For the Investor
By Marc Siegel, FASB Member
Where Corporate Reporting Meets the Markets
People often remark that investors aren’t using financial statements for decision making; some say they are at best confirmatory. Others declare that our rules are designed for a paper-based world while information is increasingly consumed digitally.
Perhaps there is a kernel of truth in these statements. Let me explain. Generally, investors seek information from many, many sources (otherwise known as the Mosaic Theory method of analysis).
I continue to believe that financial statements and the accompanying footnotes are a critical building block. For many investors, the financial statements provide a consistent starting point for analysis and financial models upon which their expectations are based. Furthermore, with the diversity of information available in the markets, as discussed below, the financial statements serve to level the playing field and create more consistency and comparability for investors.
However, in addition to financial information, users increasingly look to nonfinancial data. For example, they
- Study participants in the supply chain of companies
- Perform channel checks at retailers
- Speak to outside experts about particular technologies
- Look for information about governance or environmental impacts or risks.
Many believe that there is significant disclosure overload in the financial statements and accompanying regulatory filings. However, I also note that some information comes voluntarily from companies. A 2016 Wharton study shows an almost thirty-fold increase in the release of some voluntary disclosure (see diagram below). That implies to me that the cost of information has significantly decreased over time in contrast to the computing power of systems available to reporting organizations.
Not surprisingly, investors consider all of this information before making their decisions. To a certain extent, they are indifferent about the distribution channel from which the data comes. More and more of this information is, and will be in the future, consumed automatically.
The next step is critical. Best practice, whether performed by a human analyst or an electronic one, is to scour this information for trends and inconsistencies, or surprises. Ten years ago, I used to do this manually, or perhaps using a tool to compare information gleaned from different sources. Some examples:
- Consider a company that promotes how “green” they are in their corporate sustainability report, while the 10-K includes several pages devoted to a number of environmental remediation contingencies.
- An analyst once showed how a Hong Kong-listed company said one thing in their English financial reports, but used quite different descriptions in their Mandarin-language filing.
- A reporting organization will define a metric such as an allowance coverage ratio one way in a press release, but in a slightly different way in the 10-Q.
This is also an opportunity for preparers. When companies focus in on improving the readability of their information, streamlining immaterial information and ensuring consistency, investors take notice and think of them as more “transparent.”
For example, over the course of several years, GE revamped their 10-K in many ways, to make it more accessible. They tracked the number of downloads of their 10-K and found significantly increased numbers.
Many other companies are voluntarily making improvements to the effectiveness of their disclosures in the 10-Ks broadly, including the financial statements. An October 2016 study from Financial Executives Research Foundation (FERF) and Ernst & Young (EY) gives examples.
The evolution of information availability has broad implications for users and preparers. Irrespective of the channel from which the data is distributed, the quality and consistency of “corporate reporting,” considered broadly, and where it intersects the capital markets can make the difference in how a company is viewed by those markets. Of course, as I’ve described in prior columns (Footnotes vs Face of Financials, The Use of Non-GAAP Metrics), accounting and financial reporting are still critical tiles in the mosaic of the investment decision.