This article was first published in the September 2013 International edition of Accounting and Business magazine.
Investors should be at the heart of standard-setting and financial policy-making, but too often their voice is not heard as rules are being made or proposals formulated. But what is that voice? The reality is that many different constituencies are often lumped in together under the blanket term ‘investor’, oversimplifying their complex and differing needs.
In an initiative designed to contribute to the debate over the future of corporate reporting, ACCA is undertaking a four-stage project examining the investor landscape, post-global financial crisis. It will look at what investors want from corporate reporting, and in what format. We will then reflect on how this may change the approach taken by companies in reporting their activities and engaging those investor groups. The first two stages of the project were completed in the first half of 2013, with the final two to follow in the second half of the year.
The first stage analysed the current investor scene in the UK and Ireland, and examined how the financial crisis has affected investors’ asset allocation and investment strategies. It was clear that the trends identified were of far greater international application.
Firstly, the trend towards short-termism was clear. The change in the nature and behaviour of investment players has had a fundamental effect. The traditional domination of markets by pension funds and insurance companies has been eroded both by greater international ownership of companies, and by the emergence of other players such as hedge funds and private equity firms, with shorter-term investment horizons. And even the traditional players have switched much of their investment from equities to bonds, as a result of the financial crisis.
Added to this, the hugely increasing proportion (estimated by some to be 80%) of trades that take place via computer in nanoseconds has left a question mark over who the owners of companies actually are. It has been estimated by the BlackSun reporting consultancy that the average share of FTSE 100 companies is held for 27 seconds – given this, how can they meaningfully engage with investors? We have already seen international policymakers, such as the G20 and EU, responding with measures to enhance long-term finance and address the ‘ownership vacuum’, and given the extent of hyper-trading, more may be needed.
Another notable factor influencing investor behaviour is ultra-low interest rates. Central bank activism, leading to loose monetary policy, historically low interest rates and currency wars throughout Europe and the US, has been a major response by the authorities to the global financial crisis. This has had a clear effect on investors, making them search for yields in riskier investments. But investors also mentioned fears about governance and reporting in some emerging markets, which counter-balanced the drive for yield.
Other issues include heavier regulation, which many thought would be a continuing response to the global financial crisis. We have already seen this with the Basel capital requirements for banks and the Solvency II requirements for insurers. Asset managers are tipped to be next.
Finally, the proliferation of new technologies such as mobile and social media has led to a lot more corporate information being available, much of it on a real-time basis. How much of it is useful and how do investors prevent themselves being overwhelmed?
This analysis of the investor landscape in 2013 revealed challenges in terms of corporate governance, regulation, accounting, assurance and other areas, all of which ACCA will be considering in future research. But the immediate follow-up – stage 2 – looked in further detail at the issue of what the changed investor universe outlined in this study meant for the future of corporate reporting.
Lack of trust
This took the form of a survey of 300 UK and Ireland-based investors. Half of the survey’s respondents represent institutions with more than US$500m in assets under management. There was a good spread across sectors: 38% represented pension funds, 30% insurance companies, 10% private banks and family offices, and 11% other asset management firms. A further 9% were investment advisers or analysts, and the remaining 2% corporate treasurers.
The most important finding was a clear decline in trust in corporate reporting, post-global financial crisis: more than two-thirds of investors say they have become more sceptical about the information that companies provide since the crisis began. Almost two-thirds believe management has too much discretion in the financial numbers they report and, as a result, a similar proportion of investors say that they place greater value on information or commentary that has been generated outside the company than on traditional corporate reporting. This took the form of social media and online news, as well as more traditional sources like analysts’ presentations. Some of this was sparked by a natural desire to get additional information to give them the edge, but the fall in trust is worrying.
To keep this in perspective, it should be noted that the annual report remains the number one information source for investors – 63% said it was the most important. Yet there remains a significant minority of investors who express reservations about the quality and relevance of corporate reporting, with 45% arguing that the annual report is no longer a useful tool. A key concern is clutter – almost two-thirds of respondents say that corporate reporting is now too complex. Asked about where they would most like to see improvements to the annual report, respondents emphasise the cashflow statement, with information on the balance sheet and income statement coming second and third.
