Harmonizing to Healy et Al. ( 2001 ) , how capital markets function expeditiously relies on corporate revelations. Firms provide revelation through regulated fiscal studies, including the fiscal statements, footers, direction treatment and analysis, and other regulative filings ” ( Healy et al, 2001 ) . Directors make usage of fiscal coverage and revelation determination to inform investors of the public presentation and control of the house. Other than the compulsory revelations, directors have the option every bit good to prosecute voluntary revelations, which consist of such things as direction prognosiss, analysts ‘ presentations and meetings, imperativeness releases, cyberspace sites, and other corporate studies.
Directors ‘ options for unwraping come in the signifier of either compulsory or voluntary revelations. Consistent to the literature on managerial revelation determinations, the subdivision two of this paper has been split into two parts ; a ) focussing on positive accounting theory and B ) voluntary revelations. Positive accounting theory trades with more on the compulsory fiscal revelations and looks at the fiscal coverage picks of directors that affect the fiscal studies. Whereas empirical grounds on motive for directors to voluntarily unwrap looks more at the stock market deductions of revelation, analyzing six hypotheses for why directors unwrap voluntarily.
This paper will concentrate on measuring the current literature and empirical grounds on managerial coverage and revelation determinations. In add-on, it will turn to the inquiries on director revelation determinations found in the reappraisal of revelation literature by Healy et Al. ( 2001 ) . Discussion will be given to the factors that motivate direction ‘s revelation determinations, and account will be given to the relationship between revelation, corporate administration, and direction inducements. Brief consideration is given to the function of boards and audit commissions in doing the revelation procedure more believable. The available grounds on managerial revelation determinations is dominated by the surveies of US houses. To supplement US grounds treatment will be given on consequences in Hong Kong and any future chances for survey on managerial revelation determinations.
Here comes the basic lineation of this paper. In Section 2, literature reappraisal on positive accounting theory and accounting pick are explored, so in Section 3 the empirical grounds is described on voluntary revelations. In Section 4, the grounds of managerial revelation determinations is established. In Section 5, a reappraisal on any possible chances for future empirical revelation research in Hong Kong whereas the decision lies in Section 6.
2. Literature Review on Positive Accounting Theory Literature
The literature reappraisal on positive accounting theory is chiefly concerned with the motivations behind managerial determinations that go with a peculiar signifier of accounting pick. Harmonizing to Fields et Al. ( 2001 ) , “ an accounting pick is any determination whose primary intent is to act upon ( either in signifier or substance ) the end product of the accounting system in a peculiar manner, including non merely fiscal statements published in conformity with by and large accepted accounting rules ( GAAP ) , but besides revenue enhancement returns and regulative filings ” . Research into the deductions of accounting pick day of the month as far back as the 1960 ‘s and the relevant literature can be categorized by the undermentioned ends or motives ; a ) bureau costs, B ) information dissymmetries, and, degree Celsiuss ) outwardnesss impacting non-contracting parties. ( Fields et al. , 2001 )
By alining the inducements of directors and stockholders, the bureau costs could be reduced by utilizing the contracts such as executive compensation agreements and debt compacts. In other words, contracts are entered into so that the agent behaves as if he or she were maximising the public assistance of the principal. However, it is evident that ex-post accounting picks can be made that addition executive compensation and avoid misdemeanor of debt compacts ( Fields et al. , 2001 ) . Say for an illustration, directors may take one signifier of mensurating stock list over another or assorted other accounting picks that increase reported net incomes and, therefore, supply them with personal benefits from earnings-based compensation. Alternatively, the antonym may be done so as to cut down the present value of revenue enhancements.
Although, certain signifiers of accounting pick may supply chances for directors to bridge the information spread about the magnitude, timeline, and hazard of future hard currency flows. Information dissymmetries stem from markets that do non aggregate the information sets held by directors and stockholders. It is frequently alleged that directors act strictly on self-interest and alternatively prefer to hold higher net incomes prevail so that they can be remunerated consequently and to increase their repute. For illustration, directors can do certain picks to guarantee they run into an analyst prognosis in an effort to avoid negative stock monetary value reactions ( Levitt, 1998 ; cited in Fields et Al. 2001 ) .
Last, external parties are deemed non to be the existent and possible proprietors of the house, instead organisations such as the Inland Revenue Department ( IRD ) , or authorities regulators, providers, rivals and/or labour brotherhoods. Directors through their accounting picks hope to act upon external parties in a manner that will be good to them. For illustration, the information obtained from the accounting Numberss may assist directors to buttonhole for an accounting criterion that reduces conformity costs of the house. The undermentioned paragraphs elaborated more on accounting pick is structured around the ends and motives for accounting pick described above.
