Voluntary Disclosure - Essay Example

Voluntary Disclosure Name Institution Introduction Transparency and disclosure make up one of the pillars of corporate governance. Lack of improper disclosures has led to the rise of several scandals worldwide. According to (Duska, Duska & Ragatz, 2011), disclosure is the act of informing the public through a firm’s financial statements. Albrecht (2007), in his studies, adds that disclosure is the communication of financial or nonfinancial economic information, whether quantitative or otherwise, regarding the financial performance and position of a company. The two broad categories of corporate disclosures are mandatory and voluntary. Roy (2001)) defines voluntary disclosure as the free choice of management of a company to provide revenant information, whether accounting or not, so that the users of its annual reports can use it in their decision making. This essay discusses the concept of voluntary disclosure, aiming on its theoretical aspects and its role in the economy. The essay will focus mainly on the legitimacy, accountability and stakeholder theories and the ways in which they apply to voluntary disclosure in corporate reporting. Finally, the 2014 Cochlear LTD’s Annual Report to Shareholders will be reviewed to give examples of disclosures and evaluate whether they are positive or negative. The Concept of Voluntary Disclosure The provision of information by the management of a company, beyond the specifications of the required standards such as general accounting principles and rules of Securities and Exchange Commission is known as voluntary disclosure (Roy, 2001). The provided information, however, has to be relevant to the users of a company’s annual report during decision making. The type and extent of voluntary disclosure a company can apply is determined by its size, industry and region. The company ownership structure and corporate governance structure also affect the extent of voluntary disclosure. Many companies carry out voluntary disclosure and their respective managers have a unique influence of their disclosure styles. According to (Roy, 2001), the disclosure style a manager chooses to relate to their personal backgrounds, career paths and military experience. Companies, investors and the economy benefit from voluntary disclosure in various ways. For example, investors are able to make better capital allocation decisions. In addition, the cost of capital for the firm is lowered and the general economy is benefited. For the widely held firms, the conflicts of interest are reduced. The types of information included in voluntary disclosures can range from the strategy and characteristics of a company, financial information such as stock process and non financial information such as practices of social responsibilities. According to the Financial Accounting Standards Board, voluntary disclosure can be categorized into business data, analysis of business data, forward looking information, information about shareholders and management, company background and intangible assets information. Bebbington, Unerman & O’Dwyer (2014), argues that managers are obliged to disclose information that will meet the needs of various stakeholders voluntarily. The main aim of voluntary disclosure is to provide a clear view of the long term sustainability of a business to stakeholders and reduce asymmetry of information as well as conflicts between investors and senior leadership team. Healy & palepu (2012), however, claims that voluntary disclosure will still remain biased because it is based on selective information by managers. Various theories are used to explain the background of voluntary disclosure and its role in the economy. Voluntary Disclosures Theories The main theories of voluntary disclosure include legitimacy, stakeholder and accountability theories. Legitimacy and stakeholder theories are system oriented, and they focus on the roles information and disclosure play in relationships between groups, individuals, organizations and government. According to Tafoya (2014), an entity influences and is influenced by the society in which it operates. Stakeholders and legitimacy theories and derived from the political economy theory. Political economy, according to Tafoya (2014) is the political, social and economic framework in which human life takes place. While investigating economic issues, the political, institutional and social frameworks within which the economic activity takes place have to be investigated. Corporate reports are the result of the interchange between the firm and the environment within which it operates. Legitimacy, stakeholder and accountability theories are applied to explain the reasons why an entity might choose to make particular voluntary disclosures. The theories are discussed further below; Legitimacy Theory Legitimacy theory states that an organization seeks to make sure that they operate within the specified norms and bounds of their respective societies. The activities that an organization undertakes have to be perceived to be legitimate; otherwise the organization has no right to exist. The norms and bounds are not static, and therefore, an organization is required to be responsive. The organizations rely on the notion of social contracts between itself and the society. The social contract is based on the expectations that the society has of the organization, and the ways in which it should conduct its operations. According to Roy (2001), legitimacy is the condition or the status of an organization value system being harmonious to the society in which it operates. Calhoun, Oliverio & Wolitzer (2009) adds that legitimating is the process that causes the organization to be viewed as being legitimate. The process of legitimating includes voluntary disclosures. The main objective of accounting is to provide users with information that they can use in decision making to satisfy their social interests. Stakeholder Theory This theory of voluntary disclosure is concerned with identifying and recognizing the link between an organization’s actions and the impact on the stakeholders. An organization’s stakeholders are comprised of clients, staff members, suppliers, regulators, lenders, among others. Organizational leaders have the role of ensuring that there are no conflicts of interest between the firm and the stakeholders. As such, they are required to establish laws, rules and processes that determine how a firm operates. Stakeholder theory of voluntary disclosure states that an organization must uphold morals and values. According to this theory, organizational leaders have a fiduciary duty of putting the interests of stakeholders first (Solomon, 2007). Accountability Theory In the last few decades, there has been an increase in the number of corporate scandal cases throughout the globe. These scandals have caused the collapse of giant organizations, including the Enron and World.com. According to accountability theory, organizational leaders are required to safeguard the organization’s assets (Duska, Duska & Ragatz, 2011). A well managed and controlled firm enhances investor’s confidence, goodwill and access to capital markets. Negative or Positive Voluntary Disclosures?  