The content of disclosed information

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.

efficacy of their use for disclosure purposes into questions.⁶⁶³ As the name suggests, annual accounts are published only once a year for lack of time and resources, and often when they are published they are already old and do not reflect any longer the financial situation of the company.⁶⁶⁴ Additionally, because of their nature, namely reflecting the past financial performance of the company, they cannot serve as a basis for assessing or forecasting the probability of the company’s insolvency. To forecast insolvency, the company’s prospects and future plans are more relevant.⁶⁶⁵ Moreover, in the case of private limited liability companies, annual accounts might suffer from insufficient reliability due to their lack of skilled personnel and control mechanisms, which larger companies possess, to ensure that annual accounts are correctly compiled and can be relied upon by the interested readers.⁶⁶⁶ Against this backdrop, Mülbert suggests that an assessment on the company’s probability of default for a given timeline by the directors might be much more useful information for creditors upon which they can act accordingly.⁶⁶⁷ Merkt, on the other side, suggests the disclosure of a somewhat different kind of information, namely the publication of the results of the solvency test, including either the liquidity test or the balance sheet test, or a combination of both.⁶⁶⁸ However, both proposals are subject to limitations. Mülbert argues that evaluating the probability of default is a difficult task especially with respect to private limited companies, which lack the abilities and resources to do that accurately. Moreover, directors might be tempted to lie if they realise that the company has a higher probability of default.⁶⁶⁹ As for the proposal by Merkt, the solvency test itself is subject to the fierce debate⁶⁷⁰ as to whether the liquidity or the balance sheet test is more accurate to assess the solvency of a debtor or its ability to remain solvent. Additionally, the period of time,

663 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 24; Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 109.

664 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 24; Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 109.

665 Ibid., p. 109.

666 Ibid., p. 109.

667 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 25.

668 Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, p. 111.

669 Directors will be more tempted to lie in this case ‘since it would be difficult to detect ex-post whether the directors had lied about the probability of default or whether they had correctly calculated but were proven “wrong” by subsequent developments.’ Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 25.

670 See eg. Interdisciplinary Group on Capital Maintenance, European Business Law Review, 2004, 921;

High Level Group Report; Schön, European Business Organization Law Review, 2004, 429; Schön, in:

Eidenmüller/Schön, The Law and Economics of Creditor Protection, 186; Armour, European Business Organization Law Review, 2006, 5; Rickford, in: Eidenmüller/Schön, The Law and Economics of Creditor Protection; Mülbert/Birke, European Business Organization Law Review, 2002, 695; Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006; KPMG, Feasibility study; Boschma et al., Alternative Systems.

which the solvency test should cover is also issue of content with some scholars suggesting six months, and some others one year.⁶⁷¹

In face of the limitations mentioned above, Mülbert suggests that a less demanding requirement would be to disclose periodically whether the company has sufficient capital, i.e. that it is not undercapitalised.⁶⁷² However, this requirement suffers from an even more severe limitation, namely that there is no universally agreed criteria as to what would constitute sufficient levels of capital for a certain company considering their risk profile. Not only there are no accepted criteria on the issue of undercapitalisation, but also the setting of these levels is even considered by courts and legislators as arbitrary and economically inefficient.⁶⁷³

Alternatively, Merkt points out to an alternative and innovative idea to improve the quality of mandatory disclosure,⁶⁷⁴ namely the idea advanced by Hertig that suggests to require banks that have adopted the Internal Rating Banks Approach (IRB) following the implementation of Basel II Accord to disclose the results of their internal ratings for calculating capital requirements for companies applying for debt capital.⁶⁷⁵ In his paper, Hertig maintains that disclosing internal ratings by banks might lead to a reduction in the cost of capital for both publicly-held and closely-held firms, as investors would have richer and timelier information about the company than the information provided by the external rating firms.⁶⁷⁶ Additionally, disclosure of bank internal ratings would make smaller firms attractive to private equity investors, who would benefit from lower costs of information gathering and processing and in turn facilitate smaller firms’ access to finance.⁶⁷⁷

Despite the perceived benefits from the disclosure of banks internal rating, the idea however carries also non-negligible risks to the banks disclosing the information as well as to the

671 Interdisciplinary Group on Capital Maintenance, European Business Law Review, 2004, 921.

672 Mülbert, European Corporate Governance Institute Working Paper Series in Law, 2006, p. 25.

673 Ewang, 2007, p. 18.

674 Merkt in: Eidenmüller/Schön, The Law and Economics of Creditor Protection, pp. 111-112.

675 Hertig, European Corporate Governance Institute Working Paper Series in Law, 2005, pp. 8-13.

676 Hertig, European Corporate Governance Institute Working Paper Series in Law, 2005, p. 9. Listed firms would benefit from increased stock prices as investors will expect lower returns following the disclosure of private information, whereas non-listed firms would profit form an improved loan pricing.

677 Hertig, European Corporate Governance Institute Working Paper Series in Law, 2005, p. 9. It is generally difficult for smaller firms to get a reliable rating from an external rating firm because the rating costs and risk are not considered worth the reward. As a result, private investors would need to expend more efforts and money to gather reliable information about smaller firms. Disclosure of bank internal ratings mitigates this problem by economizing on the information gathering and processing costs.

companies, the information of which will be disclosed.⁶⁷⁸ Thus, banks disclosing the internal rating will be faced with an increased risk of being held liable for the accuracy of their ratings.⁶⁷⁹ Additionally, disclosure of bank’s internal rating might trigger early termination of loan covenants with companies facing difficulties, and like this exacerbate further the situation of the debtor company and of its creditors, especially of unsecured and involuntary creditors.⁶⁸⁰ Moreover, it is debatable whether the information contained in the bank’s internal ratings would serve the average creditor of a company who is not a financially literate investor.⁶⁸¹ IRB ratings might not meet the “easy to be understood and to be acted upon” criteria suggested by Mülbert⁶⁸² and therefore might nor serve an effective mechanism of creditor protection.