CHAPTER SIX

INTERNATIONAL TRANSPARENCY AND DISCLOSURE

INTRODUCTION

In this chapter we examine differences in transparency and disclosure practices by

multinational enterprise (MNEs) and across countries. The lack if “transparency” of company
accounts and reports is a major issue and concern in many countries around the world
consistent with the growing need to attract and retain foreign capital and facilitate capital
raisings internationally.

As Susilowat, Morris, and Gray (2004) explain, corporate transparency has become a
more widely discussed issue in the financial press and academic literature in respone to
growing accountability concerns. Some key factors have been the Asian Financial crisis of
1997/1998 and recent major corporate failures around the world, such as those of Enron and
WorldCom in the united states, HIH in Australia, and Parmalat in Italy. Achieving higher
levels of transparency of corporate operations is now a goal of regulators and standard setters
around the world.

Corporate transparency matters to firms in order to help stock market investors

distinguish good quality firms from bad quality firms; otherwise they will tend to treat all
firms as being of “average” quality which punishes good quality but rewards bad quality
firms. Corporate transparency can have signaling properties for good quality firms. Corporate
transparency matters to regulators for macroeconomic reasons to restore confidence in and
expand capital markets, and to encourage investment in the economy.

THE MEANING OF TRANSPARENCY

Bushman and Smith (2003, p. 76) defined corporate transparency as “the widespread
availability of relevant, reliable information about the period performance, financial position,
investmen opportunities, governance, value, and risk of publicly traded firms.” Corporate
transparency has been measured as a combination of many firm-specfic and country-specific
factors. Bushman and Smith’s measure of corporate transparency includes financial reporting,
governance disclosures, availability of annual reports in English, the penetration and
ownerhip of the media in a particular country, and the case with which private information
about firms can be collected and disseminated. Similarly, PricewaterhouseCoopers Opacity
Index (2001, p.4) measures opacity (the converse of transparency) at the country level as a
function of five dimensions: corruption levels, legal and judical opacity, economic/ policy
opacity, accounting/ corporate governance opacity, and the impact of regulatory opacity and
uncertanty/ arbitrarines. At the country level, Bushman, Piotroksi, and Smith (2004) identify
two kinds of coporate transparency; financial transparency and governance transparency.
Country-level financial transparency is made up primarely of corporate disclosure intensity,
timeliness of disclosure, the number of annalysis, and media development.
 In the above measurements of corporate transparency, disclosure of financial
information in company annual reports, either coluntarily or in accordance with accounting
standars, plays a central role. Indeed, it appears to be a necessary but not sufficient
component of corporate transparency.

DISCLOSURE IN CORPORATE REPORTS

The amount of information disclosed by MNEs in corporate report has expanded

considerably in recent years. The major source of pressure for increased disclosures has been
the financial and investmet community. Both MNEs and standard-setting bodies in countries
with well-developed securities markets, such as the united states, the united kingdom, france,
germany, and japan, have been concerned primarily with responding to pressures from this
direction. There has also been something of an explosion in the demand for information by a
wide range of other participant groups including governments, trade unions, employees, and
the general public.

The Pressures for Information Disclosure

Not surprisingly, MNEs are concerned about the manner in which apparently ever increasing
requirements for information disclosure are determined by regulatory bodies and standard-
setting agencies at both governmental and proffesional levels. The pace at which regulation
has accelerated since the early 1970s is such that it is sometimes suggested that only a time
lag separates a request from its eventual declaration as a required disclosure. Such a view
may vastly oversimplify the technical and political process through which standards are
established a process in which many companies directly or indirectly participate. But the
ultimate result, albeit at times postponed or slowed down, has been increasing accounting
and disclosure requirements.

The acceleration in the demand for information for investment purposes appears to be
unsustainable and hence must eventually decline. However, the increasing
internationalization of financial markets and share ownership, combined with a concurrent
growth in awareness of the cosiderable diversity of accounting participles and practices in
different countries, has fueled the demand for additional information disclosures to increase
both the quality and comparability of MNE reports.

