Issue: June/August 09
Keep it simple, stupid
Company reporting has become inordinately complex. It frightens the mass of investors for whom it’s supposedly intended. There are ways, with King’s help, to introduce much-needed change.
narrative, n. 1. a story, account, tale; 2. the art or practice of relating stories or accounts. (Webster’s Dictionary)
The purpose of reporting is communicating. In turn, the purpose of communicating is informing. For its part, informing implies that the communications reach their target audiences in ways they can readily grasp. Trite?
Not for financial reporting, it isn’t. Too often, it’s the product of directors who embroider them for spins of marketing and ego; of accountants who produce numbers overpowering in labyrinths of impenetrable detail, and of lawyers who monitor the whole for the minutiae of technical compliance. Then the ratings agencies and investment analysts have a go at interpretation; not too successfully, judging by recent market experience.
Common sense is the casualty. Financial reports have become so formalistic and burdensome that their purpose is undermined. They’re supposed to be comprehensible and friendly to possible users, generally defined as investors and potential investors which effectively extends from anybody who saves to anybody affected by a company’s behaviour, should they find the enthusiasm to plough through the tomes.
Few amongst the broad investment community are qualified in high finance, and still fewer are privy to elaboration from companies’ inner sanctums. Trustees of retirement funds, who frequently represent the largest category of beneficial shareholders, are rarely amongst them.
The problem is not an insufficiency of information. Heaven forbid. Rather, there’s too much to absorb, too much to sift and too jargon-laden to assess. “Effective reporting should take place at least once a year,” says the King III draft code of governance principles. What with all its requirements for economic, environmental, social, sustainability and governance disclosures, the main beneficiaries of phonebook-sized annual reports are not investors but the printers and the post office.
So the wheel for mass communication then turns to the financial media, poor things, as if they had the depth of expertise and insight to perform the impossible. This is set out in the King III report: “The media should ensure that skilled commentators/ journalists are used to report in an analytical, objective and unbiased manner. The financial journalist should guard against sensationalism and report pertinent information accurately.”
Thanks for the advice, Mervyn King. Let’s not now debate whether such aspirational concepts as objectivity and pertinence are absolutes, or in the eye of the beholder, or imply an obligation on the financial media to regurgitate press releases. Propounded as a means for “managing stakeholder relationships”, to which a chapter of King III is devoted, forget it.
In fairness, the chapter is brimful with comparable platitudes. In reality, with reference to the standards of the Global Reporting Initiative ostensibly omitted this time round, they appear to fall short of the more robust approach adopted in King II (see ‘Kings Compared’ box). So short, in fact, that there’s nothing to shake the standard of SA corporate reporting from its unsatisfactory as-you-were comfort zone.
t’s unsatisfactory because it fails to meet key challenges. One is to overcome the information disequilibrium between those who can understand the reporting and those who can’t. Another is to address the access distortions between those who receive it and those who don’t.
The starting point is in the nature of the reporting itself. The technical detail is obviously basic, as is the completeness of directors’ disclosures. Like a good joke, however, it falls down not in the content but in the telling.
Objectivity, pertinence and the rest are primarily the responsibility of companies. For the reporting to be “effective” – King’s term -- the way ahead is narrative reporting. Sadly, in SA there’s still no move to introduce it.
At least the UK and European Union are trying. Although the Operating & Financial Review is not mandatory under the UK Companies Act, as originally contemplated (TT June-July ’06), the European Commission has produced directives likely to have much the same effect. In any event, having prepared for the OFR, British companies increasingly use the business-review section of their annual reports to provide the “strategic forward-looking narrative reporting” that the OFR intended.
Made necessary by the sheer complexity of accounting standards, decipherable by professionals, the review contains key performance measures. Set out as narrative, the layman is told how the company performed during the past year, its position at yearend, and its principal risks into the year ahead. The underlying concept is that stakeholders are able to understand, by succinct presentation, how the company has shaped and is likely to shape. What can be so difficult about that?
Even the world’s largest accountancy firms – KMPG, Deloitte, PricewaterhouseCoopers and Ernst & Young, as well as Grant Thornton and BDO – have declared the present system for communication with stakeholders to be obsolete. They proposed that “static” financial statements be replaced by real-time, internetbased reporting.
They also suggested greater disclosure of nonfinancial information, “customised to the user”, that will help in understanding the direction of a business. This information would include indications of customer retention, employee turnover, and product or service defects (TT April-May ’07).
Surely it’s high time that “effective reporting” was jerked into the internet age, prodded rather than overlooked by King. Nowhere in “managing stakeholder relationships” is electronic communication mentioned, despite its clear advantages in reaching the range of “stakeholders” acknowledged to be far wider than shareholders. Consider, for example, whether:
Said King II:
Says King III:
SAMPLE OF ONE
The chairman of a JSE top 40 company comments:
“The production and distribution of our annual report costs us an arm and a leg. And what do we get for it? Complaints!
“Each year, we get dozens of letters from shareholders to grumble that the reports don’t fit into their mailboxes. So they get notices from the post office advising that there’s something they need to collect. If they knew what it was, they tell us, they wouldn’t go through the hassle of collecting it because they never read it. They write to us asking that in future we don’t send them a printed report but a cheque for the cost of it instead.”
How much more valuable it would be, he suggests, if companies were not only to publish reports on their websites but also make available tools to assist the user; for instance, a calculator with which the user can configure different results assuming different margins.
The electronic tools exist for much more “effective reporting” than King has considered. Its code can open the way. Advancement of such other objectives as enhanced stakeholder participation and corporate transparency go hand-in-glove. At bottom, the challenge lies in reducing the mountain of reporting to a molehill of simplicity.
It calls for concentrated effort. As Mark Twain once noted: “This letter is so long because I didn’t have time to write a short one.” Without a push from King III, this aspect of reporting reform will remain as neglected as it was under King II.
LESSONS FROM THE MELTDOWN
Although most shares in the US are owned by institutions, they say, “it is perhaps time to develop, manage and communicate the company’s strategy as though its primary investor is an individual (because) individuals have longer horizons”.
horizons”. If a company is managed for institutional investors, they ask, which institutions should it care about and for what horizon? “After all, they include everything from pension funds (longer horizons) to hedge funds (short horizons) to arbitrageurs (horizons measured in minutes).”
Companies, they advise, should change their focus to “make financial statements more retail-investor friendly”.