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).

Home Stretch for Revenue Recognition Changes

Calendar-year public companies will begin to apply new rules for revenue recognition in Q1 2018. Some companies adopted it already, such as Raytheon, Alphabet, and Microsoft. Be on the lookout for information in the 2017 Q3 10-Q as well as the Q4 2017 earnings release and 10-K documents for company guidance on the impact management might expect. The FASB also has a series of sector-specific Q&A webcasts for investors:

    •  Aerospace
    •  Airlines
    •  Defense
    •  Healthcare
    •  SaaS
    •  Software
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.
While investors have always considered a mosaic of financial and nonfinancial information in coming to their decision to provide capital, the last thirty years has seen an explosion in the availability of different kinds of data.

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.
For companies, the process users go through to analyze the disparate sources of data could be seen as a risk that information conveyed in one communication channel contradicts that in another. Sometimes, the regulatory filings are prepared by the financial reporting team, the press releases and investor roadshows information is prepared by investor relations, the sustainability information by another team, and so on. Processes naturally developed that way, but it’s probably time to re-examine that process to ensure that there aren’t glaring inconsistencies in communication messages.

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.