Financial Reporting Theory Week 6 Presentation Dennis Chow Ivan Chan Rita Lam

All new disclosure should appear in the Management Discussion & Analysis Statement Mandatory? All?

What is a Management Discussion and Analysis Statement (MD&A)? Purpose: information relevant to an assessment of the financial condition results of operations of the company

Scope of Disclosures in MD&A Relevant Reliable Material

those matters which there is substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered Certainty -- Determined by MGT or evaluated objectively for the consequences Material defined by SEC:

Talking with CEOs Mr Richard Li Chief Executive Officer of Pacific Century CyberWorks Limited (PCCW)

Mr Steven A. Ballmer Chief Executive Officer of Microsoft Incorporation Talking with CEOs

Present Application of MD&A In Hong Kong, Reference for Disclosures in Annual Report of Hong Kong Exchange and Clearing Ltd – may disclose (Not restricted) e.g.: description of the business done and intended to be done general development of last 5 years Corporate government practice Voluntary !!!

In United States, SEC Regulation S-K – Required three aspects for disclosure: Basic Information Covered: i) Liquidity ii)Capital Resources iii)Results of Operation Present Application of MD&A

Our Standpoint Oppose Voluntary disclosure besides basic requirements in MD&A I) Redundancy II) Expose the virtues and evade from the bad III) Cost & Benefit

Basic thinking process: I. Redundancy in MD&A Receiving Information Interpretation Judgment Digest & Understand Reading Annual Report Predict the performance of the company Quantity of Information ---will affect decision-making effectiveness

The reason of mentioning the process of thinking, as we have found: Decision-making effectiveness of readers has decreased by redundant disclosed information in MD & A. Lets see example: MD & A of Giordano Ltd I. Redundancy in MD&A (contd)

5. Geographical Classification 6. Divisional Classification P/L CF statement 1.Turnover of the company 2.Gross Margin 3.Distribution and Administrative Cost 4. Cash Flow 8. Liquidity and Capital Resources 9. Human Resources 7. Outlook Notes to Account Meet the required content in MD & A

I. Redundancy in MD&A (contd) 5. Geographical Classification 6. Divisional Classification P/L CF statement 1.Turnover of the company 2.Gross Margin 3.Distribution and Administrative Cost 4. Cash Flow 8. Liquidity and Capital Resources 9. Human Resources 7. Outlook Notes to Account Meet the required content in MD & A Conclude: If we add too much voluntary disclosure information to MD & A, it will cause information repetitions and redundancy. decrease understandability of MD & A decrease decision-making effectiveness

Chairman of Ernst & Young,US, NJ.Groves conducted a survey in 1994 Try to quantify the excessive disclosures in annual report. I. Redundancy in MD&A (contd)

Collect & measure the total no of pages -- annual report, footnotes, MD&A of 25 companies in USA. e.g. AT&T, Coca-Cola, IBM, etc reflect the increasing redundancy problem Increasing total no of pages Basic assumption: Not all information disclosed is useful.

I. Redundancy in MD&A (contd) Collect & measure the total no of pages -- annual report, footnotes, MD&A of 25 companies in USA. e.g. AT&T, Coca-Cola, IBM, etc reflect the increasing redundancy problem Increasing total no of pages Basic assumption: Not all information disclosed is useful. Conclusion: The redundancy problem in MD & A become serious as the new disclosure increase from year to year

II. Expose the virtues and evade from the bad Focus of MD&A –focus specifically on MATERIAL events and uncertainties known to management –would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition

Focus : material However: Material is left to the judgment of company management 1.Agency Theory 2.Need not to be audited 3.Company interest to divert investors attention Expose the virtues and evade from the bad II. Expose the virtues and evade from the bad (contd)

1. Agency Theory John K. Courtis (1996) Agency theory posits that management would be motivated to disclose items of information which have the potential to show the company and its management in a certain light E.g. Repeat the profits made II. Expose the virtues and evade from the bad (contd)

2. Credibility of Un-audited Information something about forecast judgment by management arbitrary disclosure may mislead users tend to disclose positive price-sensitive information II. Expose the virtues and evade from the bad (contd)

3. Diversion of Attention from Important Matters Product-lineProfit(loss)Prospect Ladies50M100M …The Company has an outstanding performance in Ladies cloth, it is expected that our business have a good prospect… II. Expose the virtues and evade from the bad (contd)

Diversion of Attention from Important Matters Product-lineProfit(loss)Prospect Ladies50M100M Men(30M)- Child(50M)- Total(30M)- II. Expose the virtues and evade from the bad (contd)

Handsome Strong Body Good Temper U-grade 2M salary per year Own 2 flats and 1 car Tender to you Such an all-rounded man Excellent qualification Be my valentine I DO

I Should have done an AUDIT on your marital status Conclusion: Lets Back to Basic Too many unnecessary information are meaningless Oppose Voluntary disclosure besides basic requirement Profile Name: D. Chow Age: 25 Sex: M Marital Status: MARRIED

III. Cost & Benefit Every Information is Money!!!! Companys burden increase Information disclose increase Management spent time Admin cost increase Reasons: 1.Time spent on sorting information --Directors spent a lot of time to discuss which info should be disclosed 2. Administration cost will be increased

III. Cost & Benefit (contd) But the benefit generated from the increased disclosed info in MD & A is not so great as you think!!!! In Boeings MD&A --- technical terms---describe the production process in the Research & Development --- Model of the military (e.g F/A-18 Super Honet, F-22 Raptor, AH-64 Apche, V-22 Osprey) Example: Boeing --- military aerospace products (e.g helicopters, tanks) manufacturers in US

III. Cost & Benefit (contd) But the benefit generated from the increased disclosed info in MD & A is not so great as you think!!!! In Boeings MD&A --- technical terms---describe the production process in the Research & Development --- Model of the military (e.g F/A-18 Super Honet, F-22 Raptor, AH-64 Apche, V-22 Osprey) Example: Boeing --- military aerospace products (e.g helicopters, tanks) manufacturers in US the increased disclosed information cannot help investors to predict the performance of the company!!!!!!!

Conclusion MD&A is good But be precise Avoid redundancy Avoid e xpose the virtues and evade from the bad Avoid Cost over Benefit Provide information relevant to the assessment for the financial condition and results of operation, and stick to the basic requirement dont disclose all

~ The End ~ Thank you ^_^