The Institute’s Corporate Governance Paper Competition is held annually to raise awareness of corporate governance issues among local undergraduates. This year’s competition was held on the theme ‘Corporate governance means more reports and disclosure?’ The second part of the winning paper, published here, finds that more disclosure does not necessarily mean better corporate governance.

T he first part of this article, published in last month’s journal, explored the relationship between corporate governance and disclosure. In this second part, we move on to the main argument of the study – that disclosure and reports are necessary for, but not by themselves enough for, good corporate governance.

While good reporting and disclosure practices are certainly a part of good corporate governance, more disclosure should not be regarded as a panacea for all problems. For one thing, the presence of more information in a market does not always result in a more accurate perception of market value. This might be because of the complexity of transactions involved or because of an over-reliance on third-party credit ratings.

Imperfect information

1. Complexity of transactions

In an article in the University of Illinois Law Review (“Rethinking the disclosure paradigm in a world of complexity”, vol 2004), Steven Schwarcz highlighted the dilemma that some structured transactions are so complex that disclosure to investors of the company originating the transaction is necessarily imperfect – it either oversimplifies the transaction, or provides detail and sophistication beyond the level of comprehension of retail or even most institutional investors and financial analysts.

One recent example is the subprime mortgage crisis where disclosure regarding mortgage-backed securities (MBS), collateralised debt obligations (CDO) and other asset-backed securities (ABS) generally complied with the respective laws and regulations, but the complexity of the transactions seems to have made the disclosure inadequate. Many investors still made the wrong decisions. These facts apparently go against the predominant view that full and fair disclosure of all relevant aspects of the securities enables investors to be protected as they can evaluate the merits of an investment and fend for themselves.

As many transactions have become too complex to be understood by ordinary investors, there has been an increased reliance on expert analysts. Although the costs incurred in hiring experts are usually kept below the benefits generated, a cost-benefit balance may be out of equilibrium when a company enters into more complicated transactions.

2. Over-reliance on rating agencies

Over-reliance on rating agencies such as Standard & Poor’s and Moody’s might also offset the effect of disclosure. Instead of flipping through pages of a prospectus, investors sometimes take a short-cut and rely on the rating given by the rating agencies. Investment fund managers are also inclined to follow the crowd because a fund manager who suspects a stock is overvalued but does not act on his analysis and simply follows the crowd will rarely be blamed for a poor investment decision when the stock ultimately crashes since his peers made the same mistake. This kind of collective thinking together with over-reliance on credit ratings diminishes the effectiveness of disclosure.

Too much disclosure?

Disclosure can be a double-edged sword. It is true that, generally, when more information is disclosed stakeholders are better able to monitor the management thereby improving the company’s value. Too much disclosure, however, can reduce the company’s value and lead to other side effects.

Increased accounting costs

In the wake of the subprime mortgage crisis and subsequent financial scandals, more disclosure requirements have been imposed on corporations. Catering for additional accounting and audit requirements, firms have to incur extra costs in preparing their financial statements and audit reports.

The Sarbanes-Oxley Act of 2002 was enacted in the US in response to corporate and accounting scandals such as Enron. According to section 302 of the Act, the signing officer is responsible for certifying that the report does not include any untrue statements or material omission or be considered misleading, and external auditors need to issue an opinion on whether the management maintained effective control over financial reporting (see

Hong Kong has its own accounting standards called Hong Kong Financial Reporting Standards (HKFRS) issued by the Hong Kong Institute of Certified Public Accountants (HKICPA) and based on IFRS. It should also be noted that HKICPA issued ‘HKFRS for Private Entities’ as a financial reporting option for private entities on 30 April 2010 in order to ease the reporting burden of private entities by relieving them of the requirement to apply full HKFRS.

Leaking information to competitors

A company’s management can be reluctant to disclose certain information for fear of providing rivals with too much knowledge and statistics and threatening its competitive edge. Some information, where it is not ‘inside information’ as defined by the Securities and Futures Ordinance, may need to be kept for internal use instead of being made public.

Increased managerial compensation

Benjamin Hermalin and Michael Weisbach have shown (see ‘Information disclosure and corporate governance’, The Journal of Finance, Vol. LXVII, No.1, February 2012) that increased disclosure tends to bring about greater equilibrium in managerial compensation. CEO compensation is expected to increase due to an ‘exogenously imposed increase in the quantity or quality of information that needs to be disclosed about a firm and its managers’. It is also argued that even in the absence of any bargaining power, managerial compensation will rise as a compensating differential because better monitoring tends to adversely affect managers.