2.1 Contractual Motivations
Consequences suggest the presence of inducements to increase director compensation and cut down the likeliness of go againsting bond compacts ( Fields et al. , 2001 ) . Many research workers have studied whether such contracts provide directors with an inducement to utilize specific accounting picks in an effort to make coveted fiscal coverage aims. Often direction compensation contracts and bond compacts that are used to extenuate the internal and external bureau struggles are based on reported fiscal accounting Numberss.
2.2 Internal Agency Conflicts – Executive Compensation Contracts
A big figure of surveies get downing with supported the thought that leting compensation contracts where directors get to keep equity in the company would closely aline the managerial involvements with that of stockholders ( Jensen and Meckling, 1976 ) . Resulting additions in the usage of incentive compensations as a signifier of wage meant that empirical research into executive compensation contracts has been huge. Manager ‘s wage is by and large made up of a base wage and incentive compensation.
The presence of accounting pick in compensation contracts explained by efficient undertaking creates a tradeoff. Harmonizing to Watts and Zimmerman ( 1986 ) even though fiscal describing discretion provides inducements to increase executive compensation, it should be weighed up against improved alliance of the two parties ‘ involvements. Despite the negative facets fluxing from accounting discretion, the higher net incomes that addition compensation can in turn create higher portion values and lessen the opportunity of transgressing bond compacts.
It is a common belief of research workers that directors sometimes become self-seekers. Healy ( 1985 ) introduced the statement that directors use discretional accumulations to have fillips in both current and the undermentioned period. The work conducted by Healy ( 1985 ) discusses how directors shift income from period to period in order to remain within the confines of upper and lower net incomes bounds to have fillips. This survey became the benchmark for many other surveies on compensation. Following Healy ( 1985 ) , research by Gaver et Al. ( 1995 ) found that directors merely used discretional accumulations when net incomes slipped outside the lower bounds and did non use them when net incomes moved above the upper edge. Research suggested otherwise, where he explained the usage discretional accumulations are in fact a instance of income smoothing.
Numerous surveies show us that when a new CEO is about to take over there is the inducement to cut down the current old ages ‘ net incomes so that in the wining old ages net incomes appear inflated and heighten the repute of the entrance CEO ( Strong and Meyer, 1987 ; Elliot and Shaw, 1988 ; Pourciau, 1993 ; Francis et al. , 1996 ) . Along the thought logic, Dechow and Sloan ( 1991 ) cited in Fields et Al. ( 2001 ) established that when a CEO is close to completing, less is invested in research and development due to the short-run inducements that bonus contracts present.
In drumhead, the literature reappraisal on executive compensation contracts suggests that directors may utilize accounting picks to work in their favour because of the inducements created by fillip programs. That is to state, accounting based contracts have the possible to bring on directors to move in ways that will increase their personal addition at the disbursal of overall stockholders ‘ benefits.
2.3 External Agency Conflicts – Chemical bond Covenants
Along with executive compensation contracts, debt contracts are another contractual signifier that received widespread attending. Research workers opted for two attacks to proving the impact of bond compacts on accounting picks. The first is best known as the ‘debt hypothesis ‘ and it originates from the thought that directors make accounting picks to avoid go againsting covenant maltreatment. The 2nd involved research workers look intoing the houses that are more likely to be adversely affected by mandated accounting alterations, nevertheless, this signifier of proving lost support in the 1980 ‘s.
A survey conducted by Sweeney ( 1994 ) shows that when houses are in close propinquity to defaulting on their debt compacts, they react by choosing accounting picks that increase income. In add-on to this survey, DeFond and Jiambalvo ( 1994 ) besides confirmed the ‘debt hypothesis ‘ . However, their consequences showed that taking up to and instantly following the misdemeanor of debt compacts the sampled houses manipulated accumulations instead than doing specific accounting method alterations, this is thought to be because it is less expensive to pull strings accumulations than to do complete accounting method alterations.
Harmonizing to Fields et Al. ( 2001 ) the verification that accounting picks are motivated by debt compact concerns is inconclusive. The surveies conducted on debt contracts support the theory of ‘debt hypothesis ‘ , nevertheless, Fields et Al. ( 2001 ) points out that the bulk of these surveies are besides consistent with other hypothesis. Despite it being hard to deduce the exact impact of debt compacts on accounting pick, there are a big figure of surveies that show some signifier of relationship between accounting pick and misdemeanor of debt compacts can non be ignored.
