Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Show me the balance sheet

I wrote a column
in the Financial Express suggesting that quarterly financial
disclosures should be improved. In particular, the balance sheet
should be disclosed quarterly:

In the current regulatory regime, Indian investors get to see the
balance sheet of their companies only once a year, while they get to
see the profit and loss information once a quarter. In the context of
the current crisis, we need to change this urgently because the
investor today wants to see the balance sheet as much or even more
than the profit and loss data.

For example, if an Indian real estate company or non bank finance
company were today to give its investors the choice between receiving
a quarterly balance sheet or a quarterly profit and loss account, many
investors would choose to get the balance sheet. Investors are
currently more concerned about declining liquidity and solvency than
they are about declining profitability. Indeed, the maturity and
currency composition of the debt and the debt covenants are very
critical pieces of information in assessing the survival prospects of
these companies.

Another problem is that many companies have adopted the ugly
practice of taking foreign exchange losses to the balance sheet in
defiance of the accounting standards by taking refuge in some
anachronistic arguments of doubtful legality. This means that the
balance sheet is essential even to understand the true profitability
of companies.

In the 1990s, when Sebi mandated quarterly disclosures of abridged
profit and loss data, it was a huge step forward. It moved the Indian
market to higher levels of informational efficiency and greatly
improved price discovery. It would also be fair to say that quarterly
disclosures have done more to reduce insider trading in India than the
insider trading regulations themselves.

The time has now come to build on this and take it forward to its
logical conclusion. In the 1990s, the only feasible mode of disclosure
was a newspaper advertisement, and cost considerations severely
constrained the amount of disclosure that could be mandated. The
regulators therefore chose a minimal set of line items (all from the
profit and loss account) for the quarterly disclosure.

Today online disclosure through the website of the stock exchange
has become the primary means of information dissemination. The stock
exchange data is then republished by several commercial and media web
sites as well as by many online trading platforms. The online medium
is not subject to the severe cost constraints that restricted the
amount of information that could be published through newspaper
advertisements. It is now feasible to mandate comprehensive quarterly
disclosure of information.

In the US, Form 10K for annual disclosure and Form 10Q for
quarterly disclosure are almost identical in terms of the basic
financial data (income statement, balance sheet, cash flows, notes and
other disclosures). India should also move to the same system where
the quarterly disclosure contains all the information required for
annual disclosures under Schedule VI of the Companies Act as well as
the listing agreement.

Under normal conditions, this disclosure regime would be phased in
gradually after extensive consultations and debate. But these are not
ordinary times. The ongoing crisis puts a premium on the availability
of information. I believe therefore that Sebi should take
extraordinary measures to implement this on an emergency basis.

I propose that the top 500 companies (say the BSE 500) should be
required to disclose the complete financial statements (balance sheet,
profit and loss account and cash flow statement along with notes and
schedules) through the stock exchange website beginning with the
October-December 2008 quarter in January 2009. There is nothing to be
done in the January-March quarter because it is coterminous with the
year end. Therefore the remaining companies should be asked to
disclose the extra information from the April-June 2009 quarter.

This disclosure requirement should not pose any problems for the
companies. No sensible accountant prepares a profit and loss account
without preparing the balance sheet and so my proposal would only
require the companies to disclose what they have already prepared
internally.

The stock exchanges may need software changes to upload all this
extra information to their website. But if only 500 companies are
subject to this regime in January 2009, it is quite feasible to upload
the information manually in the worst case. The exchanges should
undertake the extra effort involved in doing this while making
software changes to allow them to handle everything automatically from
July 2009.

On a related note, I also think RBI should require banks and
financial institutions to disclose vastly more information regarding
non performing assets and valuation of financial assets. Accelerated
adoption of accounting standard AS 30 for financial instruments should
also be considered. Current practices allow banks and finance
companies to hide losses by improperly parking assets in the held to
maturity category. This should be stopped. At the very least,
voluntary early adoption of AS 30 should be encouraged. The market can
be counted upon to penalise those companies that choose not to do
so.

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One response to “Show me the balance sheet

  1. ForexTradingSystemCentral November 28, 2008 at 10:47 am

    Very good article that you have written. I agree that more disclosure and transparency can only help the markets.

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