**6. Communication on risk**

with millennial collapse and the efforts of regulatory bodies and States to rectify the situation for the future. Of course, such a regulation causes additional costs of corporate governance for public companies. It has, of course, happened and with the already mentioned SOX [40–42]. The practice of financial reporting is under the influence of financial supervision and obtains the stability of the financial system primarily oriented to the protection of creditors, not the investors and their need for fundamental analysis. The stand point of the possibilities of manipulation and the missing tools against them that have investors toward financial supervision and its direct control subjects, and the standpoint of the implementation of the fundamental analysis of the orientation toward the fair market value seem illogical. Presentation of the aggregate account with estimated entries on the undisputed documented historic value together with the practice of publication of the risk which is exposed to the operations of the public company seems more logical for the purposes of the valuation of the company as investments, or for the purposes of the valuation of its common stock. Starting from the previous practice, it is possible that the financial statements contain a set of aggregate accounts estimated at fair market value and documented historic value together with a report about

The practice of rewarding the management of companies on the basis of the achieved business results has additional forces to earnings management. In this way, the company managements are double motivated for publishing the good business results; once for securing capital provider and second time for personal gain made through shares in the profits and

Manager's reward system is certainly one of the key controversies in modern public companies. One of the recommendations for the investment of the famous Warren Buffett is to buy shares of companies that are run by the fair management. Fair management is one who does not take excessive fees for their work, especially the options on the stocks of the company which they run [43]. With this, Buffet has directly linked to Graham [24], who is also against management compensation in stock options. In addition, here, EFFAS [44] recommendation is: *Remuneration systems should be based on the sustainable, long term development of a company. Extremely high remuneration packages (including base salary, bonus, and stock options) should not occur, since they will not be based upon any realistic underlying business trend. If this is the case, management assumes neither responsibility nor risk. People who are excessively highly remunerated* 

The significance of the problem of rewarding managers illustrates this EFFAS [44] recommendation about paid out dividends vs. paid out bonuses: *This is a crucial and short-term orientated issue. Investment banks, or universal banks in which investment banking is a very significant component, have been paying out overall bonuses in amounts that are similar in size to the overall annual dividend. This practice should be ceased, because shareholders have the right to receive an appropriate dividend payout that is directly related to the overall net profit of a company.* In addition, problem is that this reward, in fact, grants management to itself rather than stockholders. Furthermore,

protection from risk of takeover and loss of its position in company.

*will not necessarily be interested in the long lasting success of their company.*

the risks.

**5.6. Management compensation**

132 Firm Value - Theory and Empirical Evidence

Financial statements are determined as accounting reports on realized earnings power and financial potential. Based on them, one can make judgments about the expected earning power, as well as about the presentation of the risks associated with them. Financial statements presented on the fair market value basis implicitly include risks, but they do not eliminate the need for risk reporting.

#### **6.1. Risk contained in fair value**

Risk is implicitly included in fair market value, because market prices oscillate around assets' intrinsic value, and that is established as present values of expected cash flows discounted by risk-adjusted discount rate. However, this does not mean it satisfies the needs of reporting about the risks of a company's earning power. It is just the opposite.

First, the fair market value can be determined relatively easily for a very small number of company assets, and it is possible to provoke if so the determined values are truly fair. This means that for the majority of assets, it is all about the estimated value instead of the fair market value. Furthermore, it is a subjective assessment made by the company's management as an agent of stockholders and future company equity suppliers Rational investors with risk aversion could not make unbiased decisions based on that information, regardless of what behaviorists thought about them [45].

Second, due to the assessment subjectivity and its burdens of potential conflict of interests between management and stockholders, such assessments are targeted and subjected to manipulation significantly more than this was thought possible based on historic values. These extremely biased information that are based on management's estimates, should serve the investors for their assessment.

Third, only on the perfect market is the value of the company assets equal to the value of its liabilities and equity, and these assets are valued fairly only in conditions of the market equilibrium. Presentation of the assets' fair market value in financial reports does not include a majority of intangibility. It is presented as the sum of the estimated value of the individual, mostly tangible, assets, rather than its value as a whole. Namely, the company's earning power depends not only on the assets which it holds, but also on how those assets are used. The ability to use assets could be judged by observing how it is used in business projects. This means that the earning power is committed by the company's business portfolio, so the value of the business portfolio should match the value of the liabilities and equity, with included adjustments for additional financial risk. When you include the business portfolio approach in the values analysis, the group of companies and the need for group reporting further complicates the valuation.

risk management rather than managing only specific risks. In the US, the before-mentioned financial regulation reform foresees reporting on risk management, which implicitly requires

