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Private Benjamins: What Should Private Companies Disclose?

Key Takeaways

A few private companies that drew big headlines and even bigger valuations have imploded, taking investors’ cash down with them. Should we require private companies to tell us more? Is that like forcing teens to post on social media when they’re still in their sloppy, angst-filled years? Nemit Shroff shares his thoughts!



Private Benjamins: What Should Private Companies Disclose

Steve: Hello, and welcome to Off the Books, where we're surfing the unchartered waters of accounting, finance, risk, and wherever else the waves take us. This episode is brought to you by Workiva, the risk, reporting, and compliance platform that simplifies your complex work and perhaps even simplifies your New Year's resolution diet and exercise plan. Check it out at My name is Steve Soter, accounting enthusiast, Diet Coke aficionado, and today's host. I'm looking forward to debiting a great conversation today, and I'm very glad to have you hanging ten with us. I'm also very glad to have Catherine Tsai hosting this episode with me. Catherine, can you please tell the fine folks at home who you are?


Catherine: Well, I'm not an accountant or Diet Coke aficionado, but I like asking questions and learning new things and writing about it later. So I'm here to ask more questions.


Steve: Well, I love it. And Catherine, thank you again for joining us. As you know, we spend a lot of time brainstorming show ideas for this podcast. What can you tell us about today's episode? Because I believe today's episode was your idea.


Catherine: Yes. Well, recently there was a speech by SEC Commissioner Allison Herren Lee in which she basically raised the question of whether private companies should be forced or required to make public disclosures as well. There, according to her, is a lack of transparency in private markets that needs to be addressed. Some private companies are now bigger than public ones. So should they be required to disclose more information? We reached out to Nemit Shroff, an associate professor of accounting at the MIT Sloan School of Management, and he's written extensively about the subject of company disclosures.


Steve: Well, Catherine, you certainly have my attention. Let's go ahead and take a listen.


Catherine: Nemit, thank you for joining us today. Could you tell us a little bit about yourself?


Nemit: Well, thank you, Catherine, for having me. A little bit about myself. I grew up in India. I came here in 2011 to pursue my graduate studies, and I went to University of Michigan. Go Blue. I was there for five years and then joined the MIT Sloan School of Management.


Catherine: Steve, if I know that you probably have some thoughts about this —


Steve: Yes, I do.


Catherine: — as a former finance and accounting person for private and public companies. But Nemit, from an academic perspective, what do you think about what Commissioner Lee is suggesting?


Nemit: I looked at the article that she -- or at least her speech. And I find her suggestion to be very reasonable and in line with disclosure practices in much of the world. The U.S. and Canada are unique in some respects. They don't require any public disclosure from private companies, regardless of their size or economic footprint. So at the big picture level, I think her suggestion is very reasonable. That said, the devil is in the details, as with any policy.


Catherine: What are some of the details? What do you think should be a factor in deciding who discloses and what should be disclosed?


Nemit [00:03:10] At the conceptual level, there are two factors that should be considered when thinking about who should disclose. The first is what is the value of a company's disclosure to the broader public, which in academic terms is referred to as externalities? And second is what are the costs of making such disclosures to the company, where the two primary costs to consider are compliance costs and the costs of disclosing sensitive, proprietary information. Now it's reasonable to assume that companies consider the costs and benefits of their disclosure to themselves when making such disclosure decisions. However, it's also reasonable to assume that companies do not factor in the costs and benefits of their disclosures to other stakeholders when making disclosure decisions. And here's where the regulator comes in. So regulators can evaluate the importance of companies' disclosure to the broader stakeholder community and set policy accordingly. So a common sense idea is that mandatory disclosure requirements for private companies should be based on their size or economic footprint, the intuition being that larger companies have more stakeholders, more employees, more customers, more suppliers, and thus there is a greater benefit to public disclosure. While at the same time any compliance, the cost of complying with any regulation has a certain fixed cost element to it. And these fixed costs are proportionately smaller, the larger the size of the company. So both from a cost and benefit standpoint, the larger the company's economic footprint, it seems reasonable that those would be the types of companies that should be required to provide some disclosure, even if they're private.


