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

Voluntary disclosures in the Annual Report DO signal success

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

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: 1 st five categories: included in the AICPA Special Committee on Financial Reporting s comprehensive business report model. 6 th category: intangible assets - increasing importance to companies and investors

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

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

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

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

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

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 asymmetry - 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 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

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

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

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 & factors Different 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 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.

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

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

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 Important What 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 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

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 …… Kelly Chan ……………. The celebrity element is what makes the Group unique …… the Group has contracted with over 200 artistes …… Leon Lai …..Jackie Chan …… Kelly Chan …………….

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

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

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

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

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

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

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