Shuchita Chaubey & Abhinav Mishra
Abstract – The article delves into the crucial concept of disclosure and its significance in corporate governance It emphasizes the importance of transparency in providing relevant information to stakeholders, including customers, investors, and the public. The article highlights the role of disclosure in promoting good governance, risk management, and compliance within corporations. Focusing on the Indian corporate landscape, the article explores how corporate governance and disclosure are interlinked, influencing the functioning and accountability of companies. It discusses Clause 49 of the Listing Agreement, introduced by the Securities and Exchange Board of India (SEBI). The article on the flipside also highlights the social costs of non-disclosure citing examples and adverse effects of non-transparency of investors and society, the article lastly acknowledges the current complexities and challenges associated with current disclosure regulations and proposes key measures to strengthen the same. In conclusion, the article underscores the urgent need for stronger enforcement mechanisms, simplified reporting requirements, and increased transparency in disclosure practices in India.
Introduction-
The feeling of unease that engulfs an individual who lacks knowledge is far from pleasant. However, as humans’ thirst for knowledge grows, so does the importance of the right to know. In simple terms, disclosure refers to the act of making relevant facts and information known to someone. When corporations engage in proper disclosure, they ensure that their customers, investors, and all parties involved in their business are aware of crucial information about the company.[1]
According to the Cambridge Dictionary, disclosure is defined as “the act of making something known or the fact that is made known.”[2] In the vernacular of the common man, disclosure pertains to the act of divulging meticulous particulars or intricate data to the general public or avid readership. This particular term finds its predominant usage within the realms of corporate entities and legal practitioners, encompassing the imperative task of enlightening esteemed customers, esteemed shareholders, astute investors, and all individuals inextricably linked with the corporate fabric about the intricacies that hold significant relevance.[3] In an era where meticulous documentation and rigorous procedures are the norm, trust becomes an invaluable asset that cannot be compromised. Disclosure acts as a remedy in this regard. It serves as a focal point and a symbol of confidence for individuals seeking information to make informed investment decisions or voting choices. This article will delve into the details of how disclosure and transparency regarding operations and transactions can foster a prosperous working environment for a company.[4]
This article will dive into the details of how disclosure and transparency about the operations and transactions can lead to a prosperous working setup for the company.
Corporate Governance
Corporate Governance, as defined by the Cadbury Committee report in the year 1992, is the system that directs and controls business or the framework that balances the different interests of the shareholders.[5]
Similarly, the Hampel Committee defined disclosure as “the essential feature of accountability, and asserted in establishing a new code and set of standards that their goal was not to prescribe corporate behaviour in detail but to secure adequate disclosure so that investors and others can evaluate companies’ performance and specific responsibilities and respond in an informed manner.”[6]
In India, it refers to a collection of intrinsic controls, policies, and procedures that serve as the foundation for a company’s operations and interactions with various stakeholders such as consumers, management workers, government, and industry groups. Such policies are constructed in a manner to uphold the principles of transparency, sincerity, ethics, and honesty. In recent times, with the rise in corporates, now more than ever, corporate governance has become quintessential for an organisation and must be followed whilst engaging in business.
Governance, risk management, and compliance are all inextricably linked. When solid principles manage a corporation, it will, by its virtue, function effectively and in accordance with all statutory laws and guidelines. Following the rules and laws guarantees that the firm is well prepared for any uncertainty and, as a result, has risk mitigation strategies in place. The more disciplined a company’s operations are, the more prepared it is to meet any risk or interruption caused by political, technical, or economic events.[7]
The Indian Scenario
As a matter of policy, it has been pointed out previously that all the requisite and significant information should be made available to the users in a cost-efficient and user-friendly way, following a reasonable timeline. The disclosures that are made pertaining to any information by whichever channel should distinguish between audited and non-audited fiscal information. Managements across the globe recognise that there can be significant economic benefits from a well-maintained disclosure policy. A comprehensive and exhaustive system of disclosure equips investors to figure out and acquire reliable and precise information about the company’s assets and liabilities in order to make better investment decisions.[8]
India holds a diversity when it comes to emerging as well as established companies too. The law pertaining to Reasonable Corporate Governance in India needed to be adaptive to all the diversity the companies in the country offer, along with being stringent enough to hold them accountable for their malevolence. Clause 49 of the Listing Agreement by the Securities and Exchange Board of India (SEBI) is one of the harbingers of disclosure laws in India.
