Introduction Who demand for regulating towards more transparency? –Primary user: shareholders; –Other users: employees, creditors Why they demand that? Information asymmetry
Introduction –AICPA, 1994 report, Improving Business Reporting: A Customer Focus suggested that, effective information sharing effective functioning of capital markets management credibility analysts understanding of the firm investors patience and confidence share value (Eccles and Mavrinac, 1995) Leading to Increasing
–In Hong Kong, after financial crisis of 1997, unexpected company failures and financial scandals, negative publicity about excessive directors benefits, investor confidence many investors and auditors have called for improving company disclosure practices (A Study of Corporate Disclosure Practice and Effectiveness in Hong Kong, Simon S.M. Ho and Kar Shun Wong) Introduction Decreasing Leading to – Re-develop the confidence of financial users after collapse of Enron is a must
Part II: Market Wide Problems Information Asymmetry Lack of Credibility Lack of Comparability Dynamic of Environment Globalization (International Trade)
1.Information Asymmetry Whether there is market failure for disclosure? Window dressing is the main problem Management level know more information than investors, tends to hide bad news and show good position of company Some information not available to investors If no full and true information provided, investors will be misled
Benefits towards more disclosure More qualified and quantified information will be released, users can make better investment decisions More disclosure make investor more confident and enhance share value -also greatly related to survival and maximizing share value of a company
2.Lack of Credibility Less transparency, creditors not know whether the company is worth lending money or not Refer to Enron Case Problem: no standardized rule for recognition of earnings for energy resource industry
Energy trading earnings based on mark-to- market accounting Companies can inflate profits by using unrealistic price forecast However, Enron smoothed earnings rather than inflate them - gave appearance that Enrons earnings stream highly reliable, to pump up stock price
- creditors wrongly believed Enron has the ability to repay the debts and finally suffered great losses in the bankruptcy of Enron
3.Lack of Comparability Annual report is presented for general purpose to the public It does not fulfil the needs of any specific users E.g., a investor may need more detailed information on a companys profit generating ability but not any general figures
Although in the same industry, different companies may use different accounting policies and practices in preparing annual reports Thus, difficult for users (not professionals) to compare the information between different companies
4. Dynamic of Environment Arising of more complicated Business mode (New Economy) - e.g. E-commerce: no regulation, mostly depends on self-monitoring
Rapid technological innovation E.g. use of information system (EDP department, internet) Chang (1998) and Lev Zarowin (1999) find the decline in value relevance of financial statement items is partially explained by an increase in technological innovation
Globalization (International trade) Nowadays, institutional investors, corporations and internet-based trading invest around the globe Globalization of capital markets has been accompanied by calls for globalization of financial reporting
Some problems arise: - Is it possible to have a global accounting standard? - Which convergence of financial reporting institutions will take place? - What are political and economic consequences? Traditional financial reporting model fails to capture economic implications of changes in a timely way
Part III: Specific problems in Annual Report Non-inclusive Management Report Involuntary Disclosure Misuse of Graphical Representation Incapable for Disclosure of Complex Structure
1.Non-inclusive Management Report It includes….. - Management Discussion and Analysis -Comment from management on operation and future development - Directors Report -Guidance on the annual report - Five-Year Summary -Tubular analysis on past five yearsoperation
Whats the Problem? Merely promise by using exaggerated wordings - no guideline on how should they evaluate the company ALL about future is Optimistic! - hinder bad news, pessimistic viewpoint Un-audited - even audited, it that credible? Gradual improvement in profit figure - reliable? Even under current economic situation? - certain degree of manipulation!
2. Involuntary Disclosure Do you know the unique features of Hong Kong Business structure ? Professor Tsui, the major weakness of such companies was a lack of accountability in terms of disclosure and the quality of disclosure (SCMP, 10/2/02)
Studies in Hong Kong Of Heng Seng 100 companies - about 39% have more than 2 family members on BOD - about 38% have a chief executive being the chairman as well (15% coming from the same family ) Lower level of voluntary disclosure!!
Whys that? Control over company policy inevitably involve biased by majority interest (Big Family) what should be included Vs what is requested by SSAP - e.g. Connected party transactions Disclose it in superficial way ?
3.Misuse of Graphical Representation Techniques for misleading: - missing baseline - over-extended & multiple scales - optical illusions - omission or obtrusive gridlines…..etc…. Is that a need to regulate ?
Example: VTech Holding Limited Electronic Sector…. According to the research by Dr. Courtis, Electronic & Component Industry had around 33% graphical misrepresentation for turnover in 1994-95 Annual Report used: 2000/01
Comment: 1/ No zero baseline 2/ Scale - misleading ?
So, up till now… Again, Do you think it is a need to have more regulations on transparency?
4. Incapable for showing Complex Structure Growth of Multinational Business Entity Rise of E-commerce Business Entity - Without Physical office or even selling pure services (online movie) Active Merger and Acquisition activities - SSAP not have the best measure for this Is traditional accounting adequate?
Recommendations Enable the management level and outsider receive the same level of information as to avoid information asymmetry Standardized rule for recognition of earnings as to ensure borrowing credibility
Recommendations Specific reports should be generated for specific users in future financial statement (Accounting Theory, Ahmed Riahi Belkaoui) –Public reporting of corporate financial forecasts Provide information useful for the predictive process when it will enhance the reliability of users prediction (Trueblood report)
Rules should be generated to identify and measure earnings in e-commerce transactions Calling for regulations on globalization of financial reporting Credibility of management disclosures should be enhanced by regulators, standard setters, auditors and other capital market intermediaries (A review of the empirical disclosure literature, Paul M. Healy and Krishna G. Palepu) Recommendations
Concern on providing Quality information rather than just Quantity. FASB says, it should be –Relevant –Timely –Understandable –Reliable –Neutral –Representationally faithful (Accounting Theory, Eldon S. Hendriksen and Michael F.van Breda)
Incentives for Regulating towards More Transparency Leading to Level of Disclosure Stock Liquidity Proved by Healy et al. (1999a)
Incentives for Regulating towards More Transparency Leading to Level of Disclosure Cost of Capital Proved by Botosan (1997)
Incentives for Regulating towards More Transparency Leading to Level of Disclosure Information Intermediation Proved by Lang and Lundholm (1993)
Conclusion Regulating towards more transparency enables to disclose all relevant and material information to the user. Credibility of the financial report will then be increased. So, the users to have more confident on relying the financial report in making informed decision.
Reference List Annette Chiu, Attitudes must change before clear corporate picture seen South China Morning Post; Hong Kong; Feb 10, 2002. Ben Kwok, Governance makes gains South China Morning Post; Hong Kong; May 31, 2000. Hendriksen, Eldon S. Accounting theory 5th ed. Homewood, Ill. : Irwin, c1992. John E. Core, A review of the empirical disclosure literature: Discussion, Journal of Accounting and Economics, Volume 31, Issues 1-3, pp441-456, September 2001. Paul M. Healy & Krishna G. Palepu, Information asymmetry, Corporate disclosure, and the capital markets: A review of the empirical disclosure literature, Journal of Accounting and Economics, Volume 31, Issue 1-3, pp.405-440, September 2001. Riahi-Belkaoui, Ahmed, Accounting theory. 3rd ed. Fort Worth : Dryden Press : Harcourt Brace Jovanovich, c1993. Simon S.M. Ho & K.S. Wong, A Study of Corporate Disclosure Practice and Effectiveness in Hong Kong, Journal of International Financial Management and Accounting, 2001.