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The Role of Forward Looking Disclosures in Financial Atmosphere

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Table of contents

  1. Introduction
  2. Definition of forward-looking information
    Theoretical framework
    Agency theory
    Signaling theory
    Legitimacy theory:
  3. Literature review and existing problem


Forward-looking disclosures (FLD) have been getting an increasing volume of care in current information related studies all over the world. The frequency of FLD disclosed by organizations is one of the measures of rising capital market effectiveness by reducing information asymmetry. The existing role of FLD in financial atmosphere is so critical because money markets are too quick to depend on historical records only.

The past disclosures of the firms do not satisfy stakeholder’s varied information requirements for financial development. The stakeholders of the firms frequently want to know about the imminent forecast of the firms in the logic that what will happen to the firms in future. The management of the firms evaluates current market trends to answer the stakeholders with the descriptions about what firms is planning and proposing to do. For which the FLD have become a very concerning issue to the regulatory body.

The FLD contain economic and non-economic forecasts related information of the firms that affect the upcoming performance for future corporate uncertainty, sudden risk, evaluation and analysis, agency relationship and relevant information of the firms. In reference to IFRS practice report, the FLD should be included in management commentary to reduce information asymmetry.

Firms disclose corporate information in different ways such as annual reports, conference calls press releases, interim reports and legal communication of specialists. In reference to those sources, annual report has been used for this study. Because annual reports are the most preferred source of information”, annual reports are believed to be significant, prime and frequent source for information than all other sources to users of developing and developed countries. Other than this annual reports are audited, timely, accurate and consistent which is supported by prior studies.

The aim of the study is to investigate the nature and extent of FLD in the listed companies of DS30 index and identify the factors of forward-looking disclosures in Bangladesh. A study of Kieso et al. (2009) claimed that the FLD are beneficial to stakeholders for their policy-making process. The FLD is considered as a dependent variable since stockholders seem to attention more about the company’s future predictions compared to its previous performance.

In this study, the hypothesis has been developed about the association between FLD and firm features that influence disclosure plans monitored by executives in Bangladeshi firms. Mainly this study asserts the effect of firm features on FLD released in administration commentary. With this aim, firm features are seized into account by a full review of the relevant disclosure literature because they have a direct influence on the FLD. This analysis contributes to the past studies on disclosure approaches by presenting that firm features influence the FLD recorded in management explanations.

In addition, the FLD give signal to the market of certain probable and improbable events nearby the firm. The FLDs provides information on upcoming strategies and schemes which give signal solid feedbacks to the marketplace. A study of Aljifri & Hussainey (2007) studied the factors of FLD in firm’s annual reports. The study emphasizes to the factors of FLD by non-economic companies registered on the NSE. The outcomes specify that businesses with well performance, higher liability and with more attention of external investment include more FLD in their annual reports. Contrariwise, cross listed organizations are linked with fewer FLD.

It is noted that there are a very limited number of papers studied the influence of firm features on FLD in developing and developed countries. To the best of the author’s knowledge, no study yet has examined this topic in Bangladesh. In addition, the study contributes to the present literature by classifying FLD as both qualitative and quantitative FLD. Moreover, the judgment of the extent of FLD recorded by Bangladeshi firms will add the value of capital market and contribute to understand the factors of FLD in Bangladesh.

Definition of forward-looking information

Forward-looking disclosures refer to future forecasts and current plans which provide information about the company’s future prospects. There are two types of information published in annual reports, such as “backward looking information and forward looking information. Backward looking information means past financial result and their linked disclosures”. Since the economic environment is too dynamic to depend only on backward-looking disclosures, public firms will disclose forward-looking disclosures about their future prospects. Forward-looking disclosure (FLD) is theoretically uninformative if it does not change from the previous year, especially after a major change in firm performance.

The FLD includes economic estimates such as following year’s incomes, projected cash flows probable revenues etc. The FLD also includes non-financial disclosures such as risks, organization’s plans, valuations of chances, uncertainties and estimated data that extensively affect actual outcomes from expected targets. The terms “estimate” “expect” “forecast” “predict” “anticipate” or other similar terminology are used to identify the FLD.

In several cases, backward-looking disclosures may be considered as forward-looking disclosures while they convey messages for the future. For example, the capital expenditure was increased by 5% last year shown in CEO reports in the firm’s annual reports, this declaration absolutely denotes to the backward-looking information.

In addition, it indicates the capital expenditure is expected to increase in the upcoming cash flow. In reference to the ICAEW (2003), the FLD involves any disclosure that affect following financial reports. A study of Bujaki et al. (1999) defined the nature of FLD and identified that this kind of information can be qualitative, quantitative, economic or non- economic. The FLD would be significant to estimate the level to which the firm’s performance, liquidity and financial position may vary in future.

Theoretical framework

The forward looking disclosures disclosed by the companies have significant advantages for the companies and managers. The three theoretical methods explain these advantages for the managers and companies: Agency theory, legitimacy theory and signaling theory. The previous research has explored numerous propositions delivered by signaling theory agency theory to explain the association of firm features on FLD. To recognize the factors of FLD, these three theories are used broadly.

Agency theory

Agency theory explains the affiliation between the agent (manager) and the principal (shareholders). It assumes that management and separation of proprietorship causes agency cost creating information asymmetry. Information asymmetry causes when the agents take superior information opportunities opposed to the principals. Agency theory forecasts that agency costs will differ with different corporate features, such as leverage, size and listing status. It also proposes that highly leveraged firms disclose more FLD to reduce the agency cost and cost of capital. In reference to this theory, the FLD decreases agency cost and reduces information asymmetry. Firms provide a higher level of FLD that sustain a superior assessment of the upcoming performance of the firms.

