IMPORTANCE OF RELIABLE FINANCIAL REPORTING

There are two ways of looking at the importance of reliable financial reporting: from
what I call a deterrent perspective versus an incentive perspective.

The deterrent perspective is perhaps more common, in light of the corporate scandals
that have taken place over the past few years: Enron, Worldcom, Tyco, Parmalat,
Ahold etc. From this perspective, high quality financial reporting works to avert
such scandals, which have enormous economic and social costs. For example,

In 2001, Enron filed for bankruptcy: $67 billion in market cap.

In 2002, Worldcom filed for bankruptcy: $175 billion in market cap. / 60,000
people lost their jobs in 65 countries

Parmalat underreported loans, approx $14 billion in market cap. / 36,000 people
lost their jobs in 65 countries / 5,000 farmers are owed $150 million ($30,000 per
farmer)

The negative consequences were not restricted to investors and employees. For
example, In 1999 Worldcom represented just over 1% of the total S&P 500, and at its
peak, workers pension funds held about $25 billion in Worldcom stock, which are
now worthless.

These scandals send a very clear picture of the negative effects of bad accounting and
reporting.

But there is also the other side of the coin: good accounting and reporting are
conducive to financial sector development and private sector development, which in
turn spur economic growth.

The relationship between high quality financial reporting and financial and private
sector development works through several dimensions.

1. First, through strengthening the domestic financial architecture and reducing

the risk of financial market crises and their associated negative economic
impacts.
2. Second, by contributing to foreign direct and portfolio investment and helping
to mobilize domestic savings.
3. Third, through facilitating smaller-scale corporate borrowers access to credit
from the formal financial sector by lowering high costs of information and
borrowing.
4. Fourth, by allowing investors to evaluate corporate prospects and make
informed investment and voting decisions, which results in a lower cost of
capital and a better allocation of resources. Financial reporting is also a gauge
for market-based monitoring, which allows shareholders and the public at
large to assess a companys management performance, and thereby promotes
the active development of stock markets.
5. Finally, by supporting economic integration, both regionally and globally.
-

Hence, a sound corporate financial reporting system should not be viewed as the core
objective for its own sake, as it is much more than this: it is the cornerstone of a well
functioning market economy and a robust financial system.