Disclosure Index Approach in Accounting Research: A Review of Related Issues

Dr. Monirul Alam Hossain,

Associate Professor,

Department of Accounting,

Rajshahi University

Rajshahi-6205,

Bangladesh.

Phone: (0721)750315

Fax: (00880721) 750 064

E-mail: monirulhossain@yahoo.com

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Disclosure Index Approach in Accounting Research: A Review of Related Issues

Abstract

During the last four decades or so disclosure index approach has been used by several

researchers to measure extent of disclosure made by the firms. There are many researchers who

used disclosure indexes as a device to measure the underlying variable, corporate disclosure.

Disclosure Indexes are extensive lists of selected items that may be disclosed in corporate annual

reports. The disclosure index has been considered as the best method to measure the extent of

disclosure to which a disclosure is required. Different studies sought to examine and identify

various type of disclosure can be broadly categorised as financial or non-financial and

quantitative and qualitative. Some of the researchers used weighted disclosure indexes, while

other researchers used unweighted disclosure index (either strictly dichotomous approach or

modified dichotomous approach). The main aim of this article is to provide a critical review of

different forms of disclosure index approaches used in financial accounting research along with

the nature of items of information to be included in a disclosure index.

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1.1 INTRODUCTION

Disclosure of information is an important variable in any measurement of accounting quality,

together with such characteristics as measurement method (accounting policies), presentation and

timeliness of reporting and can take a number of different forms (Marston and Robson, 1997).

Companies usually disclose information in a number of ways, such as annual report and accounts,

interim and quarterly reports, prospectus, employee reports and announcements to the stock

exchange. Recently, the question of disclosure of information in company reports has become an

important issue for both developed and developing countries and a number of researchers are

interested in measuring disclosure. There are many researchers who used disclosure indexes as a

device to measure the underlying variable, corporate disclosure. Consequently, there is an extensive

accounting literature relating to the use of disclosure indexes to measure the information contained

in the annual reports of companies (Inchausti, 1997).

Disclosure Indexes are extensive lists of selected items which may be disclosed in corporate annual

reports (Marston and Shrieves, 1991). The disclosure index has been considered as the best method

to measure the extent of disclosure to which a disclosure is required. Different studies sought to

examine and identify various type of disclosure can be broadly categorised as financial or non-

financial and quantitative and qualitative (Marston and Shrieves, 1995). A disclosure may be either

mandatory, voluntary as well as recommendatory. Disclosure may also be quantitative, involving

numbers, or qualitative, involving description and it may also be expressed in terms of money

(turnover) or another type of amount (number of customer, weight of production etc.) (Marston and

Robson, 1997). Furthermore, disclosure may be found to be expressed in words and numbers alone

and graphically and pictorially. The main aim of this article is to provide a critical review of

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different forms of disclosure index approaches used in financial accounting research along with the

nature of items of information to be included in a disclosure index.

1.2 INFORMATION ITEMS INCLUDED IN THE DISCLOSURE INDEX

Disclosure requirements whether in the form of accounting standards, laws or other regulation

have increased significantly over the last twenty years particularly in Western countries (Marston

and Shrieves, 1995). As already noted, companies usually disclose information in a number of

ways, such as through annual report and accounts, interim and quarterly reports, prospectus,

employee reports and announcements to the stock exchange. It may be strongly argued that the

most important medium of external financial disclosure is the corporate annual report. The

quality of financial reporting in a country depends on the legal requirements governing

disclosure together with professional recommendations which may have a varying degree of

effectiveness depending on the influence of the professional bodies concerned (Marston, 1986).

In addition, national and international accounting standards and stock exchange requirements

may have an impact on the disclosure of information in corporate annual reports.

Marston and Shrieves (1991) are of the opinion that the usefulness of the disclosure index as a

measure of disclosure is dependent on the selection of items to be included in the index. The

selection of items included in the disclosure index is a major task in the construction of any

disclosure index (Marston and Shrieves, 1991). There is no generally accepted theory to predict

users‟ information needs and there is an absence of an appropriate generally accepted model for

the selection of the items of information to be included in a disclosure index to judge the quality

of information of a corporate annual report. An item of information may be of great importance

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to a particular interested user group while it may have little importance to other user groups. In

most previous studies, the number of items selected were relatively small. Most of the previous

studies have included items of information of interest to a particular group. In some other

studies, items of information have been included keeping in mind their relevance to a broad

range of users. Researchers like Wallace (1987), Spero, (1979) and Cooke (1989) included a

wide range of major disclosure items that might be found in the corporate annual report which is

not directed at a particular group of users in the context of „general purpose‟ financial reports

that should serve the needs of all users (Wallace, 1988; p. 354). Wallace (1987) included 187

items of information in his disclosure index for the Nigerian companies in his sample. Similarly,

Spero (1979) developed this type of wide ranging disclosure index consisting of 289 items of

information. The disclosure index used by one researcher and consequently adopted by other

researchers is not uncommon. The use of replication of a disclosure index by the researchers is

not uncommon. For example, Parry and Groves (1990) argued that their model was originally

developed by Singhvi (1967) index (applied in the Indian context) and they applied the same in

the context of Bangladesh (a country very similar to India in terms of both industrial framework

and level of development). However, Parry and Groves (1990) dropped 10 items of information

by Singhvi (1967) index because those were not realistic information expectations in Bangladesh

and added other six items of information in their disclosure index.

