Capital Market Theories Market Efficiency versus Investor Prospects - Essay Example

Capital market theories market efficiency versus investor prospects of the of the Number Sarbanes-Oxley Act: Changes in corporate governance The Sarbanes-Oxley act (SOX) outlines new reforms made in the financial industry that stresses the importance of setting up corporate board of directors that will comprise of majority of independent directors whose primary responsibility will be to oversee audits, executive compensation and nomination of new independent directors. The reforms specified under the Sarbanes-Oxley act mandates the practices specified above. These practices have for long been considered to be crucial factors of a robust corporate governance framework. The act stressed the importance of not allowing external auditors to perform lucrative non-audit services. One example of such services is information technology consultancy provided by the external auditors to their audit clients. This approach was an already existing policy of many good governance advocates. The huge scandals that involved companies like, Enron and WorldCom, who were associated with accounting frauds characterized by presentation of obscure, incomplete and confusing financial data and business relationships that had misled external investors, had suggested the necessity to introduce an act that will impose strict regulations on the accounting system all over the world, thereby giving rise to a robust governance framework. That being said, it is not surprising that following the scandals, the reforms that were brought in the post-SOX governance framework were mostly related to the process of auditing and presenting financial data. The largest dollar impact on the US economy was stimulated by the post-SOX changes made in the auditing regulations. The post-SOX reforms were directed towards eliminating and reducing relationships that may pressurize, tempt or influence an external auditor into acting in a biased manner towards their corporate clients. The underlying idea behind these changes was to render the auditing officials less likely to fall into the pattern of acting as reciprocating relatives. This was done in order to satisfy their interests at the expense of the investments made by the public. As far as the new audit related changes in the board of governance is concerned, the mandates had called for changes to be made in the managerial level in order to reduce any conflict of interest and interpersonal pressures. This reform was brought primarily because it would require the directors to act as judgmental monitors of management instead of acting as a reciprocating friend. In addition to these rules that emphasized on conflict reduction, other standards were also set under the Sarbanes-Oxley act that requires directors to engage in processes that will increase their due diligence and self awareness and in return, fetch general benefits to everybody associated directly or indirectly with the particular organization. Alongside that, these reforms will also increase the ability and incentives to the directors and will influence them to act diligently, thereby safeguarding the interests of the public investors and shareholders (Clark, “Corporate governance changes in the wake of the Sarbanes-Oxley act: A morality tale for policymakers too”). The Securities and Exchange Commission (SEC) and the New York Stock Exchange (NYSE) in accordance with the Sarbanes-Oxley act circulated certain rules and regulations in order to promote and enhance corporate responsibility and the accuracy with which corporations prepare and present their periodic reports and financial statements (Pli, “Corporate Governance/Sarbanes-Oxley Due Diligence”). The introduction of Sarbanes-Oxley act led to a dramatic increase in the restatements of financial statements. This is particularly because most issuers complied with the legislations passed under the act. However, a decline in the number of re-statements was also witnessed in the subsequent years after the law was passed. This event can be attributed to the improved corporate governance framework as a result of the Sarbanes-Oxley act. Figure 1 demonstrates that number of restatements which had decreased during the period between 2007 and 2009. However, the numbers remained above the pre-SOX level. As is evident from the chart, number of restatements continued to grow 2010 onwards. Figure 1: Total restatements by year (Source: Audit Analytics, “2011 financial restatements an eleven year comparison”) The SOX act had led to a sharp reduction in the numbers of securities class action filed in over the past few years. As is evident from figure 2, securities class actions filings alleging omission or misstatements have averaged a little below 150 since 2005 compared to an average of over 200 between 1997 and 2005. Figure 2: CAF index- Annual number of class action filings (1997-2011) (Source: Harwood and Simmons 3) Harwood and Simmons (3-4) stated that, the number of securities case filings has reduced significantly despite the increase in the number of restatements post-SOX. This suggests that accounting issues have become more ubiquitous in securities class actions over the last few years. SOX require management and auditors to provide reports on internal controls. Alongside that, it has helped in increasing the funding for the SEC and has also led to the creation of the Public Company Accounting Oversight Board (PCAOB), whose primary responsibility is to discipline the auditors of PLCs. SEC penalties have also increased over the past few years which have prompted corporations into increasing the level of their enforcement activity. 