Source: http://www.europeanfinancialreview.com/financial-reporting-regulation-from-the-crack-of-the-whip-to-the-soft-stick/
Timestamp: 2019-04-20 03:30:46+00:00

Document:
Effective communication between corporations and investors is important in an economic system where management is separated from capital providers. Yet how does society regulate that communication? Options range from strict rules from above (the whip) or more passive action (the soft stick). In this article, the author reviews some evidence on how these choices are made, and discusses the environments where one option or the other (or a combination of the two) prevail.
In 2012 PricewaterhouseCoopers (PwC) issued a standard one-page audit opinion to the shareholders of British American Tobacco (BAT) reporting that the annual financial statements offered a “true and fair view” of the company’s position and performance. Two years later, following a mandatory change in auditing standards in the UK, PwC’s audit report for BAT was five pages in length; set the materiality level used in the audit at £260 million; and revealed the five areas of greatest focus for the audit as well as highlights of the procedures followed when examining these accounts. The private, independent auditor now reveals much more detail – yet it is still at the discretion of the auditor. Is such information useful to investors?
Public equity markets work best when corporate management shares information with outside investors.
Capitalism relies on the separation of ownership from day to day management for many enterprises. An advantage of this arrangement includes larger amounts of capital flowing to the company, which can be vital if it requires scale to compete. Additionally, the spreading out of investments provides diversification advantages to the investor. Yet the investor faces the challenges of first knowing where to invest, and then after the fact assessing how well is that investment performing? Financial reporting is one part of the solution to this problem. Effective financial reporting can lower capital costs, and this can spur economic growth as more innovations are funded with additional capital. Therefore, financial reporting is a highly regulated activity given this importance. Yet what sorts of mechanisms are effectively employed in this regulation? I address this question in the remainder of this article and pay particular attention to what we have learned through research using large samples of global firms.
Daniel A. Bens is a Professor at INSEAD and Chair of the Accounting and Control area. He earned his Ph.D from the Wharton School of the University of Pennsylvania. His research focusses on discretionary disclosure as well as the economic effects from seemingly cosmetic accounting choices.
1. Rafael La Porta, Florencio Lopez-De-Silanes and Andrei Schleifer. “What Works in Securities Laws?” The Journal of Finance v. LXI, no. 1, 2006.
2. Rafael La Porta, Florencio Lopez-De-Silanes and Andrei Schleifer. “Law and Finance” Journal of Political Economy v. 106, no. 6, 1998.
3. Ray Ball, Ashok Robin and Joanna Wu. “Incentives Versus Standards: Properties of Accounting Income in Four East Asian Countries” Journal of Accounting and Economics v. 36, 2003.
4. Hans Christensen, Luzi Hail and Christian Leuz. “Mandatory IFRS Reporting and Changes in Enforcement” Journal of Accounting and Economics v. 56, 2013.
5. Jane Croft. “Former Tesco Executives Accused of Falsely Boosting Profits” Financial Times, 29 September 2017.
6. Daniel Bens. “The Determinants of the Amount of Information Disclosed about Corporate Restructurings” Journal of Accounting Research v. 40, no. 1, 2002.
7. Daniel Bens, Mei Cheng and Monica Neamtiu. “The Impact of SEC Disclosure Monitoring on the Uncertainty of Fair Value Estimates” The Accounting Review v. 91, no. 2, 2016.
8. Daniel Bens, Woo-Jin Chang and Sterling Huang. “The Association Between the Expanded Audit Report and Investor Uncertainty” unpublished working paper, 2017.

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