Corporate governance is composed of a set of rules that organizations apply in directing their decisions and justify their steps. Governance is a combination of contracts that assist align the interest of the shareholders to that of the managers. It is the foundation through which firms evaluate and go after their targets within the legal, market and social environment. Considering that the primary role of accounting is to keep a track of the firm’s financial performance, it plays a crucial part in evaluating how the firm fulfils its corporate mandates. In this report will focus on the role of information asymmetry in agency conflicts between the shareholders and the managers (Mehran & Mollineaux, 2012). Will critically examine the role financial reporting plays in solving the information asymmetries plus its applications in monitoring mechanism with an aim of improving credibility and transparency of information
Corporate governance is a subset of organization’s contracts formally and informally. It is what assists align the interest of the managers with those of the other stakeholders. Corporate governance is structured is away that it acts as the pathway through which shareholders can assist ensure that the managers are taking decisions that benefit the firm. The definition of corporate governance is wide and covers all type of firm’s contracts that assist in aligning the shareholders, directors and managers interests (Raheja, 2005). For instance, allowing creditors the right to view the financial reports of the firm is considered under the corporate governance (Skeel, 2015).
The focus will be on types of agency problems that generates conflict of interest between the managers and shareholders. The first type mushrooms when the interest of the directors and shareholders are assumed to be aligned while the interest of the management is not in line with those of the board and the shareholders. In this case will focus on monitoring systems meant to ensure managers act in accordance to the shareholders interest.
Another type of agency problem arises when the interest of the management and that of the directors is assumed to be aligned while the same interests are not at par with those of the shareholders. In this case will evaluate board independence and its role in ensuring accountability.
The board of directors is directly tasked with monitoring the management and developing mechanisms that align the objectives of the shareholders with those of the managers. This is done through two broad functions. One is offering advice to senior management. This requires expertise and knowledge of the firm’s financial information. The second task involves monitoring the activities of the managers. This need the directors to be independence from the managers (Ryan, 2012). The structure of the board is designed in such way that it can possess the inside information of the firm while at the same time perceived to be independence. This include having a combination of both inside and outside directors.
The outside directors need the financial reports to be delivered in time for them to monitor and advice the management. The earnings of the firm in specific should be communicated in time. The failure of a firm to commit to minimise information asymmetry between the insiders and outsiders will render the outside directors ineffective. This gives a correlation between the proportion of the outside directors and delivering financial reports in time. Lack of transparency expands the scope for agency conflict that arise between shareholders and management. This necessitates the need to have a greater proportion of outside directors to monitor the actions of the management in cases where financial reports are not delivered in a timely manner. The outside directors may work to improve transparency in their bid to try monitor and advice the management appropriately in cases where the low transparency occurring in the firm is correctable (Skeel, 2015).
The outside directors demand the provision of high quality information to fulfil their mandate of advising and monitoring the directors. Managers may occasionally have incentives to distort or hide private information. In this situation the emphasis is put on the timeline within which bad news is reported. This is an information that is likely to trigger negative reaction from the shareholders (Wang, 2010). To ensure such news is reported in time a variety of rules have been put in place to guide the reporting timeline. This forces the managers to recognise and disclose information that might be difficult to verify regarding losses faster than those relating to gains. For instance, it is mandatory to recognise a decline in inventory, long term assets or goodwill while an increase in value is only reported once the information is verifiable. By committing the managers to report bad news sooner than it will surface in a normal environment, Conservatism reporting approach aide the external directors in delivering their monitoring and advisory roles effectively (Zhao & Chen, 2008).
The emergence of high profile accounting scandals in the early 2000s lead to reactive measures which saw stricter disclosure rules being passed the Sarbanes-Oxley Act 2001. This gave financial experts a timely role in conducting accounting research. The experts are viewed as possessing superior capability with which they can monitor and advice on financial reporting and disclosure issues (Mehran & Mollineaux, 2012). Given that definition of the financial experts is not clear, with respect to corporate governance it can be used to refer to a director with a strong auditing, accounting or financial operations background. Prior to the regulatory requirement the organization would only allow a financial expert to participate on its board activities for the following reasons: when the management need corporate finance advice, when the management need to commit to an intense monitoring of the corporate financial reporting strategy and when the shareholders pressure or demand that managers add an expert to the board due to concerns over in efficiencies in monitoring (Linck, Netter, & Yang, 2008).
