Manager Reporting And Disclosure Decisions

Manager Reporting and Disclosure Decisions: A Look at Empirical Research

1.Introduction

Financial reporting and disclosure are key ways managers can inform investors of the performance and governance of the firm. According to Healy et al. (2001), capital markets need corporate disclosures for them to function efficiently. "Firms provide disclosure through regulated financial reports, including the financial statements, footnotes, management discussion and analysis, and other regulatory filings" (Healy et al, pg. 406, 2001). In addition to mandatory disclosures, managers also have the option to engage voluntary disclosures, which consist of such things as management forecasts, analyst's presentations and conference calls, press releases, Internet sites, and other corporate reports.

As discussed above, manager's options for disclosing come in the form of either mandatory or voluntary disclosures. Consistent with the literature on managerial disclosure decisions my discussion in section two has been broken into two areas, focusing on positive accounting theory, and voluntary disclosures. Positive accounting theory deals more with the mandatory financial disclosures and looks at the financial reporting choices of managers that affect the financial reports. Whereas empirical evidence on motivation for managers to voluntarily disclose looks more at the stock market implications of disclosure, examining six theories for why managers disclose voluntarily.

This paper will focus on evaluating the current literature and empirical evidence on managerial reporting and disclosure decisions. In addition, it will address the implied questions on manager disclosure decisions found in the review of disclosure literature by Healy et al. (2001). With this in mind, discussion will be given to the factors that motivate management's disclosure decisions, and explanation will be given to the relationship between disclosure, corporate governance, and management incentives. Furthermore, brief consideration is given to the role of boards and audit committees in making the disclosure process more credible. The available evidence on managerial disclosure decisions is dominated by studies of US firms. To supplement US evidence discussion will be given on results in New Zealand and any future opportunities for study on managerial disclosure decisions.

The paper proceeds as follows. In Section 2, literature on positive accounting theory and accounting choice is examined. I describe the empirical evidence on voluntary disclosures in Section 3. In Section 4, the evidence of managerial disclosure decisions is established. In Section 5, I review any possible opportunities for future empirical disclosure research in New Zealand. Section 6 concludes.

2.Positive Accounting Theory Literature

Literature on positive accounting theory is predominantly concerned with the motives behind managerial decisions that go with a particular form of accounting choice. According to Fields et al. (pg.256, 2001) "an accounting choice is any decision whose primary purpose is to influence (either in form or substance) the output of the accounting system in a particular way, including not only financial statements published in accordance with generally accepted accounting principles (GAAP), but also tax returns and regulatory filings. Research into the determinants and implications of accounting choice date as far back as the 1960's and the relevant literature can be classified by three categories of goals or motivations; agency costs, information asymmetries, and influencing external parties.

Contracts such as management compensation arrangements and debt covenants operate to reduce agency costs by aligning the incentives of managers and shareholders. In other words contracts are entered into so that the agent behaves as if he or she were maximising the welfare of the principle. However, it is apparent that ex post accounting choices can be made that increase executive compensation and avoid violation of debt covenants (Fields et al. 2001). For example mangers may choose one form of measuring inventory over another or various other accounting choices that increase reported earnings and, hence, provide them with personal benefits from earnings-based compensation. Alternatively, the opposite may be done so as to reduce the present value of taxes.

Information asymmetries stem from markets that do not aggregate the information sets held by managers and shareholders. Although, certain forms of accounting choice may provide opportunities for managers to bridge the information gap about the timing, magnitude, and risk of future cash flows. It is often alleged that managers act purely on self-interest and instead prefer to have higher earnings prevail so that they can be remunerated accordingly and to increase their reputation. An example of this is that managers can make certain choices to assure they meet an analyst forecast in an attempt to avoid negative stock price reactions (Levitt, 1998; cited in Fields et al. 2001).

Finally, the last category of goals or motivations of accounting choice is influencing external parties. External parties are deemed not to be the actual and potential owners of the firm, rather organisations such as the Inland Revenue Department (IRD), or government regulators, suppliers, competitors or union delegates. Managers through their accounting choices hope to influence external parties in a way that will be beneficial to them. For example, the information obtained from the accounting numbers may help the manager to lobby for an accounting standard that reduces compliance costs of the firm. The following review of accounting choice is structured around the goals and motivations for accounting choice described above.

Contractual Motivations

Often management compensation contracts and bond covenants that are used to mitigate the internal and external agency conflicts are based on reported financial accounting numbers. Many researchers have studied whether such contracts provide managers with an incentive to use specific accounting choices in an attempt to reach desired financial reporting objectives. Results suggest the presence of incentives to increase manager compensation and reduce the likelihood