The Financial Reporting Council’s Financial Reporting Lab has been looking into how investors regard the many different performance metrics used by businesses
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This article was first published in the September 2018 UK edition of Accounting and Business magazine.
The Financial Reporting Lab has issued a report on the thorny topic of performance metrics. Unlike many of the Lab’s projects, which bring together companies and investors to solve corporate reporting, the project so far primarily reflects the views of one stakeholder group – the investment community.
There have been many changes in reporting requirements recently, including the European Union’s directive on non-financial and diversity information, and guidance from the European Securities and Markets Association (ESMA) on alternative performance measures. The Lab hopes that the investor’s view on the reporting of performance metrics offers companies a timely framework for evaluating changes to their disclosures.
‘Companies have had to contend with numerous regulatory changes over recent years,’ says Hannah Armitage, the Lab’s performance metrics project manager. ‘To provide focus, we decided to start by highlighting what investors think about reporting today.’
But what exactly does the Lab mean by performance metric? It asked investors to describe the types of measure they find useful. The list included numbers reported under IFRS, non-GAAP and non-financial metrics – a broad but appropriate list if metrics reporting is to capture the reality of company analysis.
The Lab’s finding that investors use these metrics to perform valuation analyses and forecast future earnings comes as no shock. Perhaps more interesting is the role the metrics play in helping investors assess management’s credibility. Can you trust management that takes annual non-recurring charges? Or one that ties executive compensation to an adjusted ‘earnings before the bad stuff’ number? How companies report their performance metrics seems inextricably linked to their reputation in the markets.
So what can management do to reassure investors that the measures they report are not works of fiction? Based on conversations with investors, the Lab has developed five principles for performance metric disclosure (see panel). To help management apply these in practice, the Lab has also come up with a series of questions. ‘Management needs to hear what investors are saying about the reporting of their performance metrics, and that is what we are trying to do with the set of questions we have developed,’ explained Armitage. ‘We’re trying to turn the investors’ insights into practical steps that all management could take.’
The performance metric project has just entered its second phase, and more companies have been asked to join the debate. By gathering companies together and sharing these preliminary insights, the Lab hopes to highlight both reporting challenges and opportunities for improvements. Given the passion this topic seems to generate, it should be quite a debate.
Alison Thomas, consultant