9 - Financial reporting and corporate governance

Summary

In this chapter we shall conclude our survey of specific topics in finance by looking at some issues that cut across finance and accounting. We begin with financial management and financial reporting. A major ethical concern within financial reporting is earnings management, which can be a simple matter of accruals, but also uses financial products to alter the way in which a company’s performance is reflected in its financial accounts. Financial products also play a part in the way in which the accounts of both companies and individuals are presented to the revenue authorities for tax assessment. Questions of corporate governance have come to be dominated in recent years by arguments drawn from finance theory and by the interests of financial institutions. General ethical concerns have focused on the relationship between shareholders and other stakeholders, and we shall look at this with particular reference to institutional shareholders. A more specific ethical concern has been with CEO pay and performance, and we shall look at this with particular reference to the performance and pay of bank CEOs.

Earnings management

A company’s financial reports are supposed to give a true and fair view of its financial position to shareholders, creditors and other interested parties. Shareholders rely on these reports to monitor the company’s management. Investors and potential investors rely on them to determine the company’s value, and lenders, suppliers and customers to assess its viability. A company’s directors and senior officers are both legally and ethically bound, whatever ethical criteria may be chosen, to produce reports that are as accurate as possible and in no way misleading. (Under the Sarbanes-Oxley Act, an American company’s CEO and CFO now have to personally certify the accuracy of financial reports.) External auditors are also bound to give an honest and competent assessment of the accuracy of the reports. Accounting procedures are not so rigid, however, as to uniquely determine what the figures contained in the financial reports should be. In particular, both assets and liabilities may be of uncertain value, and the attribution of gains and losses across accounting periods may be open to interpretation.