Effects of Corporate Governance Disclosure Requirements - Essay Example

Effects of corporate governance disclosure requirements on financial reporting worldwide of the of the Number Introduction The question regarding ways in which corporate governance disclosure requirements affect financial reporting is still under tremendous debate. In-spite of the significant amount of researches done in this field, only few conclusive evidences have been set forth regarding causal effect of corporate governance disclosure requirements on financial reporting throughout the world. The fundamental rationale behind above mentioned fact is the combined endogeneity of accounting systems and governance mechanisms (Brickly and Zimmerman 235-245). According to the author, difficulty of identifying a causal effect is aggravated due to lack of conclusive theories, which enable researchers worldwide to regard a specific corporate governance code as good or bad. Corporate governance framework established within companies need to incorporate core values of accountability, transparency, responsibility and fairness (ACCA, “Disclosures on corporate governance”). Even so, reported high profile financial scandals such as, those of Enron and WorldCom, suggest that the framework was not implemented at all. Weak corporate governance and untrustworthy financial reporting were cited as major reasons behind these scandals. These facts called for the need to establish robust corporate governance framework among organizations all over the world. Following this incidents, many laws were passed such as, Cadbury Report in United Kingdom, Sarbanes Oxley Act in the United States, the Dey Report in Canada, the Vienot Report in France, the Olivencia Report in Spain, the King’s Report in South Africa, Principles and Guidelines on Corporate Governance in New Zealand and the Cromme Code in Germany. Some authors claim that these laws have proven to be immensely successful in achieving objectives of transparent financial reporting; whereas, some authors have conveyed their options against efficacy of these laws. Prior research on effects of corporate governance disclosure requirements on financial reporting A significant proportion of research has investigated whether quality of financial reporting is influenced by various disclosure requirements of corporate governance. The results of these empirical researches are mixed. For example, research done by Armstrong, et al (2010) fails to provide conclusive results regarding ways in which managerial compensation influences quality of financial reporting. Cheng and Warfield (2005) have pointed out that a negative relation exists between managerial incentives and the standard of financial reporting. According to them, managerial incentives are amplified on the basis of their performance and not because of any manipulations that they are compelled to do while publishing financial reports. On the other hand, research work done by Baber, Chen and Kang (5-19) revealed no relation between the two factors mentioned above. Armstrong, Guay and Weber (179-234) found a positive association between corporate governance disclosure requirements and the standard of financial reporting. Financial reporting is based on accounting principles stated within Internal Financial Reporting Standards (IFRS). Each and every organization is required to adhere to rules and guidelines stated within the IFRS. Accounting officials as well as internal and external auditors must abide by these laws while preparing and scrutinizing financial statements. The financial reporting standards have been drafted in order to ensure verifiability, understandability, and comparability of the reports, which makes it easier for users to interpret this information and henceforth, make informed decisions. However, Armstrong, Guay and Weber (179-234) found that existence of weak corporate governance framework leads to deterioration in quality of financial reporting. Accounting officials as well as internal and external auditors often do not comply with reporting standards as they are incentivized to manipulate accounting information. This highlights weakened corporate governance framework that is present in such organizations. Such circumstances have in reality contributed towards scandals that shook the global economy in 2001. Although several factors may contribute to mixed findings obtained from empirical literatures, the amalgamated endogeneity of corporate governance disclosure requirements and financial reporting standards is arguably the biggest contributor (Brickly and Zimmerman, 235-245). A company’s choice of a specific governance framework is endogenously decided on the basis of multiple factors such as, information flow, other governance frameworks and managerial characteristics. Many of the factors mentioned above also have a substantial impact on the way financial reporting is done in a company. This endogeneity factor raises an issue regarding the fact that any relation identified between corporate governance disclosure requirements and financial reporting can be influenced by both unobservable and observable confounding factors. It has to be understood that a particular governance disclosure requirement may not be most favourable for all companies. That is why they are likely to have dissimilar effects on different companies depending upon the standard of reporting followed in those companies (Liang, Yanfeng and Yong). Effect of Corporate governance disclosure requirements on financial reporting Liang, Yanfeng and Yong have concluded that passing of governance-associated shareholder proposals results in superior standard of financial reporting. According to the authors, this positive effect on quality of financial reporting is mainly due to strict corporate governance disclosure requirements that are associated with revelations made by board of directors of a particular company as well as rules governing executive compensation. In addition, Liang, Yanfeng and Yong also mentioned that effective corporate governance disclosure requirements have also led to improvement of financial reporting standard in companies with weaker corporate governance framework, resulting in poor financial reporting standard. According to research work done by Alleyne and Elson (91-106), Sarbanes Oxley Act (SOX) has proven to be largely successful in recognizing loopholes that existed within financial reporting standards and eliminating the same. After enactment of this law, a radical fall was noticed in median dollar loss per percent of cases. The cases that mainly involved cash schemes reduced to a great extent. Moreover, median cost associated with deceitful imbursements also lessened by a huge