Signaling theory

To understand the factors of FLD, the signaling theory is widely is developed to explain behavior in the labor market for corporate voluntary disclosures. Manager provides good news voluntarily to signal the good news to evade bad news and manager disclose bad news to signal their strengths and capabilities to eliminate future losses. According to this theory, firms will disclose FLD to signal the capital market to reduce information asymmetry, to increase business value and mitigate the financial costs. Signaling theory describes that managers provide FLD within annual reports to signal the potential users of the reports.

Legitimacy theory:

Another theoretical method used to define the forward looking disclosures is legitimacy theory. The prior studies used the legitimacy theory to express the FLD in environmental and social reporting. Legitimacy theory assures that firms signal their legitimacy through providing the FLD in annual.

Literature review and existing problem

The consequence of business features on FLD has been evaluated in many prior studies and the topic has achieved a significant attention in theoretical literature. However, experimental indication about the result of firm exact attributes on FLD is undefined and fails to give conclusive results. The FLD is considered as a subclass of corporate planned disclosures focused on stakeholders and firm which records extreme quality disclosures, contains the FLD in annual reports. The FLD is demanded and needed by stakeholders outside book value and recent earning which assists them plan future performance.

A number of past researches on FLD have focused on the association between FLD and firm’s characteristics. Menicucci (2013) examines the association between the extent of FLD and firms’ characteristics in management explanations of Italian firms. Their result showed that profitability (ROA) has substantial negative association with the FLD and leverage and firm size have an insignificant association with the extent of FLD. But another study of Menicucci (2013) investigates the factors of FLD in management explanation from the annual report of Italian listed firms. This study indicates that profitability (ROA) has a significant association with the level of FLD but leverage and firm size are unimportant to interpret the extent of FLD.

In this case Sullivan et al. (2008) discussed about the corporate governance context to reveal FLD covering sample from Australian companies. Their result of the study shows that corporate governance mechanisms is typically higher for firms which reveal FLD than non-disclosing companies in 2000. But the finding doesn’t show same result in 2002 and they suggest that increasing efficiency of corporate governance instruments does not expand the FLD as expected. In addition, Uyar & Kilic (2012) found that the FLD practices are not high among Turkish firms because the common of disclosures are qualitative and companies report good news in yearly reports but not disclose bad news.

Healy & Palepu (2001) found that litigation hypothetically decrease executive’s incentives to deliver specially FLD. Vanstraelen, Zarzeski, & Robb (2003) made a research in three inland European countries (i. e. Germany, Netherlands and Belgium) and showed that size and country have substantial influence on FLD. The practices of FLD are greatly affected by cultural effects over manager. Increased FLD might decrease cost of capital and agency cost by mitigating asymmetric information among stakeholders and officials under condition. Bravo (2016) studied that FLD and reputation of corporation reduce the stock return volatility.

The outcomes revealed that FLD have a substantial impact on money markets and firm reputation regulates this impact. In addition a study of Al-Najjar & Abed (2014) studied with governance tools on FLD for UK firms in economic crisis period. The research finding shows that the liberation of audit committee and board composition affects the FLD before the economic crisis. More non-executive directors, more business expertise and high foreign ownership can increase the disclosure benefits of managers and improve the controlling mechanisms to lead a firm by disclosing the more FLD.

In reference to the study of Ho & Taylor (2013), improved corporate mechanisms affected the disclosures of FLD, corporate policies, economic information and corporate societal accountability information. Ahmed Haji & Anifowose (2017) found that the firm’s exposes of FLD are increased by the adjustment of combined recording practices.

Several studies also focused on the association between stock return volatility and FLD. Kent & Ung (2003) investigates the voluntary disclosure of future earnings from the Australian listed company’s annual reports. This result shows that more future earning disclosures information is disclosed by larger companies with small volatile earnings. But small firms with higher volatile earning disclosed less future earning disclosures.

Bartov (2004) discussed about ancient and FLD to derive expected volatility. Their result found that administrators use both historical and FLD to determine the probable volatility parameter. They also found that the dependence on forward-looking information is restricted to situations because it reduces expected volatility and option expense. Athanasakou (2010) studies the role earnings quality in investor valuations and forward-looking performance disclosures. The result of the research indicates that the size of the statements conveying FLD about future performance generally rises in a company’s earnings quality.

Several researchers investigate the determinants of FLD and try to find out the practices of FLD in company’s annual reports. In this case, Aljifri & Hussainey (2007) search the underlying determinants that affect the FLD. Their result demonstrates that leverage ratio and profitability (ROA) have a significant relationship with the extent of FLD in UAE companies. But auditor type, firm size and sector type have not any relationship with the FLD.

Mathuva (2012) studies on the factors of the FLD covering sample from the interim financial reports (IFRs) of a developing country. He found that FLD are disclosed by the firms with better performance, higher debt, and higher capital investment. But cross listed companies are disclosed with lower FLD.

In addition, Alkhatib (2014) identifies the factors that affect the FLD in listed Jordanian firms on the Jordanian stock exchange and found that profitable firms disclose more information while total assets and auditor type have a significant association with FLD. Further, a recent study of Kılıç & Kuzey (2018) investigates the extent and nature of FLD and searches the factors of those disclosures. Their result reveals that most of the firms provide qualitative FLD rather than quantitative. Their findings also show that firm size and gender diversity are positively related to FLD but leverage is negatively related to FLD.

In reference to the above literatures, it can be said that some research has been done on FLD in different countries. According to my knowledge, there have not been done any study on FLD in Bangladesh. So, this study will investigate the extent and nature of FLD and find out the factors of those disclosures in Bangladesh.

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