Nick Main: Public or private - it’s time to rethink

Nick Main

Proposed new rules requiring private companies to publicly disclose their financial statements have been a hotly debated issue in the past few weeks.

Public submissions on proposed changes to the rules have recently closed amid a flood of publicity.

The proposal has been put forward as part of a fundamental review of the Financial Reporting Act by the Ministry of Economic Development. The filing of financial statements by private companies is just one of a range of important issues covered by the review but is the focus of these comments.

The debate centres on two competing arguments: the public interest argument that stakeholders such as creditors, employees and customers should have full public access to financial information; and the public interest argument around respecting personal privacy and commercial sensitivities.

There are also issues around the imposition of further compliance costs.

The preferred approach in the ministry's paper is to require all "large" non-issuer companies to file audited financial statements.

Only companies with foreign ownership and companies that issue securities to the public are required to file.

Companies who do not have these characteristics can also opt out of the requirement for audit.

Under the ministry's alternative proposal, all companies that are not issuers could opt out of audit and filing requirements if shareholders agree.

The paper acknowledges that the primary reason companies prepare financial accounts is for the benefit of their shareholders. The paper then goes on to say that the interests of other stakeholders should not be disregarded. In this regard, the ministry states that requiring large private companies to publicly file their accounts will help to ensure that those stakeholders who rely or should rely on financial information are also able to gain access to the relevant reports.

For "external" stakeholders such as creditors and other contractors, the paper proposes that the availability of financial information should be an important consideration when entering into contractual relations with a company.

It is further noted that people in the wider community may have an interest if their jobs (employees), businesses (suppliers and contractors, as well as independent but reliant businesses) and the local economy depend on the entity's actions.

Unfortunately, the level of analysis in the paper in support of this measure does not go much further than this.

Perhaps not surprisingly, the reaction from businesses has been almost universally against the ministry's preferred approach - the principal arguments being based on the loss of personal privacy and commercial confidentiality. This is to some degree to be expected, as most of us would not like to have the obligation for increased disclosure about our income or assets, let alone have a cost imposed on us for making that disclosure.

But there needs to be a more considered debate about the issue. At present, New Zealand seems to be the odd man out - Australia has on the face of it a disclosure regime similar to that proposed, much of Europe does (and, in particular, in Britain the definition of a "large" company has a fairly low threshold) although the United States does not.

But that does not reflect the complete view. The Australian scheme appears to be under review (although from the information in the ministry paper the review appears to have stalled) and, in any case, old exempt companies are "grandfathered". There is an increasing recognition of a cost vs benefit argument - Britain used not to have any exclusion for small entities. Unfortunately, the ministry paper does not give a value to the costs incurred by society by the asymmetry of maintaining corporate privacy. Nor does it estimate the costs of moving to a new regime.

I think there is little doubt that there is a wider interest in the economic wellbeing of entities than just that of the shareholders. This wider interest group - stakeholders - reflects those who interact with the entity: suppliers, employees and the local community are often quoted examples. But shareholders have the greater interest and it is important that the cost of meeting the interests of stakeholders, which will be imposed on shareholders, does not exceed the benefit.

Limited liability is, however, a privilege - the limited liability entity where liability does not trace back to shareholders is an artificial construct and it is reasonable there could be some costs associated with adopting that structure. And the costs are not just the cash costs of having financial statements audited and filed. They include loss of confidentiality about commercially sensitive information and the further reluctance of people to grow business above a certain size where their wealth and income is subject to the prurient gaze of the public - there is already some suggestion that the reluctance of business to grow beyond a certain size holds back economic growth in this country.

In my opinion, the paper does not adequately address these privacy concerns, which means considerably more work needs to be undertaken in this area by officials to justify the measures.

Key issues that need to be addressed include: the compliance costs will be substantial, particularly in the light of the move to the New Zealand equivalent of International Financial Reporting Standards which are complex and require substantially more disclosure.

The benefits to legitimate stakeholders of making this information publicly available are not as clear as suggested. In terms of stakeholders such as employees, suppliers and so on, who cannot otherwise obtain financial information, unlike, for example, banks, the paper does not really articulate what readers are likely to draw from these financial statements that will improve their interests. This is of particular relevance given the time delays associated with the filing of any such information.

The proposals also do not apply to all business structures. Structural arbitrage will come into play whereby economically equivalent operations will fall in or out of the rules simply because of the legal form in which they operate - it cannot simply be a trap for the uninformed or unfortunate (that is those who cannot structure to avoid them).

The size of entity to which the new rules should apply.

The criteria as proposed in the ministry paper, while having the advantage of being simple, do not narrowly target compliance to the stakeholder groups that the paper suggests are the ones in need.

It would be nonsense if the compliant organisations were, in fact, only those that were of least relevance to other stakeholders.

As with any reform, it would only be in the public interest to progress with this proposal if the public benefits outweigh the costs.

The document does not enable this analysis to be undertaken.

That analysis may, in fact, indicate a number of other options that may be available to meet the other stakeholder needs while not imposing such significant costs or such an intrusion in terms of privacy or commercial sensitivity.

I am sure a vigorous debate will continue.

* Nick Main is chief executive of Deloitte.