Hong Kong should regulate towards
more transparency?
Presentators:
Mable Tang
50192529
Mandy Cheng 50126041
Fion Lau
50194105
Agenda
•
•
•
•
Part
Part
Part
Part
I: Introduction
II: Market Wide Problems
III: Specific Problems in Annual Report
IV: Recommendations
Part I: Introduction
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
Leading to
Increasing
effective functioning of capital markets
management credibility
analysts’ understanding of the firm
investors’ patience and confidence
share value
(Eccles and Mavrinac, 1995)
Introduction
– In Hong Kong, after financial crisis of 1997,
unexpected company failures and financial scandals,
negative publicity about excessive directors benefits,
Decreasing
investor confidence
Leading to
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)
– 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-tomarket accounting
• Companies can inflate profits by using
unrealistic price forecast
• However, Enron smoothed earnings rather
than inflate them
- gave appearance that Enron’s 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 company’s 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 years’operation
What’s 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!!
Why’s 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
EBITDA/Sales
EBIT/Sales
%
15
10
10.2
12.5
12.5
9.4
9.1
7.4
5
7.8
4.4
0
-5
-10
-15
-20
Comments:
1/ Not clear Zero-baseline
1997
1998
1999
2000
2001
-11.7
-15
US$'M
1400
1335
1200
Turnover
961
1000
800
1046
842
731
600
400
200
0
Comment:
1/ No zero baseline
2/ Scale - misleading?
1997
1998
1999
2000
2001
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?
Part IV: Recommendations
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)
Recommendations
• 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
Level of
Disclosure
Leading to
Stock
Liquidity
Proved by Healy et al. (1999a)
Incentives for Regulating towards
More Transparency
Level of
Disclosure
Leading to
Proved by Botosan (1997)
Cost of
Capital
Incentives for Regulating towards
More Transparency
Level of
Disclosure
Leading to
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.