Economic agents were traditionally forced to generate funds by themselves. Upon stating up a business entity, the owner was required to possess most of the capital and would collect the additional necessary one through loans from either individuals or specialized institutions. Gradually, the capital requirements became more easily to satisfy as the incidence of financial institutions increased. In other words, banks supported the development of the business sector through the granting of loans to economic agents in all stages of development.
Within the modern day era, economic agents are presented with yet another means of collecting capital -- the issuing of stocks. The issuing of shares is based on the principles of the company issuing a valuable paper for which the individual or corporate investor pays a specific amount of money. Upon completion of the fiscal year, the economic agent that initially issued the stocks is able to participate in the distribution of the company profits.
Today, issuing equity is a highly common and popular means of raising capitals. But aside from the advantages it generates, it is also characterized by the fact that it involves a tedious and expensive legislative process. Specifically, it is legally required of the economic agents issuing stock to complete a wide array of procedures through which to disclose company information to the current and prospective investors.
In the era of information and in a time in which investors already know company information before it is actually released by the firm, a question is being raised relative to the actual need for the disclosure procedures. The current project seeks to respond to this question.
2. Problem statement
As the economic agents decide to raise capitals through equity, they are requested by the federal legislation to complete a series of disclosures about the internal state of the company. And these disclosures have to be carried out throughout the entire period in which the company has publicly traded stocks. This specifically means that periodically, the firm will have to invest resources in researching, constructing and disclosing reports to the investors.
The process is extremely tedious and it is also highly expensive. And at the internal level, it creates operational inefficiencies as staffs have to be taken out of their regular positions and tasks in order for them to handle the disclosure procedures. At a fiscal level -- which is best able to offer a depiction of the costs involved for firms -- it was estimated that the small and medium size firms come to spend 0.036 per cent of their total revenues on disclosure procedures. In 2007, a study found that a small and medium size enterprise is estimated to pay $0.7 million per annum for disclosure operations. Two years before this study, different researchers had estimated annual disclosure costs at 0.4 trillion.
The procedures of disclosure were initially created in order to provide investors and prospective investors with the information necessary in making a business decision. In other words, the main scope of the disclosures is that of ensuring transparency and easy access to information. Today however, this access to information is increased as it is supported by the impressive developments within the Information Technology industry. In this order of ideas, it is often the case that the information presented by the companies in their disclosure documents arrives at a time at which the players in the financial market are already aware of its contents. Otherwise put, the disclosure documents are mere and expensive confirmations of the information already public and known by the investors.
Another issue is raised by the fact that it is uncertain who actually reads the disclosure documents. Also, it is undetermined whether the documents generate an actual and measurable impact upon the price of stocks. This information is useful in the context in which the average time for which a share is held is of 22 seconds. It is as such possible that the owner of a share for 22 seconds does not spend time and energy reading the disclosure documents.
Based on this new context and features of the investment market, a question is being posed relative to actual need for the disclosure documents. In order to identify a final answer, emphasis would be placed on the following questions:
Do the benefits of disclosures outweigh their costs?
Do the disclosures impact the total mix of information in the market place?
Do the disclosures impose discipline upon the organizations?
3. Raising capital through equity
Equity borrowing is a more and more common form of raising capitals and this is due to the numerous advantages it generates.
A first advantage of equity funding is revealed in comparison to the alternative to equity funding, namely raising capital through bank loans. In the case of a bank loan, the company has to make specific payments at specific dates. Equity funding is however more flexible as the company will not have to make monthly payments nor will it be pressured by the bank to bring in collateral and sign restrictive contracts. Within equity funding, raising capital and repaying it is more flexible in the meaning that the dividends are only paid at the end of the fiscal year and are dependable on the profits generated. In other words, while in the case of loan funding, the company has to pay the rate and the interest regardless of its development, in the case of equity funding it only pays dividends if it registers profits.
Another advantage of equity funding is that it can generate continuity. More specifically, when the investors -- the equity holders -- are convinced of the firm's long-term sustainability and when they start to witness economic growth, they are likely to further invest. Additionally, some of the investors might possess useful knowledge and expertise they could offer the firm and as such further support its development (Business Link).
Equity funding is often used as a form of employee motivation. In this order of ideas, organizational leaders decide to allow the employees to purchase company stocks and as such share in the company profits. This technique allows the employees not only to increase their earnings, but also creates a context in which they unify their personal goals with the overall goals of the entity. Subsequently, the staff members are more motivated and enhance their performances in supporting the company to attain its objectives.
Despite the advantages however, equity funding is also characterized by a wide array of limitations, presented throughout the following lines:
The fact that third parties outside the firms invest their money in the organization gives them rights to intervene in the decision making process. In other words, the economic agent raising funds through securities is bound to lose part of the control over the business decisions. The actual control possessed by the investors depends on the company in the meaning that the more capital it raises through equity, the more control it will transfer to the share holders. Another risk is that as destination of their money, the firm is expected to promote the interests of the share holders and it can be subjected to lawsuits if it is suspected of breaching this commitment (Peavley).
Another important disadvantage pegged to equity funding is based on the legal perception of the capital. In the case of funding through bank loans, the borrowed capital and the payments made to the bank in repaying the loan are perceived as debt and as such not subjected to taxes. In the case of equity however, the dividends paid to the share holders are perceived as profits and as such subjected to taxation. This as such means that funding through equity is more expensive than funding through bank loans.
4. In favor of the disclosure laws and procedures
A major argument against the disclosure procedures is that they are redundant in the modern day context in which information is easily and readily accessible to investors and prospective investors. Nevertheless, it has to be noted that despite this increased access to information, not all investors and prospective investors are computer literates so that they are able to easily and efficiently access the company information. Additionally, the investors are often busy people who do not have time to dig up information about the company from various sources, but they need centralized reports which integrate all the information necessary to making investment decisions.
Another counter-argument of disclosures is that they present information which is already known by the public. As it has been just mentioned however, not all players in the financial market have the time and the resources to browse the internet and the specialized media in search for relevant information on their investments. But even if they did have the time and the resources to research the company, they would still require confirmation for the truth and the validity of the data collected. In other words, however redundant, the disclosure reports are official documents…