The financial expert can only be effective to the firms’ decisions when the financial reports and information is available in a transparent manner. It is therefore justified to exert a correlation between positive information transparency and the presence of a financial expert among the directors. In scenarios where the financial expert is invited to the board due to lack of proper financial reports, it is expected that this situation will improve as the financial expert is able to take actions that may promote transparency. The presence of a financial expert in the board of directors can be interpreted as away through which the firm can improve its transparency. This is helpful in aligning the interests of the directors, managers as well as the shareholders (Li, Sun, & Ettredge, 2010).
Accounting activities are highly influential as tools for defining corporate governance. Organizations can make intelligent decisions regarding operations, expansions and investments which the management possess by applying accurate accounting data. For example, accounting projections can be used to indicate the influence of cutbacks in employees to the firm’s short-term performance and the eventual outcome in the long run.
Publicly trading organizations are legally responsible to the public when it comes to disclosure of their business activities to the world. This though is not the case with the privately trading firms. The public corporation are required to release their financial statements to the public in a quarterly manner. This includes the statement of financial position, statement of comprehensive income as well as the statements of shareholders equity. This information is important to the potential investors in their decision to purchase shares in the company. This nature of information is also required by government agencies in their role as overseer of the organizations activities. For the firm to adhere to this demands the accounting practices are needed to assist generate this information (Lehn, Patro, & Zhao, 2009).
To add to the responsibility to the public and government departments corporation s are also responsible for releasing detailed financial information to the current shareholders. The decisions of the corporation is necessary in determining the actions of the shareholders to buy, sell or hold their shares in the organizations stock. The shareholders depend on the information from the organizations accounting department for them to make informed choices. In addition, the management of the organization depends on the accounting data to evaluate their revenue generation, its sources and the timeline of receiving the revenue. This nature of information is what guide recruitment, financial planning as well as investment decisions.
Almost all the decisions that the managers of a firm take are dependant on quality and accuracy of accounting data. By using this information firms can manage their assets, prioritize their investments and make intelligent choices. Its through the accuracy of accounting data that the management can keep a track of their investments and the generated outcome (Krishnan, 2005). This way the firm can decide when to purchase a new asset or terminate a loss-making project.
Conclusion
Company managers are designed to act as agents of the shareholders, in many occasions the managers do lose their way and end up following their own paths. This situation leads to agency problems where the alignment of the shareholders, directors as well as managers interests fail to be at par. The solution of this issue relies on the accounting and reporting behaviours of the firm. Buy putting in measures meant to increase the transparency of the firm the information asymmetry between the shareholder, directors and the managers can be minimised. This improves the accountability of the organization which at the end helps to align the interest of the parties. Financial reporting and accounting information is Vitol to the improvement of a firms’ effective performance as well as curtailing scandals triggered by manages following their personal paths (Kothari, Shu, & Wysocki, 2009).
References
Kothari, S. P., Shu, S., & Wysocki, P. D. (2009). Do Managers Withhold Bad News? Journal of Accounting Research , 241-76.
Krishnan, J. (2005). Audit Committee Quality and Internal Control An Empirical Analysis. Accounting Review, 649-75.
Lehn, K., Patro, S., & Zhao, M. (2009). Determinants of the Size and Composition of US Corporate Boards. Financial Management, 747-80.
Li, C., Sun, L., & Ettredge, M. (2010). Financial Executive Turnover, and Adverse SOX 404 Opinions. Journal of Accounting and Economics, 93-110.
Linck, J., Netter, J., & Yang, T. (2008). The Determinants of Board Structure. Journal of Financial Economics , 308-28.
Mehran, H., & Mollineaux, L. (2012). The Corporate Governance of Financial Institutions. Annual Review of Financial Economics 4 , 215-32.
Raheja, C. (2005). Determinants of Board Size and Composition: A Theory of Corporate Boards. Journal of Financial and Quantitative Analysis, 283-306.
Ryan, S. G. (2012). Financial Reporting for Financial Instruments. Foundations and Trends in Accounting, 187-354.
Skeel, D. (2015). The New Synthesis of Bank Regulation and Bankruptcy in the Dodd-Frank Era. University of Pennsylvania Institute for Law and Economics Research.
Wang, X. (2010). Increased Disclosure Requirements and Corporate Governance Decisions: Evidence from Chief Financial Officers in the Pre- and Post-Sarbanes-Oxley Periods. Journal of Accounting Research , 885-920.
Zhao, Y., & Chen, K. H. (2008). Staggered Boards and Earnings Management. Accounting Review , 1347-81.
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