2. Use of technology in the financial services industry Technology has long been playing a crucial role in the financial services industry. It has been providing the necessary incremental advances in order to upgrade and expand the services provided in the financial sector. It has facilitated storage management and enhanced processing speed and has had a profound impact on transactional capabilities and data management along with reducing the cost of such operations. However, despite the benefits, the industry has failed to leverage the promise, power and utility of the technologies (State Street 15). The inclusion of technology in finance has been witnessed very recently when Seven Investment Management hired a game designing company in order to build a new portal for enabling their clients to play with their investments, thereby offering them the flexibility to view and manage their portfolios in an interactive way through mobile devices (Wu and Ong 122-134). The underlying idea behind this innovation was to implement game design, mechanics and logical thinking to enhance and improve the way information related to finance is explained. The use of gaming in order to connect with financial clients is a relatively new technology that has brought about a regime shift in the field of finance. Clients can easily manage and access their capital this way. Furthermore, these innovations have also helped them to assess their exposure to risk, thereby enabling them to formulate strategies in order to mitigate such risks. Another technological innovation in the field of finance is the advent of 7IM application which allows investors to view their portfolios, thereby enabling them to create a personalized hub for each and every client. This provides customers access to information from other places which allows them to shape an exhaustive view about the current state of their investments. This kind of interactive portfolios explains the evolving partnership between the financial services industry and the technology sector. Over the last decade, technology has been hugely responsible for creating new business propositions in the financial service industry. Few examples of such technology that supports the statement made above are crowd funding or peer-to-peer financing, Google Wallet and so on and so forth. The demand for technology among wealthy clients is at an all time high compared to the last few years. They felt the need for appropriate technology in order to manage their investments and in many cases, have reported the inability of their managers regarding the usage of technology to explain portfolio strategies. High net worth clients want quality tool and information along with the elasticity to connect various financial interests. Technology plays a crucial role ensuring the same. Thus, these evolving expectations of clients suggest that companies offering financial services need to keep themselves updated with the new changes in order to survive the competition. Another example of advancement made in the field of technology as far as its implementation in finance is concerned, is a Smartphone application called stock music, adopted by La Caixa Bank in Spain, that helps its users to keep track of the stock market performance through music. The volume of the music keeps on varying for reflecting the changes in the stock market performance. This technology enables the users to track the market without having to go through any other applications. As far as other known advancements are concerned, service provided by PayPal where customers can send and receive money just by the use of an email address is widely known. This has encouraged companies like, Facebook, who has recently announced the plan of allowing their users to pay for goods and utilities online with the help of their social media login details. However, contradictory ideas regarding the implementation of technology in the field of finance have also been put forward by people in the financial industry. The number of high profile technology failures has increased at a rapid rate in the recent years. Serious issues regarding technology failures have been reported in Royal Bank of Scotland, the Tokyo Stock Exchange, Goldman Sachs and NASDAQ and so on and so forth. The primary reasons that have been attributed to these failures are heavy dependence and underinvestment in legacy systems. This fact can be associated with the phase of cost cutting that companies are going through in the recent years. However, underinvestment cannot be the only one accountable for these failures. The biggest cause for the kind of technology failures that is being witnessed in the recent times is the absence of inadequate testing procedures for newly developed software. The advent of technology in the field of finance has induced certain degree of complexity in the automated trading landscape. In order to reduce the complexity, proper quality control and rigorous testing is of utmost importance. The potential cost of technology failure is huge (Warwick-Ching, “Technology redefines financial services”). An example is the £175 million incurred by the Royal Bank of Scotland when its online banking system had completely frozen down. Even then the impacts of such scale of technology and software testing are not being discussed in the managerial level. Rather they are being left at the hands of IT divisions and tech savvy individuals who rarely have any influence on the company boards. The statements that have been made, highlighting both the advantages as well as the drawbacks of technology, are associated with certain degree of strength. It has been rightly said that technology has boosted the quality of services provided in the financial service industry. It has been playing a crucial role for a long time providing cost effective ways to its clients for managing investments as well as distributing risks (Hauswald and Marquez 921-930). Banking operations are now just a touch away from customers with the advent of mobile banking and internet banking. Technology has also changed the way stocks are being traded on daily basis. It serves as a robust information source for customers who utilize such information to value their investments as well as assess their risk