Full Disclosure: Mixed Blessing for the Everyday Investor?

Full disclosure is a principle of Generally Accepted Accounting Principles (GAAP) whereby a company lists all items that may affect its underlying value on a financial statement. Some items may not typically show up on a financial statement, such as outstanding lawsuits or losses to be expected in the immediate future. With full disclosure, companies would list these items on a memorandum or an accompanying addendum. Full disclosure is meant to give all stockholders the opportunity to see a full picture of the company's financial status. However, the good intentions often go awry.

Advantages of Full Disclosure

  • Companies must disclose pending gains and losses--Often, a company will post an excellent quarter but know the results will not last long. This can be the result of outgoing payments that have not yet come due, an outstanding lawsuit or other liabilities that will soon be called in. Currently, those liabilities are not listed on the financial report. With full disclosure, these items would be listed. This prevents a company from putting off making a payment or listing a loss until after the reports have been turned in. This practice can falsely inflate the financial standing of a corporation. The intent of full disclosure, then, is to keep companies "honest." 
  • It provides a more complete financial profile - Since the outstanding gains and losses a company expects in the immediate future are listed, a financial report with full disclosure provides a much more complete picture of the general welfare of the organization. For example, if you have just received your paycheck but have not yet written your mortgage check, you may see a large balance in your bank account. Reporting only this amount to a lender or interested party would be inaccurate since you know a large check is about to be deducted. Full disclosure would require you to note the pending payment, giving a clearer picture of your financial standing.

Disadvantages of Full Disclosure

  • It favors sophisticated investors--Many investors will lack the knowledge to accurately factor in outstanding liabilities to an existing financial report. For example, an everyday investor may not understand the implications of a "cyber liability" lawsuit. A more sophisticated investor can anticipate losses due to this problem. The sophisticated investor would have the advantage when it came time to interpret and act on the facts presented. 
  • It can create unnecessary panic--The concept that full disclosure creates more market stability is based on a theory of the rational investor. The rational investor considers all information at hand and acts intelligently. Unfortunately, studies consistently show that individuals and whole markets are not rational. On the contrary, many investors act in ways that would be considered irrational, reactionary or even fear-based. This is often called "panic" on the stock market. If a company lists an outstanding liability in a financial report, there is a chance irrational investors will act irrationally. This is particularly true of those everyday investors who are less likely to interpret the data analytically. 
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