Value-reducing activities

When more disclosure and explanations are required to be made to shareholders, managers might lose the incentive to set ambitious goals to create more value to the company. Increased monitoring measures may induce managers to engage in value-reducing activities, so as to make them appear more competent.

Transparency means good corporate governance?

This study has argued the benefits of increased transparency, but good corporate governance is about much more than disclosure. A transparent company, for example, is not necessarily practising good corporate governance – to determine that you would need to look at its record in a number of key areas.

Rights and equitable treatment of shareholders

Emphasis is put on equitable treatment of all shareholders, including minority and foreign shareholders, in the corporate governance framework so that they can seek redress in case of a violation of their rights. The OECD corporate governance principles provide some guidance in protecting shareholders:

• within any series of a class, all shareholders should be treated equally in voting rights

• insider dealing and abusive trading is not permitted, and

• members of the board should disclose to the board any conflict of interest they may have in a transaction.

Interests of other stakeholders

If we follow the traditional shareholder approach, only shareholders’ interests should be emphasised because the shareholders’ claim is consistent with the objectives of the company to generate wealth, and they are at greatest risk. A broader stakeholder approach, however, considers that the rights of stakeholders who are not shareholders, such as customers, employees, creditors, suppliers, local communities, etc, should be respected and taken into consideration in making business decisions.

For the long-term success of the company, it seems that the interests of other stakeholders and shareholders ought to be compatible with each other. The idea is that maximising customers’ satisfaction and improving employees’ welfare should have a positive influence on achieving the corporation’s governing objectives and reinforcing shareholders’ interests. Good corporate governance is indeed, as Dr Sumanjeet points out in his book Balancing the Interests of Shareholders and Stakeholders through Corporate Governance, the ‘reconciliation of otherwise diverging interests’.

Responsibilities of the board of directors

There is a division of power between directors and shareholders, dictated by the companies’ memorandum and articles of association as well as the Companies Ordinance. Hong Kong’s Corporate Governance Code (the Code) published by the Stock Exchange of Hong Kong also requires a clear division of the responsibilities of the management of the board and the daily management of the business. In Hong Kong, boards of directors comprise executive and nonexecutive directors, including independent non-executive directors (NEDs). It is required that there are at least three independent NEDs present in the board; they bear the same fiduciary duties as executive directors.

The Code stipulates that the company should be led by a board which assumes responsibility for leadership and control of the company. It is important for the board to make decisions objectively in the interest of the company. The board should also review the contributions of the directors and ensure that they perform their duties to the company to attain effective corporate governance.

Directors’ responsibilities include:

• acting in good faith and honesty and exercising independent judgement with due care and caution with regard to the interests of stakeholders

• exercising power in accordance with laws, agreed terms, and articles of association, and

• avoiding conflicts of interests.


Good disclosure practices are integral constituents of good corporate governance. The recent global financial crisis and various scandals have strengthened the need to enhance corporate transparency. Yet, owing to the inherent limitations and insufficiencies of disclosure, more disclosure does not necessarily mean better corporate governance. Excessive disclosure might even create an adverse impact on a company’s competitive advantage and add to its costs. In order to achieve better corporate governance, other factors in addition to appropriate disclosure mechanisms are vital – including protecting shareholder rights; balancing the interests of all stakeholders; ensuring the company has a competent board; and ensuring directors behave ethically.


Tommy Lau

Undergraduate, Bachelor of Business Administration and Law, University of Hong Kong


Integrity starts at the top

The importance of integrity and ethical behaviour in business should never be underestimated. Mervyn King believes that ‘Good corporate governance is about intellectual honesty and not just sticking to rules and regulations’ (see King Report on Governance for South Africa, 2009). As many commentators have pointed out, the most important criterion is that senior executives need to set the tone at the top. Firstly, an ethical leader is capable of shaping the organisational norms in a positive direction and his/ her behaviour is the benchmark of what standard of business ethics the members of the company should attain. Secondly, people tend to equate the image of the executives with that of the company. Therefore, ethical messages conveyed by the managerial team affect the company’s brand directly.