Steve: So, Catherine, I'll be honest, I had to put on the shelf both my strong opposition to the University of Michigan and this whole notion of private company disclosures. First of all, as you now know, I'm an Ohio State football fan and the most recent loss is still a bit fresh.


Catherine: I'll forgive you.


Steve: I appreciate that. But second, and germane to the conversation, while I understand conceptually that there may be reasons for larger private companies to disclose some things, I just don't understand how you would measure company size in a universally meaningful way. For example, revenue or profit isn't particularly helpful for many companies like take Rivian, for example, who is now a public company, but they have basically zero revenue, but an increasingly large environmental footprint. I mean, what am I missing here?


Catherine: We asked Nemit about that, and here's what he said.


Nemit: So I can tell you what's been done in the rest of the world. And when I say rest of the world, it's most European countries, a lot of Asian countries, a lot of South American countries as well, Australia. Most of these countries, the thresholds are based on two or three factors. So two of them are financial metrics: sales and assets. And the third is employees. Now, of course, these criteria are not set in stone. They can be adapted to something that's more suitable for the needs of, say, an economy like the U.S. And one approach to measure size is certainly the number of employees. But even there that you can envision a company like WhatsApp, right. It was acquired by Facebook, was valued for several billion dollars. But still, I believe there were 12 or 13 employees, which is fairly small. So there are ways to innovate in deciding what the firm size is.


Steve: And it's interesting to think about the implications of the reporting objectives. So this is not a conversation about ESG, but I actually feel like ESG might be a great example. If that were the thing that we were concerned about, then perhaps those metrics need to involve environmental footprint or, you know, greenhouse gas emissions or whatever. Or if it's more about, hey, we want to have more information about the company, maybe I have an employee stock purchase plan, but yet I don't get quarterly or even annual disclosures about financial metrics. I think the challenge that I that I keep coming up with is that even the act of quantifying the magnitude or the scope or the size of the company based on those objectives by itself starts to reveal and disclose certain bits of information that private companies would very rarely disclose. Does it become a bit of a slippery slope?


Nemit: With regulation there has to be some form of standardization, right? So we have to decide on what it means, what is counted as revenue, what is counted as assets. Even for employees, right? Which people might think is a simple way to determine, is a simple number to calculate. The thing is, is a part-time employee an employee? Is a contractor an employee? So there is still some gray area there. But the thing is, the benefits of disclosure for smaller companies with small economic footprints are likely to be pretty small. So the thresholds can be sufficiently large where we just prevent companies like say Koch Industries or Cargill from not having to disclose any information. And that becomes more of a philosophical or vertical or cultural debate as to what is the appropriate size threshold to set when requiring disclosure.


Steve: So, Catherine, what I heard him saying here is that he agrees that setting those thresholds would be tricky to work through, but at least on the fringes, we would get it right. Meaning that the smallest private companies still disclose nothing while the largest private companies still disclose something. Is that what you understood too?


Catherine: Yeah, I think that sounds right. And we'll be on the fringes unless we break for a commercial. We'll be right back.


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Steve: And we are back with Nemit Shroff talking about the pros and cons of private company disclosures.


Catherine: Nemit, it makes sense to me why investors would want more disclosures from private companies. And I think you've talked in your previous work about what the benefits can be for employees of these companies or prospective employees to be hearing more about the private companies that they may or may not want to work for. What are some of the advantages of disclosing more information for the company itself if you're private?


