Economics 101 Supply and Demand Concepts Applied to Financial Reporting Disclosure
Harken back to your days as a college student sitting in that Economics 101 course and the professor is enthusiastically explaining supply and demand concepts by using the term “widget.” This term, which represents an abstract unit of production, has helped many to understand introductory economics. Now, imagine the professor explaining supply and demand using “financial reporting” instead of “widget.”
The authors of an article in Accounting Today did just that, although they take the analogy even further. In the article “Financial Reporting Economics: It’s a Good Idea to Supply What’s Demanded,” authors Paul B.W. Miller and Paul R. Bahnson argue that, in economic terms, the best financial reporting* should be demand-driven.
That hypothesis, if true, means that a lot of conventional thinking is wrong. Invoking the famous Henry Ford quote, “Any customer can have a car painted any color he wants so long as it is black,” Miller and Bahnson say today’s managers, auditors, and regulators have effectively declared, “Users can have any financial information they want so long as it complies with GAAP.” In economic terms, managers who think this way are purely using supply-side reasoning.
Unfortunately, that often leads to uninformative and less useful financial reports, say the authors. A better way of achieving the best financial reporting, according to Miller and Bahnson, is to use demand thinking. In this scenario, the investors’ desire for truly useful information should inspire the type of information to be pushed to them, whether it complies with GAAP, is non-GAAP, or is some other format.
The article in Accounting Today resonated with me because I also believe demand thinking should drive the production of high-quality, useful reports that, in turn, benefit the capital markets. My beliefs are backed up by survey data.
In a previous blog, “More Transparent Financial Reporting Disclosures Needed to Boost Investor Trust,” my colleague, Mohini Singh, highlighted the report, Financial Reporting Disclosures: Investor Perspectives on Transparency, Trust, and Volume, which is based on surveys of CFA Institute members and our longstanding dialogue with the investment community. Based on the findings, the report provides recommendations on how to improve the effectiveness of financial reporting. True demand-side thinking.
*Corporate financial statements and their related disclosures are fundamental to sound investment decision making. The well-being of global financial markets, and of the investors who entrust their financial present and future to those markets, depends directly on the information financial statements and disclosures provide.
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