Financial Reporting Transparency

Abstract

This discussion raises issues concerning financial reporting transparency. We first observe that transparency is not well-defined in a financial reporting context. Extrapolating from the ways transparency is used in other contexts, we define financial reporting transparency as the extent to which financial reports reveal an entity's underlying economics in a way that is readily understandable by those using the financial reports. We discuss limitations of this definition relating to its two components, but observe that the conceptual frameworks of the IASB and FASB provide a standard setter perspective on them. We next point out that theoretical research suggests that increased reporting transparency can reduce the cost of capital provided that transparency reduces information risk, and empirical research using a variety of measures of financial reporting transparency provides evidence of an association between transparency and cost of capital. Thus, research supports the notion that transparency is a desirable characteristic of financial reports. Given this potential benefit, we then identify characteristics of financial reporting that foster transparency - either by better reflecting the firm's underlying economics or by enhancing the understandability of information in financial reports. Finally, we describe the challenges to achieving financial reporting transparency globally and discuss how the IASB is attempting to address them. Our discussion implies several standard setting actions that might increase financial reporting transparency.