1、Mandatory Accounting DisclosureMaterial Source: Mandatory Accounting Disclosure by Small Private CompaniesAuthor: Benito ArrunadaThere are substantial differences in the regulation in differeni couniries on financial disclosure by private companies and, in particular, on publication of their account
2、s.In the USA, Japan and some other countries, most private companies, whatever heir size, arc not obliged to disclose financial information.In contrast, in the European Union all companies arc required to file their accounts with a public register. Most other countries also require many of their pri
3、vate companies to publicly file their accounts.Discussions of these disclosure and publication requirements have led to disparate recommendations to slightly expand publication requirements, maintain them and reduce them, Singapore. More recently, as pari of its initiative to simplify the business e
4、nvironment and lessen administrative burdens, the European Commission(2007)has also proposed to exempt small companies so that they would not necessarily be required by national law to publish their accounts. The Commission grounds its proposal on the argument that for such companies publishing the
5、accounts causes considerable cost with no significant benefit. On the one hand, according to the Commission, the requirement constitutes a major adminisirative burden. On the other，it is inconsequential ifwhen given freedom to disclose or not一small firms choose not to disclose because iheir accounts
6、 are onlyused by a limited number of stakeholders,such as credit institutions and suppliers that have the possibility lo require financial information dircctly from the company.Mandatory publication of accounts by private companies relates to several strands of the economic, accounting and financial
7、 litcraturcs:dcregulation of business formalities, mandatory financial disclosure, and investors protection and crcdit information. Findings in all these areas thus provide complementary insights on【he issue under discussion.Since the 1960s, there has been substantial controversy on the balance of c
8、osts and benefits and the optimal conteni of mandatory financial disclosure. In the current regulatory framework of the USA, however,mast of these discussions have focused on mandatory disclosure by public companiesthat is, companies selling shares or bonds to individual investors in stock exchanges
9、. These public companies arc required by law to not only file financial information publicly on a periodic basis but also【o disclosc oihcr information on the company, provide detailed data on new issues of securities and report any trade by insiders.Even though the European Commissions proposal refe
10、rs to the mandatory publication of annual accounts by small private companies, part of the discussion on mandatory disclosure by public companies is applicable. Other parts of the analysis are substantially different, however, because of differences in the governance structure, size and availability
11、 of information of both types of companies, as well as differences in the contents of the information being mandatorily disclosed.In particular, previous research has focused on how mandatory disclosure for public companies affects the value of their equity by facilitating or not transactions on suc
12、h equity. But the main interest for private companies lies in knowing how publishing their accounts could help their trading parties(mainly banks and suppliers)estimate their credit risk, thus expanding their access to credit and lowering its cost. The main effect should be lo reduce information asy
13、mmetry in credit(incuding trade credit)transaciions instead of in equily transactions.In addition, given that the shares of public companies are traded in the stock market, it is possible to estimate the impact of mandatory disclosure on the value of the public companies. However, even if the reduct
14、ion in the transaction costs of credit causcd by mandatory publication of accounts also increases firm value, wc cannot measure this effcct bccausc wc lack market prices for equity shares in private companies. Therefore, without a comprehensive inctric for evaluating ihc impact of mandatory publicat
15、ion of accounts,wc can only aspire to building an enlightened qualitative inventory of costs and benefits. The volume of credit contracted in an economy depends on two factors:informacian available on debtors quality, and the rights that the legal system grants to creditors in case of default. For t
16、he availability of information, the factor on which we are most interested, empirical evidence shows that the volume of credit grows when banks share more information on debtors and when the quality of credit registries improves. It seems that the better the creditors know the quality and record of
17、potential debtors, the lower the transaction costs of credit, probably because of both improved debtors incentives and easier avoidance of adverse selection. As we will see, the main reason for thepublication of accounts is that ic allows improved assessment of crcdit risk for both individual transa
18、ctions and bank and macrocconomic regulation.Distortion of competitionPublication of accounts might also cause private costs to the disclosing firm by informing its competitors, which might also distort competition. However, this effect seems unlikely to be substantial when small companies are invol
19、ved. At least, these costs are clearly smaller than those of the disclosure now commonly required from public companies. A useful comparison would be that between the impact of publicly filing the annual accounts with that of announcing, for instance, the cancellation of a research programme. Doubt
20、remains on this point, however, not for the micro and small companies considered by the European Commission but for medium-sized or even large private companies, for which disclosure may be quite sensitive,given their size and presence in concentrated and difTerentiated markets.Mapping appropriable
21、benefitsPublication of company accounts also provides benefits to the companies involved, to their trading partners and to third parlies. This section examines those which are appropriable by the disclosing company.Benefits for disclosers and their partnersBenefits for disclosing companies and their
22、 trading partners arise from reducing 【he information asymmetry between【hem: publishing the accounts grants acccss to potential and current trading partners to the historical record, current financial position and profitability of the disclosing firm. This reduction in information asymmetry is espec
23、ially valuable in transactions that embody future obligations for the firm:clients purchasing durable goods, all parties investing in firm-specific assets, minority shareholders and, especially, trade and financial creditors. Understandably, more transparent firms have been found to incur lower cost
24、s of debt and equity capital.Furthermore, publishing the accounts may be more credible and less costly than communicating them individually to contractual parties or handing them only to those parties who request them explicitly. Credibility is gained because filing the accounts with an independent
25、third party(the register)commits the firm, as accounts already filed cannot be modified and future accounts will have to be consisleni wilh ihose filed in the pasl.Costs are reduced because it is no longer necessary to deliver them to a high number of trade creditors, and prospective creditors or th
