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Company Reporting Shareholders

2.1 Introduction

Good company reporting is absolutely necessary and vital as it provides valuable information to its shareholders, creditors and other stakeholder groups who may have the interest in knowing the position of the companies and their activities. It is equally important to maintain an equilibrium or balance between the cost of collecting and publishing the information and the cost of finding the information by the respective readers. It does not necessarily mean that adding bulks of information make the report a good one. It is the quality of information that counts. Government is highly dedicated to affirm that reports maintain a certain degree of quality rather than large and unwieldy information. Trade and Industry Committee (2002)

2.2 Corporate Reporting and Disclosure Concept

Clarity of purpose is the key to economic success. The companies are most likely to pretend their motto is to maximise shareholders value.

“For the business community to become more effective, companies need to be clear about the purpose of their reports and provide what their end-users need to know”.

Company reports serve the useful information to those interested in the activities of the company, mainly the stakeholder groups. Stakeholders act as nucleus, around which the future activities and strategies would be framed. Company law explicitly guards stakeholder’s value in different areas of disclosure. Zairi, M., and letza, S. (1994)

Disclosure system is recognised extensively in the company law. English law takes this concept very much for granted. The distinctive vindication for the disclosure system lay down the in the English literature is that, disclosure stem is the price paid for all the privileges of incorporation and the limited liability of its members. The disclosure philosophy is based on good faith. There is an increasing demand for more and more information to be shared in the reports of the company.

The debate on corporate governance has subjugated company law since 1990. This has resulted in more requirements to the past disclosure system, to provide much broader information rather than just the financial condition of the company. The fundamentals of disclosure system are based on many theoretical concepts and objectives. However there are imbalances between the theory and the practice due to its inherent cost and the burden of numerous questions and problems regarding its validity as a regulatory tool. Villiers, C., and Rider, B. (2002)

2.2.1 Relevance of mandatory disclosure

The value of mandatory disclosure system found an extensive place in the literature inviting controversies and debate as to whether there should be any mandatory system in practice. The debates were highly influenced by economic conditions and the efficiency levels achieved by a disclosure system were also being focused.

Ever since, the companies were accorded by the incorporation and limited liability privileges by the legislation of 1855 and 1855, the disclosure has been regarded as the fundamental principle of the company law. There are also evidences which states that the mandatory disclosure concept existed even before the introduction of limited liability for other several reasons. Davies, L, P. (1997).

The Companies Clauses consolidation Act 1845 was enacted as the relevance of fraud was considered to disclosure. This enactment was in fact an answer to the historic and the first financial scandal called the ‘South Sea Bubble scandal’. The act prevents the evils of deceitful and fabricated companies. All what is necessary is publicity and disclosure to bring down fraudulent practices. Hopt, J, K., and Teubner, G (1985).

It is most likely for the potential creditors and the shareholders to become fatalities of the fraud. Fraud prevention in a sense is investor protection. It is closely related to each other. The raising of funds from the public by the companies turned unsound which in future gave rise to the disclosure as an agency position. Gower, L., C., B, (1979)

Mahoney, P., (1995) claims that disclosure has a very significant monitoring task which rose from the agency relationship between the shareholders and the corporate managers which indicates the accountability to the owners. Berle and Means’ in their analysis which is based on the separation of two concepts , ownership and control, wherein traditionally the owner could exercise his discretion and powers according to his will and an assumption was made that he would be doing the same.

The same assumption was carried forward to the present conditions with the same expectations about the business to be run in owners’ welfare but with a change that the owners position been reduced to that having a set of lawful and realistic interest. On the other hand the group having control are in a position having legal and realistic powers over it. This may cause a divergence of interests between the owners and the controllers which divorces the relation between ownership and control. Berle, A., and Means, G., (1991).