Apart from the investor group, there is a growing belief among other groups such as
governments and trade unions that both and increased availability and an improved quality of
information are essential . It can be argued that many of these demands are general, vague,
and imprecise. However, as the demand has grown, so too has its precision at both the
national and international levels. International organizations such as the UN, UECD,
European Union, and IASB are now issuing more detailed requirements and
recommendations.

At a time when some may have thought that for MNEs headquartered in countries
with well-developed securities markets, the demand for information might have eased, there
has been a growing and articulated demand from a range of non-traditional information users
for more information. Some of it already available to and directed at investors-others
demanded by emerging user groups. This demand has been spurred, of course, by key factors
such as the Asian financial crisis and major corporate failures and scandals around the world.

Users with the ability or power to obtain “tailor-made” reports, such as trade unions at
national levels with adequate bargaining power and organizational ability, are apparently
learning the limitations of corporate annual reports. They are increasingly concentrating their
energies on obtaining special-purpose reports more in line with their specific information
needs. While this has the effect of reducing the demands on the annual publication of the
general-purpose corporate report, it increases the pressures on corporations to improve the
availability of more comprehensive information through other cannels.

Thus, the increased supply of information appears in some respects to have actually
increased, rather than reduced, the demand for additional information. If the demand for
information was fixed, corporations could include this is one of the benefits to be matched
against the costs of information disclosure. However, this is clearly not possible in the current
dynamic context of information demand. But to what extent is the information demanded
likely to be used and understood and by whom.

Communicating to Users

The decisions of corporations and/or regulatory bodies as to which groups have a right to or
should be provided with information are a major determinant of the content of corporate
reports-and influence in particular the range of information. Equally impprtant is the decision
about to whom the information is aimed; this determines its depth. Despite the long history of
information is aimed; this determines its depth. Despite the long history of information
diclosure by corporations, only recently have systematic efforts been made to assets the
ability of supposed users actually to use corporate annual reports. There is growing evidence
that these reports are neither read or nor understood by a considerable percentage of those
whom they are supposed to inform, especially the layperson investor.

The direct users are apparently the relatively small number of experts who have the
necessary ability and experience to analyze financial information. No group is without its
information analysts. Many investors and shareholders do not make investment decisions
alone but rely on the advice of experts. They may do this buying advice or by consulting the
financial press or other sources of interpretation.

Why do only a minority directly use corporate use corporate reports? The fact is that
corporations, of even moderate size, are complex organizations. A comprehensive analysis
necessitates not only the use of financial information but additional data as well as to assess
current and future trends. In the main , MNEs are especially complex, and so too are their
corporate reports. Not only do MNEs produce a variety of products, but they operate in a
number of countries and therefore in different operating environments with a variety of risks,
opportunities, and pressures. Accordingly, MNE corporate reports have some characteristics
that are rarely, and sometimes never, found in those domestic corporations. Their worldwide
consolidated financial statements are usually drawn up according to the accounting standards
and practices of one country only, usually that of the MNE’s headquarters. Few users are
familiar with the accounting practices of more than one country, and there is an inevitable
tendency by many users to interpret MNE corporate reports as if they were drawn up
according to the practices of their own rather than the source country.

Limiting or reducing (by simplifying) the information in annual accounts may make
them superficially more inteligible to a wider audience. But it may well result in their
omission of essential information useful to the direct users the experts, To suggest otherwise
is to confuse corporate annual reports with the underlying reality they attempt to portray. This
is not to say that the clarity of such reports cannot be improved, or that some information
provided may not be superfluous. However, if corporate reports were to be pitched at the
level of the layperson, they would have to be reduced substantially in size. This would mean
foregoing important elements in the accounting and information message and lowering the
standard of analysis of those who actually, rather than ideally or hypothetically, use them.

Just us the majority of information providers consider questions regarding the

comprehensiveness of information to be within the ambit of conventional wisdom,
“information for all with a legitimate interest,” so too on the demand side there is a failure to
appreciate the differnce between actual users of information and those on whose behalf the
information is used. The OECD, for example, refers to information that should “improve
public understanding.” Such a distinction is unnecessary, however, becouse what ultimately
matters, from the user’s percpective, is the expanded availibility of relevant information
information. Ironically, what might apppear elitist-aiming information at the experts-is likely
to be the most democratic. In this way, the information needs of the many groups affected by
the operations of MNEs are perhaps best served in practice. At the same time, there is
presumably some limit to the quantity of information that can be conveniently analyzed even
by experts.

