A Literature Review on the Empirical Studies of the Association between Firm’s Voluntary Information Disclosure and the Cost of Capital in an Efficient Capital Market

Corporate reporting is the interaction among users and the company . This interaction is pragmatic and useful in making contact with shareholders and aspirant users . Aside from financial statements , necessary data from the accounting system ought to be included . 1

A comparatively current modification in voluntary disclosure practices by management which is the giving out of prediction of management cash flows . The rate of the said disclosures in the 1980s is at a low level until the current years and it was only in 2000 that there has been an impressive growth in

giving out predictions of management cash flows and the amount of such predictions has increased by more than three times from pre-2000 degrees for disclosure2 . As there had been a global economic increase , corporate governance and accounting were put into higher standards and with this increasethe competition became rough resulting to extensive falsification of accounting information . The main question raised lies in the issuance of imprecise information . Having precise information is very important in evaluating the productivity of an employee . Precise information is needed to measure the worth of the firm and to be able to fix the disagreements over its value3

The importance of precise information is useful . If information were falsified or kept secretly , it can lead to the disclosure of the firm The needed information that was falsified can be a subsidiary of a particular act . Information disclosure , may it be falsification or keeping information in secret can result to very serious outcomes4 Information may be spreading in the stock price hurriedly before the public release of material company information . As regular fair disclosure is implemented then a decrease in pre-announcement abnormal returns is expected among bigger firms . However , these decreases may not be observed amongst small firms . The proportion disclosure decreased by 18 .5 for good-news disclosures and 22 .7 for bad news disclosures intended for bigger firms5

Appropriate civil and criminal penalties are tied up with failed disclosure these penalties are given to the offender is not solely based on the act committed but the risk of continuing the act of violating . Restrictions must be established for the bounds of necessary closure . Extra disclosures would mean decreasing rest urns and increasing costs . From the point of view of information recipients , the additional disclosures provide diminishing returns and increasing costs These added disclosures imply increasing costs on firms wherein the best possible information disclosure regime will not in need all the private information6

Market participants have an unfair informational advantage with voluntary disclosures . There has always been a reduction in fair disclosures . The results and its advantages are computed prior to the two-day given working days associate it with a 4-day window event of disclosures7

Information Disclosure and Assymmetry

Generally , the quality of a firm 's disclosures is linked to the intensity of information asymmetry8 over a period of time . The disclosure quality of a firm is an offshoot of short-run increases in information asymmetry because it intensifies private information search incentives having a more privately-informed trading as an outcome . The main effect of information asymmetry to firms is still being studied . A connection between disclosure scores and a variety of market interaction measures has been manifested . Disclosure and firm size , performance , and country legal origin are also linked . Cross-b economic interactions connected with correspondence in disclosure and governance practices9

Last 2003 , the association between voluntary disclosures and most company explores the relation between voluntary disclosure and the cost of capital by investigating stock returns . Firms are safe from disclosing . The forecast is still indicative that firms benefit from disclosing such forecasts . However , management earnings forecasts included good news , bad news , and confirming forecasts . The evidence obtained from the forecast is restricted10

Due to the restricted forecasts , corporate crises call for risk reporting to warn the investors of a forthcoming negative result . Risk reports verify the effects risks (and chances ) on the firm 's future financial position . It is mandatory for firm 's to report on their risks Obliged risk disclosures are not restricted even by financial service providers themselves11

The Role of Managent in Financial Decision Making

The opportunistic behavior of corporate management is the main key in financing decisions , financing costs , and the concentration of corporate ownership . The protection of the investors from such opportunistic behavior must be strictly implemented . A negative relation had been apparent between the level of disclosure and the protection that the regulations afford shareholders rather than creditors . High financing cost is interpreted as the control of few persons leading to opportunistic behavior12 . The behavior seems to be rampant instead of being controlled

The economics of information point of view and the risk management point of view when added up will result on a theoretical perspective on risk reporting . If decision makers outside the firm look forward to the manager 's risk reporting strategies , i .e , the manager 's way of exercising discretion about the disclosure of information on risk of availability , strategic reply then it is the time for theoretical setting to take place 13

Companies ' strategic actions and their outcomes are continuously measured and this evaluation does not only focus on the stock market but on the stakeholders of a company as well . The general evaluation process determines a company 's reputation . Aside from having good stock market assets and stakeholders , having a reputable name is essential . The quality of annual report disclosures of companies and their reputation are said to be related . Reputation is a multidimensional concept involving both financial and social aspects . The information that is publicly disclosed through reports would be a sufficient determinant of its reputation 14

Voluntary Information Disclosure

Voluntary disclosure of information is the main focus of a public discussion . The new necessities with regard to mandatory disclosures are needed by public companies . This proposed regulation is the belief that permitting firms to choose when and how much to disclose of their private information about the value of the firm results in too little disclosure . It has been argued that by a simple adverse selection argument may be used . That is , in the absence of frictions the informed party finds it optimal to provide full disclosure . At present , there is certainly no shortage of theoretical or empirical work on disclosure however there are still factors that need attention in so far as they affect the motivation promoting voluntary disclosure 15

