The Dynamics of Capital Market Governance - Essay Example

The world economies have continuously witnessed different accounting scandals and criminal activities. The recent global crisis is an example in this direction and economies are looking for ways to come out of the downturn. This is creating a situation where the growth rates are depleting. The prime reason for it has been the recession which has engulfed the entire globe. The recent economic crisis and debacles have highlighted the failure of accounting disclosures by accounting setters which has resulted in people exploiting it and making organizations fail. Proper accounting disclosure was an aspect which was ignored by all economies which resulted in the economies faltering. The situation started with the US housing market and slowly led to liquidity crisis. The paper thus looks into various aspect of global financial crisis and tries to draw findings as how the accounting disclosures were ignored. It also presents light into the way different organizations and economies fared due to recession and the manner in which the proper accounting disclosure could have reduced the magnitude of the crisis. The crisis started when “prices of assets started falling continuously thereby decreasing consumption expenditure which led to postponement of capital expenditure, resulting in more unemployment and finally leading to contraction”. (Ryuhei, 2009) This impacted “financial institutions and banks as it led to liquidity crunch” (Kirkpatrick, 2009) creating a serious situations. This is evident from the failure of Enron which failed to ensure proper accounting rules in its working. (Coffee, 2008) Their financial statements were inflated and the actual position of the financial conditions was not disclosed. This led to a situation where people lost confidence and finally led towards the failure of Enron. Poor accounting rules on the disclosure aspect especially when we consider the manner in which CEO’s were paid additional salary irrespective of the organizational performance shows poor accounting rules as the rules of recording revenue after it is earned was ignored. This was due to the fact that compensation were paid as an incentive for the good work but was paid before the results came out which led towards a crisis as accounting firms failed to disclose their transactions. (Mitton, 2001) The firms followed a principle where the risks were focused on few financial instruments rather than being diversified. This created a situation where risk multiplied manifold. It was seen that IAS 16 was exploited by firms to match their individual needs. Improper use of IAS 16 which with matters relating to the “treatment of assets, especially plant and equipment and property” (Deloitte, 2010) further made organisation not adheres to the accounting disclosure norms. It tries to explain how the non-current assets value will be found, situations when the assets need to be treated as long term, the treatment relating to deficiencies and surplus and impairment. This thus helps to “ascertain the correct value of the assets that will help the user of the financial statement gauge the correct value of the enterprises”. (Deloitte, 2010) Lack of organisation effort on this part led towards poor implementation of the accounting policies and disclosure affects economies all around. For example it is seen that certain quarters raised voice regarding the use of fair value accounting. Using the fair value accounting would have helped to ensure that the correct value of the assets would have been disclosed which would have reduced the effect of the crisis. (Poskitt, 2005) This would have helped the investors and helped them to ensure proper mechanism to check risk. This also demonstrates that the accounting rules at different places mounted the problems for the organization which finally led towards their failure. Since, firms did not disclose their actual working and performance the effect of this was failures of institutions. This spread to other institutions and slowly the entire economy saw lack of corporate governance. This can be seen from the example of Enron which did not disclose all its transaction to the shareholders in the financial statement. Later when it was founded it resulted in the loss of public confidence. (Austin, 2008) Thus not adhering to the accounting rules makes organization stay away from the corporate governance which made economies loose vital resources and led towards the crisis. The inefficient implementation of the accounting principles like fair value principle, market based return and the manner in which the remuneration process of CEO’s further gave organizations the freedom to use ways and measures to work in a manner which they felt suitable further led towards lack of accounting rules and the crisis. This is a condition where organizations lack disclosure in their accounting methods. Also the lack of accounting policies with relation to disclosure and corporate governance further added to the crisis as it was easy to manipulate the financials and this made companies like Enron fail and look towards government support. Thus, accounting policies along with poor corporate governance increased the problem of crisis. (Kirkpatrick, 2009) Poor risk management is seen by the lack of accounting policies at the organisational which was seen as a violence of accounting rules which led towards the crisis. The “shortcoming from the board and the internal management especially in the banking sector” (Kirkpatrick, 2009) highlights improper accounting policies and poor accounting rules. This shows the negligence on the part of the management to have a policy in store which could help to fight the worsening situation. (Ryuhei, 2009) Economies all around the world are developing rules and procedures which help to improve accounting disclosure and reduce the ethical dilemmas businesses have to face thereby increasing public trust. There are different policies which the world economies have taken in this direction. The detail analysis is as follows The financial debacle in the 2000’s forced the US government to pass a regulation which ensures that the books of companies are audited properly and accountability is held. The Sarbanes Oxley Act is a tool in that direction which states that “any company big or small will have to adhere to the compliances of the Act so that investors are protected from fraudulent accounting practices and accountability is created for the person who misuses