2 Historical Basis for Disclosure Flashcards
What are four aspects of today’s financial corporate disclosure in terms of what standardized and normal companies consistently report?
1) high quality financial information
2) through well established reporting channels
3) reinforced by legal requirements
4) creating a rich bedrock of financial information for capital markets
In 1929 the London Stock Exchange crashed due to _______________
prominent fraud claims
What are four reasons the NYSE crashed one month later in 1929?
1) fraudulent investment practices
2) declines in consumer demand
3) misguided economic policy
4) overextended credit
What are five impacts of the Great Depression?
1) wave of bank failures
2) record unemployment rate
3) declining income
4) GDP dropped 15% (compared to 1% during the Great Recession)
5) 80 percent drop in market value by end of June 1932
What had disastrous consequences, eroded investor confidence, and had real world impacts of market failures?
Lack of transparency
What did the US Supreme Court say in 1914 regarding disclosure as the basis of regulatory reform?
“sunlight is the best of disinfectants”
What are two key elements to monitoring companies and investors that collectively shape capital markets?
public exposure and transparency
What are three reasons the SEC was established in 1934?
1) protect investors
2) maintain fair, orderly and efficient markets
3) facilitate capital formation
Scholars saw mandatory disclosure as a method to do what two things?
1) hold management accountable to their shareholders
2) promote the public interest
The legislative history of formation of the SEC points to what two reasons?
1) protect investors
2) influence corporate behavior
Congress referred to SCOTUS / Brandeis when expressing the hope that the disclosure of financial information would “________________”
“change the way business was conducted”
Across countries, what are the most global and universal purposes for financial disclosure?
1) protect investors
2) foster sound markets
What are three countries that are examples of the most universal purposes for disclosure?
Japan, Hong Kong, New Zealand
The question of what information to disclose relied on what concept?
Materiality
What is materiality?
A framework through which companies differentiate information that should be disclosed from that which is not necessary to disclose
Materiality helps regulators to do what?
determine whether enforcement action is appropriate for false, misleading, or incomplete disclosures
Materiality helps courts to do what?
Make final decisions in cases of disclosure-based litigation
What does US case law demonstrate with regard to materiality?
It has changed over time
What did the National and TSC joint filing of a proxy statement demonstrate with regard to materiality?
There was an allegation that executives at National served on TSC’s board that was not disclosed
What does “total mix” refer to?
SCOTUS determined that information is material if its exclusion would alter the “total mix” of information considered by a reasonable investor
Information is deemed to be material if it is:
“significantly likely” to be considered by a reasonable investor in investment decisions
Note: threshold is higher than “might be considered”
What did the materiality definition expand to be assessed by?
The probability that an event might take place and the magnitude of the event on the company
What did the SCOTUS case regarding Basis Inc and Combustion Engineering exemplify?
They made 3 public statements denying merger conversations were taking place, and then merged, leading to an investigation as to whether it was materially false or misleading to shareholders
What is the probability and magnitude test?
Determination of materiality should consider the probability that an event will happen and the magnitude of the occurrence of the event
What did the BP pipeline statement regarding corrosion detected at a “low manageable rate” exemplify?
A Federal court found the statements materially false given a second leak was identified months later after the first spill
What does GAAP stand for?
Generally Accepted Accounting Principles
What is historical cost accounting?
Measures the assets value as the actual cost paid at the time of purchase such that the value does not change over time
After the tension of multiple non-standardized methods that persisted for over 10 years, what happened?
A new organization - Accounting Principles Board was formed and replaced the Committee on Accounting Procedure in 1959. All accounting firms followed APB guidance
What are three key aspects of decision usefulness in terms of this shift of reported information?
1) shifted the emphasis of disclosure away from strict historical asset valuation
2) shifted purpose towards informing decisions rather than performing a singular function (e.g. to provide accurate measurement)
3) recognized the importance of providing foward looking statements
What is a difference for how Australia, New Zealand and United Kingdom account?
They allow the revalue of property, plant and equipment (PPE)
Globally, in the 1970s, the International Accounting Standards Committee was founded to standardize internationally in more sophisticated markets. What did it become?
In 2001 it became the International Accounting Standards Board (IASB)
What does the International Accounting Standards Board do?
Oversees the development of the International Financial Reporting Standards (IFRS) required by public companies in over 140 jurisdictions
What are three countries where IFRS is optional?
China, Japan, United States
What replaced the Accounting Principles Board in the United States to establish U.S. GAAP?
Financial Accounting Standards Board (FASB)
The American Institute for Certified Public Accountants published a report on decision-usefulness and stated what about environment and social goals?
1) they are equally important
2) environmental externalities such as pollution pose costs on the rest of society
3) the objective of financial statements is to report on activities of enterprise affecting society which can be determined and described and measured and are important to the role of the enterprise in the social environment
CHECK FOR UNDERSTANDING: Why was disclosure the basis of regulatory reform in the wake of the 1930s stock market crash?
The stock market crash of 1929 sent shockwaves throughout global markets, leading
to global economic declines and the onset of the Great Depression in the United
States. The event provides perhaps the most striking example of how lack of transparency in capital markets can have disastrous consequences – harming socioeconomic well-being, bankrupting companies, and
eroding investors’ confidence in the information they rely on from companies to make investment decisions. Disclosure was the basis of regulatory reform in this defining period because disclosure is a means to promote transparency, and transparency is essential to fostering sound and efficient capital markets. As evidenced by the basis of the formation of the US SEC, regulated corporate disclosure is an effective mechanism to protect investors, positively influence
corporate behavior, and enable informed investor decisions.
CHECK FOR UNDERSTANDING: What is the relevance of “materiality” in the context of disclosure, and how has the concept historically been interpreted?
The concept of “materiality” traditionally focuses on information that impacts financial performance and investor decision-making. n the wake of regulatory efforts to enhance transparency from corporations, the concept was adopted to provide guidance to reporting companies. Though companies were now held to higher standards of transparency, to require the disclosure of all information would place undue burden on reporting companies. “Materiality” dictates what companies are (and are not) obligated to disclose.
CHECK FOR UNDERSTANDING: How has the purpose of accounting changed since the 1930s, and why did financial reporting move towards standardization?
In early years, accounting practices centered around accurate recordkeeping via historical cost accounting. This founding purpose shaped the accounting profession, where
accuracy and reliable record keeping are paramount. However, to serve their own
unique goals, firms began accounting and reporting financial information using a range of methodologies, ultimately inhibiting the comparability of financial statements. This fragmentation of accounting practices necessitated a push by accounting associations to come to a consensus regarding the true purpose of accounting and to promote standardization. The profession ultimately determined that accounting exists to provide information for the purpose of making economic decisions, which can include both historical records and forward looking information. High levels of adoption of standards such as the International Financial Reporting Standards (IFRS) and US GAAP allow investors around the world to efficiently source and use the information yielded through the standards. With higher levels of standardized disclosure comes more consistent, comparable, and reliable information across
markets, allowing investors to equally assess and compare companies’ performance and
prospects.
