Federal Securities Laws Disclosure Pros and Cons

Federal Securiies Laws Disclosure: Pros and Cons

Federal securities laws disclosure: pros and cons

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 that state the company's position as well as bring confirmations to the investors.

In a different note, the disclosure documents are also advantageous for the economic agents as they allow them to centralize information and present it to the stockholders in a clear and concise manner. This specifically means that the companies can use the disclosure documents to ease the minds of any distressed investors who might have heard a rumor. In other words then, the disclosure documents allow the company to consolidate its reputation and reduce the power of negative rumors in the industry and in the market.

And this ability is generated not only by the presentation of the official figures which testify to the organizational statements, but also by the fact that the disclosure documents are prepared by the firm and the firm can as such integrate information which puts the company in a favorable light. This could for instance mean that the employees editing the disclosure reports could restate the company's mission, values and commitment to the well-being of the customers, employees, the general public, the community they serve, the environment and so on. Additionally, they can also discuss the efforts they have made since the previous disclosure agreements have been issued and present these efforts and strategies in a means which appeals to the investors.

It has so far been established that the disclosure documents increase the access of investors to information and improve company image to as such generate increases in the perception of the company and improvements in its role with the external environment. But aside from these however, disclosure documents also generate internal benefits. In this order of ideas, the preparation of the disclosure documents allows the company to carefully review its decisions, strategies and resources. In this line of thoughts, it could be said that the preparation of the disclosure documents represents an internal process of control and evaluation. This subsequently means that the company reveals an increased ability to prepare for its internal audits, as well as the audits conducted by the Securities and Exchange Commission.

Otherwise put, the creation of the disclosure documents allows the company to recognize any errors, inconsistencies or any other problems at its internal level. As it identifies these issues, it is also able to correct them. Otherwise, the problems might be directly discovered by the reviewing authorities and the firm could be fined or suffer other types of repercussion for failure of legislative compliance. Additionally, the financial disclosures create a context in which the economic agent reviews and corrects legal breaches, but also ethical issues (U.S. Department of the Interior). In other words, it helps it create a more balanced and moral workplace, which in turn stands increased chances of attaining its objectives in a reliable manner.

In the category of both ethical and well as legal issues, the conflicts of interest are also a valid reason in favor of continuing to create disclosure documents.

"The public financial disclosure system is designed to reveal actual and potential conflicts of interest" (U.S. Office of Government Ethics).

Conflicts of interest could be highly damaging for the economic agent as they could lead to corruption or other morally unsound decisions and actions. These in turn could materialize in breaches of legal stipulations or the loss of trust by the various stakeholder categories involved or witnessing the conflict of interest materialize. The creation of the disclosure documents then develops a setting in which the economic agents can quickly identify and resolve conflicts of interests and as such not suffer the negative repercussions.

5. Against the disclosure laws and procedures

As it has been mentioned throughout the Problem statement section, the creation of disclosure documents and procedures is complex and tedious and it even appears as redundant within the modern day community. Today's investors have easy access to the Internet, to company websites and to the media. This specifically means that they gain quick and easy access to company information. If for instance a publicly traded economic agent merges with another entity, acquires a smaller economic agent or invests in another company, the firm would immediately inform the media and the stakeholders of these decisions. But these would have to be reassessed and reintegrated within the disclosure documents to as such result in redundancies. In other words, the disclosure documents are unnecessary in today's community and they represent repetitions of the information with which the public is already familiar.

A second limitation of disclosures is that they generate additional costs for the economic agent. The expenditures associated with disclosure operations have yet to be fully measured and comprehended, but it is generally accepted that they grew in time as the demands for disclosure increased. In other words, minimum disclosure requirements imply lower levels of costs. Throughout the recent decades however, the Sarbanes-Oxley Act and other additions made to the disclosure legislation have increased the demands, to subsequently materialize in an increase in the efforts made by economic agents and their consequent increase in disclosure costs.

"Typically, disclosers' costs increase with the amount, scope and level of detail of information they provide to users. For example, firms providing financial information incur costs in gathering, processing and releasing that information that rise with the stringency of disclosure requirements. The more information required and the more frequently reports must be created, the higher the costs. The average incremental costs of disclosure requirements under the Sarbanes-Oxley accounting reform law were originally estimated by the SEC to be ninety thousand dollars, but more recent estimates put the number at many multiples above that" (Fung, Graham and Weil, 2007).

