Mitigating Information Asymmetry Between Inside and Outside Directors On the Corporate Board
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Owners (shareholders) of a corporation do not directly run the business. Instead they elect directors as their representatives and assign them with responsibilities for overseeing the entire business. The directors, in turn, hire management who is responsible for running the business for the best interests of owners and accountability for the operating activities. The purposes of the accountability are twofold: evaluation of the management’s performance and provision of financial reports for the stakeholder’s decision making. Even though the management should strive to provide reliable financial reports, he often distorts them due to various motives. Such a fraudulent financial reporting hurts not only employees, vendors, creditors, or investors, but credibilities of financial reporting, which is essential for the smooth functioning of the securities market. Loss of public confidence to the transparency of financial reports may bring the collapse of the securities market. To restore the public confidence, government has endeavored to set up various rules and regulations. But creating an environment that reinforces fair financial reporting is more effective, because management fraud is extremely difficult to detect. Management is in position to forge the original documents, override internal control procedures, or collude with the third parties to perpetrate fraud without being easily detected. For the directors to monitor the management’s activities and decisions, they must be independent of management. To that end, the majority of the board must be filled with outsiders. But outside directors have less information about business activities than insiders, which hinder them discharge their duties satisfactorily. The board delegates responsibilities for overseeing financial reporting and internal control procedures to the audit committee. The committee maintains close contacts with internal and external auditors, and keeps a line of communications with them. By delivering information the committee has gathered to the board, it helps outside directors overcome information deficiencies and exert their expertises. But mere existence of the board and the audit committee filled with independent and expert directors is not enough. The directors must be vigilant and diligent in discharging their responsibilities.
Abstract
Owners (shareholders) of a corporation do not directly run the business. Instead they elect directors as their representatives and assign them with responsibilities for overseeing the entire business. The directors, in turn, hire management who is responsible for running the business for the best interests of owners and accountability for the operating activities. The purposes of the accountability are twofold: evaluation of the management’s performance and provision of financial reports for the stakeholder’s decision making. Even though the management should strive to provide reliable financial reports, he often distorts them due to various motives. Such a fraudulent financial reporting hurts not only employees, vendors, creditors, or investors, but credibilities of financial reporting, which is essential for the smooth functioning of the securities market. Loss of public confidence to the transparency of financial reports may bring the collapse of the securities market. To restore the public confidence, government has endeavored to set up various rules and regulations. But creating an environment that reinforces fair financial reporting is more effective, because management fraud is extremely difficult to detect. Management is in position to forge the original documents, override internal control procedures, or collude with the third parties to perpetrate fraud without being easily detected. For the directors to monitor the management’s activities and decisions, they must be independent of management. To that end, the majority of the board must be filled with outsiders. But outside directors have less information about business activities than insiders, which hinder them discharge their duties satisfactorily. The board delegates responsibilities for overseeing financial reporting and internal control procedures to the audit committee. The committee maintains close contacts with internal and external auditors, and keeps a line of communications with them. By delivering information the committee has gathered to the board, it helps outside directors overcome information deficiencies and exert their expertises. But mere existence of the board and the audit committee filled with independent and expert directors is not enough. The directors must be vigilant and diligent in discharging their responsibilities.
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