Wednesday, April 29, 2009

Mandatory Accounting Disclosure by Small Private Companies

Mandatory publication of accounts by private companies relates to several strands of the economic, accounting and financial literatures: deregulation of business formalities, mandatory financial disclosure, and investors’ protection and credit information. Findings in all these areas thus provide complementary insights on the issue under discussion.

The European Commission aims to improve the environment of businesses by simplifying business formalities, a popular policy since the European Charter for Small Enterprises (2000) and the efforts of the World Bank through the “Doing Business” project (2003-2007). This origin of the initiative helps explain the focus of the Commission on reducing costs without considering benefits. As we will see, however, mandatory publication of accounts is not only an issue of reducing the costs of operating businesses but also of easing businesses’ access to credit. The discussion therefore fits in with the argument given by Arruñada (2007, 2008) that simplification policies that narrowly focus on reducing the cost of institutional arrangements are counterproductive when they disregard the value of the services being provided (compare, however, Djankov et al., 2002, and Djankov, 2008).

Furthermore, in the case at hand, other strands of the accounting and finance literatures provide complementary perspectives for understanding the complex sets of costs and benefits involved. Since the 1960s, there has been substantial controversy on the balance of costs and benefits and the optimal content of mandatory financial disclosure. In the current regulatory framework of the USA,2 however, most of these discussions have focused on mandatory disclosure by public companies—that is, companies selling shares or bonds to individual investors in stock exchanges. These public companies are required by law to not only file financial information publicly on a periodic basis but also to disclose other information on the company, provide detailed data on new issues of securities and report any trade by insiders.

Even though the European Commission’s proposal refers to the mandatory publication of annual accounts by small private companies, part of the discussion on mandatory disclosure by public companies is applicable. Other parts of the analysis are substantially different, however, because of differences in the governance structure, size and availability of information of both types of companies, as well as differences in the contents of the information being mandatorily disclosed. In particular, previous research has focused on how mandatory disclosure for public companies affects the value of their equity by facilitating or not transactions on such equity. But the main interest for private companies lies in knowing how publishing their accounts could help their trading parties (mainly banks and suppliers) estimate their credit risk, thus expanding their access to credit and lowering its cost. The main effect should be to reduce information asymmetry in credit (including trade credit) transactions instead of in equity transactions.

Download journal of accounting and financial: ziddu


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