Disclosure Requirements Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Disclosure requirements relate to the data collection, analysis, and dissemination relevant to specific transactions that is required by law. Disclosure is part of many legal regimes around the world that protect business from the indisputable temptation of corporate insiders to loot business treasuries, a phenomenon that often goes undetected. Disclosure is a way to protect investors and shareholders against self-dealing—the use of corporate assets for personal gain. It is a prerequisite for robust equity markets to develop.

To be efficient and growth-oriented, entrepreneurs require regulatory regimes that give investors such as stock markets, private shareholders, and other financial institutions the confidence they need to provide finance without the need to exercise daily control of the business. They need laws that prevent expropriation and expose it when it happens. This requires protection of shareholders and enforcement of defaults and irregularities. It means that a well-governed business should disclose ownership and financial performance information. Information on financial transactions, on board directors, and on voting agreements among the shareholders must be freely available to current and potential investors. It also means that a director should face legal liability for self-dealing, and that shareholders should be able to sue officers and directors for misconduct.

In a comparative analysis of disclosure requirements, the World Bank’s Doing Business (DB) survey comparatively examines national disclosure requirements. For an example using a hypothetical case, say that a Mr. Singh owns 60 percent of Buyer Ltd., a commercial delivery firm, and he owns 90 percent of Seller Ltd., a retailer. Seller Ltd. is facing financial problems, recently shut a large number of its stores, and has trucks for sale. Mr. Singh proposes to Buyer Ltd. that it purchase Seller’s unused trucks to expand Buyer’s capability. Shareholders then sue Mr. Singh and the parties who approved the transaction. In such a case, one must ask (1) whether and in what detail Mr. Singh must make mandatory disclosures regarding his interest to Buyer’s board of directors; (2) whether and in what detail disclosures regarding the Buyer-Seller transaction are legally required to be made immediately to the public, the regulator, or the stock exchange; and (3) whether and in what detail disclosures regarding the Buyer-Seller transaction are legally required in Buyer’s annual report.

The World Bank’s index ranges from zero to 10, with higher values indicating greater disclosure. Taking the Asia-Pacific region as an example, New Zealand and Singapore have the highest rankings in the disclosure index. In 2007 the United States ranked at seven on this index, and the lowest rating went to Laos, at zero.

Another example of disclosure requirements is often seen in an initial public offering (IPO). In this case, detailed disclosures of the company’s affairs must be made public. New-venture firms often prefer to keep such information private. In an IPO, the firm usually must issue a prospectus, which is a formal written offer to sell securities that provides an investor with the necessary information to make an informed decision. If a company is raising capital by offering its shares or other securities to the public for the first time (usually called a “float” or IPO), it will issue a disclosure document called a prospectus.

In Australia, for example, a prospectus must be lodged with the Australian Securities and Investments Commission (ASIC). The prospectus will then be made available in an electronic format, called eprospectuses, via the internet. The prospectus must fully disclose all pertinent information about a company and must present a fair representation of the firm’s true prospects. All negative information must be clearly highlighted and explained. Some of the specific detailed information that must be presented includes the history and nature of the company; capital structure; description of any material contracts; description of securities being registered; salaries and security holdings of major officers and directors and the price they paid for them; holdings; underwriting arrangements; estimate and use of net proceeds; audited financial statements; and information about the competition with an estimation of the chances of the company’s survival.

Disclosure (or its absence) is connected to a country’s level of transparency (or corruption). The knowledge of amounts in financial transactions must be reasonably exact before they can be controlled, curtailed, or reformed. Disclosure fulfills two very important functions: Accounting and accountability, which serve as both preventive measures and monitoring tools in combating corruption. The accounting function allows for the construction of itemized reports of funds received and spent. The accountability function is the presentation of these reports so that shareholders, investors, and regulators can make more informed choices about business performance.

Benefits And Pitfalls

There are three major benefits of disclosure requirements. The first is the ability to “follow the money.” Without it there is no way to keep track of—and thereby enforce—regulations. The ability to “follow the money,” or construct an “audit trail,” is the first defense against system irregularities and can have an impact on good governance.

The second benefit of disclosure is that it acts as a preventive measure. Disclosure serves to monitor and reveal information that can prevent conflicts of interest. It provides watchdog groups and the media with informed analysis of business finance and creates more educated shareholders. Through “name and shame” exercises, it also serves to warn corporate officials that they must act in the shareholders’ interest, not for private gain.

Another benefit to disclosure is that it builds confidence in the business process. On a level business playing field, the underlying principle behind disclosure is that the more transparent and open a company’s finances, the more its shareholders and investors will trust the business.

In the absence of any international standards, pitfalls that mar the disclosure process include: (1) Deceptive interpretations. Few words in finance are as overused and poorly defined as disclosure. (2) Limited access to data. Opening records to the public is the ideal, but some legal regimes make accessing them difficult. (3) Poor quality of data. A more subtle form of deception is the low quality of data that many disclosure laws produce. (4) Low quantity of data. Many countries claim disclosure, but fulfill only some of the variables required for full disclosure.

Full disclosure, or the maximum extent of openness in reporting political contributions, requires information on how much money a business has received; how much free or in-kind support was given to the business (e.g., goods, services, or loans); the names (and sometimes addresses) of the “givers”; how much money the business has spent and on what; and names (and sometimes addresses) of companies or persons who received the money spent on goods and services provided to the campaign. Full disclosure also requires businesses to file financial assets (ownership and debts).

Bibliography:

Huddart, J. S. Hughes, and M. Brunnermeier, “Disclosure Requirements and Stock Exchange Listing Choice in an International Context,” Journal of Accounting & Economics (v.26/1–3, 1999);
Usha Rodrigues and Mike Stegemoller, “An Inconsistency in SEC Disclosure Requirements? The Case of the ‘Insignificant’ Private Target,” Journal of Corporate Finance (v.13/2–3, 2007);
S. Securities and Exchange Commission, “Current Accounting and Disclosure Issues,” www.sec.gov (cited March 2009).

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