The view that does not differentiate between different levels of interpretive abilities
within groups, but sees them as homogeneous, has tended do dominate the disclosure debate.
A major objective of corporate reports is, or perhaps should be tp serve primarily those users
who have limited authority, ability, or resources to obtain information and who rely on
financial statements as their principle source of information. As we have suggested, however
this is probably best achieved through the medium of expert users, in that they are likely to be
able to make the most effective use of the information disclosed.

The Importance of Information Disclosures

Although there is no doubt about the continuing significance of accounting measurement

issues, the importance of information disclosed in financial statements and accompanying
reports is being increasingly recognized by multinational coporations. This information
provides an important input to the financial analysis process of evaluating the quality of
earnings and financial position, both current and prospective. A particularly important
motivation for voluntary information disclosures by MNEs is that corporate reports provide
the opportunity to communicate more policy and future oriented information about the
corporation. This may better inform or influence investors in the increasingly globalized
securities markets. Is is interesting, for example, that most of the fortune Global 500 firms
now provide financial and other corporate information on the Internet. This trend is likely to
have an increasing impact on the disclosure practices of stock exchange-listed companies
around the world.

It is generally accepted that the costs of providing information should not exceed the
benefits derived by the users of the information. In particular, the need for MNEs to maintain
business confidentiality in sensitive areas and to avoid jeopardizing their competitive position
should be taken into account. At the same time, this need must be weighed against the
interests of analysts, investors, and the public inn the transparency of multinational business
operations. In practice, it appears that the more specific and the more future oriented and
especially the more quantitative the information proposed for disclosure, the more sensitive
becomes the attitude of MNEs toward its provision.

Managerial Incentives to Disclose Information

Managements provides information both voluntarily and in response to regulation. There may
be incentives for the management of an MNE to disclosure information voluntarily if it
perceives it to be in its own interests and those of the corporation to respond to the
information demands of users and particapant groups. Research by Meek and Gray (1989)
and othershas shown, for example, that voluntary disclosures are forthcoming when
corporations are competing for finance from investors, especially in a cross-border context.
Where governments and trade unions exert an influence over the environment in which the
MNE operates, there will also be strong influence on the MNE o disclose information to
compete with other MNEs for investment opportunities or to exchange it to maintain existing
rights or avoid potential constraints on their operations.

On the other hand, if management decides that the information demands are
unreasonable or inimical to their interests or those of the MNE (e.g., when the information is
unfavorable or contains”bad news”), they must either achieve some compromise or accept the
consequences, if any, of nondisclosure. Thus, a diverse and complex set of factors influence
corporate disclosures (see figure 6.1)
 Figure 6.1 The costs amd Benefits of voluntary Disclosures by MNCs

Costs of Information Production

The disclosure of information has a direct monetary cost. MNEs are understandably
unwilling to incur increased costs through expanded disclosures unless they are required to
do so or the potential benefits exceed the estimated costs. The direct cost of information
disclosure to a corporation is the value of the resources used in gathering and processing the
information as well as in its audit and communication.

The direct costs of such disclosures will preeminently depend on the internal structure
of the MNE and information generated in order to manage this structure. The closer existing
information is to the disclosure requested, the lower will be the actual direct cost of
producing the information. Becouse the information needs of complete harmony between
internal and external information needs is inevitable.

Apart from the direct costs of disclosure there are the indirect costs relating to
competitive disadvantage, with its associated disincentives to innovate or invest, as well as
the costs resulting from interference or regulation by governments.

Competitive Disadvantage of Disclosure

The most frequently cited objection to increased disclosure requirements is that of

competitive disadvantage (i.e., the use of the additional information by competitors to the
detriment of the corporation disclosing the information). It is a major basis for the resistance
to expanded disclosures.

