Information asymmetry
Our week four lecture notes say, “information asymmetry is when it is difficult for the principals (shareholders), to verify the activities of the agents (board of directors and management) because they do not have access to the complete information. (BC Virtual Course Slide Template, pg. 35) There are several ways to reduce information asymmetry in accounting. Some of the strategies that stood out to me included: 1. When a company has good corporate governance, management will act on one accord with the interest of the shareholders. (BC Virtual Course Slide Template, pg. 115) 2. Regulating companies through the SEC. 3. Executing internal controls can reduce information asymmetry by eliminating the possibility of management manipulation to a company’s assets by limiting their authorization power, and making managers aware of employee transactions. 4. “Providing incentives through management contracts to better serve shareholders.” (BC Virtual Course Slide Template, pg. 36) I believe that good behavior or a job well done should be acknowledged to continue to promote ethical behavior.
Although there are several ways to eliminate information asymmetry, I think that one of the most effective systems is good corporate governance. A corporation should include a responsible, accountable, fair, and transparent corporate structure. (BC Virtual Course Slide Template, pg. 34) My reasoning for choosing this system is because it can potentially prevent an issue before it is too late, such as avoiding years of financial misstatements, et cetera. I have learned that although there are internal accounting and auditing departments, it is mandatory that corporations hire external auditors to audit the financial statements before presenting them to the shareholders.
Response 2:
As Professor Goldsmith explained in our lesson this week, several things changed in corporate structure as a result of SOX. The Public Company Accounting Oversight Board (PCAOB) was established, and it now required companies to have an audit committee. Though most already did have an audit committee, the PCAOB also added some regulations:
1) The independent auditor is no longer responsible to the board of directors (BOD) but instead to the audit committee, and the audit committee selects and hires the auditor.
2) The majority of the audit committee members must be independent of the corporation.
3) The audit committee must have at least one expert in financial reporting, and if not, they must disclose this to the shareholders.
4) Members of the audit committee are identified on shareholder ballots (even if they are part of the BOD).
I think these regulations are a good idea. For instance, the point of telling the shareholders in #3 above is that they would not be happy if they heard you did not have an expert on your committee (I know I would not be). I do not think there is a shareholder who would not find these things appropriate. I would be disturbed if the audit committee was entirely composed of dependent board directors, for example.
In forensic accounting I learned the following: 30% of people are always honest, 40% of people’s honesty depends on their environment (thus, the tone management sets is very important) and 30% are always dishonest. I would guess these regulations are most important for those managers of the always honest 30% and sometimes honest 40%, as they provide accountability. So, I think the PCAOB regulations probably are helpful with that first 70% of employees, but I think those 30% dishonest employees will, sadly, always find a way to commit fraud. Therefore, perhaps these regulations have reduced fraud at least somewhat.
Solution preview for the order on information asymmetry
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