(http://www.investopedia.com/) What Would Full Disclosure Mean For The Market? by Andrew Beattie The calls for _full disclosure_ (http://www.investopedia.com/terms/f/fulldisclosure.asp) grow with every accounting scandal. The domino-like procession of _Worldcom_ (http://www.investopedia.com/terms/w/worldcom.asp) , _Enron_ (http://www.investopedia.com/terms/e/enron.asp) and Tyco brought manipulative accounting to the forefront for the first time, and prompted calls for legislation and accounting reforms all aimed at forcing corporations to make frank and full disclosure in their financials. The question is whether full disclosure is the answer to existing problems and what impact it would have on the market. (Learn more about post-Enron Wall Street by reading _Lady Godiva Accounting Principles_ (http://www.investopedia.com/articles/analyst/032502.asp) .) Practical Limitations There are "natural" limitations to the term "full disclosure". The primary limitation is that full disclosure would be defined and enforced by legislation. No matter how carefully a document is drafted, there will be room for companies to do the bare minimum. There are already companies that willingly disclose much more than what is required by law. Usually, these are the companies with strong management holding a majority position and thus risking nothing by telling the truth. Take _Warren Buffett's_ (http://www.investopedia.com/terms/w/warrenbuffet.asp) letter to the shareholders in which he admits to losing millions by acting slowly on closing the trading arm of Gen Re, Berkshire Hathaway's wholly owned subsidiary. Buffett is honest, but he is also not likely to be fired because he controls a majority stake of Berkshire. On the other hand, management with no significant stake in the company, that is management working for the wage, will still be motivated to find ways to mute any bad results to the extent that the law allows. While it would be refreshing for a company to state what challenges it faces and what worries it has rather than simply presenting a glossy fairytale to investors peppered with enthusiasm, this type of disclosure will continue to be a personal choice of management - you can't legislate honesty. (Don't get fooled by these releases full of company ruses. Read _Five Tricks Companies Use During Earnings Season_ (http://www.investopedia.com/articles/stocks/08/earnings-tricks.asp) .) Realistic Numbers and Their Source The best one can hope for from full disclosure is to end the use of deceptive _footnoting_ (http://www.investopedia.com/terms/f/footnote.asp) to hide important information and to ensure a more in-depth assessment of costs, investment risks, and so on. It's unlikely that a company could be legislated into disclosing its unquantifiable anxieties like looming labor problems or a lack of new areas for growth. Still, any additional information helps. (For more on this, see _Footnotes: Start Reading The Fine Print_ (http://www.investopedia.com/articles/02/050102.asp) .) A clear explanation of the way firms calculate the risk of an investment went a long way toward heading off the _toxic mortgage assets_ (http://www.investopedia.com/terms/t/toxic-assets.asp) that companies were piling into based on overly sunny assessments. In short, full disclosure would simply mean more numbers to work with. Culling Analysts One of the most noticeable effects of full disclosure would be increased pressure on analysts. With more information made public as it occurs, much of the attraction of whisper numbers would vanish. The simultaneous release of information to the public under _Regulation Fair Disclosure_ (http://www.investopedia.com/terms/r/regulationfd.asp) (Reg FD) has already made analysts' jobs more difficult. Ironically, some believe Reg FD may actually limit disclosure in the sense that businesses may speak less freely with analysts for fear of violating the rule. Rather than removing analysts as information brokers and leveling the playing field, Reg FD may actually choke off an important information source. In a market with less substantial information, earning surprises and quarterly volatility could increase. Even with true full disclosure, however, the fact-rooting analysts are necessary. To stay in business under full disclosure, analysts will have to make meaningful reports rather than relying on the information lag between Wall Street and average investors. (Thinking about relying on analyst recommendations for your next trade? First, check out _What To Know About Financial Analysts_ (http://www.investopedia.com/articles/basics/03/041703.asp) .) In the past, analysts have benefited merely from being on the dial for conference calls or able to tap other informal information sources. There will still be an important role for good analysts, namely those whose understanding of an industry allows them to condense vital information into time-saving and accurate reports for investors. Full disclosure would simply up the natural selection for analysts that are squeaking by on an information edge today. Rewarding Honesty One of the possible positive effects of full corporate disclosure would be a lower _cost of capital_ (http://www.investopedia.com/terms/c/costofcapital.asp) as