margin. This highlights the fact that enactment of SOX was an appropriate step, which has been responsible this far in strengthening the framework according to which financial reports are drafted. Even though the authors suggested relevance of SOX, yet they also stated that financial reporting quality cannot only be enhanced by formulation of effective corporate governance disclosure requirements. The requirements need to be followed appropriately by organizations in order to reap the benefits that this law has to offer. In addition, companies also need to adopt certain preventive measures in order to make sure that even if the law fails at a juncture, management would still have a strong backup plan (Alleyne and Elson 34-62). Lasher (27-56) and Fred have stated that SOX have had a significant contribution in enhancing quality of financial reporting by restricting the practice of self regulation, that was mainly done in the government accounting sector. The reason behind this achievement was formulation of PCOAB through the right that was given to federal regulators who created the SOX. The regulators were vested with the power to enforce any regulation that they see fit in order to supervise the public accounting sector. The SOX stated that all accounting firms have to obtain registration, which means that any unregistered firm engaged in issuance of audit and accounting reports for a listed company will be accused of being involved in illegal practice. By stating such a requirement, the federal regulators have made it a mandate for every accounting firm to be registered. So, the firms required to abide by corporate governance disclosure requirements and hence, had to bring upon modifications in the way they prepare and issue accounting and audit reports, thereby ensuring transparent financial reporting. Acts related to corporate governance disclosure requirements, such as, the Cadbury report and the SOX, have been immensely successful in reinstating consistency maintained while preparing financial report in the present business settings. The corporate governance disclosure requirements stated within these acts have enabled organizations to minimize probability of conflict of interest that existed within the internal workspace due to inadequate corporate governance codes. These acts have also enabled companies to reduce several other conflicts of interest, which escalated between external auditors and senior executives of those companies. This was achieved by drafting of unified corporate governance disclosure requirements, which had to be followed by every registered organization while preparing their financial reports. A strengthened internal control as well as enhanced transparency in financial reports is the end result of these corporate governed disclosure requirements. Opposing views on corporate governance disclosure requirements Dodwell (39-44) stated that corporate governance disclosure requirements such as, ones stated by the SOX, have not had positive impact on quality of financial reporting. This is because no particular individual is adequately able to control or construct the ethical actions of a specific company. It has been witnessed in certain cases that an individual’s actions are driven by his/her intention to safeguard personal interest. Hence, this factor will always prove to be a barrier in the path of transparency, which corporate governance disclosure requirements aim to achieve. Tackett, Wolf and Claypool (340-350) also agreed upon the fact mentioned by Dodwell (39-44). According to Tackett, Wolf and Claypool (340-350), corporate governance disclosure requirements do not have any control over an individual’s morality. An individual will always choose to manipulate accounting statements, if he is blindfolded by company compensations that prevent him/her from questioning the morality of doing such a practice. Other exiting barriers in the pathway towards preventing manipulation of financial statement figures such as, stock options, personal interest of auditors and that of senior executives, have proven to be a big issue for federal regulators. Conclusion On the basis of the research done in this particular field, it can be said that corporate governance disclosure requirements have been hugely effective in bringing about improvements in quality of financial reporting throughout the world. However, despite this success, there are certain gaps that exist in the corporate governance framework as well as in disclosure requirements, which have proven to be the cause of certain conflicts. Thus, these disclosure requirements need to be modified in order to establish a robust system that would set higher standards of financial reporting. Federal regulators all over the world will have to come up with strict rules in order to increase efficacy of Sarbanes Oxley Act (SOX). In addition, efforts made by federal regulators will have to be equally complimented by companies, in terms of adhering to rules stated by the standard setters. Works Cited ACCA. Disclosures on corporate governance. Accaglobal. ACCA, 2009. Web. 14 May 2014. Alleyne, Beverley J. and Raymond J. Elson. “The impact of federal regulations on identifying, preventing, and eliminating corporate fraud.” Journal of Legal, Ethical and Regulatory Issues 16.1 (2013): 91-106. Print. Armstrong, Christopher S., Wayne R. Guay and Joseph P. Weber. “The role of information and financial reporting in corporate governance and debt contracting.” Journal of Accounting and Economics 50.2-3 (2010): 179–234. Print. Baber, William R., Shuping Chen and Sok-Hyon Kang. “Stock price reaction to evidence of earnings management: implications for supplementary financial disclosure.” Review of Accounting Studies 11 (2006): 5–19. Print Brickly, James A. and Jerold L. Zimmerman. “Corporate governance myths: comments on Armstrong, Guay, and Weber.” Journal of Accounting and Economics 50.2-3 (2010): 235-245. Print. Dodwell, William J. “Six years of the Sarbanes-Oxley act: are we better off?” The CPA Journal 78.8 (2008): 39-44. Print. Lasher, William R. Practical Financial Management. 5th edition. Connecticut: Thomson South-Western, 2008. Print. Sewe, Fred O. “The Sarbanes Oxley Act and its Impacts on Corporate Finance and Corporate Governance Behavior.” (2012): 1-42. SSRN. Pdf file. Tackett, James, Fran Wolf and Gregory Claypool. “Sarbanes-Oxley and audit failure A critical examination.” Managerial Auditing Journal 19.3 (2004): 340-350. Print. Tan, Liang, Yanfeng Xue and Yong Yu. “Does Stronger Corporate Governance Improve Financial Reporting Quality? Evidence from a Regression Discontinuity Analysis of Shareholder-Sponsored Governance Proposals” (no date): 1-34. Virginia. PDF file. Read More