In some cases, information items were selected by the researchers for their disclosure indexes from

a careful review of other studies of financial disclosure as well as after a review of recent annual

reports of listed companies. In addition, the disclosure requirements relating to national accounting

standards were considered and taken into account by these researchers in selecting items of

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information that ought to be disclosed by the companies and as such, where relevant, have been

included in the disclosure index.

1.3 SCORING IN THE DISCLOSURE INDEX

There are various approaches available to develop a scoring scheme to determine the disclosure

level of corporate annual reports from the works of other researchers. Weighted disclosure index

approach has been employed in several prior studies The approach used by Courtis (1979), Barrett

(1976 and 1977) and Marston (1986) was for a weighted disclosure index to be employed where

weights were replicated from similar previous studies. In some cases the weights were

predetermined by the researchers subjectively (e.g., Cerf, 1961 and Singhvi and Desai, 1971).

Alternatively, Buzby (1974 and 1975), Stanga (1979), Firth (1979) and Hossain (1999) have used

average weights derived from questionnaire surveys of users' perceptions of the importance of

disclosure items. Wallace (1988), Cooke (1991, 1992 and 1993), Robbins and Austin (1986),

Hossain et al. (1994) and Ahmed and Nicholls (1994) adopted a dichotomous procedure in which

an item scores one if disclosed and zero if not disclosed.

1.3.1 Scoring the Disclosure under the Weighted Disclosure Index

An important issue in the use of disclosure indexes is whether values are attached to each item in the

disclosure index (Inchausti, 1997). Another important issue in the construction of an index of

disclosure is whether some items in the index should be more heavily than others (Patton and

Zelenka, 1997). Some of the earlier disclosure studies used weighted disclosure index. Marston and

Shrives (1997) while reviewing disclosure studies noted that some of the earlier disclosure studies

used disclosure studies and commented that

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“introducing weights can be said to favour a particular user-orientation

and as such introduces a further degree of subjectivity into the development of

disclosure models”

(Marston and Shrives; 1995, p.4).

As all items of information under weighted disclosure index approach are not of equal weight, it is

necessary to develop a weighting scheme where a mean importance weight can be attached to each

of the disclosure items. The objective behind developing such a weighting scheme is to discriminate

between more important items and less important items. However, this presents difficult problems

for any researcher since the importance of an item may vary not just from one user to another, but

the importance of a particular item of information may vary from one company to another as well as

one industry to another.

Using a weighted disclosure index (WDI) may seem attractive because it allows distinctions to be

made for the relative importance of items of information to the users of annual reports (Inchausti,

1997; p.49). It has already been mentioned that many disclosure studies have followed an weighted

disclosure index approach. However, other researchers criticised assignments of weights to

disclosure items as some arbitrariness is clearly inherent in the use of weighted index. Other

researchers like Dhaliwal (1980) comment that decision makers, in general lack insight regarding

their own use of information and the relative importance assigned to different items of information

by different perceptions about those items of information (Inchausti, 1997). In addition, it has been

argued by Cooke (1989, 1991 and 1992) that an approach like weighted disclosure index which tries

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to encapsulate the subjective weights of a multitude of user groups will be unwidely and probably

futile.

As already noted, in some earlier studies, weights were assigned to individual item of information

based on the subjective judgement of the researcher. In order to reduce the impact of their own

subjective judgement other subsequent researchers have conducted questionnaire surveys among

user groups to determine how they perceive an item of information to be important based on a

predetermined scale of rating each item of information. The rating scales used have varied although

most have followed either 4-0 or 5-1 Likert scales. Buzby (1974) used a 0-4 scale, while Firth

(1978), McNally, Eng and Hasseldine (1982), and Wallace (1987) used a 1-5 scale. Chow and

Wong-Boren (1987) used a 1-7 scale. Such researchers have used the mean scores received by

each item of information as weights to individual item of information to be applied in the disclosure

index. Under a Weighted Disclosure Index (WDI), each company is awarded the mean score of

that particular item of information if it discloses an item of information and a zero for not

disclosing the item. Care must be exercised in using the WDI approach. Cooke and Wallace

(1989) were of the opinion that `any scaling method for assigning weights to individual disclosure

items has the potential to mislead’ (p.51). They argued that „the level of importance which is

attributable to a disclosure item varies according to the entities, transactions/accounts, the users,

company, industry, country and the time of the study’ (Cooke and Wallace, 1989; p.51).

It has been argued by some researchers that information relevance is harder to define since

potential users of annual reports may have extremely different interest. Therefore, researchers

like Cooke (1989) and Wallace (1987) used large number of disclosure items although it has

been claimed that the choice remains largely subjective (Raffournier, 1995). Wallace and Naser

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(1995) argued that weights are usually cited from the perceptions of one or two user-groups

given the pooling their opinions; but one or two user-groups are only subset of users of the

corporate annual report. This point has been emphasised by Wallace and Naser (1995) in the

following manner:

“Because as the human information processing literature (e.g., Libby 1981, pp.