a reward for honesty. With companies laying their balance sheets bare, lenders would be able to assess the risks more accurately and adjust their interest rates to match. Lenders usually add to the _interest rate_ (http://www.investopedia.com/terms/i/interestrate.asp) on a loan as a margin of safety against undisclosed risks. The size of this margin varies naturally from industry to industry, but more complete disclosure by companies would allow them to differentiate themselves from other companies. Companies with strong balance sheets would have a cheaper cost of capital and those with weak balance sheets pay more as a matter of course. Companies attempt to do this on their own but banks are understandably skeptical from experience. Of course, banks may continue to charge a premium simply because even the strictest legislation will leave room for weak companies to hide. (To learn more about a company’s balance sheet, check out _Breaking Down The Balance Sheet_ (http://www.investopedia.com/articles/basics/06/balancesheet.asp) .) Inundating Investors One of the big questions about full disclosure is whether it would actually help the average investor. The impact of full disclosure depends on the type of investor. _Momentum traders_ (http://www.investopedia.com/terms/m/momentum_investing.asp) care little for deep info, whereas _value investors_ (http://www.investopedia.com/terms/v/valueinvesting.asp) constantly seek more meaningful numbers. Surprisingly, one of the great value investors, Ben Graham, lamented disclosure because he believed it made it harder to find undervalued companies before the general market. Would full disclosure kill value investing? This is highly unlikely for the same reason that full disclosure wouldn't kill momentum trading. Even with full disclosure, the market would be moved to extremes by funds, trend chasers/traders, investor overreaction and so on. If anything, full disclosure would make it easier for investors to make certain that what appears to be a value play truly is one. Working with more detailed numbers, an investor would be able to create customized _metrics_ (http://www.investopedia.com/terms/m/metrics.asp) rather than depending on blunt instrument like _P/E_ (http://www.investopedia.com/terms/p/price-earningsratio.asp) and _P/B_ (http://www.investopedia.com/terms/p/price-to-bookratio.asp) ratios. For a mathematically inclined investor, full disclosure would be a blessing. It's the emotional investors that would pay a price for full disclosure, and all investors are emotional at times. For many, less information is an advantage because a deluge of information often leads to overload. More figures and more frequent reporting/press releases will no doubt lead to some investors second-guessing their investments and selling on market reactions rather than fundamental changes. These investors will have to learn to depend only on the financial reports and not the increased drone of financial news releases. The Bottom Line Full disclosure has a lot of possibilities, including decreased cost of capital, pressure on analysts and more realistic financials, but it may not be the solution for all investors. Even with partial disclosure, investors can easily be drowned in information. To make the most of full disclosure, investors need to become educated in investing theory to know what information they should be demanding to fit a given technique. You may find that the information is already there for the asking with most companies and, if not, perhaps the company isn't the investment you want. By rewarding, that is investing in, companies that voluntarily disclose more than necessary, and not in companies that do the bare minimum, you'll be casting your small but important vote in favor of fuller disclosure. Investor pressure for frank disclosure will do more to promote honesty in the stock market than any legislative change. (To learn more, check out _Disclosures: The Good, The Bad, And The Ugly_ (http:// www.investopedia.com/articles/analyst/073002.asp) .) by Andrew Beattie, (_Contact Author_ (http://investopedia.com/contact.aspx?ContentType=A&Subject=Investopedia Contact Form&ContentID=4722) | _Biography_ (http://investopedia.com/contributors/default.aspx?id=82) ) Andrew Beattie is a freelance writer and self-educated investor. He worked for Investopedia as an editor and staff writer before moving to Japan in 2003. Andrew still lives in Japan with his wife, Rie. Since leaving Investopedia, he has continued to study and write about the financial world's tics and charms. Although his interests have been necessarily broad while learning and writing at the same time, perennial favorites include economic history, index funds, Warren Buffett and personal finance. He may also be the only financial writer who can claim to have read "The Encyclopedia of Business and Finance" cover to cover. ** This article and more are available at Investopedia.com - Your Source for Investing Education **
_______________________________________________ Centroids mailing list: [email protected] http://radicalcentrism.com/mailman/listinfo/centroids_radicalcentrism.com Archives at http://radicalcentrism.org/pipermail/centroids_radicalcentrism.com/