exposures. In fact, technology has also brought down the cost that customers had to bear prior to its development, while banking or trading. One such example of cost reduction is the transport cost reduction. However, on the flip side, technology has also been associated with failures of huge magnitude. Inadequate testing tools for newly developed technologies as well as improper quality control have been attributed to such failures. Moreover, inadequate knowledge possessed by managers regarding undated technologies has also been attributed as the factors which lead to the failures of technology. In the recent past, both customers as well as company managers who use technology to conduct financial operations have reported certain disruptions that they face quite frequently. This suggests that, implementation of technology has been a boon for the financial industry. However, it comes with its fair share of drawbacks. 3. Researcher’s assessment Information and communication technology is playing a crucial role in the lives of human beings giving them access to all sorts of facilities. The major impact of this technology is being witnessed in the field of finance, which has been happening for the last ten years. The financial system that comprises of the markets, institutions and financial intermediaries has become a critical part of the economy and hence, has become an integral part of the lives of human beings. They bear the similar importance in the economy as the blood circulation system bear in a human being’s life. Starting from the local moneylender to the high level derivatives trader, all of them are involved in allocating the resources from those who have it to those who need it. This process has been eased by a significant level with the inclusion of information technology in the financial services industry. Technology has helped both companies and their clients to distribute risk, conduct operations with absolute ease and undertake large and complex projects related to finance. In the nineties, when technology was not that developed, electronic trading was done with the use of leased lines and VSATs. This had limited the equity market in terms of geography and access. Transaction costs as well as the time associated with such processes were huge. Thus, it rendered the overall financial system very inefficient. However, electronic exchanges and depositories brought about a paradigm shift in the way the market functioned. Then came the era of internet banking and mobile banking, where customers were able to conduct banking operations right from their home. Applications were developed for enabling customers to manage their investments and track useful information related to such investments. With the onset of globalization, the economy is becoming more and more complex. As such, the investing, financing and risk management needs of governments and businesses are growing both in size and complexity which needs to be handled appropriately. This stresses the importance of technology in the field of finance as it provides flexibility to its users in order carry out both simple and complex financial operations (Narain, “Technology in financial matters”). However, on the flipside, technology has also been associated with certain failures. On one hand, technology provides new opportunities to those who are quick but it proves to be a threat to those who are relatively slow in accepting this change (Laplanche, “Technology is disrupting financial services at a quickening pace”). It has been witnessed quite often that technologies fail while handling large and complex operations. This proves to be a massive disruption when customers and corporations are completely dependent on technology in order to deal with such complexities. Such failures come at a huge cost to both the corporation as well as their customers, thereby disrupting critical operations. Inadequate maintenance and testing system can be cited as the reasons for these technology failures. Inadequate discussion about technology failures in the managerial level is also another aspect giving rise to such failures. However, through a thorough research on the use of technology in finance, it can be said that the advantages of technology in the field of finance outweighs its drawbacks. Hence, it should be implemented rigorously and efforts should be made to address its loopholes in order to make it a near perfect system for conducting financial operations. Works Cited Audit Analytics. “2011 financial restatements: An eleven year comparison.” Compliance week, Audit Analytics, April, 2012. Web. 21 November, 2013. Clark, Robert C. “Corporate governance changes in the wake of the Sarbanes-Oxley act: A morality tale for policymakers too.” Harvard University, Harvard University, September, 2005. Web. 20 November, 2013. Harwood, Elaine and Laura Simmons. The tenth anniversary of SOX: Its impact and implications for future securities litigation and regulatory enforcement activity. Corporate Accountability Report 10.28 (2012): 1-7. Print. Hauswald, Robert and Robert Marquez. Information technology and financial services competition. The Review of Financial Studies 16.3 (2003): 921-948. Print. Laplanche, Renaud. “Technology is disrupting financial services at a quickening pace.” CNN, CNN, 30 July, 2012. Web. 21 November, 2013. Narain, Ravi. “Technology in financial matters.” Forbes, Forbes, 15 June, 2010. Web. 21 November, 2013. Pli. “Corporate Governance/Sarbanes-Oxley Due Diligence.” PLI, PLI, 2002. Web. 20 November, 2013. State Street. The evolving role of technology in financial services. Vision 6.1 (2011): 1-36. Print. Warwick-Ching, Lucy. “Technology redefines financial services.” Financial times, Financial times. 30 August, 2013. Web. 21 November, 2013. Wu, Liang C. and Chorng-Shyong Ong. Management of information technology investment: A framework based on a Real Options and Mean–Variance theory perspective. Technovation 28.3 (2008): 122-134. Print. Read More