Importance of Financial Reporting in Corporate Governance

Running Head: Financial Reporting and Corporate Governance
IMPORTANCE OF FINANCIAL REPORTING
IN CORPORATE GOVERNANCE

Introduction:
An entity operates its business in an environment that is not isolated rather there are various
parties that are associated with the business of the entity in direct or indirect manner. Due to this
business connection, these parties are always concerned about the financial performance of the
entity and its overall financial situation in the market. Such information is delivered through the
financial reports of the company that are generally prepared and presented in compliance with
the best standards of financial reporting framework. As the readers of financial reports base their
economic decisions, in relation to the entity' business, on such financial reports they expect the
owners and managers of the entity to remain transparent in exposing the true picture of entity's
financial performance. Transparency is the key element of good corporate governance system.
Corporate governance is a system through which an enterprise is managed, directed and
controlled to safeguard the interest of its stakeholders by maintaining proper balance of their
interests. There are broadly two categories of the stakeholders of entity i.e. internal stakeholders
and external stakeholders. Internal stakeholders are those parties that are directly involved in the
operations of the company such as owners, managers and other board members and its
employees. However, external stakeholders are the parties who are not within the organization
but who are concerned about the performance of the company to make certain economic
decisions in relation to that particular entity. There can be various external stakeholders such as
providers of finance-banks or financial institutions, trade creditors, supplier, customers,
government etc. All the stakeholders, whether internal or external, requires certain amount of
financial information about the company to make sound decisions. This information is delivered
to them in the form of financial reports that contains the information of company’s performance
and status in financial terms (Kirkpatrick, 2009). As the financial report is used by the different

stakeholders of the entity for the purpose of their decision making, this report must be prepared
in the most transparent manner so that it can depict the true picture of company’s financial
position. Irrespective of the type of ownership of an organization, transparency and
accountability must be maintained by the owners in maintaining the relationship with its
stakeholders (Graham, Harvey & Rajgopal, 2005).
Corporate governance is being focused these days with the objective of reducing the
unscrupulous corporate practices so as to preserve a fair environment of business. Stakeholders
like creditors and investors consider good corporate governance as the key strength of the
business corporation. The need of improving quality of disclosures made by an entity to the
public through the financial report is continuously increasing because nowadays stakeholders are
paying enough attention to what is being reported and how it is reported by the entities. It has
been generally observed that the major reasons behind the corporate scandals, financial crisis is
the lack of disclosure of relevant and necessary financial information and absence of adequate
corporate governance practices in the areas of financial reporting. As a result of scandals and
unethical financial practices, the regulatory bodies are constantly making efforts to issue
stringent compliance requirements for the reporting of financial information. The accounting
standard setters have increased the disclosure requirements of financial information so as to
protect the interests of potential investors and other stakeholders of the reporting entity. Thus, as
a part of good corporate governance practices, entities must provide accurate, relevant, fair and
timely information to the stakeholders regarding the financial performance, ownership and other
corporate governance issues. Entities with better governance mechanisms disclose more
information whereas the entities with weak governance mechanism are lacking in disclosures of