Will You Adopt Quality Financial Reporting?

1. Preface
§ Company is presently “playing around with the scorecard”
i. Embracing the Quality Financial Reporting (QFR)
ii. Start representing as much useful public information as possible
§ Those ways → promises low capital cost → higher security prices → because its more than likely that the capital markets respond to inadequate reporting by bidding stock prices down

2. The traditional reporting model
§ Traditional reporting strategies → Capital markets depend totally on managers to provide public information for their use
§ No standardize Generally Accepted Accounting Principles (GAAP) → compromised
§ Report → too long → managers resisted to initiate new requirements
§ Political pressure → severely compromised standards
§ TQM → The goal is to build good customer relationship and keep working as good as possible
§ Adopt QFR → Build better relationship with capital markets by providing the best financial statement

3. Solving the problem
§ Capital markets have needs and desires for financial information that are not addressed by traditional public reports
§ Balance sheet → perceived as irrelevant
§ Footnotes seem to frustrate analysts the most → capital markets cannot understand them → they do not contain adequate information
§ Three negative outcomes of complying with GAAP:
i. Lack of useful information in financial statements → cause market to pursue other investment opportunities → securities’ lower prices and higher capital cost
ii. Markets decide that the company’s investment potential is great → people may invest after:
1. Taking into consideration the resulting high degree of uncertainty
2. Insisting on higher expected rate of return
→ doesn’t advance the stockholders’ interests
iii. Sophisticated investors and credits will turn elsewhere → market want to discover information that no one else know
§ Managers provide additional public information:
i. Less uncertainty would exist
ii. The analyst’ extra effort and the redundant cost of finding that information would be avoided
iii. Information would be more reliable
§ Uncertainty means more risk to investors → demand higher return

4. Quality financial reporting-A superior strategy
Adopting QFR has positive effects for essentially everyone
§ Managers
i. Having access to cheaper capital
ii. Earn more income and enjoy payoffs from appreciated stock options and other incentives
§ Stockholders
i. Greater demand for their shares
ii. A rate of return that’s appropriate for their real risk
§ Investors and creditors
i. They can evaluate investment opportunities with more emphasis on their financial merits
ii. Less concern for risk created by incomplete information
§ The economy operates more productively
i. The capital markets can establish security prices more efficiently
Two groups will lose when QFR is practiced:
§ People who has somehow fooled the market
§ People who successfully cheat the markets with illegal insider information

5. The high road
Get started with QFL
§ Doing what FASB recommended instead doing what it has permitted
i. Managers usually do not use preferred method → they think that footnote will not improve their securities’ prices
ii. QFR suggest → Markets usually penalized stockholders with lower security prices even management reports larger earnings on the income statement
§ Engage tough auditors and do what they say instead of picking cheap and easy auditors who do what managers say
§ Branch out into new areas based on your own market research and common sense as to what helps statement readers make better decisions

6. Objection and Are you ready?
§ QFR → higher preparation costs created by additional reporting and auditing efforts
§ Respond:
i. The cost of them is still less than the benefit to financial statement users of:
o Minimizing the cost of providing the data by having the firms doing it at once
o Having the firms as the source of information
o Making available an additional source of information that confirms or denies other sources
§ Resisting QFR because of preparation costs seems to be very shortsighted
§ It must flow from the efforts