Critical elements for an efficient protection through disclosure

Whereas there is not much dissent about the rationales of mandatory disclosure, there is however much debate regarding several other issues, such as what company types should face mandatory disclosures,⁶⁴⁵ who should be the addressees of the disclosed information; what kind of information should be disclosed; how detailed should the information be in order to strike a

639 Sørensen, European Business Organization Law Review, 2009, 255, p. 266.

640 Actually, the shareholders have a right to information about the company’s business, a right that goes hand in hand with the share capital they own. The thesis of the uniform right of information, thoroughly discussed by Roth, Das einheitliche Recht auf Information, pp. 182 ff., holds that once a legal relationship (like for example that between a shareholder and a company) gives rise to the right of information, that right includes all kinds of information that are necessary to satisfy the information need of the party claiming the right of information, in our case, of the shareholder.

641 Sørensen, European Business Organization Law Review, 2009, 255, p. 266.

642 In practice though this is very difficult to happen. In an innovative economy, access to information on innovation is limited at the outset only to some market participants who will also exploit it to their own advantage. Schön, Journal of Corporate Law Studies, 2006, 259, p. 272.

643 Extending the uniform right of information, that shareholders enjoy (see Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 111), also to other investors, could address the issue of unfair treatment.

644 Mahoney, University of Chicago Law Review, 1995, 1047. Schön, Journal of Corporate Law Studies, 2006, 259, p. 273.

645 In the US, only listed companies are subject to mandatory disclosures, whereas in Europe all sorts of incorporate companies are subject to European directives on discloure. Schön, Journal of Corporate Law Studies, 2006, 259, p. 260.

balance between the comprehensibility of information useful to serve as a self-help tool for creditors and the costs related to such comprehensibility, considering that information needs of the various creditors types of a company may vary considerably; when and how often should information be disclosed and in what way should it be disclosed; and last but not least who shall police the disclosure of information to ensure observance with the disclosure requirements, which is necessary to maintain confidence in the markets and stability of debtor – creditor relationships.

As to the question of to whom should the disclosure be addressed legal scholars⁶⁴⁶ make different proposals, because of the different target groups they have in mind. Some commentators do not specify any particular type of creditor to whom disclosure should be addressed, but focuses more on what type of information should be addressed and when,⁶⁴⁷ whereas some others suggests that mandatory disclosure should target the “financially literate investor”⁶⁴⁸ referring mainly to investment companies and fund managers⁶⁴⁹ and not to the proverbial small trader or supplier dealing with a private limited liability company. As a matter of fact the key issue is the “what”

of information that should be disclosed compared to the “how” this information is to be disclosed. Determining who the audience of the disclosure is, has a major bearing on the type of information to be disclosed, because creditors and equity investors are not interested on the same type of information about a company. As Merkt rightly points out, “the typical share capital investor is looking for return on investment whereas the average creditor is looking for return of investment”.⁶⁵⁰ These diverging expectations on the company have a bearing on the type and amount of information that is to be disclosed. The capital market investor needs the kind of information that would enable him on a daily basis to decide whether to keep the investment with the current company or to reinvest it,⁶⁵¹ whereas the average creditor needs basically the information whether the company is sufficiently solvent to repay the credit and the interest when

646 See eg. Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, and Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection.

647 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, in pp. 24-28 categorises mandatory disclosure in “related” and “non-related to insolvency”.

648 Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 116 argues that nowadays Europe’s financial markets traditionally are more intermediary-oriented, and therefore the addressee of the disclosed information has changed from the creditor himself to the intermediary.

Hence, disclosure need no longer be primarily tailored to the knowledge of the unsophisticated or average investor, but rather to the financially literate investor.

649 Merkt, in: Ferrarini et al. Reforming company law, p. 29.

650 Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 110.

651 E.g. information on promising research and development or innovative business strategies. See Schön, Journal of Corporate Law Studies, 2006, 259, p. 272.

they fall due.⁶⁵² Merkt maintains that while equity investors need more information on a more frequent basis to make their investment decisions, average creditors have no such need, as they are interested only in information about events that might threaten the debtor’s solvency and thus trigger the creditors’ reactions to that.⁶⁵³ However, this does not mean that equity investors and average creditors need completely different sets of information to protect their interests. Merkt establishes a strong link between the disclosure of information to equity investors and the protection of average creditors’ interests: “the higher the standard of investor disclosure, the less comprehensive creditor disclosure is needed.”⁶⁵⁴ In supporting this reasoning, Merkt maintains the idea that smaller and unsophisticated creditors reap the benefits of protection when sophisticated and powerful creditors impose certain standards of behaviour on debtor companies.

Furthermore, the average creditor is also not willing to spend money in collecting and analysing information pertaining to the financial position of the debtor if they can spread the risk by means of diversification or including possible losses in the prices they charge to the debtor.⁶⁵⁵ However, the difficult question of how much information is necessary to enable creditors to satisfy their needs for information⁶⁵⁶ and like this help themselves still remains. Ideally it should be all the amount of information that a creditor needs to calculate the appropriate risk premium.⁶⁵⁷ However, issues of information complexity and information overload arise.⁶⁵⁸ Additionally, it could be prohibitively costly for the producer of information to make disclosure on an ongoing basis.⁶⁵⁹ The company would be busy just producing the amount and the type of information that the various investors would require of her and she would stop then doing the business she should actually be doing. Therefore, a balance needs to be struck between the benefits of mandating

652 Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 110.

653 Ibid., p. 111.

654 Ibid., p. 111.

655 Ibid., p. 111.

656 Roth, Das einheitliche Recht auf Information discusses thoroughly in his book the need, recognized by law, of shareholders for information on the company. Although in the focus of his discussion are the shareholders, by analogy, one can extend the need for information about the company also for the company’s creditors. This need can either be recognised by statutory law or by the contract underlying the relationship between the creditor and the debtor company.

657 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 24.

658 Information could be difficult to understand and costly to interpret. Additionally, too much information would not improve the knowledge level of investors either. It will be difficult for them to digest all the information, and therefore they might be able to act upon that information. See Sørensen, European Business Organization Law Review, 2009, 255, pp. 272-5.

659 Cost of information include the assembling of information, its verification (e.g. by employing an auditor to improve the credibility of information) as well as its publication through the means of mass-media.

See Schön, Journal of Corporate Law Studies, 2006, 259, p. 276.

disclosure, the type and amount of information that should be disclosed and the costs of producing comprehensible and useful information.

The situation might seem to complicate further if one expands the question above, namely: “How much information of what type is enough to enable creditors to help themselves?” This is a question of the effectiveness of the creditor protection system, and as such it cannot be seen separated also from the issue of the time when the information is disclosed and the way how it is being disclosed. A list of four prerequisites has been suggested, the fulfilment of which would help achieve effective creditor protection through mandatory disclosure. The prerequisites are⁶⁶⁰: i) information should be easily available, e.g. via the internet from the company’s

homepage or commercial register;

ii) information is renewed periodically, e.g. every three months;

iii) information is standardized, i.e. all companies use the same standardized methodologies and calculations and reporting format in order to enable comparison of data;

iv) information is easily understood and can be easily acted upon accordingly.