AC 4304Financial Reporting Theory

Hong Kong Should Regulate More Transparency

Dennis Kwok (50189955)

Nicolas Wong (50185380)

Wilson Wong (50189236)

Introduction

• Regulate towards more transparency does not mean more useful information is provided

• Beneficial to companies?

Introduction

• Companies lose competitive advantages

• High uncertainties and misleading for expectations

• Disclose moreCost higher

Introduction

• Ethical problems

• Managers intense to manipulate accounts

• Extra and redundant audit work is needed

• Public will doubt the present regulations: trust and credibility

Our Standpoint

Voluntary disclosureRegulation

Competitive advantages

• Even strong companies do not willing to disclose too much:

– For flexibility: companies can change their strategies easily

Loss competitive advantages

• Competitors can set:– Lower cost

– Lower price

– More favor promotion

– Similar strategy

• Potential competitors can:– Lower cost of suppliers

– licensed

– More focus on targeted customers

Loss competitive advantages

• Hostile takeover may exist

• Outsiders recognize the risk and return of companies

• Companies may lose controlling power

Who protect minority interests?

Loss competitive advantages

Example:

• Cheung Kong Holdings acquired Hutchison Whampoa

• Hutchison Whampoa could not afford the financial costs

• Hutchison Whampoa owned plants and docks which is valuable

Uncertain expectations

• Strategies can be changed– E.g. Dr. Ho in Macau

• Operating environment may be changed

• Earnings cannot be sure

Conclusion: not reliable and misleading

Everything is money!!

Information disclose increase

Management prepare more

disclosure

Auditors’ work done and time cost

increaseAdministration cost increase

Audit fee increase

Company’s burden increase

Ethical issue

• For ethical & responsible management:– Disclose information which is significant for

outsiders’ decision making in voluntary basis

• For unethical management:– Even forced to disclose by regulation,

reliability of disclosure is doubtful– Private-interest Theory

Ethical issue

• For ethical & responsible management:– Disclose information which is significant for

outsiders’ decision making in voluntary basis

• For unethical management:– Even forced to disclose by regulation,

reliability of disclosure is doubtful– Private-interest Theory

Private-interest Theory

• George Stigler (1971)

• Regulatory activities reflect relative political power between interest groups

• Interest group (e.g. business executives) rationally self-interested

• Politicians seek to maximize their chance of future electoral success

Private-interest Theory

Business executives Politicians

Electoral contribution

Consideration in establishing regulations

Regulations bias to business executives’ interest

Usefulness of disclosure

• Users would have expectations on the company’s performance after considering the information in the disclosures

Usefulness of disclosure

• High expectation:– Increase management’s pressure– May have intention to manipulate

• Low expectation:– Affect investors’ & creditors’ willingness to

invest and grant loan to company– Disclosure is not fairly represent the

expectation and situation of management still useful?

Social Responsibility

• Hide the bad news?

• Income warning– Responsible to social and shareholders– Lower impact to the share price– Give confidence for the future operations of the

company

Auditors role

• Auditors: act as the role of monitoring

• Self-regulationuse professional judgment to ensure there are no significant misstatement and misrepresentation

• Good self-regulatory system in HK: up to now there are not many fault cases

Audit efficiency

• If regulatedmore redundant and useless information may be asked to discloseincrease auditors’ workload

• From 145 annual reports (1993, English version only):

TIME DIMENSION

NO. OF REDUNDANCIES

%

Expectational 83 21.3

Present 268 68.7

Historical 39 10.0

Total 390 100.0

Audit efficiency

• Present trend: do less redundant work, increase the audit efficiency

Conclusion

• Cost and benefit relationship: – Regulations will cost more, but make similar benefit to

society as voluntary disclosures

• Regulations will have negative impact:– Lose of the competitive advantage

– Management will have more intention to manipulate the accounts

– Audit efficiency

Conclusion

• Present regulations are enough

• Trust of management and auditors– Management have social responsibility– Auditors are monitoring the disclosure:

sufficient to prevent any misstatement or omission of any important information

We strongly DISAGREE that Hong Kong should regulate towards more transparency

Q & A