The Listing Agreement is the same for all Indian Stock Exchanges and was incorporated as recently as the year 2000 after the recommendations of the Kumar Mangalam Birla Committee on Corporate Governance constituted by SEBI in 1999. The clause intended to establish a few corporate governance practices in the Indian corporate atmosphere and ended up bringing some revolutionary changes in governance and disclosures. In the last months of 2002, Narayana Murthy Committee was constituted to determine the competence of current practices of corporate governance and suggest ways for improvement.
The recommendations made SEBI revise Clause 49 of the Listing Agreement, which now requires all listed companies to file a corporate governance report every quarter, which ultimately depreciates the chances of inconspicuousness of data, reports and exchanges.
Effectiveness of Disclosure
Lack of disclosure has always been considered lying at the heart of economic or corporate crises. The one shoe that fits all solutions to such a crisis is transparency. Increased transparency has been observed as one of the main components of improved financial conditions. Whether obligatory or discretionary, transparency through disclosure essentially deducts the asymmetrical flow of information in the public domain and establishes good governance.[9]
Obligatory disclosure of information that targets transparency is the most apparent and least disputed sector of public policy among corporations.[10] This transparency can be and is very customer friendly and makes certain information public, which by contrast respects freedom of choice; for example, if restaurant patrons are informed of the calories present along with the food choices, then people concerned with calories will have the information they need to choose. Accordingly, this information increases the trust factor and respects freedom of choice for versatile patrons, making the desirability quotient high for this particular restaurant.
Transparency can be achieved via reporting allowances and dues, amongst other things. The ‘robustness’ of the reporting standards on which financial/non-financial information is created and reported substantially impacts the quality of financial and non-financial disclosures. Furthermore, disclosure reflects the firm’s product and business model quality, growth plan, and market placement, as well as the dangers it faces.[11]
A firm must comply with severe disclosure rules regarding compensation for directors and executives under the law. Every year, all publicly traded firms must declare the ratio of median employee salary and the percentage increment in remuneration for every director, CEO, company secretary, or management.[12]
Some of the effective benefits are listed below-
1. It creates shareholder value- Studies have helped to point out that the increase in disclosures creates value for shareholders. For instance, the firms listed in Germany which follow the regulations related to disclosure observed their share values appreciate for a period of 1 year;[13] the form of the disclosure may be voluntary or mandated by regulations like clause 49 of the listing agreement by the Securities Exchange Board of India (SEBI), which prescribes the norms under which any company listed should operate. Clause 49(1) of the listing mentions the rights of shareholders and further talks about disclosure and transparency and states, “Disclosures must be made regarding proper compliance of prescribed standards of accounting, financial and non-financial disclosure. Maintenance of records containing minutes of the meeting must be done, specifically recording dissenting opinions.”[14]
2. Improved information held by third parties- Providing information as disclosure is the first mechanism of information that a third party looks out for the company, being positive or negative is a later aspect, Hope (2003)[15] shows a positive link between the degree of disclosures and the quality of financial forecasts among traders and financial analysts. A sense of information asymmetry prevails in the market wherein the informed agents or insiders make profitable trades at the detriment of uninformed traders, known as informed trading. As a result, the market movers increase the bid-ask spread. Enhancing the information released in the market/open public allows traders and investors to set parameters for their expectations. The transparency of a firm regarding its information is directly proportional to the performance of a share owing to the quality of the firm rather than the general market trend, i.e., the rapid price volatility decreases.