40-43) suggests, the revealed perceptions of respondents to opinion surveys do not often

represent what the respondents actually do, it is possible to argue what weights derived

from opinion pools may not mirror reality. For example, weights may not represent real

economic consequences to the subjects whose opinions were pooled (Chow and Wong-

Boren 1987, p. 536), may not reflect stable perceptions on similar disclosure items across

subjects, over time (Dhaliwal 1980, p. 387) and from similar subjects across countries

(Firer and Meth 1986, pp. 377-378).

(Wallace and Naser, 1995, p. 331)

1.3.2 Scoring Disclosure Items under the Unweighted Disclosure Index

In the unweighted disclosure index disclosure of individual items has been treated as a dichotomous

variable. Here, the only consideration is whether or not a company discloses an item of information

in its corporate annual report. If a company discloses an item of information in its annual report it

will be awarded `1' and if not it will be awarded `0'. The disclosure model for the unweighted

disclosure thus measures the total disclosure (TD) score for a company as additive as follows:

TD= dii

n

1

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Where,

d = 1 if the item di is disclosed

0 if the item di is not disclosed

n = number of items

Under an unweighted disclosure index, all items of information in the index are considered equally

important to the average user of corporate annual reports. For the unweighted disclosure index, the

value of an item of information can range from 0 to 1 and the total or aggregate of the disclosure

index represents extent of disclosure. The followers of dichotomous disclosure index approach

believe that the resulting bias is lower than if an erroneous weighting had been used.

Under weighted disclosure index approach, the implied assumption is that one class of user will

attach different weights to an item of information than another class of information, whereas an

unweighted disclosure approach focuses not one particular user group rather on all users of

corporate annual reports (Cooke, 1992). The unique advantage of using an unweighted index is that

it permits an analysis independent of the perception of a particular user group (Chow and Wong-

Boren, 1987; p.537). If various users of accounting information are asked to weigh the importance

of different items of information in the disclosure index, they may attach different weights to the

same items of information. Despite the attractions of reflecting users‟ perceptions, the perceptions

of different groups of users vary due to subjective judgement and interests, subjective judgements

may average each other out (Cooke, 1992; p.233) or neutralise the relative importance of each

disclosure item to all members of a user group (Wallace, 1987; p.355). Robbins and Austin (1986)

while measuring governmental financial reporting commented that there were no important

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differences in their empirical results if a sample of disclosure index was used instead of a simple

disclosure index. The choice of an unweighted index over a weighted one does not produce

substantially different results (e.g. Chow and Wong-Boren, 1987; p.537) and there are researchers

who favoured the use of unweighted indexes (e.g. Spero, 1979; p.57 and Robbins and Austin,

1986). Inchausti (1997) argued that there are evidence that if both weighted and unweighted indexes

are used, they will provide similar types of results from both types of studies.

Another important issue regarding measuring disclosure is the problem of the applicability and non-

applicability of a particular item of information. In the cases of some important voluntary items of

information, it is very difficult to judge whether a particular firm inappropriately excluded a

particular information item (Patton and Zelenka, 1997). As Raffournier (1995) noted that a

methodological problem inherent to disclosure index approach because of the fact that every item of

information may not be relevant to all companies. For example, a firm without financial leases will

consider it has no need to mention anything about leasing in its corporate annual report.

Under modified dichotomous approach, where an item of information is clearly not relevant to a

particular firm, that firm is not penalised for non-disclosure (Cooke, 1992). For example, if a

company does not have any subsidiaries, it would be inappropriate to penalise the company not

preparing consolidated accounts. Although this approach has been criticised on the ground of

introducing a judgemental element into the scoring procedure, modified dichotomous approach has

been considered to provide more realistic assessment of corporate disclosure than a strictly

dichotomous approach (Cooke, 1992). To overcome the potential bias, Cooke (1989) suggested to

read the whole corporate annual report and make such judgements rather than adopting a strictly

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dichotomous procedure. Such type of modified dichotomous approach was adopted by Buzby

(1972), Wallace (1987), Cooke (1989), Hossain et al. (1994) and Ahmed and Nicholls (1994).

1.4 CONCLUSION

During the last four decades or so disclosure index approach has been used by several researchers to

measure extent of disclosure made by the firms. Many researchers used disclosure index to test

hypotheses of their research. Despite its inherent problems (e.g., subjective judgement), disclosure

index approach has become an important vehicle for the measurement of the company information

disclosure. Some of the researchers used weighted disclosure indexes, while other researchers used

unweighted disclosure index (either strictly dichotomous approach or modified dichotomous

approach). However, both weighted and unweighted indexes should be considered separately, and

weighted and unweighted indexes could be analysed to see whether the weighted disclosure index

could provide any significant deviation from the unweighted disclosure index in examining the

extent of disclosure or to test hypotheses.

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