it”. (Bob, 2009) This act stresses on companies to disclose their financial transactions. There are 11 sections which deal with this act but the prime important is the Section 302 and 404 where Section 302 states that “the senior management needs to state that the financial records are accurate” (Bob, 2009) and Section 404 stating that “the management team and the auditors have maintained internal control system to report the method of accounting”. (Bob, 2009) Thus, this act has increased transparency. An example is this direction is Google. Google has been adhering to the Sarbanes Oxley Act as seen from their financial data. The company has also given “a certification that they are adhering to the compliance of the Act and Section 302 and 906 has been adopted”. (Annual Report, 2010) Declaration in such a statement highlights the fact that Google has adhered to the financial disclosure and their accounting information is free from biasness. Signing and adhering to Section 302 specifies that “the signing authority holds responsible for any frauds and the corporate responsibility related to financial reports have been compiled with”. (Sarbanes Oxley Act, 2006) Also section 906 pertains to be held accountable and all statements are true in nature. This will thus create a positive impact and will help Google to grow at the same time help the society by delivering on the promises made by adhering to ethical requirements. Another step which helps business to ensure that proper accounting disclosures are maintained is IAS 16. IAS 16 deals with matters relating to the “treatment of assets, especially plant and equipment and property”. (Deloitte, 2010) It tries to explain how the non-current assets value will be found, situations when the assets need to be treated as long term, the treatment relating to deficiencies and surplus and impairment. This thus helps to “ascertain the correct value of the assets that will help the user of the financial statement gauge the correct value of the enterprises”. (Deloitte, 2010) IAS 16 provides business units with two methods that can be sued to ascertain the fair value. It depends on the business unit to identify one and mostly it is seen that business take up those models followed in the industry so that comparison becomes easy. The methods are as follows Revaluation Model: In this method “assets are re-valued at the correct value after deducting depreciation and impairment cost at fair value”. (KPMG, 2005) Cost Model: In this method “assets are ascertained at cost after deducting the depreciation and impairment cost”. (KPMG, 2005) Revaluation model is being used by many business concerns. This model states the fact that assets “provide the fair value at the balance sheet date therefore needs to be done at regular time interval so that the measurement of value in the balance sheet is correct”. (Malik, 2010) It also stresses the fact that when an assets has being re-valued it should be seen that the “entire class of the asset is re-valued”. (Malik, 2010) The measurement of increase or decrease in the value calls for special entries that have to be made so that the routine cycle of the business in not hampered and the profits are neither over nor under estimated. This thus also checks that those profits are ascertained correctly. This model lays stress on the fact that “if revaluation increases the value of the assets then the increase in the value should be credited as income and accumulated as equity in the balance sheet under the head revaluation surplus”. (Holt, 2010) Opposite entries need to be passed, it the value of the assets falls on the revaluation date. Example: Suppose the initial value of an asset is $1, 00,000. Accumulated depreciation on revaluation date is $55,000. Fair value is $65,000. Then the business unit need to treat and pass the following entries on that day. The business has to debit accumulated depreciation by 55000 and credit the asset cost by 55000. To eliminate the depreciation cost to ascertain the fair value the business needs to pass the following entries. The business has to debit asset cost by 20000 and credit revaluation reserve by 20000. This will help to bring the value of the asset at fair value as 100000-55000 + 20000 = $ 65,000. Thus we see that adjusting entries help to revalue the fair value correctly. Under this cost model the value of the asset are ascertained at cost. This lays stress on the fact that “assets need to be reduced at cost and that value needs to be placed in the balance sheet so that it shows that assets are valued at cost”. (IASC, 2010) This is an easy and convenient method but does not always give a fair value. Organisations also are saved from the extra pressure to ascertain the value each time. Thus proper accounting disclosure helps business units to ensure that they are able to win the public confidence and ensure that there is proper corporate governance. The importance laid to disclosure in accounting policies can be seen from the stress being laid by the Australian Stock Exchange (ASX). The Australian Securities Exchange (ASX) has also laid stress on continuous disclosure and bringing to the notice of the exchange as it has become a part of corporate governance. (Chartered Secretaries, 2010) It is important that business units continuously provide information relating to such matters as it can have an effect on price of securities and affect the long term potential. The ASX has laid importance on continuous disclosure as it ensures that the prices of the shares are determined correctly. To ensure the effective implementation of it “ASX has recommended the CLERP 9 package” (Lucy, 2004) which looks into these aspects and helps to provide areas which when worked upon will ensure that the organisation discloses all important information. There are various factors which made economies introduce the continuous disclosure regulation. They are as follows The “growth in size of financial institutions” (Grant, 2005) forced the regulators to ensure that there was continuous disclosure. Since, the investments were increasing and to ensure that the company didn’t fail as some of the companies in other economies forced the regulators to take this step. To match with the “international markets demand for disclosure and to be equal with other exchanges” (Brien, 2007) also made economies look towards adopting the continuous disclosure. Doing so would help the securities traded in the Australian exchange to meet the international market norms. The rise