded in company books at the value for which they are purchased, stakeholders and competitors are able to more accurately gauge how these assets will perform in the market depending on changes in economic conditions, currency, and related factors.

Alternatively, a company's intangible assets have historically not been mandated for public disclosure, as their non-physical nature leaves significant uncertainty regarding the future benefits they will bring to a company. Such assets lack physical form but nonetheless provide value to the firm that possesses them. Examples of intangible assets include contracts, patents, brand names, and even unique organizational structures (Gray and Kang 2008, pp. 58). Such assets have long been hidden from the public, but the recent growth of the service sector, the prevalence of information technology businesses, and the dramatic increase in the size and number of international mergers and acquisitions have made accounting for intangible assets extremely significant, as the value they bring to their respective companies is substantial (Diga and Saudagaran 2008, pp. 44). More precisely, the voluntary disclosure of a firm's intangibles accounts for the projected profitability of that firm in a manner that was long overlooked (Apostolou and Nanopoulos 2009, pp. 396).

The Financial Accounting Standards Board (FASB) and the Enhanced Business Reporting Consortium (EBRC) suggest that companies should be encouraged to make more voluntary disclosures, especially in the areas of nonfinancial performance and intangible asset disclosure (Reddy and Subramanian 2010, p. 31). However, voluntary disclosures are only useful if they are perceived as credible, and the voluntary disclosure of information raises potential questions about the motivations behind the disclosure and its perceived credibility (Coram, Monroe, and Woodliff 2009, pp. 137). Questions about companies' motivations to disclose accounting information — both financial and asset-related — have generated significant debate, and research has shown that firms' alignment with voluntary disclosure tactics is largely driven by a desire to remain favorably viewed in the social contexts in which they operate.

In viewing this reasoning within a social context, one must consider the groups that corporations seek to satisfy through their voluntary disclosure of accounting information. Corporations have largely cited the reduction of information asymmetry between managers and outsiders as a key motivation, and many have further cited the desire to reduce uncertainty about their firm's prospects (Giorgioni, Hassan, Power, and Romilly 2011, pp. 33). Such prospects have long been viewed as the prime motivation for companies to release such information, since without future prospects a company will cease to exist.

Additionally, such prospects cannot come to fruition without the support of the general public and the assistance of stakeholders. Given this, it can be assumed that corporations also tend to disclose information to satisfy these participants and to act consistently with widely shared social priorities (Crawford and Williams 2010, pp. 512). By acting accordingly, companies are able to ensure that the social and environmental landscape in which they function remains supportive of their ability to make informed, long-term decisions that focus on corporate interests (Adams and Frost 2007, pp. 2).

Research has also shown that regulatory pressures have pushed many companies toward voluntary disclosure, and these pressures are reinforced by the public's perception of how companies abide by changing market rules and regulations. Companies that choose not to comply with these standards begin to appear as if they have something to hide. Corporate motivation to publicize accounting information can therefore be largely attributed to a desire to enhance transparency and lower the veil that has long existed between a company's internal workings and outside observers.

Companies have also acted in accordance with this rising standard of voluntary disclosure as a preemptive maneuver. For example, large companies have recently come under public scrutiny for withholding information from the market and consumers, only for that information to be disclosed publicly in later court proceedings. By acting proactively, companies choose instead to disclose information in a manner they themselves control, allowing the public response to be managed in a timely way that does not create additional legal risk down the line.

Researchers have long investigated the motivations for corporate voluntary disclosure by surveying large numbers of financial executives, and such research has produced important findings about the specifics of accounting disclosures. Recent empirical work has found that pension fund pressure, for example, is effective in increasing the social responsibility of the companies they own — particularly on environmental and corporate governance dimensions — providing further reasoning for corporations to embrace voluntary disclosure tactics (Chatterji and Listokin 2009, pp. 299).

