Dilemma of Mandatory Reporting

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AC3103 ACCOUNTING ANALYSIS AND EQUITY VALUATION

TAKE-HOME ASSIGNMENT

Submitted on 8 March 2016

Seminar Group No. 07

Professor: Kevin Koh Whee Ling

Done by:

1. Introduction

Since the introduction of mandatory quarterly financial reporting by SGX in 2003, there were many movements in the other major financial markets.

Following the 2008 financial crisis, US Securities Exchange Commission faced strong criticisms on its mandatory quarterly reporting requirement, with the main issue of top management being overly focused on short term results.

After the global financial crisis in 2012, there were an increased surge of disagreements against the requirement in the European Union after a well-known economist in UK published a report called ‘The Kay Review’. As inconsistent quality of disclosure in quarterly reports were strongly highlighted, the requirement was eventually removed. Hence, all EU members, including UK removed the obligation to publish quarterly reports.

At the recent Singapore Institute of Directors (SID) Directors' Conference in September 2014, 78 per cent of the directors and corporate leaders present voted for voluntary quarterly reporting in the opinion poll. (Lee su shyan, 2016). 

With the seemingly majority against the obligation to publish quarterly reports, SGX ought to review the need of the requirement for the better of Singapore economy.

2. Arguments against Mandatory Reporting

2.1 Decision usefulness of information

2.1.1 Reliability

In the study “"Do Investors Respond Differently To Interim Versus Final Quarterly Earnings Numbers" conducted by the SMU’s School of Accountancy, it reflects that investors reacted more strongly to earnings in the final quarter compared with those in the interim quarters.” This study included 307 Singapore-listed companies which reported quarterly earnings between 2011 and 2013. (Lee su shyan, 2016). 

This suggests that the final audited quarter results may be seen as more reliable than the other quarters which are not being reviewed. In other words, the quarterly reports may not be deemed as useful to the investors in their decision making process.  

2.1.1.1 Greater use of estimates         

Higher level of estimation is also involved for preparation of quarterly reports which affects the reliability of these quarterly reports. For instance, the valuation of inventories may be based on sales margin as stocktake is only performed at financial year end, which may not be entirely accurate.  

2.2. Quality of information

2.2.1. Creates little value for investor

SGX Exchange requires listed companies to make timely announcements on company news and developments in every annual report or at least, semi-annually.  Hence, increasing the frequency of reporting may not create much value for the investors, taking in the consideration of the following two rationales.  

2.2.1.2. Sustainability of Figures

It has also been argued that the figures in the quarterly reports are not seen to be sustainable in the eyes of the investors such as the changes between quarters are unlikely to change the investment direction. Investors will prefer in-depth discussion relating to company’s business strategies to predict future firm performance which are already reflected in the annual reports.

2.2.1.3 Inconsistent Report Format across Firms

Under Manual Rule 705 of SGX Listing, listed companies are allowed to present financial information in any format given that it is consistent throughout all quarters. As companies also have no requirement to abide to any framework or accounting principles, this may lead to a haphazard approach in the preparation and presentation of such financial information. Hence, it could reduce the reliability and comparability of the information reported among companies. With different companies adopting their own practises, users of reports may have to conduct their own research to extract the relevant information for their investment decisions, further reducing the usefulness of the reported information.  

2.3 Promotes Short-term Perspective 

In the survey done by Graham, Harvey and Rajgopal in 2005 which aimed to analyse the behaviour of 400 chief financial officers, found that majority of these CFOs would not take on a project that would fall short of the analysts' earnings' expectations in the current quarter, even if it had a positive net present value. (Lee su shyan, 2016). 

This clearly demonstrated that mandatory quarterly reporting has led to management adopting a short-term perspective which is detrimental to the firm value in the long run.

In addition, earnings management may also be used to produce more favourable quarterly figures, leading to information having a lower earnings quality. According to the survey done by Dichev et al. (2013), the top rationales for earning management were because of the pressure to meet earnings benchmark, both externally and internally.

2.4 Not Cost Beneficial for Firm

The mandatory requirement raises the preparation and analysis cost of firms. Coupling with the arguments that the information is of low quality and little decision usefulness to investors, many companies do not think it is cost beneficial.  

3. Support towards Mandatory Reporting

3.1 Increased Capital Market Efficiency

Given the rapidly evolving economy and increasingly volatile markets, the proponents see that there is a need for more timely reporting to promote transparency and good corporate governance. By providing regular release of information, it is believed that they can better manage investors’ expectations and reassures investors, assisting investors with their investment decisions.

3.2 Instil Greater Discipline on Companies