One of the most intriguing findings concerned quarterly reporting, on which opinions are sharply divided, even within individual investors. Three-quarters of respondents say that the quarterly report remains a valuable input to their investment decision-making. Yet, at the same time, almost half said mandatory quarterly reporting should be abandoned, while almost two-thirds think the increase in information has encouraged ‘hyper-investment’. Many investors interviewed for this report expressed strong views that quarterly reporting drives short-termism in the market and consumes management time. This suggests a ‘tragedy of the commons’ effect, whereby individual investors want to consume quarterly reporting for their own self-interest, despite recognising that this focus on shortening time horizons is damaging for the overall market’s long-term interests. It surely leaves policymakers in a quandary.
Given all this gloom for the current state of corporate reporting, there was one area of hope for the finance profession and, perhaps surprisingly, this concerned auditors, under much regulatory fire of late. Investors viewed assurance high on their list – timeliness of information may be important, but respondents stressed that assurance is just as critical – if not more so. Only in areas such as profit warnings and emerging risks and opportunities did investors opt for speed over assurance. And 41% wanted to see auditing being extended to quarterly reports. The decline in trust in corporate information since the financial crisis suggests there is a bigger role for audit to play in rebuilding trust in company statements.
In terms of future directions, investors indicate a strong interest in integrated reporting. More than 90% of respondents believe it would be valuable for companies to combine financial and non-financial information into an integrated reporting model, which would enhance their understanding of the long-term outlook of a company. But there is still a strong element of uncertainty as to what exactly integrated reporting would involve. And almost half of investors are using XBRL, with another 40% considering it. The main benefit of using XBRL, say investors, would be to compare performance between companies more easily, although detractors worry that there remains a lack of standardisation in taxonomies.
Time for reflection
So what do all these findings mean for policymakers and other players? There is much to consider and reflect on here for various constituencies.
Accounting standard-setters and regulators must surely be concerned over the clear decline in trust in corporate reporting since the financial crisis. The fact that 44% find nothing of use in the annual report is a particular worry, and shows that initiatives such as the UK Financial Reporting Council’s ‘cutting clutter’ campaign need to be reinvigorated. Investor concerns over the amount of management discretion in the numbers suggests accounting standards need to be reviewed, or considerably more engagement by standard-setters with investors is required. ACCA itself is trying to help this process.
For policymakers and governments, the issue of quarterly reporting surely needs to be addressed. While investors find it useful, they also accept that it leads to a short-termist approach by companies, with management more concerned with the next three months’ numbers than proper planning. In Europe, there are moves to remove it as a requirement – there might be some logic in leaving it as an option, given the mixed feelings on the individual company and market effect.
For the audit profession there is good news in that only external assurance seems to give corporate reporting much validity in the eyes of investors, and that people mostly value assurance over speed. But would auditors be geared up to doing quarterly audited accounts? Or auditing of real-time information?
For the International Integrated Reporting Council, the survey shows a promising level of interest in integrated reporting, but still a considerable degree of uncertainty. So the onus is on the IIRC to explain much more clearly – in terms investors understand – what integrated reporting is all about.
But there is also an onus on investors themselves – the only way that long-lasting solutions to many of the problems raised in the course of this research will be found is if the investor community engages more with the corporate reporting process, both at an individual company level and more widely with the standard-setting process. Following the age-old mantra that ‘decisions are made by those who show up’, it is crucial that wider engagement – assisted by developments like the UK Stewardship Code, which sets out investor obligations – takes place, so that the views of the end users of accounts are fully considered. And if they are truly prepared to pay extra to have real-time information externally assured, they need to make that point clearly to auditing standard-setters and policymakers, given the various current international proposals on the future of audit.
Which of the following sources of information are most valuable for you as an input for decisions about investing in a company?
Annual report 63%
Quarterly earnings reports 36%
One-to-one conversations 35%
Investment advisers 35%
Analyst presentations/reports 27%
Media coverage and interviews 23%
Interim report 20%
Investor roadshows 6%
Ian Welch is ACCA’s head of policy