Voluntary disclosures in the Annual Report

signal success

Stephen Wong Siu Kei (50184032)Stephen Wong Siu Kei (50184032)

Tony Chan Sai Chung (50183940)Tony Chan Sai Chung (50183940)

Voluntary disclosures in the Annual Report

DO signal success

AgendaDefinition of voluntary disclosureMeaning of successTypes of voluntary disclosureStudy findingsMajor benefits of voluntary disclosureReal life Examples & Enron’s CaseConclusion

Definition of voluntary disclosure

mandatory

describes disclosures, primarily outside the financial statements, that is not explicitly required by GAAP or an SEC rule

Meaning of success

From Company’s view:1) Financial aspect- cost of capital is lower- profit & share price

2) Non-Financial aspect- better internal management- growth e.g. market share

Meaning of success

From investor’s view:3) increase transparency- helpful to investors for making

investment decisions - satisfy the objective of disclosures

Types of voluntary disclosure

FASB study classifies 6 categories:1st five categories: included in the AICPA S

pecial Committee on Financial Reporting’s comprehensive business report model.

6th category: intangible assets - increasing importance to companies and investors

Types of voluntary disclosure

1) Business datae.g. high-level operating data

2) Management’s analysis of business data

e.g. reasons for changes in the operating and performance-related data

Types of voluntary disclosure

3) Forward-looking informatione.g. opportunities and risks including

those resulting from key trends

4) Information about management and shareholders

e.g. directors, management, major shareholders

Types of voluntary disclosure

5) Background about the companye.g. broad objective and strategies

6) Information about intangible assets

e.g. R&D, human resources, customer relations

Study findings1) FASB study “Improving Business Reporting:

Insights into Enhancing Voluntary Disclosures”- support voluntary disclosure

2) “Disclosure Redundancy in Annual Reports”- “there is no persuasive evidence that annual

report redundant voluntary disclosure is a problem requiring intervention by professional accounting or regulatory authorities”

Major benefits of voluntary disclosure

1) Enhance transparency & credibility1) Enhance transparency & credibility- provide more information:

Good News + Disappointments

lower risk and uncertainty cost of capital & required rate of return

attract more investment

Major benefits of voluntary disclosure

e.g. If a company disclosed nothing, its cost of capital, if any was available would be very expensive. However, informative disclosures that help investors interpret companies’ economic prospects are believed to reduce the cost of capital.

Major benefits of voluntary disclosure

2) Prevent information 2) Prevent information asymmetryasymmetry

- different level of information between management and investors

- different level of information - investors can know if there are shirking

& insider trading by management

Major benefits of voluntary disclosure

3) Innovative business 3) Innovative business environmentenvironment

- manifest an increasing and changing demand for business information and a larger role for voluntary disclosures

- setting or changing a new standard require much time & discussion

the existing regulatory and standard-setting system may not be fast enough to keep up with the changes

Different Companies do have Different Important Aspects to

Disclose

4) Different aspects to disclose4) Different aspects to discloseEach single company has different factors and aspects that are especially important to its success

Information about those factors and aspects for the company will be especially useful to investors

Different Companies do have Different Important Aspects to

Disclose

ExamplesR & D activities appear to be important for companies that manufacture and sell medicinesThe qualities of pop stars appear to be important for entertainment companies

Different Companies do have Different Important Aspects to

Disclose

Can accounting standards determine a definitive list of all important aspects to disclose in any particular industry?

No. That’s Impossible

Why?

Different Companies do have Different Important Aspects to

Disclose

The reasons are:Different companies have different views on their own important aspects & factorsDifferent companies compete with each other by employing different strategies in a same industry

Different Companies do have Different Important Aspects to

Disclose

In summary:Each company is uniqueA one-size-fit-all accounting standard approach will not work for all companies’ disclosure demandsAccounting standards can just rule all companies to disclose some common owned information – cash, liabilities, amount of expenses, etc.

Different Companies do have Different Important Aspects to

DiscloseVoluntary disclosures provide a good way for companies to disclose their own important aspects to investorsE.g. Medicines Company will disclose more information about its R & D activities while Entertainment Company will disclose more information about its contracted StarsInvestors will have more relevant information for making a better investment decisionCompanies will be successful by attracting more investors

Unrecognized Intangible Assets are also Important

5) Unrecognized Intangible 5) Unrecognized Intangible AssetsAssetsAccounting standards only allow a few kinds of intangible assets to be stated in balance sheets For Example: Internally generated goodwill is not allowed to disclose in any financial statements

Unrecognized Intangible Assets are also Important

However in some companies, the value of their intangible assets are definitely more valuable than tangible assets It is very unfair to those companies if their valuable intangible assets are not allowed to disclose Result Unlikely to attract investors & may mislead users’ decisions

Unrecognized Intangible Assets are also Important

Example:

It is one of the Hong Kong famous media and entertainment companies to provide multimedia content and lifestyle information to the global Chinese community

Unrecognized Intangible Assets are also ImportantWhat are the most important assets of StarEastnet Company?ALL POP STARS

Unrecognized Intangible Assets are also Important

However, all Pop Stars are not included in the company’s balance sheetGAAP prohibits the inclusion of human assets in any financial statementsInvestors would miss this important information if they only investigate the company’s balance sheet

Unrecognized Intangible Assets are also Important

Extracted from Stareastnet’s annual report:

““The celebrity element is what makes The celebrity element is what makes the Group unique……the Group has the Group unique……the Group has cocontracted with over 200 artistesntracted with over 200 artistes…………LeoLeon Lain Lai….…..Jackie Chan.Jackie Chan…… …… KellyKelly ChanChan……………….” ………….”

Corporate GovernanceBest Hong Kong Corporate Governance Disclosure Award 2001 organized by HKSAWinners are all successful companies e.g. HSBCAll winners did a lot effective voluntary disclosures in their annual reportsAnnual Reports Good transparency & accountabilityProve that successful companies do make a lot of voluntary disclosures and more voluntary disclosures signal better corporate governance

Real Life ExamplesWell Performed companies like HKBC & Hutchison Whampoa Ltd, they do have a lot of voluntary disclosuresIncrease Transparency & Attract More InvestorsBad Performed companies are not the sameLess voluntary disclosures

Real Life Examples

Successful companies do disclose moreFurther Supported by the Study “Disclosure Redundancy in Annual Reports”“ t-tests indicate that large, profitable, low risk companies disclose significantly more than smaller, less profitable and high risk companies”

Enron’s CaseImplication After the figures in financial statements were audited, investors have to trust and they do not have other means to judge the correctness of the figures

After the collapse of Enron, investors become more vigilant than before and look deeper into companies and demand full disclosures

Enron’s Case

Voluntary disclosures provide an extra way for investors to judge a company’s performance

Only successful companies are confident to disclose more information voluntarily as to increase transparency and attract more investments

ConclusionWe stress that effective voluntary disclosures do signal success

In company’s view, voluntary disclosures increase transparency, reduce information asymmetry & disclose more intangible assets

Success Lower cost of capital, attract more investments, more credibility & enhance corporate governance

Conclusion

In Investor’s view, voluntary disclosures provide extra information

Success Able to make better investment decisions & better capital allocations