2.4 Asset Pricing Motivations
A farther class of accounting pick literature looks at the relationship of accounting Numberss to stock monetary values, proving whether accounting pick affects a house ‘s cost of capital. Directors could be utilizing assorted signifiers of accounting pick such as smoothing net incomes ; avoiding losingss ; or avoiding net incomes diminution that influence stock monetary values ( Fields et al. 2001 ) .
A figure of surveies conducted have examined loosely at the relationship of portion monetary values with net incomes direction. Erickson and Wang ( 1999 ) found that when houses use stock as a signifier of payment, the house is more likely to pull off net incomes upwards so that when the acquisition takes topographic point it will non affect as many portions. A survey conducted by Kasznik ( 1999 ) shows that in times when directors issue an net incomes prognosis they tend to pull off reported net incomes towards the initial prognosis. In add-on, legion surveies provide the belief that opportune directors will pull off net incomes ( Perry and Williams, 1994 ; DeAngelo, 1986 ) .
2.5 Motivation Due to Impact on Third Parties
In times when external parties to the house rely on accounting Numberss, directors have an inducement to choose accounting picks that influence their revelations and therefore hold a positive affect for them on 3rd parties. It is normally agreed that the motive behind such patterns is to either cut down revenue enhancements or to postpone them to subsequently periods, and to avoid the debut of new ordinance otherwise known as political costs.
The engagement of multiple inducements and multiple accounting methods make it hard to construe the consequences of research into both revenue enhancement and ordinances. There is nevertheless, overpowering grounds that directors implement accounting picks that will cut down their revenue enhancement load ( Guenther, 1994 ; Dhaliwal and Wang, 1992 ) . Results for revenue enhancement inducement research are non surprising because cut downing the revenue enhancement load is likely to be at the head of the director ‘s head and the chance to cut down revenue enhancement through accounting pick is non likely to be missed.
A survey into the affect of accounting pick on ordinance has tended to take an industry-specific attack. For illustration, Han and Wang ( 1998 ) look into the oil and gas industry and they found that in times of lifting gas and oil monetary values directors are likely to utilize accounting pick to cut down their income and frequently hold back on coverage good intelligence. In add-on, Blacconiere and Patten ( 1994 ) looked at the impact of revelation degrees for chemical houses on stock monetary values at the clip of a chemical leak. They found that the houses that choose to hold higher degrees of environmental revelations before the chemical leak were non affected every bit much as the houses with limited environmental revelations.
3. Voluntary Disclosures
The research of voluntary revelation investigates the motivations that stock markets create for managerial accounting and revelation determinations and provides support to the positive accounting literature ( Healy et al. , 2001 ) . Surveies have shown that information dissymmetries prevail and that frequently directors have entree to superior cognition than the current and possible investors. When imperfect markets exist “ directors tradeoff between doing accounting determinations and revelations to pass on their superior cognition of house ‘s public presentation to investors, and to pull off reported public presentation for catching, political or corporate administration grounds ” ( Healy et al. , 2001 ) . Empirical research hypothesis besides unveiled capital market minutess, stock compensation, judicial proceeding cost, corporate control competition, direction endowment signaling, and proprietary cost as six motivations behind revelation determinations for capital market grounds.
3.1 Capital Market Transactions Hypothesis
Near to the clip when houses are about to publish public debt or in amalgamations and acquisitions, what the investors perceive can be highly of import and it is hence non improbable for directors to increase voluntary revelations to shut the spread caused through information dissymmetries, later take downing the cost of external finance ( Healy et al. , 2001 ) .
Assorted surveies detailed the voluntary revelation attacks of directors at times when new capital is issued. Lang and Lundholm ( 2000 ) investigated the corporate revelation activity about seasoned equity offerings and its relationship to stock monetary values. They found that houses that maintain a consistent degree of revelation experience monetary value additions prior to the offering, and merely minor monetary value diminutions at the offering proclamation relation to the control houses, proposing that revelation may hold reduced the information dissymmetry inherent in the offering. Firms who increase their voluntary revelations 6 months prior to the issue day of the month besides experience monetary value additions prior but much larger diminutions afterwards. This is perceived to be because the voluntary revelations used were to hype the stock and the market subsequently corrects the monetary value.
3.2 Stock Compensation Hypothesis
It is really common for executives to be compensated with a base wage and on stock monetary values excessively. Core and Guay ( 2001 ) produce figures that show stock options as a signifier of executive wage more than doubled in the late 1990 ‘s from what they were in the 1980 ‘s. Management incentives to voluntarily unwrap information are justified foremost to cut down undertaking costs and secondly to run into the limitations imposed by insider trading.