I would expect a company to make more negative voluntary disclosures than positive voluntary disclosures. There’s no perfect organization because companies sometimes make losses during their operations. Therefore, organizational leaders are supposed to report both the negative and positive results. During hard times, some organizations hardly bother to report negative performances in order to keep the investors satisfied. Integrity requires an organization to exhibit honesty and be straightforward with the stakeholders. A company that reports negative information on a regular basis gains trust from the shareholders (Internal Revenue Service, 2007). Due to the sensitivity of information, organizational leaders should restrict themselves to high standards of truth and transparency refraining from false information or hiding some of the information (Campbell and Houghton, 2005). Information (whether positive or negative) should be in detail. The managers should include all required information in their official reports to avoid secrets and loopholes for false information. Concealing information, especially concerning losses, leads to more errors and lack of confidence and trust from shareholders. Organizational leaders are not restricted to only satisfy the needs of their organizations, but also work in stakeholders’ interest. It is highly imperative that managers adhere to stipulated ethics as a guide to achieve desired objectives. The last decades saw organizations such as Enron, Xerox, and World.com collapse as a result of false and manipulative information that was used to make organization wide decisions. Therefore, a company that makes more negative disclosures enables the stakeholders to have a clear overview of what is happening. This enables them to take corrective action. Case Study: Cochlear Ltd Cochlear Ltd’s Annual Report to Shareholders To our shareholders: Cochlear Ltd has passed many milestones in 2014: by year end, we had served more than 1.2 million customers, yielding 18% revenue growth to $820.9. During this year, we launched new products. As a result, we achieved an increased market share in the highly competitive health care equipment & services industry. Below is the disclosure report for 2014: Voluntary disclosure Page number Identified theory/theories Positive or negative  Slowdown of sales in Q1  2  Accountability  Negative Sales increased in Q2 as we launched new products   23  Accountability  Positive EPS have been declining over the last 5 years 24 Accountability/Stakeholder Negative There are potential risks that may hinder the realization of set objectives. The company’s performance is affected by various variables, including currency fluctuations, global economic and geographical conditions, intense competition in the market and a sluggish market growth for its products. 24 Legitimacy Negative The company has a global quality assurance system in place 6 Stakeholder Positive  The incentive bonus that are awarded to the executives annually have been increasing  25  Legitimacy  Negative The executives awarded themselves huge salaries during the year 26 Legitimacy Negative There has been a gradual rise in the use of share based payment component in Cochlear. Stock options align the interests of the executives to those of the shareholders. In addition, they are counted as the expense of the corporate (non-cash) which influences the income statement of the firm and enhances transparency of distribution of options to shareholders. 28 Stakeholder Positive The company adopts fair value measurements. The financial statements are not complex, and thus, shareholders are able to analyze them easily 29 36-88 Legitimacy/Stakeholder Legitimacy/stakeholder Positive Positive The accountability theory best describes the above disclosures as it helps the management team to define the general social and political environment within which Cochlear operates. The way resources are managed and controlled affects an organization’s competitiveness and performance in the long run. It determines the conditions for enhancing investor’s confidence, goodwill and access to capital markets. The stakeholder theory is linked to Cochlear’s performance. This theory mainly focuses on the economic motivations (Calhoun, Oliverio & Wolitzer, 2009). Thus, the theory explains how the managers at Cochlear manage and controls resources. A positive disclosure, therefore, enhances investor’s confidence. Legitimacy theory indicates the extent to which Cochlear is regarded as legitimate by the society. This theory explains the social motivations of Cochlear behaviours (Tafoya, 2014). Conclusion The concept of voluntary disclosure has gained a lot of attention in the recent past due to the increased number of corporate scandals that have seen major corporations collapse. Both positive and negative disclosures have effects on the cost of capital, goodwill and investors’ confidence (Healy & Palepu, 2012). There are no perfect organizations, and therefore, organizations that report negative information builds public trust. Cochlear makes both positive and negative voluntary disclosures. By reporting both good and bad news, Cochlear makes voluntary disclosures to be reliable. Mandatory disclosures cause major variations between the organizations’ value and reported results, and therefore, should be discouraged. References Albrecht, W. S. (2007). Accounting, concepts & applications. Mason: Ohio: Thomson/South-Western Bebbington, J. , Unerman, J. & O’Dwyer, B. (2014). Sustainability Accounting and Accountability. London: Routledge. Calhoun, C. H., Oliverio, M. E., & Wolitzer, P. (2009). Ethics and the CPA: Building trust and value-added services. New York: John Wiley. Campbell, T., & Houghton, K. A. (2005). Ethics and auditing. Canberra: ANU E Press. Duska, R. F., Duska, B. S., & Ragatz, J. (2011). Accounting ethics. Chichester, West Sussex, U.K: Wiley-Blackwell. Healy, P. & Palepu, K. (2012). Business Analysis Valuation: Using Financial Statements.Ed: 5. London: Cengage Learning. Internal Revenue Service. (2007). Corporation Income Tax Returns, 2004, Statistics of Income: Government Printing Office. Roy, P. (2001). Voluntary Disclosure of Company Information - Costly Additions or a step towards Competitive Advantage? An Application to the Case of Publicly Quoted Football Clubs in Europe. France: diplom.de. Solomon, J. (2007). Corporate Governance and Accountability. New York (NY): John Wiley & Sons. Tafoya, D. (2014). Marginal Organizations: Analyzing Organizations at the Edge of Society's Mainstream. Basingstoke: Palgrave Macmillan. Read More