related documents

top stories

Campbell & Slack, 2008

Executive summary

Introduction to the topic

This research report is about the voluntary narrative sections of company annual reports, with particular reference to the annual reports of UK banks. Voluntary narratives are defined as those parts of the annual report not mandated by Companies Act requirements and not reported on as part of the audit report. Such disclosure narratives include, among other things, the chairman's statement, chief executive's review, social and environmental reports, and risk disclosures. There is an academic literature that has examined the patterns of voluntary disclosure and these contributions have fallen roughly into three general categories: empirical studies examining trends and changes in reporting; theory building and testing contributions; and user-needs analyses. It is to this latter strand of literature that this study aims to make a contribution.

There has been a marked growth in many types of voluntary and narrative reporting in recent years, with media other than the hard copy annual reports in the ascendant as carriers of reporting messages. Despite this growth, large companies continue to produce elaborate, lengthy and detailed annual reports with narrative sections extending to, in some cases, hundreds of pages. The annual reports for 2006 of HSBC Holdings plc and Barclays plc were 458 pages and 310 pages respectively.

One of the questions frequently raised, but not well answered, in considering this growth is the actual usefulness of this surfeit of narrative in annual reports. Who reads it, is the information useful and is it material to fund allocation decisions made by investors? And if not, what are the implications for preparers of annual reports?

Aims and objectives of the research

The primary aim of this research is to explore questions of usefulness and materiality of annual report narrative disclosures. The research addresses calls made by, among others, Smith (2004: 202), who suggests that, 'future research will more widely examine the discretionary disclosures made by firms to explore their impact on decision makers and on investment analysts' stock recommendations'. In order to do this, a method was chosen that would facilitate an in-depth and narrative-rich discussion of the issues in question with perhaps the single most important and influential user group of audited and narrative company reporting: sell-side analysts.

The sell-side's role as the primary interpreter of company information for buy-side and fund management purposes makes it a suitable source of opinion on the research question, as it is the sell-side's consumption of corporate reporting upon which fund allocation decisions are ultimately made. Given that, in volume terms, most institutional 'real money' changes hands on the basis of sell-side advice, sell-side analysts are uniquely placed to comment on the investment materiality of a range of voluntary narratives and it was upon that basis that they were selected for this study.

Nineteen London-based sell-side analysts were interviewed between late 2004 and mid 2006, each of whom analysed only the banking sector. The focus on the banking sector was for several reasons, prominent among which was the fact that banking (along with technology, pharmaceutical and oil/gas) is one of the four main 'volume' trading sectors in London, strategically important to the UK economy and comprising approximately 15% of the total FTSE 100 market value. It was further believed that focusing on one sector rather than performing a shallower cross-sectional study would enable a greater penetration to be made of issues relevant to materiality in that single sector. All analysts were interviewed using a semi-formal method, and interview transcriptions were content analysed and sorted by the category of voluntary disclosure being discussed.

Summary of findings

Each analyst expressed views on a range of voluntary and narrative disclosure categories, including management commentaries such as the chairman's statement, chief executive's review, operating and financial review, risk reporting and the corporate governance statement. In addition, other areas of voluntary narrative were discussed at some length including social, environmental and ethical reporting (partly because these issues have preoccupied many academic researchers in the field).

There was a general belief that narrative reporting was not immediately applicable nor helpful in the primary tasks of the sell-side which is to construct forecast models and produce written reports for the buy-side. The normal view was that narrative reporting was less useful to analysts than to other putative users of annual reports but most analysts were unable to identify specific consumers of any given disclosure category.

The chairman's statement was generally considered to be less useful than the chief executive's review because the latter was more likely (in most annual reports) to contain meaningful information on future strategy. The content of the chairman's statement was generally dismissed as irrelevant to the investment decision or to any forecasting figure. Risk disclosure was generally thought of as too general in nature to be useful. Corporate governance reporting (mandatory under listing rules under UK 'comply or explain' practice) was usually unread because governance in UK banking was generally trusted by the analysts. Social and environmental reporting was universally considered irrelevant and incapable of influencing a financial forecast. It was rarely read by analysts and any suggestion that the environmental reporting might contain disclosures germane to the description of secondary (ie loan book) environmental risk was dismissed.

Implications of findings

Analysts were shown by this research to be technocratic and rules-driven in nature, and unlikely to be a source of change in respect of social and environmental issues. They were generally sceptical about all voluntary narrative reporting and were dismissive of large sections of it as irrelevant, 'useless' or worse.

There are a number of issues raised by the findings. Prominently, these findings represent a challenge to preparers of annual reports, who have presided over a period of volumetric expansion of narrative content, the value of much of which to analysts can now be questioned. If it is the intention of preparers to make narrative reporting relevant and material to investors, they appear to have some way to go or some rethinking to do.

Similarly, however, the findings highlight the way in which analysts are dismissive of anything other than directly value-relevant numerical data. The belief that no narrative reporting is capable of informing, amending or challenging a financial forecast is a curious one.

Back to top