Motivations and Empirical Research Regarding Voluntary Disclosure

Empirical studies have also concentrated on investigating the relationship between disclosure level and stock liquidity, and on testing the link between disclosure level and the overall cost of equity capital (Giorgioni, Hassan, Power, and Romilly 2011, pp. 33). Studies have further shown that a company's decision to voluntarily disclose accounting information can be directly correlated with market competition. A 2008 study empirically investigated the effect of product market competition on voluntary disclosure of proprietary information, proposing that there are two types of strategic interaction relevant to voluntary disclosures: capacity competition and price competition (Bushman and Smith 2007, pp. 75). The results found that when firms compete on capacities, they disclose more information to lower the cost of capital needed for investments; when they compete on prices, they disclose less because proprietary costs would be high, allowing the company to benefit from any decreased cost of capital due to a lesser need for additional capital (Reddy and Subramanian 2010, pp. 41). This finding suggests that the reasoning for voluntary disclosure aligns less with social responsibility and more with internal company motivations for power and market presence.

One area that has received little research despite growing concern is the regulation of voluntary disclosure, which remains virtually non-existent in today's financial environment. However, extensive research has been done to determine the factors that push corporations and management toward voluntary disclosure, and six principal findings have been widely utilized to gauge motive and success.

The first is the capital markets transactions hypothesis, which suggests that investors' perceptions of a firm are important to corporate managers expecting to issue public debt or equity, or to acquire another company in a stock transaction (Healy and Palepu 2008, pp. 405). To reduce information asymmetry and thereby lower the firm's cost of external financing, managers anticipating capital market transactions have an additional incentive to provide voluntary disclosures.

This is followed by the corporate control hypothesis, which is motivated by empirical evidence that boards of directors and investors hold managers accountable for current stock performance. In this case, voluntary disclosure is used by managers to reduce the likelihood of under-valuation while providing clear, publicly available data that can explain poor earnings performance. The stock compensation hypothesis builds on this by noting that managers are directly rewarded through a variety of stock-based compensation plans, such as stock option grants and stock appreciation rights, which create incentives to encourage voluntary disclosures — both to meet restrictions imposed by insider trading rules and to increase the liquidity of the firm's stock (Healy and Palepu 2008, pp. 407). The litigation cost hypothesis mirrors the previously described tactic of managers releasing information to the public before legal action could force its disclosure under less favorable circumstances.

Two final motivations are also widely recognized. The management talent signaling hypothesis argues that managers and companies have an incentive to make voluntary earnings forecasts to signal their type and market position. By disclosing accounting information, managers believe they can demonstrate an enhanced ability to anticipate future changes and, in turn, increase the firm's market value. The proprietary cost hypothesis asserts that firms' decisions to disclose information to investors are driven largely by concern that such disclosures could damage their competitive position in the product market. As described previously, a company's position in a large-capacity market versus a price-competitive market shapes its disclosure tactics. This hypothesis notes that by releasing information, companies can increase consumer understanding and interest — for example, encouraging the public to support or purchase stock in these companies.

Voluntary disclosure has further been thought to be directly correlated with agency costs within a corporation, though the precise strength of this relationship remains an area of ongoing inquiry. To examine this relationship, one must first understand the concept of agency costs, which can then be aligned with what has already been established about voluntary disclosure.

An agency cost is an economic concept relating to the costs incurred by an organization due to problems such as divergent management–shareholder objectives and information asymmetry (Cohen and Webb 2007, pp. 302). These costs generally consist of two main sources: the costs inherently associated with using an agent (i.e., the risk that agents will use organizational resources for their own benefit), and the costs of techniques used to mitigate those problems (i.e., the costs of producing financial statements or using stock options to align executive and shareholder interests) (Cohen and Webb 2007, pp. 302).

