Definitely in government. Of course,
I'm not sure that career liars can come clean. Take Barney Franks,
please. :-)
David
"There
is no virtue in compulsory government charity, and
there is no virtue in advocating it. A politician who portrays himself
as
"caring" and "sensitive" because he wants to expand the
government's charitable programs is merely saying that he's willing to
try to
do good with other people's money. Well, who isn't? And a voter who
takes pride
in supporting such programs is telling us that he'll do good with his
own money
-- if a gun is held to his head."--P.
J. O'Rourke
The calls for full disclosure grow with every accounting
scandal. The domino-like procession of Worldcom, Enron 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.)
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 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.)
Realistic Numbers and Their Source The best one can hope for from full disclosure is to end the
use of deceptive footnoting 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.)
A clear explanation of the way firms calculate the risk of an
investment went a long way toward heading off the toxic mortgage assets 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 (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.)
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 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 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.)
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 care little for deep info,
whereas value investors 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 rather than depending on blunt
instrument like P/E and P/B 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.)
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 **
