The following corporate fraud scandals in the United States and Europe (e.g. Enron, Tyco, WorldCom) in the early 2000s amplified the importance of this issue even more.
Varying knowledge of the quality of a product in the goods and services industry is referenced by the „lemons“ problem or described by the situation of both informed and uninformed investors participating in the financial markets.
Then one party might engage in risky behavior or deceiving actions due to the lack of transparency (e.g. insured drivers acting riskier in the traffic).
By the reason of different individual objectives, the principle demands the disclosure of information about effort and outcome to assure the agent does not act purely in their own interest.
The application of transparency underlying the relationship between employer and employee, investor and firm (owner and manager) or the public and the government has two main objectives: predictability and accountability.
Based on information about policy choices (“effort”) and the result (“outcome”) of the government’s (agent’s) decisions the public (”principal“) decides whether to keep or remove them from office.
In public policy area the stress is on the “ex-post transparency” in the way that it improves the electorate’s ability to hold the government accountable.
“Ex-ante” transparency is not very effective in assessing the government’s actions because the electorate is not familiar with what the optimal policy decisions should be.
Whenever there was insufficient transparency and negative information appeared, investors could not distinguish between individual firms and borrowers, thus they departed investments from the entire market.
In conclusion, countries and companies with transparent policies have lower borrowing costs, get more investment, and are less susceptible to financial crises.
If the incentive for the sender is based on the results of (involuntary) monitoring, they make costly actions to (deceitfully) signal abilities.
Leuz and Verrecchia (2000) discovered that if transparency reaches a certain point, further disclosure of information has little power on decreasing the firm’s cost of capital.
[4] Examples: All of these mechanisms face the following challenges: Transparency and openness can help accelerate reforms in developing countries in situations which foreign aid and other US programmatic and diplomatic efforts will have less potency and influence.