Definition of Financial Disclosure Management and Corporate Governance
Financial disclosure is the process of presenting financial information like financial statements that consist of balance sheets, income statements, and cash flow statements, to stakeholders such as shareholders, investors, and regulatory agencies as a part of legal and statutory requirements.
The purpose of financial disclosure is to provide accurate, transparent, and timely financial information to investors enabling them to make informed investment decisions. The regulators use the information to ensure companies are meeting all regulatory compliances. A stable and healthy financial market with optimized capital allotment depends on the fairness, consistency, and quality of financial disclosures made by the market participants.
And Corporate Governance ensures a company has a due structure and process to ensure accountability and compliance.
Companies require rules, practices, and processes to ensure fair and transparent operations with reasonable accountability. An effective corporate governance structure ensures that the interests of a diverse group of stakeholders remain balanced and the management adheres to guidelines to facilitate prudent decision-making to deliver long-term success for the company. From the regulatory perspective, effective corporate governance helps in fostering a culture of compliance and mitigates risks of fraud and non-compliance while enhancing the image of the organization as a transparent and accountable entity in the eyes of the investors, market, and regulators.
Corporate Governance helps to:
- Distribute rights and responsibilities among different participants in the company such as the board, management, shareholders, and other stakeholders
- Set rules for corporate decision-making
- Establish a structure to define the company’s objectives and the means of attaining them and monitoring and measuring performance against identified goals
- Facilitate a culture of collaboration and compliance in the organization
But the question to explore is if there is a relationship between corporate governance, and financial disclosures and whether an effective former has an impact on the latter.
The Inter-relationship Between Corporate Governance and Financial Disclosures
This century started with one of the biggest financial scandals of recent times. Enron was a turning point for the capital markets worldwide and Wall Street, bringing them all to their knees and leaving regulatory authorities questioning the validity, effectiveness, and relevance of statutory and regulatory compliances.
Enron was engaged in extensive accounting fraud that led to misrepresentations and imprecision in financial reports hiding massive debts through accounting malpractices. The company’s management and board of directors failed to take due cognizance of the fraud and did nothing to prevent them in the first place.
The Enron debacle was a wake-up call for the investors and regulatory authorities and led to several reforms, especially the Sarbanes-Oxley Act or SOX. SOX required organizations to have governance provisions that protected shareholder rights, considered the interests of employees, suppliers, buyers, and the local community, and expanded the responsibilities of the Board and the Directors. SOX brought in obligations like establishing and maintaining ethical standards for officer and director conduct and decision-making and increased transparency in corporate governance practices.
Today, SEC stands strengthened by the regulatory process prescribed by SOX and has an enhanced ability to oversee corporate governance matters and enforce violations.
As we move into the third decade of the century, the SOX regulations and SEC’s role has been critical in ensuring the stakeholder’s interests remain protected, and the management and board are held accountable for their actions even in this digital age. This assumption stands proven by Activision Blizzard Inc., a video game development and publishing company that has to pay $35 million to settle charges for failing to maintain disclosure controls and procedures and for violating the SEC whistleblower protection rule.
Business sustainability rests on a robust corporate governance structure and transparent financial disclosure practices to mitigate risks and protect stakeholder interests in the most efficient manner possible.
The benefits of having a good corporate governance structure and a transparent financial disclosure include:
- Enhanced Transparency and Accountability – A corporate governance structure ensures that the organization has its native set of rules, processes, and policies regarding every operation and business aspect built to ensure transparency and accountability at all touchpoints.
- Building Trust with Investors and Stakeholders – A robust corporate governance with an established channel of communication between various stakeholders helps to build and maintain trust.
- Ensuring Compliance with Regulations – Corporate governance framework enforces accountability and responsibility at each step and thus facilitates a culture of compliance within the organization. It leads to fewer compliance risks and wins the trust of the regulatory authorities that look leniently at companies with a robust structure in place in case of incidents of non-compliance.
- Facilitating Effective Decision-Making – Corporate Governance structure also acts as a catalyst for the management in making decisions that are most effective to achieve long-term business goals while protecting shareholder interest. When management and the Board work within the confines of rules and regulations with established accountabilities, planning and risk management are strengthened, and decisions can be monitored and evaluated for effectiveness.
Effective Corporate Governance relies on the availability of accurate, relevant, and reliable financial information to stakeholders, which is achieved through robust financial disclosure practices.
Challenges In Managing the Inter-dependability Between Corporate Governance and Financial Disclosures
Effective corporate governance and trustworthy financial disclosures are interdependent but, despite overlaps and collective goals, managing this inter-dependability comes with challenges.
Data Management and Storage – In a digital economy large volumes and velocity of data are not restricted to a few sectors. Most businesses generate a considerable amount of data on daily basis, while financial reports consist of data from multiple sources of diverse natures. Business decision-makers are challenged with extracting insights from this complex and large data pool while fulfilling corporate governance and compliance requirements.
Integration – Most organizations have isolated financial disclosures and corporate governance departments with only occasional overlaps. Integrating both departments to ensure collaboration is challenging because of the different systems, processes, and structures.