3. Lowers the risk of fraud- Ethics and financial disclosure have recently found their space as an element that establishes trust not only among the investors and potential investors but also in the eyes of the regulators post the Enron and Worldcom scandals. A voluntary ethics disclosure is associated with a lower risk of fraud, and the same applies to the financial part of it as well. According to a study, no fraud firms tend to disclose slightly more ethics than fraud firms, and the report further suggests that firms providing more details in their earlier voluntary ethics disclosure are less likely to be involved in fraudulent financial reporting, additionally had had a more independent and larger audit committee.[16] Mostly the fraudulent disclosures involve voluntary omissions of liabilities, significant measures, accounting changes, management changes and related party transactions so as long as, to the naked eye, the above omissions are absent, the disclosure, among other things, is canonical in the eyes of regulators.[17]
Cost of non-disclosure
The social cost of non-disclosure is not trivial enough to be endured by everyone. The stock market crash of 1929 was one of the initial examples of the consequences of non-disclosure. This episode, to date, stands as the flag bearer of continuous discussion over corporate disclosure, which is still unsettled at local, national, and global corporate levels. From the standpoint of disclosure range, the shortcomings of traditional financial reporting become increasingly apparent with each stride towards a knowledge-based economy. Accounting procedures, measuring tools, accounting estimates on one end, and sources of value creation through intellectual assets on the other are growing apart.[18] The Securities and Exchange Commission of the United States requires all the reports filed with the commission to have disclosures attached which include
i) How they operate their business now and how they intend to do so in the future, and in some cases, how they did it before,
ii) profit statements of the past fiscal years,
iii) details of prominent stakeholders coupled with money borrowed and repaid,
iv) a description of background and experience of the directors of the corporation.
Such information makes the transparency quotient high and helps investors evaluate corporations on their merits. The unfavourable circumstances, devoid of disclosure agreements, for a stakeholder, the community of investors, and society, in general, are discussed below-
1. Surprising profits for informed investors- when management keeps internal knowledge on early test findings, once made public, that information would boost the value of the company’s shares they own.
2. Investors’ trust in the credibility of markets has diminished, resulting in poor trading volumes and engagements and low overall productivity in resource allocation spanning through sectors and enterprises.
3. Increasing capital costs due to increased perceived risk drive investors to seek more significant returns to offset the higher risk of firms with poor disclosure standards. This results in increased overall expenses for products and services for society.[19]
Conclusion
While the concept of disclosure in India’s corporate law is aimed at promoting transparency and accountability, its effectiveness raises significant concerns. Despite the existence of regulatory frameworks and reporting requirements, the actual implementation and enforcement of disclosure practices remain questionable. There are instances of inadequate and misleading disclosures, which undermine the trust of stakeholders and investors. The lack of stringent penalties for non-compliance further weakens the effectiveness of disclosure provisions.
Moreover, the complexity of disclosure regulations often leads to ambiguity and loopholes that allow certain corporations to manipulate or obscure information. This undermines the intended purpose of disclosure, as it fails to provide a comprehensive and accurate picture of a company’s financial health and operations. Inadequate disclosures can have severe repercussions for investors and the overall stability of the financial markets.
Furthermore, the accessibility and readability of disclosed information pose significant challenges. The voluminous and technical nature of disclosure documents often makes it difficult for the general public to comprehend and assess the true risks associated with their investments. This information asymmetry limits the ability of individual investors to make informed decisions and reinforces the advantages of institutional investors with greater resources and expertise.
To ensure the effectiveness of disclosure in India’s corporate law, there is a pressing need for stronger enforcement mechanisms, simplified reporting requirements, and increased transparency. Stricter penalties for non-compliance should be enforced, while efforts should be made to simplify and standardize disclosure formats for better accessibility. Additionally, promoting investor education and awareness campaigns can empower stakeholders to actively scrutinize and demand accurate and meaningful disclosures.
