ACC 6050 Module 4 Written Assignment: Disclosure, Efficient Markets and Overload Example

More Information or Better Information? Market Efficiency, Voluntary Disclosure and the Problem of Overload

Student Name

Master of Science in Accounting, Thomas Edison State University

ACC-6050: Fundamentals of Accounting II

Mentor Name

Month Day, Year

More Information or Better Information? Market Efficiency, Voluntary Disclosure and the Problem of Overload

Introduction

If accounting information is useful, more of it should help. Yet annual reports have grown so long that regulators and standard setters now worry about clutter. Wolk et al. (2017) present disclosure as an area where theory, evidence and practical judgment must be combined.

The Efficient Markets Hypothesis

Fama (1970) called a market efficient when its prices already absorb the information available, and split efficiency into weak, semi-strong and strong forms by how much information counts. In a semi-strong efficient market, prices reflect all public information, so it should not matter whether information appears in the financial statements, the notes or a press release: investors will process it wherever it is. This implication supported disclosure in notes as an alternative to recognition in the statements. Later research qualified it, finding that investors sometimes respond differently to recognized and disclosed amounts and that some information is absorbed slowly, which suggests that location and presentation can matter.

Voluntary Disclosure Theory

Even without regulation, managers have incentives to disclose. If investors know a manager has information and the manager stays silent, they assume the worst, so managers with good news disclose, then those with moderately good news, and so on, an unraveling that predicts full disclosure. In practice, disclosure is incomplete because of costs, proprietary concerns and uncertainty about whether the manager has information at all. Theory therefore predicts that firms disclose more when the benefits, such as a lower cost of capital, outweigh the costs, such as revealing information to competitors.

Evidence on Disclosure and the Cost of Capital

Botosan (1997) measured the disclosure level of manufacturing firms' annual reports and found that, for firms followed by few analysts, greater disclosure was associated with a lower cost of equity capital; for firms with heavy analyst following, the effect was not significant, perhaps because analysts already supplied the information. Healy and Palepu (2001) review further evidence that disclosure is associated with greater liquidity, analyst following and lower cost of capital. The evidence supports the benefit of disclosure, especially for firms with less outside attention.

Disclosure Overload

Notes have lengthened as each new standard adds requirements, and few are removed. Critics argue that material information is buried among immaterial details, raising processing costs for investors and compliance costs for preparers. The FASB's disclosure framework project aimed to help the board and companies decide what is relevant, and both boards encourage companies to apply materiality to disclosures rather than treating every requirement as a checklist. Overload is not an argument against disclosure but for disclosure that is organized, specific and material.

Standard setters have responded with materiality guidance rather than new rules. The FASB's disclosure framework project and the IASB's materiality practice statement both encourage companies to omit immaterial items and to organize notes around what matters most, though in practice few companies have shortened their reports, partly for fear of liability for omissions.

Application: Raritan Bay Medical Supply

Raritan Bay Medical Supply, a composite distributor of hospital supplies with $600 million of revenue and light analyst coverage, has an 84-page annual report in which the notes repeat accounting policy boilerplate and give the same detail to immaterial leases as to its most important contract, a supply agreement with one hospital system that provides 31 percent of revenue. Three recommendations follow from theory and evidence. First, given light analyst coverage, Botosan's findings suggest that clearer disclosure could lower the company's cost of equity, so the customer concentration, contract terms and renewal risk should be disclosed prominently. Second, boilerplate policy notes should be replaced with company-specific explanations of the judgments that matter, such as rebate accruals. Third, immaterial items can be condensed, applying materiality to disclosure as the boards encourage. The goal is a shorter report that tells investors more.

For a lightly followed company like Raritan Bay, Botosan's evidence suggests that a clearer report could lower the cost of equity, which gives management a financial reason to edit rather than add.

Conclusion

Efficient markets theory suggests investors use information wherever it appears, though evidence shows presentation matters. Voluntary disclosure theory explains why firms disclose and why they stop short. Evidence links disclosure to lower cost of capital, especially for firms with little analyst attention. Overload is a problem of organization and materiality, and Raritan Bay's report illustrates how better disclosure can also be less disclosure.

References

Botosan, C. A. (1997). Disclosure level and the cost of equity capital. The Accounting Review, 72(3), 323-349. https://doi.org/10.2308/tar-9709240185

Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2), 383-417. https://doi.org/10.2307/2325486

Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of Accounting and Economics, 31(1-3), 405-440. https://doi.org/10.1016/S0165-4101(01)00018-0

Wolk, H. I., Dodd, J. L., & Rozycki, J. J. (2017). Accounting theory: Conceptual issues in a political and economic environment (9th ed.). Sage Publications.