| Author: | Fan, Kin Nang |
| Title: | Buried signal in financial reporting |
| Advisors: | Wu, Qiang (AF) |
| Degree: | D.B.A. |
| Year: | 2024 |
| Subject: | Financial statements Auditing Hong Kong Polytechnic University -- Dissertations |
| Department: | Faculty of Business |
| Pages: | ix, 132 pages : color illustrations |
| Language: | English |
| Abstract: | This thesis, to the best of my knowledge, is the first to discuss the buried signal in financial reporting. A buried signal is a signal sent in a manner such that the information therein is not directly observable. In financial reporting, companies may choose not to send a signal, or they may send a signal, either voluntarily or because it is mandatory. When they have positive information, companies send a signal voluntarily even if disclosure is not mandatory. When they have unfavourable information, if disclosure is voluntary, companies prefer not to send any signal rather than to send a buried signal. However, if disclosure is mandatory, the cost of not doing so is prohibitively high. Therefore, in the case of mandatory disclosure and unfavourable information (or bad news), companies prefer to send a buried signal. They may do this using the technique of a nudge, with or without auditors acting as spin doctors to aid in burying the signal. Companies may also strategically use the inattention or limited attention of investors as an alternative or additional burying device. Certain investors may take action according to a buried signal, but their action is considered noise in the market, as such investors are very few. As such, the market cannot observe a buried signal in financial reporting but only a clear or no signal. I show that a non-cash special dividend, declared before a company proceeds with an IPO, that is used to offset a loan due from its directors or shareholders constitutes a buried signal. It is mandatory for dividends (in cash or in specie) to be disclosed in an IPO prospectus; therefore, it is in the interest of pre-IPO companies to send a buried signal of such non-cash special dividends. In addition, I demonstrate that directors who instruct their companies to advance them personal loans are likely to be grandiose narcissistic leaders because they have multi-layered personality attributes, including a sense of entitlement to favourable treatment and a lack of empathy, that enable them to exploit their companies, fellows, or subordinates for their personal gain. My empirical results also show evidence that there is a positive association between the non-cash special dividends and accounting-based performance measures of listed companies after initial public offerings (IPOs). This is explained by the existence of narcissistic leaders, who are likely to manipulate profits by accrual earnings management. Focusing on a sample of companies that issued non-cash special dividends before their IPOs in Hong Kong, I found no material effect on accounting-based measures of performance, even when Big 4 auditors were appointed by these companies to verify whether their financial statements were true and fair. This may indicate that Big 4 auditors cannot influence the accounting decisions made by narcissistic leaders. I also found that high ownership (where a director holds 75% or more of the company shares) had a negative correlation with these firms’ accounting-based measures of performance. This may indicate that narcissistic leaders with significant stakes in their companies avoid engaging in earnings management, either because they have sufficient self-confidence in their company to not feel a need to manipulate accounting figures or because they understand that the application of accrual-based earnings management techniques may negatively affect their share price, as investors perceive such practices as indicating poor earnings quality. To address the issue of companies using nudges, with auditors as spin doctors, to bury unfavourable signals, I recommend that the listing rules be amended to require a company to appoint independent, non-executive directors (INEDs) not less than one year before an IPO. As INEDs are responsible for appointing auditors, this would reduce companies’ incentives to use auditors as spin doctors. Moreover, when the INEDs acquired sufficient knowledge about the business and the company operations, they would be able to identify buried signals in a draft prospectus and propose further information disclosure or amended presentation to ensure full and frank disclosure of the information therein. Alternatively, or in addition, profit or salary tax could be charged against loans advanced to directors or shareholders. Furthermore, I argue that voluntary disclosure of financial information can deter companies from sending buried signals. It is feasible to rely on voluntary disclosure if investors deem that any information withheld by companies is bad news and if the cost of sending a negative signal is lower than the cost of sending none, as is the case because investors react disproportionately negatively to the absence of a signal. |
| Rights: | All rights reserved |
| Access: | restricted access |
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| File | Description | Size | Format | |
|---|---|---|---|---|
| 7305.pdf | For All Users (off-campus access for PolyU Staff & Students only) | 3.14 MB | Adobe PDF | View/Open |
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