The informational imbalance between the investors and managers could be redressed with the help of disclosure regulations and it also help to avoid divergence of interest between the owners’ and the managers which empower the owners to take more active position in decision making and monitoring the managers. Sargent, M., A, (1987)

An unambiguous legislative idea of corporate disclosure is indeed to promote fair corporate suffrage. This encourages the participation of the shareholders, and helps them to exercise their power to vote more effectively which in turn improves the quality of corporate democracy. Weiss, E., (1979)

From 1980,s a wider focus was made on information and efficiency. Efficiency turned out to be the key issue in several debates on corporate disclosure obligations. Boyle, A., J, (1999). Department of trade and Industry (DTI) made it clear about the influences of efficiency and economics in their law reform policy. Transparency in action and disclosure show the way to efficient operation and enables beneficial economic choices without being distorted by the costly effects of any legal interventions. From this point of view disclosure, might be considered as the ideal choice to substantive parameter. DTI, (2000)

In a mandatory disclosure system, the companies are required to provide specific information about their activities at different levels. This brings in standardisation of data which will also help to save cost. The use of prescribed forms and table make the data’s’ more standardised and eventually the stakeholders become more familiarised with the presentation and will carry a positive impact on the cost saving with regards to the interpretation of the collected data. In due course the language progresses into a uniform language making the information more feasible and easily understandable. Comparison of data’s will also become much easier when the standardisation is in place. (Meier-Schatz)

Disclosure system has a potential advantage offering the companies a choice to other forms of regulation. Disclosure itself solves many problems in certain circumstances. It is less intrusive compared to other forms of regulation which makes it more attractive. Disclosure also tends to avoid the familiar petrifying effect of the European substantive law.

For example, certain transactions such as loans to the directors’ need not be penalised as it could be ratified by proper disclosure. The shareholders in this case will be in a better view to understand whether the directors’ action would cause any damage to the organization. Hopt, K., J., (2003)

Social impact and public interest is one of the important aspects of disclosure. A company’s social performance should be distinguished from its economical efficiency because it may be performing very well in market and economic efficiency but its societal performance may be very poor. The activities of a company may have external effects that could be either positive or negative.

Where the effect is found to be negative it becomes necessary to compare with the efficiency returns to check whether the company’s performance is up to the standard. In certain cases there are interested parties who may not contribute financially to the company but are very interested and keen in the company’s activities, for example, the customers may not necessarily be interested in the company’s share price, but, in the quality of products they offer. Social disclosure plays a very important role in these areas. Weiss, E., (1979)

In short the advice in favour of disclosure comprises of:

• Fraud prevention

• Protection for the investors

• Accountability and corporate governance

• Corporate democracy

• Standardisation

• Substitute to regulatory intervention

• Social benefits and public interest

Irrespective of all these advantages the disclosure concept is not free from limitations. The commonly observed problems are complexity of information in a prescribed legal form, work overload to make sure that the requirements are complied with, the cost of collecting, providing and interpreting the information disclosed, the threat to the confidentiality of a company when its activities are disclosed, incomplete information which may mislead shareholders and the lack of interest from the shareholders to go through all the information disclosed. Villiers, C., and Rider, B. (2002)

2.2.2 Shortcomings of the existing reporting systems

Much literature has invited the attention of many investors and stakeholders about the key concerns which brought the big business giants down to the ground. IBM, Enron, Global Crossing and many others failed to provide full proof information about their liabilities to their stakeholders which threw a great deal of adverse effect on the firms valuation. This may result in misrepresentation which can be a serious offence against the organisation and may even end up in dissolution of the firm. Atkinson, S, A. (2002)

Many experts have agreed upon certain common defects and limitations in the prevailing reporting systems. In actual fact the areas of deficiency in financial reports are discussed below;

• The quality of information provided in the financial reports is always under suspicion, as to, whether the same is of any benefit to its ultimate users.

• The data’s provided in the financial reports are of historical nature. It gives a backward looking angle on the company’s past performance and behaviour which in turn leaves the end user with very limited or almost no flexibility in taking future decisions.

• The reports concentrate more on single earnings figures rather than the company’s state of health in terms of liquidity and cash flows.

• In most of the reports it is found that more emphasis and care is undertaken to comply with the legal formalities than presenting the actual economic and business performance.

• A gap is always found in the reports especially on matters regarding the future plans, strategies and commitment to the public regarding the levels of improved performance.

