Question

a) Explain the options available to companies reporting voluntary disclosures

b) Identify three theories that explain the motivation for voluntary disclosures in annual reports

Answer 1

a)Voluntary disclosure refers to disclosing on the part of company's financial, non-financial and other relevant information in it's annual report for the need of it's users (investors , potential investors, shareholders and others).

Options available to companies for voluntary disclosures include mass communication sources like magazines , newspapers , annual reports , letter to shareholders , press reports , management forecasts , employee reports , interim reports , analyst's presentation . But annual reports are the major formal source of information among all the options available because it provides deep information disclosure and are produced regularly.

b)Although there are several theories to explain voluntary disclosure practices,three of them are as follows:

• Signalling Theory-It was initially developed to resolve the information asymmetry in the labour market but now it is used in corporates as well. In it,companies disclose information to investors in order to prove themselves better than other companies in the market and gain goodwill.Here signalling implies depicting more information to signal that jthey are better players.
• Capital need theory- It's main aim is to raise finance from external sources(debt or equity) at a low cost.Return for investors's uncertainty is a cost of capital for the company.Therefore reduction in cost of capital is acheived when investors are able to interpret companiy's economies of scale through voluntary disclosure.It was thought to be a positive relation between cost of capital and voluntary disclosure but Boston research has shown that it might have opposite effect also.
• Legitimacy theory- According to this, a company's values must match with the society where it operates in order to exist in the market.It has developed in accounting as a means to answer "what, why, how and when" certain situations are handled by the company.The annual report legitimates the information to outside public about the company's social acheivements.It is done both through mandatory and voluntary disclosures.