Addressing these critical issues will be instrumental in restoring trust in the corporate sector, protecting investors’ interests, and fostering a robust and responsible business environment in India.
[1] Rick Wayman, What Is a Disclosure? Definition in Business and How They Work, INVESTOPEDIA, (Jul. 18, 2023, 4:09 PM), https://www.investopedia.com/articles/analyst/073002.asp
[2] CAMBRIDGE DICTIONARY, https://dictionary.cambridge.org/dictionary/english/disclosure (Last visited Jul. 18, 2023).
[3] RICK, supra note 1
[4] Mary Jo White, The Path Forward on Disclosure, U.S, SECURITIES AND EXCHANGE COMMISSION, (Jul. 18, 2023, 4:46 PM) https://www.sec.gov/news/speech/spch101513mjw
[5] Definition Of Corporate Governance, APPLIED CORPORATE GOVERNANCE https://www.applied-corporate-governance.com/definition-of-corporate-governance/
[6] COMMITTEE ON CORPORATE GOVERNANCE, https://www.ecgi.global/sites/default/files/codes/documents/hampel.pdf
[7] Corporate Governance in India – Why is it so critical?, PROSCHOOL , (Jul. 18, 2023, 05.07 PM) https://proschoolonline.com/blog/corporate-governance-india#:~:text=What%20is%20Corporate%20Governance%3F,employees%2C%20government%20and%20industry%20bodies
[8] Madan Bhasin & Adilya Manama, Corporate Governance Disclosure Practices In India: An Empirical Study, (Jul. 18, 2023, 05.22 PM) https://www.researchgate.net/publication/228435019_Corporate_Governance_Disclosure_Practices_In_India_An_Empirical_Study
[9] S. Chahine and I. Filatochev, The Effects of Information Disclosure and Board Independence on IPO Discounts, 46, TJSBM, 227, 219-241, (2008).
[10] George Loewenstein, Cass R. Sunstein & Russell Golman, Disclosure: Psychology Changes Everything, 6, ARoE, 396, 391-419 (2014)
[11] Id. at 410
[12]ICLG,https://iclg.com/practice-areas/corporate-governance-laws-and-regulations/india#:~:text=The%20law%20imposes%20strict%20disclosure,company%20secretary%20or%20manager%20annually (Jul. 18, 2023)
[13] Igor Goncharov & Joerg Richard Werner, Does Compliance with the German Corporate Governance Code Have an Impact on Stock Valuation? An empirical analysis, 14, CGIR, 432-445 (2006) https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1467-8683.2006.00516.x
[14] Securities and Exchange Board of India, https://www.sebi.gov.in/legal/circulars/oct-2004/corporate-governance-in-listed-companies-clause-49-of-the-listing-agreement_13153.html
[15] Ole Kristian Hope, Accounting Policy Disclosures and Analysts’ Forecasts, 20 CAAAACPC 295-321 (2003) https://onlinelibrary.wiley.com/doi/abs/10.1506/LA87-D1NF-BF06-FW1B
[16] Obeua S. Persons, Audit committee characteristics and earlier voluntary ethics disclosure among fraud and no-fraud firms, 6, IJDG, 29 (2008) https://www.researchgate.net/publication/31933180_Audit_committee_characteristics_and_earlier_voluntary_ethics_disclosure_among_fraud_and_no-fraud_firms
[17] Joseph T. Wells, …And Nothing but the Truth: Uncovering Fraudulent Disclosures, JOURNAL OF ACCOUNTANCY https://www.journalofaccountancy.com/issues/2001/jul/andnothingbutthetruthuncoveringfraudulentdisclosures.html
[18] Allen L. White, Why We Need Global Standards for Corporate Disclosures, 69 LCP 167 (2008) https://www.jstor.org/stable/27592143
[19] Baruch Lev “Intangibles: Management, Measurement And Reporting” BIP 97 (2001) http://www.jstor.org/stable/10.7864/j.ctvcj2rf2
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