Ensuring Accuracy and Timeliness of Disclosures – Corporate governance rules and policies can become a limiting factor for financial disclosures if the structure does not accommodate the time-sensitiveness of disclosures. The corporate governance structures should be such that they make the disclosure process transparent, reliable, and smooth by ensuring accountability and internal controls and audits.
Managing Complex Regulations and Standards – Businesses today are global that operate in different jurisdictions and have to abide by complex local and international statutory and regulatory compliances. Not to forget, these standards and mandates are constantly updating, changing, and expanding. A corporate government program of organizations needs to be comprehensive enough to ensure financial disclosures comply with all relevant regulations and laws.
Excessive Executive Compensation – The corporate governance framework of a company provides guidelines to make sure capable executives lead the firm. CFOs need to collaborate with human resources to guarantee executive salary is based on defined performance-based metrics and consists of benefits and rewards for performance.
Conflicting Interests – Companies need to protect and serve the interests of a diverse group of stakeholders and members of the board should not have financial interests in the company to ensure that financial disclosures remain authentic and accurate without any hidden agenda to serve specific interests.
To effectively manage the inter-dependability between corporate governance and financial disclosures, several factors like conflicting interests, regulatory environment, quality and accuracy of financial disclosures, internal controls, and audits should be balanced and aligned with the organizational goals.
Ensuring Transparency and Accountability in Corporate Governance and Financial Disclosures
We explored in detail how a corporate governance framework is essential to maintain transparency and accountability in financial disclosures, and transparent financial disclosures are a testimony to robust corporate governance, looked favorably upon by both investors and regulators; we now come to the point where we discuss how companies can ensure transparency in both these aspects.
Frameworks and Policies – Organizations should invest time in research to develop their corporate governance framework that will help them navigate all the regulatory and statutory requirements while rooted in the core business objectives. Also, policies should be such that they establish unambiguous guidelines and processes, accountabilities, rewards, punishments, and protection for whistleblowers. Corporate governance should drive the compliance culture within the organization to ensure that when the company’s financial disclosures reach investors, regulators, and the market, they are accepted to be authentic and trustworthy.
Adoption of Digital Technologies – Technology has simplified and automated most business processes, especially critical ones like financial planning, analysis, forecasting, and disclosures, and has also been instrumental in ensuring transparency and accountability through features like workflow management, version control, and audit trails. Today, the data generated within organizations are in high velocity and volume while being sensitive and subject to several compliance mandates. A digital platform or solution ensures that companies can run their processes smoothly without compromising transparency, accountability, collaboration, or quality of financial disclosures. Decision-making in modern organizations takes place in a rather democratic fashion with involvement and stakes from different functions. Technology helps meet corporate governance and business continuity goals by making business processes open and accessible.
Development of Standardized Disclosure Processes – Organizations should create a well-defined disclosure process that takes into account all the financial reporting requirements like following the GAAP or IFRS accounting standards, XBRL tagging, and other regulatory guidelines, and also have an independent board overseeing and actively involved with the financial disclosure management within the company. A system of internal controls and audits also helps in ensuring that the financial reporting and disclosure process is optimized, timely and accurate.
Communication and Collaboration between Internal Stakeholders – A corporate governance structure and transparent financial disclosure management need commitment from the senior leadership and employees. People drive the processes, and the best technological interventions can fail to deliver the desired results if people are not on-boarded well. A clear road map to communicate with employees about proposed technological intervention for financial disclosures or corporate governance, transparency about the corporate governance framework, code of ethics, and conduct while ensuring collaboration between the functions to remove any wrinkles in the way processes and policies are comprehended and will get implemented, are some aspects to consider.
Transparent Investor Relations – A healthy two-and-fro communication channel between the company and the investors builds credibility and trust. Companies should engage with stakeholders beyond the annual or bi-annual meetings to understand their priorities and perspectives and use that insight for inclusive decisions in line with investor expectations.
Education and Awareness for Companies and Investors – Companies should also develop strategies to invest in education and awareness initiatives to educate employees, directors, and investors on the importance of robust financial disclosure practices and their role in corporate governance. In the long run, it also helps cushion a company’s reputation by encouraging investors to look beyond in case of an unsatisfactory quarter displayed in the balance sheets.
The Future: Non-Financial Disclosure Mandates and Corporate Governance
The future of financial reporting includes non-financial disclosures like ESG, climate-related risks, GHG emissions-related data, and other impacts a business has on the environment and communities within which it operates. Non-financial disclosures will come with their own set of regulations and require greater prudence and management of data within the organization. Determining the scope of non-financial disclosures will be a significant aspect, which needs to remain aligned with materiality and what is relevant for the investors. Corporate governance will require dedicated policies to cover non-financial disclosures and related data management, with continuous improvement and stakeholder involvement.
Corporate governance and financial disclosures rely on each other to drive an organization towards long-term success by meeting all the compliance mandates and investor expectations. After each financial crisis that rocks the capital markets, investors seek more transparency and accountability from the businesses; an effective corporate governance structure and financial disclosure management can help organizations meet the transparency and accountability challenges.