Significance of Financial Reporting
The Collapse of the Corporate Giants like Enron and WorldCom have raised the imminent question, which always remains in the back of an investor¡'s mind, "Can I trust my hard earned Capital in somebody else's hand?" This is not the first time that investors have lost their trust in companies however the fact does not change that the cost of capital from the market has increased significantly for the companies. Investors have started to invest their capital in risk free securities rather than in company stocks.
Investors have also started to look with contempt and doubt at a company¡¦s financial reports because some of these collapses were preceded by financial frauds cleverly covered by the management of such companies. Investors have arrived to a stage where they no more trust the financial reports provided by the company. However some of the intellectuals believe that financial reporting is of no significance for investment decisions. The reason being the fact that most of the financial reports are historical and they have already been taken into consideration while deciding the price of the stock of the company and it also does not give an idea about the future position of the company.
On the other hand there are also some intellectuals who argue that there are still a lot of investors who still takes their investment decisions on the basis of a company¡¦s financial reports. Ask investors what kind of financial information they want companies to publish and you'll probably hear two words: more and better. But let's face it, the financial statements of some firms are designed to hide rather than reveal information. So what would ensure investor¡¦s trust in companies and its governance? The answer is a good, future oriented and more transparent financial reporting system.
One cannot deny the importance of a good financial reporting system for ensuring sound corporate governance. There is now a clear need to restore confidence in capital markets and elsewhere by enhancing corporate governance in order to provide financial information of the highest quality.
The lifeblood of markets is information and barriers to the flow of relevant information represent imperfections in the market. The need to sift and correct the information put out by companies adds cost and uncertainty to the market¡¦s pricing function. The more the activities of companies are transparent, the more accurately will their securities be valued.
A basic weakness in the current system of financial reporting is the possibility of different accounting treatments being applied to, essentially the same facts.