Many people believe that the reporting mechanisms should be more like a ‘guiding tool’ rather than an ‘inhibitor’ so as to change management attitudes and behaviour. [Binney, G. (1991), ASSC (1975), Arnold, J. (1991)]

In accordance with the argument made by the ASSC in 1975:

“It is important to keep in mind the pervasive influence of reporting practices on management attitudes. Managements naturally respond to those indicators by which they consider their performance is judged, and strive to achieve and present results accordingly. Special attention is bound to be given to those areas where the spotlight falls. Our view is that management attitudes and objectives can be profoundly affected by changes in reporting practices”. ASSC (1975)

2.2.3 Reasons pointed out for the limitations of corporate reporting

Despite of the clear justifications given by many experts, corporate reports are not free from limitations. Corporate reports are mostly seen to lack a conceptual framework for the values and standards which are to be maintained by a disclosure system. The evolutionary practices such as accounting and reporting are endlessly affected by the changing business environment.

One other reason causing a negative impact is the fact that the need of various entities to be addressed is not adequate. One party might consider the information to be too narrow, the other may find it unnecessary; the other may need the information in much broader terms.

There are different types of entity and participants whose needs and interest are to be included by the regime. In the UK the needs and interests of small, medium and large companies are well appreciated but the inadequacy in addressing all these needs in the regime is a down beating aspect.

The failure in coordinating the roles of different participants poses to be another important limitation of disclosure process. It fails to explain the responsibilities of those who are to publish the information to meet the needs at various levels. It also misses out the opportunity to explain the negotiations of different parties to the company. Villiers, C., (2006)

2.2.4 Mandatory disclosure logics

In spite of all the limitations there are strong reasons to support a mandatory disclosure system. The overall merits of a disclosure system outweigh its demerits rendering the information more reliable. The value of disclosure is directly related with the value of disclosed information. Generally two kinds of information are disclosed in the reports namely:

• Accounting information

• Non accounting information

Accounting information needs proper accounting treatments and procedures for disclosure. It is based on underlying guidelines and principles. However proper accounting treatment is not clear in today’s dynamic world. The same is inviting many debates into the topic. The trend of today is recognising market value accounting than the traditional methods of accounting. The non accounting information may be represented by narrative reporting. Organisation for Economic Co-operation and Development, (2001)

• An introduction to the Operating and Financial Review [OFR]

The Operating and Financial Review (OFR) was one of the most controversial developments in the history of the UK company law. Even before the regulation gained any practical effect, decisions were webbed out to scrap the regulations. This has invited much more controversy into the topic. FT,. (2005).

The OFR is a narrative report with the objective to provide a review of company’s activities by taking the future potential of the company into consideration. The OFR tries to achieve good corporate governance by improving the quality of information which in turn improves the reliability, authenticity and usefulness of information whereby the shareholders could exercise an effective control. The Companies Act 1985. , Regulations., (2005)

Thus the OFR is a report ? setting out the principal drivers of a company?s performance both in the past and in the future?.

3 According to the DTI, the OFR should ?cover the issues traditionally seen as key to a company?s performance ? an account of its business, objectives and strategy, a review of developments over the past year, and a description of the main risks?.

4 The Government adds that the OFR ?will also cover prospects for the future and, where necessary, information about the environment, employees, customers or social and community.

1 See, for example, letter page in Financial Times, 29 November and 1 December 2005.

2 Explanatory Memorandum to the Regulations for an Operating and Financial Review, para. 7.3: the Companies Act 1985 (Operating and Financial Review and Directors Report etc) Regulations 2005, SI 2005/ 1011.

3 See Foreword by Patricia Hewitt, Secretary of State for Trade and Industry, in the Consultation Document, Draft Regulations on the Operating and Financial Review and Directors? Report (DTI, London, May 2004), available at www. dti. gov. uk/.

4 Ibid. issues where that information is important for an assessment of the company?.

5 The Government regarded this as ?a step change to the quality of reporting by companies?.6 In this way the OFR might have been a major element of the transparency and accountability aspect of corporate governance contributing to improvements to the quality, timeliness and accessibility of information available for shareholders. The OFR should furnish shareholders with the information necessary for them to exercise effective control and informed influence over companies.

The OFR would have been a new statutory requirement for quoted companies while at the same time unquoted large and medium-sized companies are required to provide a narrative report in their Directors? Report that provides a ?fair review of the business of the company and its subsidiary undertakings

7 Small companies have no obligation to provide an OFR or an enhanced business review in their Directors? Report.

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