Public Company Communications with Equity Investors and Firm Value

http://dx.doi.org/10.5772/intechopen.76171

135

Risk reporting and accounting reports are identified as an integral part of the financial statements presented to the public companies stockholders and equity investors of these companies. In this context, setting requirements for this reporting by those who have an impact on the reporting practice are an important step and challenge for the improvement of financial reporting and communication between public company and existing and potential investors in ownership equity. It would not be a good to identify risks reporting, as an integral part of the financial reporting, with drawing up of the accounting reports, as has been the case until now, because communication with the public exceeds the accounting responsibility and activity. Also, it would not be a good thing to reduce risks reporting on the reporting of risk management, which is today's financial supervision request from financial institutions, because it is again reporting evaluated by those who send specific picture to

Although the financial function is one of the fundamental functions of every company, Chief Financial Officer (CFO), as stated in this analysis, is needed only for the public companies. He or she is a member of the company's Board whose key task is permanent communication with the investor's public. In that sense, he is the procurator of the Chief Executive Officer (CEO) in the area of mediation between the needs of the company for the money and capital and investor's public. CFO is also responsible for other financial operations: treasurer and controller of the business. Thus, CFO is the most responsible person for the financial statement presentation, as the CEO Deputy, who bears the ultimate responsibility running the business. An accountant may only be responsible for the preparation and the presentation of accounting statements. Because accounting statements are the basis for the financial statements preparation, the responsibility of the accountant is internal, toward the CFO and the Board, and not external, toward the investor's public. Financial officer is not required in private companies because the integrity of the communication for them is an unnecessary and an expensive activity. These companies report for tax purposes and some wider control

Based on the analysis of the practices and institutional framework of the company's communication with the investor's public, in the context of the totality of corporate management, a special attention is paid to the communication through financial reporting, as it is today commonly observed in the standard set of financial statements, which are indeed accounting statements presented with the combination of historical and fair market prices. The chapter determinates that this reporting practice is not oriented toward investors in public company equities, because this practice enables sufficient insight in the expected earnings power and the risks to achieve it. In that context, a request is set that the correct financial reporting

organization of these efforts.

the investors' public.

**7. Conclusion**

requirements of the State.

Fourth, and also connected with the previous, the assets' fair value implicitly includes the risks of keeping the individual forms of assets. In no way does it include business risks that are connected with the way of combining these assets and using them in the company operations. Thus, it is evident that reporting based on a fair value is not intrinsically connected with risks of expected earning power of the company, and thus, it provides insufficient information about the risks for the investors in the company owners' equity. The risks included in the assets' fair value are not essential for equity investors, but for creditors, and especially for commercial banks that modify its internal credit ratings and so reduce the asymmetry of information in relation to other investors.

#### **6.2. Risk management**

Risk and yield are key value components. Value is realized by risk-reward trade-off during specific time. In the context of economic value, risks determine risk-adjusted discount rate for discounting expected yields, expressed by cash flows. According to modern portfolio theory, the only relevant is systematic or market risk, meaning the risk that could not be avoided by diversification [46, 47]. These assumptions are built into the CAPM [48] as still the most popular model for establishing risk-adjusted discount rate.

The risk of achieving expected cash flows is one of the key value components. It is therefore logical that risk management is one of the areas of value management and a means of achieving greater value. Primarily, this is the management of financial risks, and therefore diversification imposes as a means of reducing risk. Diversification helps avoid a significant part of the total risk, the specific part, based on the principle "don't keep all eggs in the same basket." Diversification is basis for financial investments portfolio management. Although the diversification scope of the real investment is limited, diversification can also reduce the risk of keeping such investments. Thus, regardless of the controversy should the company diversify its activities or not, today, it is difficult to find a mono product company.

The increased importance of risk management outside the diversification area appeared at the beginning of 1970s, when, due to leaving the Breton Woods Agreements and the oil shock, significant currency and interest rate risks have emerged. At the same time financial futures contracts, financial options, and other financial derivatives appeared, as the powerful tools to reduce, and even eliminate these risks [49]. The most intense managing of such specific financial risks was in the banks and financial institutions, partially due to the fact that these companies employed most highly educated and well-trained financial analysts, and partly under the influence of financial supervision [50]. Specific risks managing practice transferred to non-financial companies, so that it has become an integral part of the corporate governance [51].

In modern conditions, risks management becomes an organized activity. Financial institutions are encouraged by financial supervision. Other public companies also require organized risk management rather than managing only specific risks. In the US, the before-mentioned financial regulation reform foresees reporting on risk management, which implicitly requires organization of these efforts.

Risk reporting and accounting reports are identified as an integral part of the financial statements presented to the public companies stockholders and equity investors of these companies. In this context, setting requirements for this reporting by those who have an impact on the reporting practice are an important step and challenge for the improvement of financial reporting and communication between public company and existing and potential investors in ownership equity. It would not be a good to identify risks reporting, as an integral part of the financial reporting, with drawing up of the accounting reports, as has been the case until now, because communication with the public exceeds the accounting responsibility and activity. Also, it would not be a good thing to reduce risks reporting on the reporting of risk management, which is today's financial supervision request from financial institutions, because it is again reporting evaluated by those who send specific picture to the investors' public.