Nemit: First off, it's important to keep in mind, if the benefits of public disclosure exceeded the cost of such disclosure, then we would see private companies voluntarily disclose information. But since we don't see this for the vast majority of U.S. private companies, it's reasonable to assume that on a net basis, the overall costs perhaps exceed the perceived benefits. That said, while overall costs — perceived costs — might exceed the benefits to the disclosing company, disclosure still has some benefits. So, for example, public disclosure is a cost-effective and efficient way for companies to let their stakeholders simultaneously know basic information that everyone might ask for. Basic financial information is something that everyone that transacts with the company would require. That's one. Another more controversial benefit, but one that I tend to believe in, is that this process of complying with disclosure rules, so the process of disclosing information itself, can help managers better understand the information that's being disclosed, and this can improve their decision making. So the idea is that information that is publicly disclosed gets more scrutinized even by managers before they disclose such information, because now the information is public. You are more aware of what is being said. So you think more about what is being said, and that information is more salient. And to the extent that information is more salient to you, and it's important, that can improve your decision making. Simple example is in the early 1990s, stock options were not required to be expensed. So companies basically thought of it as a free way to compensate employees. Prior to 1996, even before there was any disclosure requirement for stock options, the practice of issuing stock options to employees was fairly broad. But yet companies did not have a good record of how many options they were handing out to employees. Once the rules came into place, companies started to collect information about how many options they have outstanding, how many options have actually been issued to employees, and that helped them better understand the cost of such a practice. The true cost of compensating employees. So there's some evidence to suggest that the act of disclosure itself can provide managers with information that is beneficial and useful for decision making.


Steve: It's interesting you bring up that example, Nemit. One of my first accounting memories, which is a pretty geeky thing to say, let's just be pretty clear, but it was actually at that time, and you had people wearing Stop the FASB T-shirts, the Financial Accounting Standards Board that set the rule that those options and RSUs and whatever needed to be expensed. They were protesting to Congress. I was still trying to figure out what all this stuff means, but I still vividly remember when all of that was going on. And on that actually, among all the other disagreements that might exist here in our conversation, I think you are right. Disclosure kind of demands management's attention right, wrong, or indifferent. Right? I mean, if you're going to be disclosing that information, I think you're absolutely right. You do need to be, and will of necessity, be more aware of what it means, especially within the context of other decision making and reporting. So I I'll give you a point on that one.


Catherine: Side note, Steve, do you have a stop the FASB T-shirt?


Steve: I do not have a stop the FASB T-shirt. I've often thought about maybe buying one on eBay. You can actually still buy them. Of course, those are not originals, they're reproductions. But I don't know what I would do with it. I probably wouldn't wear it. If I do wear a T-shirt, it's always under a pullover, so maybe I'm wearing one right now. You just can't tell. Who knows?


Nemit: I do have an I love FASB hat.


Steve: Oh, there you go.


Nemit: It's for my class. It's whenever I teach certain days when I'd like to wear it and show my affection for what's going on.


Steve: I think the thing that I struggle with the most is that, you know, companies need time to grow up, right? They've got to move beyond just the lackluster books and records to something that could stand up to the scrutiny of an audit, for example. You know, that doesn't happen overnight, and this is an extreme example. But I think about this within the context of providing social media for a teenager. Like, what adult person wants to be confronted with their 15-year-old self for the rest of their life, right? The stupid things they said, or the things that they liked or the things that they looked at or whatever. This probably sounds really bad, but it's almost like a lot of that stuff just needs to be swept under the rug until you've reached some kind of level of maturity where that sort of public reporting that is going to live almost indefinitely won't necessarily come back to haunt the company that you will eventually or aspire to become in the future. As I was thinking about this episode, I was trying to get to the heart of why I disagree with this principle so much. And I think that might be it. It won't be a surprise to anybody that my children do not have any access to social media, and I am not a social media user myself. But I mean, do you have a reaction to that, Nemit? Am I missing the boat here completely?


Nemit: No, this is a fair point. In the conceptual sense, this gets to the idea of compliance costs. So some companies are in the business of, say, creating value for the customers, then taking care of the stakeholders like their employees and investors. But if the way in which they create value really does not require them to have safe, sophisticated recordkeeping, then it is fair to say I think that by imposing such requirements, would we then be hurting certain small companies? And that is a fair consideration. So as with any regulation, it's it's not like there is zero cost to implementing any new rule. What it has to be evaluated against is the overall benefits of such disclosure. So even for the company that does not have sophisticated recordkeeping, part of the benefits that you consider is that would it help your own decision making if you knew what all your peers were doing? Maybe you'd feel less opposition towards disclosure if you see that it's not just you that's disclosing, it's everyone else of similar size as well, right? The thing is, yes, while it's costly and painful for you to provide this information, you also get to see what others are doing and then you can learn from those practices. You can learn from what's going on in your industry, in the economy.


