Skip to main content
Nov 30, 2000

The value picture

The birth of a new model of corporate reporting

Throughout the history of science, new ways of looking at the world have swept away the old. Thomas Kuhn called it revolution when one paradigm replaces another. In the evolution of corporate reporting today, some observers see a current shift akin to Einstein usurping Newton. 'We see a revolution in corporate reporting gathering momentum,' announces Roger Hughes, PricewaterhouseCoopers' UK leader of audit and business advisory services.

Indeed there is an air of expectancy and excitement greeting the latest crop of shareholder value-based reporting studies, such as PwC's second annual ValueReporting Forecast. Several factors are combining to force a new era of corporate reporting: new economy companies are devising ways to value the 'soft' factors of business; old economy companies are following suit in an attempt to bring their see-sawing stock prices back under control; a worldwide crackdown on selective disclosure is forcing companies to structure the myriad of tiny off-balance sheet details which can no longer be incrementally communicated to the market; and finally – obviously – the internet has made it possible to communicate that Byzantine matrix of data to all stakeholders.

'Some companies may balk at providing more details than required by regulators,' muses David Philips, PwC's European leader of ValueReporting, 'but greater transparency can prove to be a decisive tool in the competition for capital. I believe that the internet kick and the e-commerce tidal wave are the catalysts we've all been waiting for to drive this vital, increased transparency of business information.'

Mark Goyder of the UK's Centre for Tomorrow's Company describes the forces on corporate reporting as a pincer movement. 'On one side there are all the pressures from shareholders; on the other, all the pressures from society,' he says. 'The difference between the winners and losers in corporate reporting is that the winners recognize this is all part of one conversation. The losers tend to deal with two separate conversations in separate boxes, which is a recipe for corporate schizophrenia and confusion.'

Goyder likens the new corporate reporting model to a 'success jigsaw': some of the pieces are about social impact, some are about internal business drivers like innovation, knowledge and employee commitment. 'It's the sum total of these external impacts and internal drivers, as well as all of a company's other relationships throughout the supply chain, that create the picture of value now and in the future.'

Catching on

Plenty of companies are pioneering new ways of reporting value, as evidenced in PwC's best practice examples. Take Barclays and Lloyds, for example, which set total shareholder return targets, or Dow Chemical which measures itself against an annual report scorecard. Siemens has wholeheartedly adopted EVA, and reports on the cost of capital for each of its business units.

The question is, though, is the investment community catching on? Are investors and analysts moving away from their quarter-to-quarter earnings obsession and taking notice of the 'soft' measures of shareholder value? According to Robert Herz, PwC's US ValueReporting leader and the head of professional and technical matters in the US, at least the buy side is. 'The large mutual funds and pension funds have become tired of being whipsawed in the quarterly earnings game. Value funds in particular would rather understand the intrinsics of what they're investing in, preferring not to think about turning portfolios over because of the short-term ups and downs of the market.'

Dr Stephen Gates is the principal researcher in capabilities management and human resources strategies for the Conference Board. He's also the project director of the European Council of Investor Relations, and in that capacity he arranges panels of investors to talk to investor relations officers. In Dublin recently, he recounts, fund managers reinforced the fact that pension fund consultants are 'driving them to a shorter and shorter time horizon because their performance is now being measured on a shorter time horizon. It's a total paradox: everybody's investing for the long-term, yet the performance measures used by consultants are becoming shorter. Even with the best intentions, and even though they know it doesn't make sense, the fund managers are constrained to use shorter time periods.'

On the other hand, those Dublin fund managers also said they find value-based measures help a company communicate its business story, and help them check on the progress of the story. Gates has indeed found evidence of a link between superior stock performance and strategic performance measurement (SPM) systems. His Conference Board study sponsored by management consulting firm AT Kearney, Aligning strategic performance measures and results from December 1999, was based on a survey of CFOs and corporate strategists at 113 companies. Turns out 52 percent of those with SPM systems outperformed their competitors, while 30 percent simply held steady and only 18 percent fared worse.

The problem, though, says Gates, is that too few companies are actually reporting their strategic performance results externally – only 36 percent. Still, things are looking up, with an additional 58 percent saying they intend to do so over the next three years. The top financial SPMs cited are cash flow, return on capital employed and economic profit, while the most frequently mentioned non-financial SPMs are customer satisfaction, market share and new product development.

When it comes to forward-looking information, confusion reigns over what are leading versus lagging indicators of performance. 'If these people who are creating and using these measures are so split, how can we expect investors to be totally uniform in assuming what are leading indicators?' demands Gates.

Worse yet, the survey of CFOs and corporate strategists revealed that measures considered to be lagging indicators are more frequently reported than leading ones. For example, 74 percent said they consider new product development to be a leading indicator, but just 18 percent release the information to the investment community. Conversely, 64 percent said market share is a lagging indicator, and 28 percent release that information.

Excuses, excuses

What excuse does company management offer for keeping leading performance measures to themselves? The typical answer is that Wall Street analysts are fixated on the numbers, therefore companies are simply being 'customer responsive' in delivering what the analysts want. Clearly management is nervous about breaking away from traditional investor dialogue, while also hesitant to adopt measures that are still under development. Others say that the measures are simply too complex, or that they're not verifiable.