In some circumstances, disclosure of information could be damaging to MNEs. As a

general rule, the more specific or future oriented a disclosure is, the greater the potential
competitive disadvantage for the disclosing corporation. What of the relatively small
percentage of possible disclosures that hypothetically could same damage to the discloser?
Should this danger definitevely rule out their release? Information that allows competitors to
increase their well-being at the expense of the discloser is damaging for the discloser but
profitable for the competitor.

Exhibit. 6.1 Cost Factors Constraining Voluntary Information Disclosure as Perceived by

U.K. and U.S. Financial Executives.

Rank
U.K. U.S.
Cost of competitive disadvantage 1 1
Cost of data collection and processing 2 2
Cost of auditing 3 3
Possibility of claims from employees or trade unions 4 9
Threat of takeover or merger 5 6
Cost of publication 6 5
Technical processing problems 7 3
Possibility of intervention by government agencies 8 8
Possibility of claims from political or consumer groups 9 10
Possibility of intervention by taxation authorities 10 7

The dilemma is to distinguish between disclosure, which, for the economy as a whole, result
in anggregate competitive advantages exceeding aggregate competitive disadvantages from
those that do not. What is detrimental or beneficial to the economy to the in the short them
may, in some circumstances, have the opposite effect in the longer term. Increased
competition through disclosure could lead to greater vigor in the economy. It could also lead
to a decline in business incentives as a result of the appropriation of rewards by competitors
facilitated by expanded disclosure.

The relative importance of various possible costs of diclosure was explored, for example, in a
study by Gray, Radebaugh, and Roberts (1990). The study found general aggrement by both
U.S. and U.K. financial executives (see Exhibit 6.1) that the indirect cost of competitive
disadvantage was the most important cost factor constarining voluntary diclosures. However,
the results of the tests showed that, overall, there were significantly different perceptions in
the responses concerning the impact of several of the types of costs involved, including the
possibility of claims from emoloyees or trade unions and technical processing problems.

Managerial Attitudes to Voluntary Disclosure

Demands for additional information disclosures have come from both international
organizations (in particular the UN, OECD, EU, and IASB) and the host governmnets and
societies in which MNEs operate. However, the growing globalization of capital markets
indicates the presence of significant market pressures for additional information about MNE
operations as well as the existence of prospects for and concern about the international
coordination of capital market regulations. It is against this background that MNE
management must weigh the costs and benefits of voluntary information disclosures.
Exhibit 6.2 The Net Costs or Benefits of Disclosure of Specific Items Perceived by U.K. and
U.S. Financial Executives-Items wit Highest Net Costs

Rank
U.K. U.S.
LoB profits; narrow definition 1 2
Describe major legal proceedings 2 9
Quantitative forecasts; sales and profits 3 7
LoB sales; narrow definition 4 4
Geographical profits; narrow definition 5 3
Inflation-adjusted profits 6 5
LoB segment transfers 7 12
Geographical segment transfers 8 13
Describe major patents and expiry dates 9 8
Foreign assets by country 10 10
Geographical sales data; narrow definition 11 6
Employement information 23 2
Value-added statements 24 1

Gray Radebaugh, and Roberts (1990) also exzmined the extent to which there are
perceived net costs or benefits for disclosing specific items of information voluntarily, the
types of costs involved, and tge significance of cost constraints with respect to specific
disclosures. The results of the study showed that, on average, the respondents tended to
perceive most voluntary or discretionary disclosure items as giving rise to a net cost (see
Exhibit 6.2). At the same time, there was a wide range of views depending on the specific
item of information concerned. However, items perceived as giving rise to major net costs in
both the United States and the United Kingdom were inflanation-adjusted profits, quantified
forecasts, and narrowly defined segment information.

Corporate Disclosure Practices

In term of voluntary disclosure practices by MNEs, a study by Meek, Roberts, and Gray
(1995) examined the factors influencing the voluntary disclosures of 226 MNEs from the
United States, the United Kingdom, and continental Europe. A wide range of informatin
disclosures were examined and categorized into three types; strategic, nonfinancial, and
financial. A common benchmark of voluntary disclosures was established that would apply to
all countries, and s disclosure score was calculated for each company. The means and
standard deviations for all companies and for the United States, the United Kingdom, and the
continental European groupings are shown in Exhibit 6.3. Scores for the these groupings are
also given for the internationally listed and domestically listed samples; from these it can be
seen that the internationally listed MNEs tend to disclose more information voluntarily.

