Agency Assurance - Universität St.Gallen

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1.2 Recognition of the Moral Hazard
1.2.1 Higher Incidence of Information Asymmetry
To understand how the corporate governance system of checks and balances failed, it
is important to answer the question, “What caused the catastrophic reversal of trust in
the financial markets for corporate shares at the turn of the century in 2000” It is now
known that the public was fed false as well as falsified investment information as
related to securities of publicly traded corporations. As time advanced it also appears
that the frequency and size of the misleading disclosures, that is the incidence and
impact of information asymmetry, grew.
First, dissatisfaction with financial reporting standards was almost universal, leading to
new and different reporting methods which were more easily accepted, whether or not
they were more accurate or truthful. Many investment allocation decisions were made
with resultant wrong or biased information. Second, corporate executives, who are
entrusted to act as agents of the shareholding owners, either themselves believed, or
they did not fully question, the false information, or they even participated in its
falsification. They failed to fulfill their fiduciary responsibilities to society in favor of
supporting their own personal interests. Third, the professional accounting firms
routinely missed key indicators and issues during their legally required audits of
companies, while financial analysts and investment advisors continued to recommend
the purchase of company securities, sometimes long after it was clear to them that such
investments were no longer advisable. The public depends entirely upon these
certified public accountants and licensed financial advisors to have the professional
training and methods in place to appropriately and independently evaluate the financial
condition of these businesses.
Finally, and most critically, the board of directors of each of these corporations was
unable to protect the interests of their stakeholders, i.e. owners, claimants, employees,
suppliers, customers, and society in general. Relying on the same faulty disclosure
system as the investors, they did not realize the risks inherent in the company’s
business practices. Despite their apparent positions as insiders with authority over
management, directors, usually unwittingly, allowed company executives, investment
bankers, and auditors to expropriate company assets to support their own personal
interests ahead of corporate interests.