Catherine: This is probably the most polite back and forth that I've ever been a part of in terms of people who have totally different views of this topic.


Steve: Oh, I didn't even get into Michigan and Ohio State. Still too fresh. I'm a Buckeye fan, still a little too fresh. Wasn't going to go there.


Nemit: For what it's worth, the five years that I was at Michigan now, we lost Ohio State. Our football team really suffered.


Steve: Oh, yes, they they've I think they haven't won in 11 years or something like that. I don't know what the statistic is. I didn't want to look. I'm still too depressed about that game.


Catherine: Any final thoughts from anybody?


Nemit: I don't think so. I would say one thing the opposition partly or at least, is it's hard to underestimate the opposition that's going to come from a cultural standpoint or protocol standpoint in the sense that whenever I've had this discussion about private companies being asked to disclose information, my colleagues would often say that it's un-American to do this or it's none of anyone else's business what a private company does. It's private for a reason. And so I think even if people agree on the economic costs and benefits of private company reporting, there is also a cultural aspect that needs to be considered from a policy setting standpoint, at least.


Catherine: I appreciate the thoughts that both of you have shared today, and I think we're ready for our closing question of the day. I'm so excited. I finally get to ask one, Steve.


Steve: This is amazing. I can't wait.


Catherine: On the subject of disclosures, what is one corporate disclosure you would really love to know?


Nemit: So I was thinking about this, and I think, you know, so there's this whole academic literature that's based on the idea that the CEOs and CFOs, they're required to sign off on companies' financial statements. And there is the premise that the larger the size of a CEO's signature captures narcissism.


Catherine: That's amazing.


Nemit: I'd like to know. OK. Is that true? Can you ask the employees to ask others? Does your signature size actually correlate with some form of narcissism?


Steve: Huh. You know, a little tidbit. So I have, for several different companies, been the one to collect the CEO and the CFO signature for financial statements and management rep letters and SEC filings and all those things. And I'm not going to name any examples, Nemit, I think you're probably on to something. I think you're probably on to something. Have never drawn that connection before.


Nemit: All right, OK. That's helpful to know


Catherine: That's awesome. Steve, what's the one corporate disclosure you want to know?


Steve: Well, I'm going to give you three, and they're all relevant to me today. The first is now I want to know who's your college football team because suddenly I find myself in the midst of, you know, Michigan blue, where this whole time, these people, I like them, they've got to be Ohio State fans. So, you know, that's there on my list. You will appreciate the fact that I would love to know how many soda fountains they have at their corporate office and what is being dispensed from the soda fountain. You know, you show up and there's Pepsi there, and that's just not going to work. No offense to our Pepsi flavored listeners. But the third, and this is specific to Netflix. I would really, really like to know when Stranger Things, Season 4 is coming out. These kids are all going to be grown up. It's just not going to be the same, and I'm still struggling to find out when I can expect that season four.


Catherine: Fair enough. That's a good answer. I kind of want to know what the recipe is for, I don't know, Ben and Jerry's cookie dough ice cream. How do they get it to freeze, but I can still eat it.


Steve: Good question. I can tell you what's in a quart of that, and it's about 1,200 calories.


Catherine: Don't. OK, that I don't need to know.


Steve: Oh golly. Maybe it's a pint, not a quart. I don't know. But it's a lot of calories.


Catherine: Well, thanks both of you for being here today.


Steve: Well, Catherine, that was a pretty good one. I'd like to think I softened him up a bit. Maybe just like a slightly melted pint of Ben and Jerry's. What do you think?


Catherine: You and Nemit are melting hearts and minds all over our podcast audience. And I think that wraps up today's episode. Big thanks to Nemit Shroff, associate professor of accounting at the MIT Sloan School of Management for joining us.


Steve: And big thanks to you, dear listener, for surfing along with us as well. I'm Steve Soter, and that was Catherine Tsai, and this has been Off the Books. Please subscribe! Leave a podcast review, tell your buddies if you like the show, and feel free to drop us a line Surf's up, and we'll see you on the next wave.


Off the Books season 3


21 minutes


Steve Soter, Catherine Tsai, Nemit Shroff

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