Gates sees verifiability and standardization – for comparability between companies – as key issues to be addressed, and hopes that policy groups at the OECD and the SEC will achieve these goals. 'But it's not for tomorrow; the problems are pretty major,' he opines. 'This is an area where companies are experimenting, and of course fund managers are experimenting in how they use the information.'

PwC says the internet is coming to the rescue of standardization, particularly with the adoption of XML – a new language for the internet that will easily exchange data between disparate systems. But Mark Goyder, for one, doesn't see XML as a panacea for shortfalls in today's corporate reporting. 'It's all very well having a language to extract and compare what is apparently the same information from one company to another, but context is all. In the absence of a consistent success language, it's very hard to look at predictive information and do a like-for-like comparison. Technology has raced ahead of accounting and measuring methodology, and what is needed is a significant rethink by all users of accounts about what comparability is and what it requires. Until then, we're just going to have more and more sophisticated systems comparing apples with pears.'

Still, technology is helping reporting to move 'from a snapshot to a cinefilm process,' says Goyder. Technology also gives companies the means to report non-financial information just as quickly as they do the time-critical financial data.

Human capital

Interestingly, the Conference Board's Gates places Canada's big banks at the forefront of performance measurement and reporting, while PwC agrees that Canada and Scandinavia have the most progressive companies. Take Royal Bank of Canada, for example, which publishes annual and medium-term SPM targets in its annual reports, and records progress against previous years' targets in a 'corporate report card'. PwC commends the Bank of Montreal for reporting on its 'value based management' framework in its annual report, outlining eleven key financial performance measures including total shareholder return and net economic profit – the latter a new addition in the 1999 report.

One reason for the leadership by Canada's banks, comments Gates, is that 'they have more freedom than they would in the US regulatory environment.' Banks such as Deutsche Bank along with Spain's Banco Bilbao Vizcaya Argentaria and Banco Santander Central Hispano are now releasing a lot of information about employees, focusing on 'intellectual capital' – a term Gates recognizes as fashionable but puts aside in favor of 'human capital'.

The impetus for change in the US is greatly heightened by Regulation FD, however. 'Before FD you could get a lot of information out to analysts and investors in one-on-ones. Now you're forced to do it in a more structured way,' remarks PwC's Herz. It's the inside view of the company that you used to show just to analysts; now you have to structure it to communicate to all audiences at once.'

Herz shares his feeling that 'if you get more of this information out, then maybe the market would be a little less volatile too.' It's hard to prove, he admits, but market volatility is in part a reflection of 'inadequate information sets'. One hindrance is that 'few companies want to be first on the block, and they have concerns about giving away competitive secrets.' That concern may be unrealistic, however, as PwC has found that a company's competitors often know far more than management might think. This is particularly so with workforce mobility in today's economy.

List toppers

With all this attention on reporting intangibles, companies and investors alike are striving to identify just which measures help predict performance. A byproduct of this is the shareholder value league table. Take the new Shareholder Value Magazine, just launched in the US with former Niri Update editor Bill Mahoney. Its inaugural issue featured The Shareholder Value 100 which measures the contribution of management to a company's total market performance.

Perhaps the most extensive shareholder value ranking comes from The Boston Consulting Group, which in November released New perspectives on value creation, based on a survey of 4,125 listed companies worldwide. In looking at total shareholder return (rise in share price plus dividends), BCG found that 'the gap between the world's top stock market performers and the also-rans has increased substantially over the last five years.' And in studying the top performers, BCG says it can identify growth 'levers' that can be used by any company to narrow that gap.

Not surprisingly, the top of BCG's list is dominated by e-commerce, IT and communications companies, with all but two of the top ten from the US. BCG also finds that the top US performers are focused on growth, in contrast to Europe where the best companies have been creating value out of restructuring.

Still, BCG insists value creation is not the exclusive domain of high tech. It's all just a matter of pulling the right 'levers'. Then there's the phenomenon of 'expectation premium'. Turns out many of BCG's top performers had total shareholder return (TSR) much greater than can be accounted for by changes in fundamentals. The premium, then, must be explained by non-financial factors, including the notion that 'success breeds success'. Adds Dr Daniel Stelter, vice president at BCG based in Munich, 'The market gives you all the more credit assuming you'll keep on doing as well as you did in the past. But if you then miss the target, you're punished even more for disappointing the market.'

Stelter calls for companies to report their value management process, and particularly in industries driven by people more than capital – employees as well as customers – companies should be including related data in their reports. 'We need to have more transparency with respect to the true value drivers of a company and how they change. It will make it easier for outsiders to assess true value,' he says.

Sounds simple, yet just about every word there raises another question: what are the true value drivers? How often should they be measured? Who are the outsiders that need to be communicated to, and how do they go about their assessment? These and other questions like verifiability and standardization need to be answered before a new paradigm in corporate reporting can be universally adopted. Perhaps the only question that has already been answered is whether such a revolution is underway. In fact it is already raging, under the banners of shareholder value, fair disclosure and technology.