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transparency and financial disclosure

Editorial

The Relationship between Corporate Governance,Transparency and Financial Disclosure

Introduction

C orporate governance has evolved and

grown significantly in the last decade. Numerous countries have issued corporate governance codes and the recommendations of these codes that typify‘‘good’’corporate governance undoubtedly contribute towards increased transparency and disclosure. Following the Enron collapse there has been an increased emphasis on various aspects of corporate governance,including transparency and disclosure aspects.

With the internationalisation of cross-border portfolios,and the financial crises that have occurred in many parts of the world,it is perhaps not surprising that institutional in-vestors in particular increasingly look more carefully at the corporate governance of com-panies.After all,corporate governance goes hand in hand with increased transparency and accountability.This increased transpar-ency and accountability should,of itself,lead to a better flow of foreign direct investment and more stable financial markets.

Transparency and disclosure

In order to understand why good corporate governance practices can contribute towards increased transparency and financial disclo-sure,encourage a better flow of foreign direct investment(FDI)and lead to more stable financial markets,it is useful to refer to the OECD(1998a)principles which identify the key elements of good corporate governance: .Rights and obligations of the shareholders .Equitable treatment of shareholders .Role of stakeholders and corporate govern-ance

.Transparency,disclosure of information and audit

.Board of directors

.Non-executive members of the board

.Executive management,compensation and performance

For the purpose of this piece,the section on transparency and disclosure is detailed be-low.

Transparency,disclosure of information and audit

.Corporate governance framework should ensure the full,timely and detailed dis-closure of information on all material matters,including its financial situation, performance,ownership structure and governance of the corporation.

.Includes establishment of(internal)audit committee.

.Transparency/disclosure includes disclosure of information on:

–financial/operating results

–ownership structure

–members of Board of Directors and

management

–quantitative and qualitative matters con-

cerning employees and other stake-

holders in the corporation

–governance structures and policies

–corporate targets and prospects

–execution of unusual and complex trans-

actions,transactions on derivative prod-

ucts and their level of risk.

The disclosures mentioned above are clearly fundamental to ensuring that the shareholders

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have important information on key aspects of the business.The OECD(1998b)sums up well the value of good corporate governance in its report on Corporate Governance:Improving Competitiveness and Access to Capital in Global Markets,which highlighted the importance of transparency and disclosure:

‘‘The disclosure of the corporation’s con-tractual and governance structures may reduce uncertainties for investors and help lower capital costs by decreasing related risk premia.Such transparency may also encourage a common understanding of the ‘rules of the game’,and provide employees with information that may help reduce labour friction’’.

Corporate governance may also be used as a key to help restore investor confidence in markets that have experienced financial crises.We have seen this happening in the last few years in Malaysia,Japan and Russia, for example.In these countries,as in a number of other countries that have similarly been affected by a lack of investor confidence, particularly overseas investor confidence, new or improved corporate governance prac-tices have been introduced.Key features of these changes include measures to try to improve investor confidence by improving transparency and accountability in these markets.

Transparency and disclosure in corporate governance rating systems

Corporate governance rating systems include transparency and disclosure as an important element in their rating systems.For example, Deminor state‘‘information to shareholders is one of the most important aspects of cor-porate governance,as it reflects the degree of transparency and accountability of the cor-poration towards its shareholders’’.The‘‘dis-closure’’category looks at the transparency of a corporation as measured by the quantity and quality of the publicly available informa-tion on the governance structure.

In the case of the Standard and Poor’s cor-porate governance rating,the scores from 10(highest)to1(lowest)will be awarded to each of four individual components that together contribute to the overall corporate governance score.The individual components are:

(i)ownership structure and influence (ii)financial stakeholder relations (iii)financial transparency and information disclosure

(iv)board management structure and pro-cess.

In relation to‘‘financial transparency and dis-closure’’,the criteria examined are the type of public disclosure standards adopted;the timing of,and access to,public disclosure;and in-dependence and standing of the auditor. Other corporate governance ratings systems such as GovernanceMetrics and the Corporate Library’s Board Analyst service are currently being developed and finalised for launch.The latter service will grade boards‘‘A’’through ‘‘F’’.Interestingly,accounting issues will be overweighted in the analysis so that com-panies with a history of special charges or poor audit practices will rapidly acquire a poor grade.

A desire for improved transparency and accountability to help inter alia to ensure that companies are perceived as attractive invest-ments,has led to significant corporate govern-ance reform in countries as diverse as Greece, Poland,Japan,Hong Kong and Malaysia.

Concluding comments

Whilst it is important to recognise that‘‘no single universal model of corporate govern-ance exists nor is there a static,final structure in corporate governance that every country or enterprise should emulate’’(CACG,2000), it is also fair to say that transparency and disclosure are key attributes of any model of good corporate governance.

Surveys of investor opinion highlight the importance of transparency and disclosure in a good corporate governance system.Addi-tionally,the corporate governance ratings systems mentioned above all include dis-closure and transparency aspects as part of a core assessment of good corporate govern-ance–and rightly so.For without transpar-ency and disclosure,shareholders and stakeholders would not be able to assess how,and in what manner,the company was being managed,and hence accountability would not exist in any meaningful way.

It is appropriate to conclude with a quote from Arthur Levitt,who sums up succinctly the importance of the relationship between good corporate governance,transparency and disclosure,and the consequent impact on foreign direct investment and economic growth if these attributes are lacking:‘‘If a country does not have a reputation for strong corporate governance practices,

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capital will flow elsewhere.If investors are not confident with the level of disclosure, capital will flow elsewhere.If a country opts for lax accounting and reporting standards,capital will flow elsewhere.All enterprises in that country–regardless of how steadfast a particular company’s practices may be–suffer the conse-quences’’.References

CACG(2000)Principles for Corporate Governance in the Commonwealth.New Zealand:Commonwealth Association for Corporate Governance.

OECD(1998a)Global Corporate Governance Principles. Paris:OECD.

OECD(1998b)Corporate Governance:Improving Competitiveness and Access to Capital in Global Markets.Paris:OECD.

‘‘The legal obligation on an external director is to act in a non-negligent way.Directors

should concentrate on identifying those risks which,no matter how fantastic,might

destroy the business.Of course,boards should take some risks,or no profit could ever be

made,but‘betting the farm’is not usually appropriate.Boards should focus their

stewardship on making sure they are aware of what these risks,both financial and non-

financial,are.Insisting on answers to these questions is vital.’’Alastair Ross Goobey,Hermes,

in‘The Independent Director’,Winter2001/2,No.8.

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