Corporate Financial Reporting: The Price to Pay for Investor Skepticism

CFA Institute will soon release a study that examines investor perceptions of financial reporting effectiveness in the context of the 2008 financial crisis and other events influencing the current financial reporting environment. Further, it considers the types of reforms needed to address investor concerns.

The Association of Chartered Certified Accountants (ACCA) is examining similar issues to ascertain what investors want from corporate reporting. The ACCA’s recently issued report Understanding Investors: Directions for Corporate Reporting — based on a survey of 300 investors — outlines the type of information investors need to make their decisions and the level of trust in the information received. Here are some of the more interesting survey findings:

• 69% of survey respondents say they are more skeptical about the information companies provide since the financial crisis.
• 63% of respondents believe that management has too much discretion over the financial numbers they report.
• While the majority of respondents indicate that the annual report is the most valuable source of information, a significant minority (45%) express concerns about the quality of corporate reporting and that the annual report is no longer a useful tool.

Given the discontent with traditional corporate reporting, the report finds that investors consume information from a wide variety of sources. In fact, 63% of survey respondents say they place greater value on information from outside sources rather than on the company’s own reporting. The ACCA survey found that investors also find it necessary to rely on diverse information sources, such as analysts’ reports and social media, to build as complete a picture as possible of a company’s business.

The ACCA report illustrates the critical relationship between transparency in financial reporting and investors’ trust — and the potential ramifications for investment activity:

“Clarity and transparency matter. More than two out of three investors said they would apply a bigger discount to a company if its corporate reporting lacked clarity. Good reporting can also help to strengthen financial markets and ensure that capital flows to where it can be most usefully invested.

Better reporting is essential to the smooth running of the capitalist system. It helps companies attract investment and build deeper relationships with investors, and it allows stakeholders to develop a deeper understanding of a company’s strategy and position.”

Many of the findings of this report, albeit not all, are consistent with our own research. Our upcoming report will address how investors believe the 2008 financial crisis — and the ensuing five years of economic uneasiness —  plainly revealed the insufficiency of disclosures, especially in the case of financial institutions. It was the undisclosed risks (sub-prime and liquidity risks), judgments and estimates (fair values of certain credit derivatives), and off-balance-sheet items (repos, special purpose entities) that precipitated the problems at many financial institutions.

One of the most challenging aspects of effective disclosures is effectively communicating the judgments and estimates made in preparing the financial statements; providing a clear and complete picture of economic assets and obligations not included in the financial statements; and conveying the risks associated with the business.

The lack of transparency in financial reporting — especially when it involves financial institutions — creates a vicious cycle; it affects the level of trust and willingness to invest, which in turn influences the broader economy. As in the case of the ACCA report, our publication highlights that if transparency in financial reporting is not enhanced, other, less reliable sources of information could become mainstays for investors.

Contact us to request an electronic copy of our upcoming report Financial Reporting Disclosures: Investor Perspectives on Transparency, Trust and Volume, which is scheduled for release in late July.

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