Surveies show that the happening of direction prognosiss is positively associated with insider trading. In add-on, houses withhold good intelligence and alternatively let go of bad intelligence earlier when nearing stock option award periods. The accelerated revelation of bad intelligence is consistent with the stock compensation hypothesis because such revelations are made to increase the personal additions of directors through stock-based compensations ( Noe, 1999 ; Aboody and Kasznik, 2000 ; cited in Healy and Palepu, 2001 ) .
3.3 Litigation Cost Hypothesis
The literature proposes two effects of menaces from stockholders of judicial proceeding against direction. First, voluntary revelations may be used to take chances for legal actions against directors for inadequate or ill-timed revelations. Conversely, the possibility of judicial proceeding could do the director to keep back revelations of advanced cognition ( Healy et al. , 2001 ) .
Healy et Al. ( 2001 ) note that the bulk of research is into the first of the two effects on judicial proceeding. Skinner ( 1994 ) cited in Healy et Al. ( 2001 ) investigated director efforts to take judicial proceeding hazard. Results strongly suggest that bad intelligence houses are more likely to do early voluntary revelations than houses who will unwrap good intelligence, houses showing reduced net incomes are more likely to be sued, and even pre-disclosing information will non cut down the costs of judicial proceeding.
3.4 Corporate Control Contest Hypothesis
The board of managers in some instances can be held responsible by investors based on stock monetary value public presentation. Additionally, corporate coup d’etats have been linked to hapless stock monetary value public presentation. With this in head, corporate control competition hypothesis explains that directors use voluntary revelations such as early acknowledgment of an awaited hapless net incomes public presentation to avoid possible occupation loss. Harmonizing to Healy et Al. ( 2001 ) there has been small empirical grounds to back up this theory except to state that voluntary revelations emerge more frequently in times of contested coup d’etat commands.
3.5 Management Talent Signaling Hypothesis
Corporate directors often release an internally generated prognosis of quarterly or one-year net incomes proclamation. The market value of the director ‘s house is a map of investors ‘ perceptual experiences of the director ‘s ability to expect future alterations in the house ‘s economic environment and change the house ‘s production program consequently. The earlier that investors infer that the director has received information, the more favourable will be their appraisal of the director ‘s ability to expect future alterations and the higher will be the house ‘s market value and the degree of the director ‘s compensation. In other words, directors have inducements to increase their voluntary revelations in an effort to signal their endowment and increase their single wage bundles ( Trueman, 1986 ) . This is nevertheless no empirical grounds so far to corroborate or deny this hypothesis ( Healy et al. , 2001 ) .
3.6 Proprietary Cost Hypothesis
Several faculty members hypothesize that directors are likely to cut down voluntary revelations because they believe to unwrap excessively much information would significantly impact the house ‘s competitory borders in the market even if this means that the cost of added finance additions. The proprietary cost hypothesis is considered to be separate from that of the old five as it assumes that the involvements of stockholders and directors are the same. There is small direct empirical grounds to back up the proprietary cost hypothesis ( Healy et al. , 2001 ) .
In sum-up of the credibleness of voluntary revelations, the grade to which voluntary revelations assist in bridging the spread caused by information dissymmetries is dependent on the credibleness of such revelations. Given the huge scope of inducements that can act upon a directors revelation determinations becomes difficult to construe the degrees of credibleness possible.
The literature reappraisal assumes two possible ways to supply credibleness to voluntary revelations. First, third-party mediators can supply confidence on voluntary revelations. Second, past voluntary revelations can be validated through fiscal describing itself. Say for an illustration, look intoing if net incomes match direction net incomes prognosiss. Most of the verification of credibleness expression at the truth of direction prognosiss and there impact on stock monetary values. At this point, hearers play an of import function in this country as research “ suggests direction prognosiss have comparable credibleness to audited fiscal information ” ( Healy et al. , 2001 ) .
4. Evidence in Hong Kong
Hong Kong presents the general legal and fiscal coverage model and identifies the major institutional participants within the regulative model of Hong Kong. Bing an international fiscal Centre in Asia, Hong Kong differs from other Asian Pacific economic systems in that it exhibits both the Anglo-Saxon type of unfastened market features and the conventional type of Chinese family-orientation in ownership plus control in corporations. The bequest of the British regulation after 1997 is still prevailing in concern, accounting, fiscal and legal governments. The authorities functionaries of the Hong Kong Special Administrative Region ( HKSAR ) have been argus-eyed in doing the stock market more crystalline and fairer to all investors, local or abroad, in order to upkeep and farther promote Hong Kong as a fiscal Centre ( being the 2nd largest in Asia outside Japan ) .