is “corporate governance and companies looking to disclose all material information” (Grant, 2005) so that the investors are not harmed made economies adopt a continuous disclosure regulation. This would help the economy and investors could get correct information thereby adhering to corporate governance. Adopting the continuous disclosure model was important as “the recommendations by Ramsay and HIH inquiries which followed from the Wallis Report” (Poskitt, 2005) also required such a change. This would help the auditors as all material information would be disclosed which could have been verified to be acted as true. It was imperative to adopt this regulations as it helped “to protect the whistle blowers and extend liability of individual” (Grant, 2005) who were using this information for their advantage. This thereby helped economies as it looked into the fact that material information was not concealed. The continuous disclosure regulation provided various benefits to the economies. This helps to win the confidence of the consumer and investor and helps to develop public trust. They are as It helped economies to ensure that “the stock prices are neither over nor under stated”. (Welsh, 2009) This has ensured that neither bull nor bear trading is done by an individual thereby directing the market to act at its whims. It helped all economies “to match with the standards internationally” (Grant, 2005) which created a platform for the corporations to trade easily in the international market. It has ensured that economies adheres to “stockholders vigilance and better corporate governance” (Grant, 2005) thereby making the investments safer than they were previously. It had increased the financial investment from abroad thereby helping the economy economy to grow (Marsden & Wang, 1997) It has reduced the risk for the investors as a mechanism is in place to check that important information is not concealed. (Findlay & Surat, 2010) Accounting disclosures give rise to proper corporate governance. A theory which also looks into the corporate governance is the Stakeholder theory. This theory states that “business organisation needs to see that the organisation works for the well being of people associated with the organisation and ensure that their well being is looked after”. (Hill & Jones, 1992) It shows that corporation should take decision which will improve the performance for the customer, community, employee, trade association and everyone associated with the corporation. Thus stakeholder theory looks into various aspects and people associated with the company. This thereby ensures that decision taken affects all. The shareholders being the owner needs to ensure that the management i.e. the agent acting on behalf of the principal takes decision which helps to see the well being of all and ensure that the policy of corporate governance is adhered to. The shareholders can ensure that corporate governance remains in the organisation ensure that “decisions taken are such that affects all the stakeholders associated with the organisation”. (Corfield, 1998) This will help each stakeholder to perform the duties which will transform into a better picture for the corporation. Even economists support the stakeholders’ theory because “it looks into the well being of every individual associated with the company”. (Corfield, 1998) This theory as takes decision for every individual associated with the company so it takes care of the corporate governance aspect from the view of the shareholders and the managers also. To increase the effectiveness of stakeholder theory and to ensure proper corporate governance the shareholders need to ensure that “managers are clearly made to understand the business and the kind of relationship they need to create with the stakeholders”. (Freeman, Edward, Wicks & Andrew, 2004) This will give the manager the sense of purpose and define the objective of working. It will also present a clear picture and the establishment of relationship will ensure that managers take decision which helps to increase value for the stakeholders. The stakeholder theory thus will help to look things from the shareholders perspective and maximizing returns for them will ensure that all the other stakeholders’ value also maximizes. This will help to “overcome the unethical practices of the management and help the board of directors to manage their stakeholders issue in relation to the shareholder”. (Tony & Kerry, 2009) This thus will help to ensure proper corporate governance and ensure that the corporation is able to deliver on the promises and thereby ensuring that management is effective. Another theory in this direction is the Agency Theory. This theory puts a new perspective and deviates from the old philosophy of profit maximization. This theory says that “corporations need to have agents who will work on behalf of the principal owner i.e. the shareholders and will be given certain incentive for it.” (Nicholson, 1998) For this to happen and ensure that corporate governance follows it is essential to differentiate the role of board of directors and the executive management. This will define the path each has to follow and will strengthen the core values of the unit. To ensure that they get proper governance shareholders need to “incur agency cost where they hire someone from outside the organisation who audits the performances, communicates with the shareholders regarding the changes and brings forward issues which might harm the shareholders”. (Fama, Eugene & Jensen, 1983) This cost will help to bring a check and ensure that there is proper corporate governance and shareholders get their dues as well as the society is looked after. There have been other theories which have been developed which looks into corporate governance and proper disclosures. It is imperative that organization use some sort of theories and techniques to ensure proper disclosures. Economies and world bodies need to unite and develop theories and mechanism which helps in proper disclosure to reduce crisis of the nature the world has recently witnessed. Thus, proper accounting policies which looks into disclosure and corporate governance ensures that business are able to provide the correct picture and value of the organization through different techniques and means helps to improve public trust. This is an important aspect for business and helps to build long term relationship thereby helping to avert crisis. 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