25 Jun 2014
Some investors say that cutting volume and clutter shouldn’t be a priority. Hilary Eastman considers their arguments.
You could be forgiven for thinking that investors aren’t happy. There’s a real wind of change blowing, with legal reforms to investment-critical documents such as the auditor’s report; proposals to explode reporting on things like alternative performance measures from the European Securities and Markets Authority (ESMA); and a whole sheaf of papers doing the rounds detailing what type of information investors like and don’t like.
Of the bundle of consultations, proposals and articles that are out there, it’s the CFA Institute’s paper on financial reporting disclosures that’s perhaps most eye-catching. In it, the CFA Institute points out that the conversation about ‘cutting the clutter’ that regulators and preparers have been having has been conceived without the formal consultation of investors. What’s more, according to the paper, clutter isn’t even a priority for the investors they spoke with.
Is that fair? Cutting the clutter is something that the financial reporting community has been talking about for a while now. It’s a pretty big statement that I think deserves some kind of a response. I think that there are two questions to answer here. The first is: are we talking to investors when we come up with all these initiatives? The second is: is ‘cutting the clutter’ really something that isn’t important?
My answer to the first – from my perspective anyway – is an emphatic ‘yes’. The reports the CFA Institute paper cites maybe didn’t survey investors before coming to their respective conclusions. But at PwC we’re talking to investors – in fact, we’re publishing a survey of investors in the next few weeks to get their views on alternative performance measures, and will publish two others later this year. We consider investor surveys to be an essential component of our research into and recommendations for improving financial reporting.
The second question is a little more complex. I think that there is some confusion here between clutter and volume. The CFA Institute reckons financial reporting has become more complex and much bigger because business has become more complex and much bigger. The paper is very strongly against reducing volume as a priority, saying that there are some things that actually need including and clarifying, rather than taking anything away.
I would agree with that volume isn’t top of the list for improving financial reports, but only cautiously: yes, investors deal with high volumes of information every day. And they can deal with high volume financial reports. But no one wants to see a report that’s long for the wrong reasons. So I think in that sense, volume certainly should be up there as a primary concern, but not as a problem in itself. But when you start thinking about volume carefully, you begin thinking about things like materiality and clarity of communication. To my mind, clutter is different from volume, but they are closely related.
Take ESMA’s proposals on alternative performance measures (APMs). This is a good example of why volume should be, if not a top priority, at least front of mind. The proposed guidelines aim to pierce the veil of ‘widely diverse financial information’ by pushing companies to define APMs, reconcile them back to the most appropriate figure in the financial statements and explain why they have used them – in every case. When we’ve spoken to investors, they’re almost universally in favour of these concepts. But they’re worried – and so am I – that the proposals are too prescriptive as well as too broad. First of all, they could discourage companies from reporting using APMs in the first place– and that would be a disaster; investors use APMs to gain a better understanding of entities. Secondly, the proposals – followed to the letter – could just result in epic amounts of boilerplate information, which is useful to no one.
Clearly there’s a bit of a ‘Goldilocks syndrome’ going on with the idea of volume: not too much, not too little – but just right. From my perspective, too much volume can be a bad thing when its source is over-prescriptive or legislation that is too broad. But as the CFA Institute says, too little means you could be omitting things that investors desperately want—or need—to know about. How to get it just right then? And whose problem is it?
Many point to the accounting standard setters and regulators. Some point to investors demanding more and more information. Others point to auditors requiring companies to check the box on every item that standard setters and regulators require to be disclosed. Why is HSBC’s 2013 annual report 598 pages? The financial statements are nearly 150 pages. But where do the rest come from? A summary of the financials alone is about 30 pages. There are also directors’ statements and, as a bank, numerous risk disclosures. How to get the right balance, and get the relevant parties talking, will be key to solving the problem of too much volume, as well as too much clutter.
I think it is also important for companies themselves to play a part – keeping the focus on the quality of disclosures is key. The CFA Institute is rightly worried that the opacity in financial reporting could continue into the post-crisis era if it’s not addressed. They take a tough line, but they’re right. The focus should be on quality and what changes should be made whilst listening to the whole range of stakeholder voices.
But is there a grand conclusion to be drawn from the criticism and calls for reform? There isn’t always a neat answer, but there’s one thing that everyone should bear in mind: do your research. Firstly, as many stakeholders as possible – including investors and analysts – should participate in standard-setting consultations; secondly, preparers should sit down to come up with big ideas to innovate in financial reporting, and they should ask their shareholders and analysts for their ideas on how to cut clutter while staying relevant.
Come and listen to the experts discuss clutter, volume and other key disclosure topics at our annual Meet the Experts conference
|Financial statement presentation||Communication and presentational enhancements||Most troublesome disclosures||Considerations to incorporate in decisions to improve disclosures||Considerations specific to the development of a disclosure framework|
|Disaggregation||Integration||Estimates, judgements and choices||Materiality||Focus on equity investors|
|Direct method cash flow statement||Entity-specific information||Risks||Technology||Include disclosure objectives|
|Cohesiveness||Emphasising matters of importance||Off-balance sheet items||Costs and benefits||Maintain specific disclosure standards|
|Roll-forwards of key balance sheet accounts||Organising and layering information||Commitments and contingencies||Behavioural elements||Disclosures should be a focus, not an afterthought, in development of standards|
|Simple language||Intangible assets||Comprehensive information source|
|Tables and charts||Going concern issues||Applicability (entities and reporting periods)|
|Go beyond requirements if necessary|