26、ird parties will no longer have lo ask for the accounts lo be delivered to iheni.Individual disclosure as an alternative to public disclosureThe alternative solution proposed by the European Commission is for the creditor to ask for the borrowers financial statements. This solution is problematic, n
27、ot least because there are often more than two parties to the transaction.Information provided to a party in a one-to-one interaction is often less credible than that provided to all potential parties by filing it in a public registry. Some evidence on this is given by the common practice in banking
28、 of, as a first step, checking loan applications!which often include specifically adapted financial statements)against reports prepared by business.information agencies. 19 One may assume that if some credit applicants make up their accounts when dealing with banks, they are even more likely to do s
29、o when dealing with suppliers, given (hat suppliers are not experts in crcdii evaluation, do not have such ready acccss to additional information and arc less likely to be a party in future transactions.In addition, asking contractual parties for sensitive information is not always a sensible negoti
30、ating strategy, bccausc it may destroy trust, which might he needed to adapt the transaction in the future. It may force the transaction to be more formal and legalistic. This seems especially imponani when making credit decisions as by-products of commercial transactions,many of which need future a
31、daptation. On the other hand，explicit contracting for safeguards is relatively more common and accepted for credit than for commercial transactions, and fewer adaptations are needed.Mapping externalitiesEvery time a company publishes its accounts, it benefits third parties in ways that could hardly
32、compensate the disclosing company in any practical way. Aggregated information on individual firms, even if very small, is valuable for credit information agencies, to improve the accuracy and predictive power of their credit rating models; for analysts and investors, as it allows them to do compara
33、tive analysis when allocating capital among firms and industries; for competitors and competitors investors, when analysing the industr； for regulators and policymakers, when making decisions; for ccntral banks, when evaluating the level of indebtness of the economy and the soundness of banks; and e
34、ven for researchers doing empirical work.One may cxpect that these cffects would also indircctly benefit other economic agents, both at the micro and macrocconomic levels. This is the ease,in particular, of credit information, bank regulation and national accounting.Externalities in credit informati
35、onFinancial information agencies produce reports containing all sorts of information thai is. of use for evaluating companies creditworthiness. These reports， which may be customised depending on the needs of the client, often include several years of accounts as filed at ihe Company Register and th
36、e identity of the companies shareholders and legal representatives. In addition, not only for companies bul also for individual firms, reports might also include, if available, negative information about previous defaults, as filed by trade and financial creditors and courts, as well as contact info
37、rmation and news clips on the firm.As a summary, they may also offer a crcdit rating or even an estimated probability of default.The accounts filed with the Company Register arc a major componcni of crcdit reports，because of the problems plaguing alternative sources of information. Exclusive relianc
38、e on negative information about credit defaults worsens the quality of credit assessment, and financial institutions are often unwilling to share positive information on debtors.Furthennore,even sharing arrangements depend on the cooperation of established financial institutions, which poses serious
39、 risks to competition.Externalities in national accountingWhen building the financial accounts of national economies, many central banks rely partly on the financial statements of non-financial firms, mainly to produce information on【heir financial operations. Some countries have developed specific
40、databases of accounts, lo which firms send their accounts voluntarily,getting in return privileged access to aggregate inforination on their industry and the economv.Participation, however, tends to be low and suffers from several biasese.g. large firms are more inclined lo participate. This makes i
41、t necessary lo complement the analysis of their own databases with the accounts of small companies.Do firms balance costs and benefits well?Voluntary decisions by rational decision makers may deviate from the optimal trade-off of costs and benefits for two main reasons: the asymmetric structure of t
42、he information available and the prcscncc of externalities. In addition, this balancing of costs and benefits may also be hindered when the decision maker deviates from rationality.Information asymmetry constraintsIn situations of information asymmetry, parties who are better informed may lend to vo
43、luntarily disclose their information to uninformed parties to avoid their inferring the worst and reading accordingly, withdrawing their cooperation or taking precautionary measures. Some evidence on the presence of incentives for voluntary disclosure by private firms is provided,for instance, by th
44、e common practice of credit rating agencies, of using as an indicator of creditworthiness the fact that a company keeps all sorts of registrations up to date:from its listing in the telephone directory to its file in the company register.Informed parties may not disclose the information,however, whe
45、n one of rhe following assumptions does not hold: (I)When disclosure is costly,the possibility that uninformed trading parties will infer the worst from nondisclosure does not necessarily provide enough incentives to disclose. (2)For the same reason, a similar outcome arises when it is not publicly
46、known if the informed party is wel】 informed or not. (3)When noi all uninformed parlies understand the information, their lack of understanding may limit the benefits of disclosure for good firms and finns may end up in a nondisclosure equilibrium. (4)When ihe informed party cannot disclose all info
47、rmation(for instance, because it would have to prepare several sets of financial statements using different principles, which would be prohibitively expensive), a rule constraining disclosure choice will increase the value of【he disclosed infonnation.For disclosure of financial statements by private
48、 small companies, three of these assumptions do not hold, hindering voluntary disclosure. First, disclosure is costly, which may deter voluntary disclosure and cause confusion in the signal sent by non-disclosure. Second, it is public knowledge that companies have financial statements, which they us
49、e for their own management, so the second assumption does not hold. Third，a substantial proportion of market participants probably do not fully understand the accounts. Fourth, mandatory accounting principles are needed to increase the value of the information by limiting discretion.Difficulties for internalising externalitiesThe most important reason for subaptimal disclosure is the presence of externalities: firms lack incentives to voluntarily disclose the optimal amount of information，given that they in
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