In Defense of Transparency September 6th, 2011 Tim Dooling, CFAIn a perfectly transparent world, there would be no incentive for the con-artist to play the shell game. It simply would not work, the artist’s financial incentives for creating the deception would not exist. Wouldn’t that be nice. Traditionally corporations tend to treat financial information as “confidential” and therefore are loathe to disclose any more than they have to. Why is this? The answer is easy; since financial statements are the ultimate scorecard of a managers skill, the less information disclosed provides potential critics with less ammunition. This is where the shell game begins. In the situation of a private corporation, the management generally relies on a prosaic presentation of summary information as sufficient. What they are doing is nothing different than the three-card-Monte dealer. All may not be as it is portrayed, for instance: “Revenue is growing and our balance sheet is strong, thanks for calling” - This could also mean “We are selling $10 bills for $8.50 and doing lots of business, we noticed our cash was running out so we sold securities diluting your interest to .00001% in return for more cash” In a Perfect World What would be wrong with full transparency? Would it not allow everyone to make more informed (hence better) decisions. Hmmm…. If a customer or supplier had full information to assess the creditworthiness of a company, would they not offer better prices? It would speed the process of prosperity for good businesses and the demise of bad ones. This is a good thing, that is how capitalism works. Instead here in 2011 we have an edifice of law that protects and encourages the three-card-Monte dealer. It hinders proper evaluation of investments and is essentially a tax on society. A bad company with a good lawyer will destroy vast amounts of value before their inevitable failure. This should not be the case. If a business is prosperous, why not advertise that prosperity to gain better terms from suppliers and customers? Oh, you say because that would alert the world to the opportunity the company is enjoying and invite competition……hmmmm….. So is it preferable to hide in a dark cave fearful of competition? That is tantamount to admitting to have a low skill level which would not be able to succeed in a fair game. Therefore the principal should hire a better agent. The Informational Advantage and Agency Problem Just as time is money, so is information. To withhold information is to withhold money. To the extent a manager (an agent for a principal) can withhold information from the principal for whom they are supposed to be acting on behalf of they will. This creates conflict. In my world obfuscation of information is the same as withholding it. It is not sufficient to supply information buried within the dense legal text of some agreement, yet this happens all the time. In fact the reality of the recent financial crisis is exactly this. Unskilled agents made poor decisions which they insulated themselves from with legal formulations. Wall Street sold toxic assets because they had an informational advantage, and a thick prospectus. The Directors who hired the unskilled agents had "Directors and Officers Insurance", insulating them from the consequences of their poor decisions. Again shifting the ultimate cost along to society at large.....This is the reality of our society today which is sadly distant from the vision of the founders. An investor (or Principal) via a Board of Directors hires a manager (an Agent) to run a company. That manager is supposed to utilize their specialized knowledge for the benefit of the Principal. Seems easy enough until you try to do it. What happens is that the manager gains access to information and can choose which information to share with the Principal. How do they decide what information to share with the Principal? In my experience it is only the information which is in the best interest of the Agent, not the Principal…..hmmmm. |