Incentives for Disclosure

If a firm commits to intensify its level of disclosure , the potential for information asymmetries to arise between the management of the firm and its shareholders or among buyers and sellers of the firm 's shares decreases . There are many reasons why a firm would opt to reduce information asymmetry by increasing disclosure . Managers making capital market transactions provide incentives to voluntary disclosure for the reduction of the information risks brought about by investors eventually reducing the firm 's cost of external financing . Firms having high disclosure levels are more likely to attract investors who are confident in dealing that stock transactions occur at fair ' prices , thereby increasing the liquidity in the stock . At the same time , voluntary disclosure can also reduce the cost of information acquisition for analysts and hence increase their supply 16

The link between disclosure and financial market still poses a question Why disclosure affects asset pricing ? How much disclosure is priced What factors affect such pricing and what are testable implications These questions are just offshoot of the main question about the link of disclosure and financial market . The disclosure is a subset of signaling . The disclosure is from an informed sender to an uninformed receiver . The informed sender makes an optimal decision about the given disclosure of a contract between two parties . The contract accounts for the optimal decision of the receiver as well as that of the sender . The contract must satisfy market equilibrium condition . The optimal disclosure and the equilibrium contract specify the quality of information endogenously . The quality of information received and transferred in the economy affects asset pricing 17

This rich disclosure environment makes a firm 's commitment to higher disclosure levels less noticeable , and hence , makes its economic consequences difficult to observe . An emerging market environment provides an ideal setting to detect the incremental effects of increased disclosure on the market microstructures . In contrast to developed capital markets , the information environment in the emerging markets like China is characterized for its low quantity and quality of accounting disclosure . From 1996 to 1999 , the accounting professionals and regulators in China carried out a series of auditing standards patterned after the International Auditing Standards . The standards covered a wide range of auditing issues from standards on audit of financial statements , audit reports , going concerns , fraud and errors illegal behaviors , as well as other information disclosed with audited accounting information . All domestic auditors are mandated to follow all of these standards 18

Transparency has become a vital regulatory frontier . In countries like the United States , the European Union , and developing countries governments have establish disclosure systems to lessen health and safety risks , minimize corruption , protect civil rights , and for public service enhancement . Many countries have adhere to the idea that the public has a right to know ' about information acquired or developed by government agencies19 . At present , transparency has become a means of regulation

Information Disclosure and Capital

A firm 's commitment to disclose information on an ongoing basis is an essential part of the capital-raising process . Without such a commitment , made in a credible manner , potential investors cannot insure that funds envested in the firm will be used properly or that there will be a liquid secondary market for the firm 's shares . The federal government mandating the content of these disclosures is , however , a comparatively more recent and more controversial practice . Securities legislation establishing minimum disclosure requirements for public companies was enacted in the U .S . in the 1930s premised on the belief that regulating disclosure practices would help protect investors . But investor protection may not provide a compelling justification for the federal regulation of public company disclosures . Investors and owners can agree among themselves on the firm 's disclosure policy , and share prices rapidly incorporate available information 20

Many studies document positive associations between capital market benefits and financial reporting and disclosure quality , such as evidence that suggests expanded disclosure is associated with greater market liquidity and lower cost of equity capital .1 Evidence from multiple country settings is relatively limited , but generally consistent with results from single country studies . However , little evidence links corporate financial reporting and disclosure quality to the ability to raise new external equity capital in global markets particularly in the context of emerging markets (EM ) companies21 The disclosure and financial reporting affects the manager 's decision to voluntarily provide supplemental disclosures . In the present context the manager 's private information , if disclosed , reduces the market 's uncertainty about how information in the firm 's financial reports translates into long-term value and thus is valuable only in the presence of the firm 's financial reports . The advantage of this structure is that it allows us to examine how the items in the firm 's financial reports22 1 Joshi , A , `Disclosure Practices in Corporate Reporting of Public Sector Financial

Institution , ACRM , vol .1 , no .1 , 2006 , pp . 30-33

2 Wasley , E and Wu , J , ` Why do managers voluntarily issue cash flow forecast . Simon School of Business , 2005 , pp . 1-50

3 Hertzberg , A , `A Theory of Disclosure in Speculative Markets , 2006 pp 1-46

4 Manne , G , `The hydraulic theory of disclosure regulation and other costs of disclosure

regulation . 2006 . pp . 1-45

5 Regulation FD (Fair Disclosure ) is a new issuer disclosure rule that addresses selective disclosure . The regulation provides that when an issuer , or person acting on its behalf , discloses material nonpublic information to certain enumerated persons (in general , securities market professionals and holders of the issuer 's securities who may well trade on the basis of the information , it must make public disclosure of that information