Taken overall, the results of the study showed that all MNEs regardless of size or
home country provide more information in their annual reports that the regulations require.
With respect to the factors influencing voluntary disclosure, statistical supports was found for
size, international listing status, country or region of origin, and industry. A relatively weak
multinantional effect was also detected. The results aldo indicate that the factors explaining
voluntary annual report disclosures differ by information type.

The largest MNEs are those that set the trends in providing voluntary disclosures of
nonfinancial and financial information. There are also industry patterns to there two types of
disclosures, suggesting that MNEs pay attention to what their closest competitiors disclose
when making decisions about such disclosures. Nonfinancial information is also a European
phenomenon. Finally, startegic information disclosures are a special feature of continental
European MNEs and, generally speaking, are also significant for internationally listed MNEs.

As suggested Gray (1998), cultural value are also likely to influence the values of
managers, which in turn may affect their attitudes, behavior, and decision making relating to
corporate disclosures. Archambault and Archambault (2003), for example, developed a
“model of cultural. National, and corporate factors that influence the financial disclosure of
corporations” (p. 173) The empirical evidence from 33 countries showed that disclosure is a
complex process that is affected by a broad range of social systems, including culture.
National, political, economy system, and corporat financial and operating systems.
Companies were found to diclose more information if they were in common law countries,
consistent with Gray (1988) and Doupnik and Salter (1995). Hofstede’s four cultural
dimensions were also shown to be associated with disclosure. In addition, disclosure was
found to decrease in assosiation with adoult litteracy. Religon was also reported to be a
significant factor influencing disclosure. There was a significant negative association
between disclosure and inflation, possibly owing to the higher inflation levels in emerging
markets. At the same time, disclosure was significantly positively associated with market
capitalization, number of foreign listings, dividens, and the use of a large multinational
auditor. In examining corporate financial and operating systems, they nevertheless found that
individual company differences still strongly influenced disclosure practices.

Disclosure behavior may also be explained by different attitudes and practices relating
to corruption. If corruption hinders economic development, then it may also hinder financial
reporting transparency due to the secretive nature of the corrupt activity itself. Attempts may
be made to ensure that any corrupt activities a corporation has enganged in are not discovered
by the public or by governmnet authorities. In short, corruption could act as a hindrance to
the enforcement of accounting standards and to the suppression of information dissemination
generally.

La Porta et al. (1998) include corruption as one of their (negative) enforcement

variables. They demonstrate a negative relationship betweem corruption and accounting
standards: the higher the level of corruption in a country, the power the quality of its
accounting. The PricewaterhouseCoopers Opacity Index (2001) also includes corruption as
one of the five factors making up the index. Levels of corruption tend to be higher in
developing countries than in developed countries and corruption is positively correlected with
the opacity of accounting standards, a finding consistent with La Porta. Salter (1998) also
found that the average levels of actual disclosure practices in developing nations were
significantly lower that those in developed countries. Overall, these findings suggest that
higher corruption levels are associated with poorer disclosure practices, though this does not
necessarily establish a causal link.

Strategic Information Nonfinancial Information Financial Information

Standard
Mean Standard Deviation Mean Standard Deviation Mean Deviation
All Companies 21,03 13,81 18,06 11,01 16,62 8,89
U.S. All Companies 17,22 10,52 11,89 7,1 16,54 6,81
U.S. International 20,03 10,98 14,5 7,41 17,27 7,12
U.S. Domestic 14,41 9,32 9,27 5,73 15,81 6,46
U.K All Companies 16,83 8,52 25,7 9,15 14,58 9,3
U.K Internationa 17,41 9,7 25,71 10,28 16,92 10,44
U.K Domestic 16,24 7,27 25,69 8,03 12,24 7,44
Cont. Euro. All
Companies 36,52 16,56 23,01 12,41 19,67 11,83
Cont. Euro. Internationa 36,51 17,54 21,87 13,28 23,19 9,34
Cont. Euro. Domestic 36,53 15,05 24,16 11,65 16,15 13,16