Aside from the expenditures incurred, the need to comply with the disclosure requirements also generates organizational inefficiencies. This limitation is explained by the fact that the company employees are retrieved from their traditional positions and asked to focus on the disclosure requirements. This means that the traditional core tasks of the employees are neglected for a period of time, with the immediate impact of organizational inefficiencies.

Overall then, aside from being redundant, the disclosure documents also consume high amounts of organizational resources. In turn, this means that the companies come to possess fewer resources to further invest. In other words, the investment budgets are decreased due to the disclosure requirements. In such a context, the economic agents are prevented from fully researching and developing their products and services. Ultimately, the very development of the business community and of the industries is delayed through the disclosure procedures. And this in turn impacts the final consumer at two different levels:

The firm has to recuperate its costs and will most likely integrate it within the retail price of the products to as such force buyers to pay higher prices, and secondly

The firm inefficiencies will delay the creation of higher quality products and services which better satisfy the changing needs of the consumer base.

Another disadvantage of the disclosure procedures is that they could harm the levels of business competitiveness for the economic agents. This is explained by the fact that the company could disclose important strategic information. In the hands of its competitors, this information on the organizational strategies could harm the company. Also, in the case of a public entity disclosing, its reputation could be negatively affected.

"However, disclosers face still more significant costs associated with competitive or political risks arising from reporting -- for example, the risk of a company revealing strategic information useful to competitors or a politician exposing herself in the thick of an election to potential embarrassment because of a particular campaign donor. Providing more detailed information may also open the discloser to grater pressure from certain user groups to adopt costly change policies" (Fung, Graham and Weil, 2007).

Aside from the risk of reveling valuable information to the competition, detailed disclosure also generates the risk of proving too much information to stakeholders. The most relevant example at this stage is represented by the share owners, who do have the right and ability to intervene in the decision making process. They could as such demand that the organization followed a different course of action than that already decided upon by the firm. The most challenging feature of this outcome is that the share owners are seldom business people with an increased analytical ability to make long-term sustainable and responsible decisions. Their emotions could as such interfere with the decision making process and could lead to negative outcomes at the organizational level.

Overall then, it has to be noted that the disclosure procedures generate not only the limitations of increased expenditures for the economic agents, but also industry wide delays in developments, negative impacts upon the customers and the endangerment of the competitive position. All these counter-arguments of disclosure drive the individual to declare against the procedures, but one must not forget about the benefits of disclosure. In order to make the final decision, a discussion is launched throughout the following section.

6. Decision

In order to make the final decision, it is essential to review the arguments in favor and against disclosure documents and procedures in a more schematic presentation. The lines below serve this purpose. Specifically, the advantages of the federal securities disclosure refer to:

The ability to ensure investors' access to information

The ability to confirm information already existent about the firm

The ability to deny rumors

The ability to promote company efforts and as such enhance organizational reputation

The ability to conduct internal evaluations and controls

The ability to prepare for audits by the Securities and Exchange Commission, and last

The ability to identify conflicts of interest and maintain high ethical standards.

In terms of the disadvantages of federal securities law disclosure, these refer to the following:

The redundant feature as the documents only confirm what is already known by the players in the financial market

The costs associated with the gathering, processing and presentation of the information

The creation of operational inefficiencies

The limitation of the investment opportunities

The generation of negative impacts upon the consumers

The exercising of pressures from the external environment.

In a numeric presentation, the advantages of disclosure outweigh the disadvantages of financial disclosure to which stock issuing firms are obliged. Nevertheless, such a comparison and measurement of the advantages and disadvantages is insufficient as each feature is different and generates more or less severe outcomes. The table below reveals the arguments against and in favor of disclosure and assigns a coefficient of importance to each argument. 1 represents the least important and 5 stands for most important.

Advantages

Coefficient of importance

Disadvantages

Coefficient of importance

1.

Ensure investors' access to information

5

Redundancy

4

2.

Brings conformation

4

Costs

5

3.

Controls rumors

5

Operational inefficiencies

4

4.

Improve reputation

5

Decreased investment opportunities

3

5.

Internal evaluation

4

Negative consumer impacts

3

6.

Preparation for SEC audits

5

External pressures

3

7.

Identification and elimination of conflicts of interest