Given that the objective of this study is to investigate the information content of complementary and supplementary disclosures, it is imperative to relate to the theoretical perspectives in the market for regulation. Complementing and supplementing arise from the regulatory guidelines by ASB (2005; 2006) where it was conceptualised the disclosures should reflect management‟s view of performance with an aim of aiding investors understand the performance for investment decision-making. This implies that Accounting Standards Board recognised the entity concept thereby necessitating the disclosure from management about performance through complementary and supplementary narratives to investors. In turn, the Board expected that such disclosures would alleviate information asymmetry and help investors make decisions about their investment. This reflects the arguments in chapters 5 and 6 that the entity concept of the firm is prone to information asymmetry due to the agency relationship between investors and management. To reduce the asymmetry, the mechanisms of the mainstream economic market (market for capital) and heterodox economic market (markets for information and regulation) make the disclosures relevant for investment decision-making. Whilst the market for capital (mainly based on EMH semi-strong efficiency) and the market for information (based on criticism of EMH semi-strong efficiency)
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mutually interact, the market for regulation plays the role of ensuring equitable resource allocation within the two markets. This role of regulation theories with respect to usefulness of accounting disclosures is acknowledged by Riahi-Belkaoui (2004) by the suggestion that agency is the main realm fostering the debate between regulating and deregulating accounting disclosures for investment decision-making. The reasons for regulating disclosures arise from the impression management perspective of agency, including concealment, misinformation and underproduction of accounting information. The reasons indicate free economic market failures, correctible through regulation by monitoring the nature of information provided to investors and penalising management for incompetence or intent to provide reliable disclosures.
These market failures are either explicit or implicit. Gonedes and Dopuch (1974) suggested that the explicit market failure arises from the disparity between quality or quantity of a commodity produced in an regulated market and the benefits or costs derived or arising from the commodity. Given that accounting information is a public good by nature, if not regulated, it may be impossible to reduce the benefits of non-purchasers. This possibility to gain from information without paying for it presents the non-Pareto equilibria. Secondly, the likelihood of disparity between the quality or the quantity of disclosures and the value paid (in form of share pricing) justifies the need of regulation (Riahi-Belkaoui 2004).
The implicit arguments for regulating accounting disclosures are various. Ball (1972) suggests that managers have a monopolistic advantage regarding information about the firm which they may inappropriately use to impress investors. Regulation therefore deters the occurrence of such behaviour. Riahi-Belkaoui (2004) explains four implicit market failure hypotheses arising from accounting methods variety, that is, naive investors, functional fixation, misleading numbers and procedural diversity. The naive investor concept claims that unsophisticated investors may be fooled through various accounting methods and performance measure terminologies. Functional fixation recognises that some investors, whether sophisticated or non-sophisticated fail to change their processing of accounting disclosures in relation to changes in accounting technique changes or types. Impliedly, the change in accounting techniques may result into change in accounting numbers and may mislead
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investors due to naivety or functional fixation. Even without change in accounting techniques, the diversity in accounting procedures may makes it difficult for investors to make adequate investment decisions amongst firms on a cross-sectional basis. Leftwich (1980) attributes the longitudinal and cross-sectional incomparability of accounting disclosures to the lack of objective criteria that management may use to select an accounting technique or discourse.
Hammersley, et al (2008) expounded that the requirement by the Sarbanes-Oxley Act 2008 to provide disclosures of internal controls in the US was intended to warn investors on the potential financial statement problems resulting from controls. Resultantly, the information asymmetry problem would be curbed. The results of their study supported this hypothesis with share price returns were impacted by the disclosures. Results in Greenstone, et al (2006) were in agreement that mandatory disclosures have information content. The provisions in the US Securities Act of 1964 were amended to require audited financial reports, informative proxies, insider trading disclosures and over-the-counter trades to big firms. Firms affected by the disclosures had statistically significant abnormal returns in the period the laws were passed compared to the unaffected firms on the NYSE and AMEX. The study argued that there are high costs contained in formulating and enforcing complete contracts; therefore regulation through mandated disclosures is sufficient to monitor the private contracts. The mandatory disclosures eliminate any ambiguity regarding what ought to be disclosed and provide shareholders with certainty on the information expected from managers. A demonstration of the irrelevance of regulation is arguably in evidence of information content of voluntary disclosures. Lev and Penman (1990) argue that non-mandated disclosures substantiate the conjecture that management are willing to reduce information asymmetry by providing information that screens or signals their firms as viable investment ventures in comparison to those that do not provide discretionary information. This screening or signalling is an indication that the firm is undervalued and the information will aid correction of the firm‟s price. However, Lang and Lundholm (2000) had mixed findings regarding the provision of voluntary disclosures prior to equity offering. Firms that maintained a constant level of disclosure suffered minimal price declines on equity issuance; suggesting that their pre-offer disclosures reduced asymmetry. Firms that substantially increased their disclosures in the
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offer period faced significant price decline on declaration of their intent to issue equity manifested adverse selection.