Recent research examining the link between companies’ governance, disclosure practices and equity market transparency has produced some surprising results.
The study looked at over 5,000 listed companies in 23 countries. As might be expected, better-governed companies were found to make more frequent disclosures to the market. But the surprise lies in the finding that better corporate governance was associated with the less timely reaction of share prices. The researchers concluded that, even if information is disclosed more frequently, it does not necessarily follow that that information is reflected in share prices on a more timely basis: ‘We think people are shocked by the amount of information produced and they just can’t process it. It looks like a case of information overload.’
Professionals and corporate governance experts would welcome further analysis of the study findings. ‘There are so many things going on in a market that it’s difficult to isolate any specific factor as affecting the share price,’ says Hilary Eastman, head of global investor engagement at PwC. She also points out that the period covered by the study – 1 January 2003 to 31 December 2008 – includes the start of the global financial crisis, when trust in the market collapsed. ‘So analysis of that period is difficult,’ she says.
Mala Shah-Coulon, executive director and corporate governance specialist at EY, agrees. ‘A lot has happened since then,’ she says, noting that in the UK, for example, 2007 saw the introduction of the disclosure and transparency rules, including the requirement for listed companies to issue interim management statements – an element that is no longer in force. ‘We’ve also had several revisions to the corporate governance code,’ Shah-Coulon says. ‘A lot has changed.’
Nevertheless, the research fuels the debate about the challenges of information overload and the responsibilities of companies and investors to manage information flows so as to support efficient markets.
One of the challenges in digesting corporate information is that it can all seem to come at once. ‘In the UK we have tended to default to a reporting year-end of 31 December,’ says Guy Jubb, global head of governance and stewardship at Standard Life Investments. ‘Many annual reports arrive in a short space of time, so we have an information logjam.’ He refers to the enhanced auditor reports introduced in the UK, highlighting key audit risks and conclusions. ‘There’s a significant risk that they don’t get read in the manner that was intended,’ Jubb says. ‘Timely scrutiny is challenging to achieve.’
One problem in addressing information overload is that investors are a disparate group, so disclosure reduction is difficult. ‘Different investors or analysts play different roles in the investment chain, and they all have different information needs,’ Eastman says. ‘You might cut out something not relevant to one party that is very relevant to someone else. I know forensic analysts who read the annual report from cover to cover and dissect every word. Those are the people that usually uncover fraudulent accounting practices, so you don’t want to take information away from them.’
Another challenge is that some listing rules and regulations may require the reporting of potentially immaterial information. ‘Timely disclosure of price-sensitive information has been one of the cornerstones of the London Stock Exchange listing rules,’ Jubb notes. ‘That needs to be upheld, but it’s a moot point these days as to whether all the information that gets disclosed is price-sensitive. In a takeover situation, for example, we get a never-ending stream of disclosures when investors have changed their positions by relatively small amounts. Do they make any difference? There perhaps needs to be a greater sense of the materiality and relevance of the information.’
‘Part of the problem is that investors are investing in so many companies,’ says Andrew Hobbs, partner, public policy and corporate governance, at EY. ‘They have too much waterfront to cover. That’s why proxies are used so much. The investors we talk to are always looking for flags – for the auditors or preparers to disclose information in a way that flags up issues for them on the governance side. They don’t have the bandwidth to be investigating things themselves. But it takes two to tango. You can’t constantly ask companies to keep on making up for their [investors’] shortfalls. They need to invest in resources as well.’
George Dallas, policy director at the International Corporate Governance Network, says: ‘The issue of how investors are resourced to look after governance and stewardship is key. They probably are under-resourced – particularly institutions with hundreds if not thousands of holdings. How do you look after all these companies? It doesn’t mean companies should be let off disclosing material aspects about their businesses, but there is also a responsibility on investors. Some will subscribe to service providers that highlight anomalies, or they can develop other tactics that might be risk-based. If a problem does emerge, they then want to be able to go to a company’s public disclosures and get a handle on what’s happening that way.’
Investors’ responsibility for monitoring company behaviour is increasingly recognised by the spread of stewardship codes – around 10 countries now have them. Dallas is working with the World Bank on a stewardship code in Kenya. ‘They are popping up all over the place, recognising that investors have rights, but they have responsibilities as well,’ he says. ‘They’re part of the equation in terms of what good governance looks like.’
Information overload could be partly caused by reporting being too frequent, which is also thought by some to encourage a short-term outlook among companies and investors. Debate about the pros and cons of quarterly reporting has been under way in Europe for some time. ‘Quarterly reporting can create a lot of noise in the short term that isn’t relevant for the long term,’ says Jubb. UK-listed insurer Legal and General announced last month that it is to stop quarterly reporting.
Dallas supports coupling six-monthly disclosure with the principle of fair and continuous disclosure, so that if something significant happens outside of reporting cycles it is disclosed to everyone at the same time. ‘That’s probably getting the right balance between having a regular reporting cycle that’s not as short-term as it could be, and ensuring that events or actions that pass the materiality test are disclosed even if ahead of the end of the six-monthly period,’ he says.
Eastman, however, finds that investors express a range of views: some want quarterly information, others don’t. Those that do perhaps have less trust in management and are looking for ‘an early indication of something going wrong that they need to know about’, she says.
There is little expectation that the US Securities and Exchange Commission will remove quarterly reporting requirements any time soon. That said, if a move away from quarterly reporting in UK and European markets results in fewer short-term swings in share prices, that might strengthen the argument for SEC action.
In the meantime, it may be that the need for comparability with US companies (or others in markets that require quarterly reporting) creates pressure for companies to report equally frequently on a voluntary basis, even if they are not required to do so.
‘If you are a sell-side analyst or a fund manager in New York following the global auto sector, you’ll have US and perhaps Japanese companies publishing quarterly,’ Eastman says. ‘You’ll have to be really engaging with UK companies [that don’t report quarterly] so you trust them and don’t worry there’s something you’re missing – or those companies could end up getting penalised. It will be interesting to see what happens to companies that are part of global portfolios.’
‘Any form of communication, whether the annual report or a trading update, has to be fair and balanced,’ says Shah-Coulon. ‘Companies need to give the reader a good sense of how the business is performing, and how risks might affect strategies or their achievement. It should place equal weight on good and bad news, and shouldn’t have spin.’
Sarah Perrin, journalist