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=
di
i
n

1



9
Where,
d = 1 if the item d
i
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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