Gadarowski , C , and Praveen S , `the Efficacy of Regulation Fair Disclosure : Theory Evidence ' Rowan University Press , 2005 , pp . 1-51

6 locit /occit

7 . Gadarowski , C , and Praveen S , `the Efficacy of Regulation Fair Disclosure : Theory Evidence ' Rowan University Press , 2005 , pp . 1-51

8 Information asymmetry exhibit itself when investors trade on the basis of their private

information serving two purposes . Its first purpose , it intensifies the private information based trading relative to level of uninformed trading which is termed as the trading environment . The second purpose deals on how often an investor knows the kept information on what to trade

9 Khanna T , Palepu K , and Srinivasan , S , Disclosure Practices of Foreign Companies Interacting with U .S . Markets ' Journal of Accounting Research vol . 42 , no . 2 , 2004

10 Kim , J , `Voluntary Disclosure and the Cost of Capital : Evidence from Management Earnings Forecasts , John Molson Business School , Concordia University , pp . 1 -34

11 Dobler , M , `How Informative is Risk Reporting ? - A Review of Disclosure Models - , Munich Business Research , pp . 1-26

12 Farina , V , `Corporate disclosure determinants : a cross-country investigation , University of Rome , pp . 1-26

13 Dobler , M , `How Informative is Risk Reporting ? - A Review of Disclosure Models - , Munich Business Research , pp . 1-26

14 Kim , J , `Voluntary Disclosure and the Cost of Capital : Evidence from Management Earnings Forecasts , John Molson Business School , Concordia University , pp . 1 -34

15 Karmel , R , `Brooklyn Law School Legal Studies Research s Accepted Series , Research No . 38 , 2005 , pp . 1-40

16 Farina , V , `Corporate disclosure determinants : a cross-country investigation , University of Rome , 2005 , pp . 1-26

17 Dobler , M , `How Informative is Risk Reporting ? - A Review of Disclosure Models -` , Munich Business Research , 2005 , pp . 1-34

18 Dorobantu , F , `Information Disclosure in Speculative Markets , Duke University , 2005 , pp . 1-26

19 Also , lawmakers have required that corporations , public agencies , and other organizations disclose information about their activities that affect public welfare . Legislators in the United States have created scores of other transparency systems aimed at promoting public priorities : annual factory-by-factory reporting to reduce toxic pollution nutritional labeling to reduce heart disease and cancer disclosure of bank lending patterns to reduce race and gender discrimination school report cards to improve performance and disclosure of sources of campaign contributions to reduce corruption Transparency has gained prominence as policy makers have seen the shortcomings of more conventional regulation , searched for approaches to problems that do not lend themselves to standardized rules , and recognized the potential of information technology to make complex data accessible to broad audiences

Fung , A et . al . ` The Political Economy of Transparency What Makes Disclosure Policies Sustainable ? ` , Harvard Univeristy , 2003 , pp . 1-46

20 Guttentag , M , `Disclosure Regulation , Agency Information , and Interfirm Externalities , 2004 , pp . 1-33

21 EM companies face greater barriers to capital access than their developed market counterparts , and higher financial reporting and disclosure quality might lessen such barriers . Barriers to EM companies access to capital include the following . First , EM generally have limited pools of available capital . Second , the high degree of risk - economic , political , and financial - in EM deters foreign investors . A third factor is that the generally weak corporate reporting and disclosure quality in emerging economies introduces information risk that has been cited as a further deterrent to investors

Frost , C , Gordon , E , and Pownall G , `Financial Reporting Quality Disclosure , and Emerging Market Companies ' Access to Capital

in Global Equity Markets , 2006 , pp . 1-63

22 how they translate into long-term firm value , and how they are related affect (1 ) what the manager chooses to disclose and (2 ) the probability that the manager makes a voluntary disclosure . In our model the firm 's financial reports provide multiple pieces of information that the market uses to estimate firm value , and the manager seeks to maximize this value . In the simpler case when the key items in the firm 's financial reports (e .g , revenues and expenses ) have uncorrelated transitory components ,2 the set of values of the manager 's private information that she voluntarily discloses depends on whether the firm 's financial report is better or worse than the market expects . As a result , the manager 's voluntary supplemental disclosure strategy enhances (mitigates ) the market 's upward (downward ) revision in price conditional on the information in the firm 's financial reports . Further the probability of voluntary disclosure is greater if the firm 's mandatory reports contain larger surprises (in either direction Intuitively , if the firm 's reported performance is close to market expectations , the benefits of voluntary disclosure (the associated increase in the firm 's stock price ) do not exceed the costs , whereas if the firm misses or beats market expectations by a lot , the benefits of voluntary disclosure exceed the costs

Bagnoli , M and Watts , S `FINANCIAL REPORTING AND SUPPLEMENTAL VOLUNTARY DISCLOSURES , Purdue University , 2006 , pp . 1-39 ...