Session 2: Factors Affecting Demand for and Supply of Financial Statement Information

A: Factors affecting Demand for financial statements information
The demand for financial statement information is derived from the improvement in decision making or monitoring that arise with its use.

Potential of the Information to Reduce Uncertainty
An important element in many decisions is uncertainty. There may be, for instance, uncertainty over the future profitability of a firm, the quality of its management, or the ability of a supplier to fulfil obligations under a warranty agreement.

Example: A lender wishes to forecast the profitability of a loan applicant that is in a relatively stable industry, and a presumption of continuity of management appears to be reasonable. In this case, the past and current profitability record can be a very useful starting point when forecasting profitability over the life of a proposed loan.

The Availability of Competing Information Sources
Financial statements information is one of many information sources available to different parties as mentioned earlier. Other sources however, include:

• Company-oriented releases such as divided releases and production reports
• Industry-oriented releases such as new wage contracts with unions, and
• Economy-oriented releases such as money supply announcements.

Financial statements have a comparative advantage over these other sources of information because the financial statements are:

• More directly related to the variable of interest.
• A more reliable information source. One rationale for reliability could be the existence of auditors to certify the financial statements presented by management.
• A lower-cost information source. In most jurisdictions, firms do not charge individual users when providing financial statements.
• A more timely information source. In some cases however, management can reduce the value of information provided by competing sources such as outside agencies by making prompt release of budget information, information on the impact of new events for the firm, and so forth.

B: Factors Affecting the Supply of Financial Statements Information
There are various factors that affect the supply of the financial statements to external parties.
Most are regulatory and the market forces that affect the content of financial reports or the timing with which these reports are released. Management has considerable discretion over the content and timing of the many diverse public disclosures it makes. These disclosures can be partial substitutes for each other with the result that expansion (or contraction) in one form of disclosure can affect the supply of information provided in other forms.

Regulatory Forces and the Supply of Financial Statement Information
A common feature of the financial reporting environment in many countries is the existence of public sector-based regulatory forces that affect the disclosure decisions of firms and other entities. In some cases, specific legislation governing the content of financial reports exists, such as Companies Act in many British Commonwealth Countries. In other cases, legislation associated with corporate taxation is an important determinant of the content of financial statements. In yet other cases, decisions by government regulatory bodies exert an important influence.

Market Forces and the Supply of Financial Statement Information
There are normally three major market forces affecting the content or timing of financial statement disclosures:

• The capital market
• The labour market, and
• The corporate control market.

The Capital Market Forces
Firms normally compete with each other in the capital market on many dimensions, such as the instruments offered (equity securities, preferred securities, bank loans, etc); the terms of the instrument offered (the taxation status of dividend payments, convertibility features of debt, the interest rate on loans, the security offered to lenders, etc); or the distribution of expected returns from each instrument. Market forces can exert pressure on firms to provide financial information that relate to the foregoing factors.

The Labour Market Forces
If left unrestricted, management could make decisions that significantly reduce the value of the equity or debt components of the firm. Consider the following instances:

• Management sells all the assets of the firm, distributing the cash proceeds as dividends to equity holders and leaving debt holders with a “corporate shell”.
• Management reinvest all the assets of the firm in high-variance projects i.e the projects which one can not predict its earnings that redistribute wealth from debt holders to stock holders (due to debt holders sharing in large losses but not in large gains)
• Management paying themselves salaries many times what their counterparts in other firms are earning for comparable jobs, thus reducing the value of both the equity and debt components.

One must remember that the equity and debt holders have a vested interest in reducing the propensity of management to take such actions. Management also can have an incentive to signal to the capital market that it will not take such actions. These incentives arise from the labour forces.

Managers who are not willing to agree to constraints being placed on their behaviour or mechanisms being put into place to monitor their actions may not be hired, or if they are hired, they may be paid relatively low salary.

Labour market forces can arise from both external sources e.g. via changes in the marketability of executives to other firms, or/and internal sources e.g. via changes in promotion prospects, salary etc.

Corporate Control Market Forces
Managers appear to value very high their ability to control the financing, investment, and operating decisions of firms. Attempts by external parties to take this control from existing management often encounter stiff opposition.

Example: In the situation of takeover, there are always battles between existing management and an unfriendly suitor. One tactic that managements can use in such a battle is to release financial information that they perceive will increase the likelihood of their retaining control.

Discussion 5
Post your response in the discussions area. (See the procedure for discussions in Course Info.)

1. What factors affect the demand and supply of financial statement specifically to the telecommunication companies?

2. What are your general suggestions on the supply of the financial statements of the telecommunication and ICT companies to the following specifically to your country
• Regulatory body
• Association of telephone/ICT operators
• Registrar of Companies
• The accounting board
• The capital market and securities authority