Voluntary disclosures in the Annual Report signal success

1. Voluntary disclosures in the Annual Report signal success Stephen Wong Siu Kei (50184032) Tony Chan Sai Chung (50183940)

2. Voluntary disclosures in the Annual Report DO signal success

3. Agenda • Definition of voluntary disclosure • Meaning of success • Types of voluntary disclosure • Study findings • Major benefits of voluntary disclosure • Real life Examples & Enron’s Case • Conclusion

4. Definition of voluntary disclosure •  mandatory • describes disclosures, primarily outside the financial statements, that is not explicitly required by GAAP or an SEC rule

5. 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 

6. Meaning of success From investor’s view: 3) increase transparency - helpful to investors for making investment decisions - satisfy the objective of disclosures

7. Types of voluntary disclosure FASB study classifies 6 categories: 1st five categories: included in the AICPA Special Committee on Financial Reporting’s comprehensive business report model. 6th category: intangible assets - increasing importance to companies and investors

8. Types of voluntary disclosure 1) Business data e.g. high-level operating data 2) Management’s analysis of business data e.g. reasons for changes in the operating and performance-related data

9. Types of voluntary disclosure 3) Forward-looking information e.g. opportunities and risks including those resulting from key trends 4) Information about management and shareholders e.g. directors, management, major shareholders

10. Types of voluntary disclosure 5) Background about the company e.g. broad objective and strategies 6) Information about intangible assets e.g. R&D, human resources, customer relations

11. Study findings 1) 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”

12. Major benefits of voluntary disclosure 1) Enhance transparency & credibility - provide more information: Good News + Disappointments  lower risk and uncertainty • cost of capital & required rate of return  • attract more investment

13. 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.

14. Major benefits of voluntary disclosure 2) Prevent information asymmetry - different level of information between management and investors -  different level of information - investors can know if there are shirking & insider trading by management

15. Major benefits of voluntary disclosure 3) Innovative business environment - 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

16. Different Companies do have Different Important Aspects to Disclose 4) Different aspects to disclose • Each 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

17. Different Companies do have Different Important Aspects to Disclose • Examples • R & D activities appear to be important for companies that manufacture and sell medicines • The qualities of pop stars appear to be important for entertainment companies

18. 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?

19. Different Companies do have Different Important Aspects to Disclose • The reasons are: • Different companies have different views on their own important aspects & factors • Different companies compete with each other by employing different strategies in a same industry

20. Different Companies do have Different Important Aspects to Disclose • In summary: • Each company is unique • A one-size-fit-all accounting standard approach will not work for all companies’ disclosure demands • Accounting standards can just rule all companies to disclose some common owned information – cash, liabilities, amount of expenses, etc.

21. Different Companies do have Different Important Aspects to Disclose • Voluntary disclosures provide a good way for companies to disclose their own important aspects to investors • E.g. Medicines Company will disclose more information about its R & D activities while Entertainment Company will disclose more information about its contracted Stars • Investors will have more relevant information for making a better investment decision • Companies will be successful by attracting more investors

22. Unrecognized Intangible Assets are also Important 5) Unrecognized Intangible Assets • Accounting 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

23. 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

24. 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

25. Unrecognized Intangible Assets are also Important • What are the most important assets of StarEastnet Company? • ALL POP STARS  

26. Unrecognized Intangible Assets are also Important • However, all Pop Stars are not included in the company’s balance sheet • GAAP prohibits the inclusion of human assets in any financial statements • Investors would miss this important information if they only investigate the company’s balance sheet

27. Unrecognized Intangible Assets are also Important • Extracted from Stareastnet’s annual report: “The celebrity element is what makes the Group unique……the Group has contracted with over 200 artistes……Leon Lai…..Jackie Chan……KellyChan…………….”

28. Corporate Governance • Best Hong Kong Corporate Governance Disclosure Award 2001 organized by HKSA • Winners are all successful companies e.g. HSBC • All winners did a lot effective voluntary disclosures in their annual reports • Annual Reports  Good transparency & accountability • Prove that successful companies do make a lot of voluntary disclosures and more voluntary disclosures signal better corporate governance

30. Real Life Examples • Well Performed companies like HKBC & Hutchison Whampoa Ltd, they do have a lot of voluntary disclosures • Increase Transparency & Attract More Investors • Bad Performed companies are not the same • Less voluntary disclosures

31. Real Life Examples • Successful companies do disclose more • Further 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”

32. Enron’s Case • Implication 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

33. 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

34. Conclusion • We 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

35. Conclusion • In Investor’s view, voluntary disclosures provide extra information • Success  Able to make better investment decisions & better capital allocations