Consideraciones para determinar la Demanda Máxima Unitaria (DMU)

The demand for financial information arises due to information asymmetry and incentives misalignment between principals and agents (Healy and Palepu, 2001). Corporate reporting serves as a monitoring tool that helps reduce the information gap that arises due to the separation of ownership and control, where principals do not have full rights in decision making and where the agents’ behaviour is unobservable (due to adverse selection or moral hazard). Ideally, corporate reporting and auditing help provide shareholders with reliable and relevant information that is used to assist in the effective monitoring of agents’ behaviour and thus reduce principal-agent problems (Armstrong et al., 2010).

Companies started to report financial information even before it was legally required. The 19th

century provides evidence of an unregulated economy where corporations in the US and the UK present their financial statements to the shareholders, although not legally required to do so (Watts, 1977). In alleviating agency conflicts, the implicit and explicit principal-agent contracts typically use accounting information that includes aspects such as business decisions

taken, usage of resources, and returns generated from investments (Beyer et al., 2010). This

enables shareholders to monitor agents’ compliance with the contractual agreements and to determine whether a firm’s resources are managed in line with the shareholders’ interests. However, misalignment of incentives between principals and agents (principal-agent conflict) can impede managers from conveying reliable information. In a business environment with concentrated firm ownership that is prevalent in emerging countries such as Malaysia, the principal-principal conflict is more likely to prevail. The controlling shareholders (who are also the firm’s managers) have superior firm-specific information than the minority shareholders, i.e., by virtue of being closer to a firm’s production process and other aspects of the firm’s business activities; this gives rise to information asymmetry. Due to the informational advantage that controlling shareholders have over the minority shareholders, they are prone to selectively and strategically disclose information, and may not voluntarily disclose all private information. Controlling shareholders often do not report information that is harmful to their personal interests, e.g. information that indicates extraction of private benefits or firm’s poor performance (Verrecchia, 2001). The minority shareholders are typically at an informational disadvantage, which thus creates or exacerbates principal-principal conflicts (Armstrong et al.,

2010). The information gap that exists may hinder even highly skilled board members from monitoring and evaluating controlling shareholder’s actions effectively (Jensen, 1993).

The regulation of disclosure and auditing is among the mechanisms that help regulate controlling shareholders/managers in the disclosure of certain accounting information levels and improves information credibility. Accounting standards and disclosure regulations are used to regulate financial reporting choices that are available to the managers in preparing the financial statements. For instance, local and international accounting standards are designed to increase the level of transparency and quality of financial information. The accounting standards probably fail because there are forced restatements, but they only fail in extreme circumstances and are therefore actually fulfilling their functions. The reasons why there are rare cases of earnings misstatements, or why their systems generally work, are that the standards are well thought through and are of high quality; hence there are these outliers of misstatements and forced restatements.

Disclosures can be effectively enforced by the regulators (where shareholders are unable to enforce on their own) as regulators can execute certain sanctions that are not available in

private contracting (Beyer et al., 2010). For example, stock market supervision in Malaysia is

performed by the Securities Commission (SC) by setting certain disclosure rules for listed firms. In cases of non-compliance, the SC have the authority to instruct firms to take rectifying actions, make announcements of the non-compliances, or even penalise the firms for such offences (Wan Ismail et al., 2013). Furthermore, by having minimum disclosure requirements as imposed by the ruling accounting standards, the information gap between controlling shareholders and minority shareholders can be reduced (Healy and Palepu, 2001).

Alternatively, monitoring expenditure incurred by the shareholders in hiring reputable information intermediaries, such as auditors, may help align principal-principal interests by scrutinising the credibility of financial statements. External auditors may provide independent assurance on the quality of financial information being disclosed publicly, thereby limiting managers’ ability to engage in earnings manipulation, and thus the incentive to extract minority shareholders’ wealth (Fan and Wong, 2005). Establishing an internal audit within companies acts as an adjunct to the external audit function, the difference being that internal audit costs are incurred by the managers (Adams, 1994). Incurring internal audit costs (i.e.,

bonding expenditure) may signal to the shareholders that managers are behaving responsibly and fulfil shareholders’ demand for accountability. Ideally, disclosure regulations and auditing are among the corporate governance mechanisms that can reduce information asymmetry. Nonetheless, the ineffectiveness of financial reporting regulations and auditing may hinder the efforts of curbing agency problems and information asymmetry in capital markets. Problems specific to Malaysia, such as weak regulatory enforcement, may limit the efficacy of regulations to impede managerial opportunism in financial reporting. Poor audit quality may also render auditing to be ineffective. When there are imperfections in accounting regulations and auditing, among others, it is likely that managers may trade-off between implementing and disclosing accounting decisions to disseminate their superior information on the firm’s performance to the shareholders, and to manage financial information that suits managers’ self-interests.

In the case of Malaysia, notable cases of forced restatement that have emerged indicate the continued failure to ensure that there is reliable and credible financial reporting. In effect, unscrupulous shareholders or blockholders use corporate reporting as a medium to increase information asymmetry by not reporting accurately. Overall, incidences of forced restatement that occur in Malaysia can also be taken as symptoms of poor corporate governance (further discussed in Chapter 2). The Malaysian government, as well as international agencies, advocated that improving Malaysian corporate governance practices is a crucial reform; it is also a significant way of making the Malaysian corporations resilient to any opportunistic behaviour and deviant actions, thus enhancing the quality and credibility of a firm’s financial reporting. As advocated by the World Bank (2000, p. 69), “Deficiencies in corporate governance did not constrain the impressive pre-crisis performance of East Asia’s emerging market economies – but they amplified the subsequent downturns”.