Question

what is the advantages and disadvantages of voluntary disclosure ?

Answer 1

Disclosing business and financial information can be risky for any business owner. Disclosure has distinct advantages for a business's public relations image, but disclosing certain financial and business information can put business growth and financial plans at risk

Advantages

There are six different factors that encourage managers to voluntary disclosure. Those
factors are: capital market transactions, corporate control contests, stock compensation,
litigation, proprietary costs, management talent signalling and limitations of mandatory
disclosures. (Healy and Palepu 2001; Graham 2005).

Capital market transactions hypothesis

The perception of how the company is seen by the investors has impact on disclosing
decisions taken by the management. It has a stronger impact in case when the company is in
need of external source of financing. Providing only mandatory information does not decrease the information asymmetry. As mentioned before in my thesis, that gap leads to higher cost of capital and higher risk associated with that investment. While facing the need of acquiring external capital at a lower cost possible that inequality in information should be reduced.

Regarding that, the managers who are planning to make capital market transactions will be
willing to voluntarily disclose internal information of the company.

Corporate control contest hypothesis

The main tool to control the managers by the boards of directors and investors is the
stock performance of the company – price of shares. Managers use voluntary disclosure in
order to protect the company from undervaluation and in case of poor performance, they
prefer to communicate bad news step by step by themselves in order to avoid a sharp drop in
stock prices. They are willing to better communicate with stakeholders because of the risk of
job loss. Managers use voluntary disclosure as a tool to explain poor stock and earnings
performance. Higher level of voluntary disclosure would drive to increased analyst coverage. More information available will lead to higher interest from analyst as the cost of acquiring information has deceased. It would result in higher interest in
analysis performed about the company and therefore, reflect its fair value in the market.
(Graham, 2005)

Stock compensation hypothesis

In order to motivate the management into better performance several rewards are used.
One of the most common method is stock compensation. This type of premium positively
influences managers decisions regarding voluntary disclosure mainly because of two reasons.
First, as they are also “owners” of the company and they are interested in trading their
shares they will try to increase its stock value, and moreover to correct it in case of
underestimation. Therefore, they would be willing to share internal information and to
voluntarily disclose private information.
The second reason to increase the level of voluntary disclosure is the reduction of
contracting costs which are related to stock compensation for new employees. In this case
managers would act in favour of the existing shareholders. Increased level of voluntary disclosure would therefore, reduce contracting cost connected to stock compensation for new employees
A study carried out by Aboody and Kasznik (2000) points out that during the stock
option award period managers tent to postpone disclosure of positive news and enhance bad
news in order to increase future stock-based compensation. (Aboody and Kasznik, 2000).

Litigation Cost Hypothesis

Managers concern about shareholders litigation can affect their disclosure decisions.
First, the firm might decide to increase the level of voluntary disclosure due to inadequate or
untimely disclosures. On the other hand, the fear of litigation might decrease the willingness
to disclosure, especially of the forward-looking information, I will focus on this negative aspect further on in my thesis. In his work, Skinner (1994) investigates
the effect of pre-disclosed bad information and cost of litigation. He realises that in case of
absence of litigation, managers prefer to keep the balance in disclosing good and bad news.
Also he states that pre-disclosure of poor performance of the company reduces the probability of litigation. It is mainly because the drop in share prices is distributed over time and there is no sudden drop in stock value of the company which is easier to recover once good news
come. (Skinner 1994).

Management Talent Signalling Hypothesis

Managers with the capability of accurate earnings forecasting will be willing to
voluntarily disclosure their personal information. It is mainly because company's market
values depends on investors' perception of management skills of recognizing and responding to future environmental changes. If the forecast performed by the manager is adequate it is more than probable that the market value of the company will increase.

Limitations of mandatory disclosures

As mentioned before, compulsory information is what the government requires. It is a
basic and limited form of communicating company's performance. Many people complain
that mandatory data published it hard to understand and includes only financial aspects of the
firm forgetting about non-financial indicators and intangible assets. Also, mandatory information is published every three months causing lack of timeliness and a need for more
frequent channels of communication. Those concerns and inequalities push towards voluntary
disclosure, which would reduce the information gap arising from providing stakeholders only
with compulsory form of knowledge. ( Graham, 2005)

Disadvantages

Disclosure precedent

Once the company decides to voluntarily disclosure its internal information it is really
hard to back off. Managers are afraid that if they decide towards voluntary disclosure in the
future they will be pushed to continue doing so. It would not be so bad if the additional information would be always good. In case of poor performance or bad times management
probably would rather just keep the information for themselves or simply would not be too
proud of sharing it. Although, it is usually better for the company's interest if the bad news are
coming out directly from the management I believe that many times the firm would rather
hide this data or at least postpone them in time. This practice would have higher use in case
when there is a high probability that poor performance is just temporary and the toxic news can be easily hidden or, shared latter on together with good news.
Voluntary disclosure practise also entails an increase in people's expectations
regarding future information, people would expect more and more internal data to be shared.
(Graham 2005).

Litigation costs

litigation hypothesis has two possible outcomes on voluntary disclosure. One, affects it positively, driving managers towards increased voluntary
disclosure. The other one has negative impact, preventing the management of sharing too
much. That aspect will be discussed in this section of my thesis. Managers are pushed away
from voluntary disclosure mainly because of the lack of willingness to share their privateforward-looking speculations. It would have stronger impact in case when the manager could
be penalised for bad speculations. ( Graham 2005; Healy and Palepu 2001). In case of the fear
of litigation managers prefer not to share that much in order to avoid unnecessary conflicts. If
the stakeholders do not know as much about the company they will be less involved and
therefore, the decision-making process would be faster. The tactic to step away from
voluntary disclosure would also decrease the possible costs of litigation. (Graham, 2005;
Haley and Palepu, 2001).

Proprietary Cost Hypothesis

One of the reasons why firms are not willing to voluntarily disclosure more
information that necessary is the threat of loosing their competitive advantage. Even though, the additional information would decrease the cost of capital, many times the managers prefer to keep the internal information within the company and pay a premium for getting external financing. Proprietary cost hypothesis can negatively affect voluntary disclosure of information because of managements fear of revealing too much and loosing their competitive
position in the market. (Healy and Palepu 2001).

Agency costs

Managers decide to avoid unnecessary attention from the stakeholders. Limiting
voluntary disclosure of unimportant information would safe many not desariable questions
and comments leading to faster decision making process and saving agency costs. (Graham,
2005)

Political costs

For own comfort managers would prefer not to disclosure that much in order to limit
the amount of information that can be used against them. The level of impact of political costs depends on the size of the company. Big companies with a high level of profits are more
likely to decrease the level of voluntary disclosure. It is mainly to avoid being involved in any political attacks. (Graham, 2005; Shehata, 2013).