In assessing the correlation between voluntary disclosure and agency costs, one can point to cost reductions observed at companies that have begun utilizing voluntary disclosure through corporate websites and other internet-based technologies. Many corporate websites now provide a detailed and frequently updated overview of a company's acquired assets and performance, through press releases, stock quotes, investor FAQs, analyst earnings forecasts, annual reports, and SEC filings (Healy and Palepu 2008, pp. 410). The ever-increasing use of the internet by investors and stakeholders appears firmly embedded in corporate financial culture, suggesting that continued use of such disclosure channels will reduce other agency costs — particularly by replacing costly backup documentation and accountability mechanisms that were previously required only upon release of traditional annual financial statements. Companies and firms therefore voluntarily place more information on their websites because doing so reaps the economic advantages of reducing agency costs and the cost of capital (Pendley and Rai 2009, p. 89).

Historically, many agency costs arose from a lack of information available to investors. Research suggests that managers with superior knowledge of firm performance who increase voluntary disclosure to non-management investors can reduce agency costs and thereby increase firm value — a conclusion that empirical research further supports (Baek, Johnson, and Kim 2009, pp. 48).

To conclude, the voluntary disclosure of accounting information not only reduces information asymmetry between stakeholders and the market, but also reduces agency costs by leveraging technology to give stakeholders and investors consistent access to information that was once available only in limited forms. When investors have an ongoing understanding of a company's accounting assets, they are increasingly likely to commit more capital to that company, increasing profits and market presence. Additionally, empirical research has shown that voluntary disclosure benefits not only each company that adopts it, but is increasingly becoming the standard for corporate governance more broadly.

In assessing voluntary disclosure of accounting information within the financial field, both corporate managers and outside observers have the research needed to understand the benefits it brings not only to a company, but to every individual and entity associated with that company. As companies around the globe continue to face public scrutiny for withholding operational tactics and accounting data from investors, the option to adhere to voluntary disclosure standards is becoming ever more appealing on an international basis. Widespread adoption of this approach should prove beneficial to companies that assert, through its use, their commitment to the standards of honesty, integrity, and enhanced transparency in their operations.

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Apostolou, A. and Nanopoulos, K. 2009. "Voluntary accounting disclosure and corporate governance," in The International Journal of Accounting and Finance, 1(4): pp. 395–414. Retrieved from ProQuest Database.

Baek, H., Johnson, D., and Kim, J. 2009. "Managerial ownership, corporate governance, and voluntary disclosure," in The Journal of Business and Economic Studies, 15(2): pp. 44–65. Retrieved from Science Direct Database.

Bushman, R. and Smith, A. 2007. "Transparency, financial accounting information and corporate governance," in FRBNY Economic Policy Review, 9(1): pp. 65–87. Retrieved from ProQuest Database.

Chatterji, A. and Listokin, S. 2009. "Buying good companies or making them? The impact of pension fund ownership on corporate social responsibility," in Journal of Business Ethics, 87(1): pp. 299–317. Retrieved from JSTOR Database.

Conclusion

Giorgioni, G., Hassan, O., Power, D., and Romilly, P. 2011. "Voluntary disclosure and risk in an emerging market," in The Journal of Accounting in Emerging Economies, 1(1): pp. 33. Retrieved from ProQuest Database.

Gray, S. and Kang, H. 2009. "Reporting intangible assets: voluntary disclosure practices of top emerging market companies," in The International Journal of Accounting, 42(1): pp. 57–81. Retrieved from ProQuest Database.

Healy, M. and Palepu, K. 2008. "Information asymmetry, corporate disclosure, and the capital markets: a review of the empirical disclosure literature," in Journal of Accounting and Economics, 41(1): pp. 405–440. Retrieved from JSTOR Database.

Pendley, J. and Rai, A. 2009. "Internet financial reporting: an examination of current practice," in International Journal of Disclosure and Governance, 6(3): pp. 89–106. Retrieved from ProQuest Database.

Reddy, V. and Subramanian, S. 2010. "Voluntary disclosures and international product market interactions," in Decision, 37(2): pp. 31–52. Retrieved from JSTOR Database.