On the other manus, the cultural environment in which Hong Kong houses operate ( being dominated by Chinese people ) does non promote voluntary revelation of corporate information ( Chau and Gray, 2002 ; Chow, Chau and Gray, 1995 ) . The influence of conservativism and inclination to secrecy of Chinese family-controlled houses, the turning demand for transparence, and the desire for internationalisation of the market jointly do Hong Kong the ideal scene for through empirical observation analyzing how houses behave in corporate administration revelation within an unfastened economic system and the impact, if any, of such voluntary revelation on house ‘s rating.
Ho and Wong ( 2003 ) performed a study of 98 preparers, it was found that preparers are more inclined to fulfill the information demands of external institutional finance providers than those of single investors and fiscal analysts or stockbrokers. CFOs and CEOs have more influence on corporate revelation policies and determinations than board presidents and company managers. Although merely a little per centum of preparers felt that the current revelations were either effectual or really effectual in functioning investors ‘ demands, merely a little figure of them agreed to hold more fiscal coverage and revelation ordinances. To shut the communications spread and better market efficiency, they suggested alternatively an betterment in investor relationships, developing more industry-specific revelation guidelines and more voluntary revelations.
For houses using for a new stock exchange listing, net incomes prognosiss represent a significant proportion of the information available about the organisation to the populace. However, proviso of such net incomes prognosiss varies, with inclusion being rare in the United States and in Hong Kong.
5. Future Empirical Disclosure Research in Hong Kong
Surveies that have been used in the US should be adopted and replicated in Hong Kong to see if the findings hold true for Hong Kong directors. For illustration, does the judicial proceeding cost hypothesis have applications in Hong Kong? Given the presence of the securities exchange committee ( SEC ) and strong menace of stockholder judicial proceeding in the US it is non surprising that directors would hold inducements to voluntarily unwrap hapless public presentation earlier to avoid judicial proceeding. However, it is less likely that a director in Hong Kong will be litigated against and therefore the judicial proceeding cost hypothesis becomes questionable in Hong Kong accounting scene.
Surveies in the United States to day of the month look to look into by singling out specific accounting issues and proving them in separate industries. Suggestion that in the future research in Hong Kong adopts an attack that considers anterior US cognition on the managerial motivations behind peculiar accounting picks to assist develop accounting criterions that produce high quality information. Particularly that Hong Kong is so close to following international accounting criterions ( IAS ‘s ) . Healy et Al. ( 2001 ) establishes some inquiries that are left unreciprocated and research in Hong Kong could be aimed at make fulling the information spread these create. For illustration, surveies could be designed to find the effectivity of fiscal coverage and revelation in Hong Kong or who should be given the occupation of formalizing voluntary revelations?
Hearers play an of import function in supplying credibleness for compulsory fiscal revelations through the confirmation of fiscal statements. In my sentiment, it is outside the range of the hearer to find the credibleness of voluntary revelations. As the literature reappraisal has shown, directors have assorted inducements for presenting voluntary revelations. It would be good if surveies could turn to the credibleness of voluntary revelations and possibly happen a manner to formalize them so that investors are non holding the wool pulled over their eyes, so to talk. Particularly now, as increasing societal and environmental coverage has resulted in environmental revelations that can be frequently hard to quantify and construe.
Manager discretion with regard to choosing accounting picks has received big involvement in US accounting literature but probes in Hong Kong are limited. Studies to day of the month hold focused on what motivates directors to take one accounting option over another and the logical thinking behind increased voluntary revelation.
The implicit in subject of managerial coverage and revelation determinations is that directors have available to them the chances and inducements to use personally good accounting picks. For illustration, the contractual understandings affecting executive compensation bundles frequently remunerate directors on net incomes or stock monetary values ; hence directors have inducements to choose accounting methods or picks that are likely to raise net incomes or stock monetary values and their ain compensation.
Motivation behind voluntary revelation has led to the development of six hypotheses based on the inducements created by stock markets. Empirical research has been undertaken on these hypotheses and consequences show that directors are frequently likely to voluntarily unwrap information to make things such as signal their endowment, avoid the menace of judicial proceeding, or increase stock compensation.
Surveies in Hong Kong have done small to back up US grounds. In the hereafter adopted and replicated surveies of US corporations need to be undertaken in Hong Kong to find if findings on managerial coverage and revelation determinations hold true for Hong Kong houses. There are spreads in our information on direction revelation and many unreciprocated inquiries. I propose that the hereafter should see that Hong Kong surveies set up the effectivity of fiscal coverage and revelation in Hong Kong and to assist form accounting criterions that produce higher quality information.