The great edifice of corporate governance which provides the underlying integrity for a company’s financial reporting is about to be found wanting. There is one key link which is about to break – the link to the investment community. Or, to put it another way, the analysts.
In 1991, Accounting for Growth was published by then UBS Phillips & Drew. The research paper made the name of the man behind it – and it lost him his job. That man was Terry Smith, today’s chief executive of Collins Stewart Tullett. His thesis was simple – to explain the creative accounting dodges which the UK’s finest companies were using. It added extra impetus to the work of Sir David Tweedie, then of the Accounting Standards Board, who in 1990 had commenced his task of cleaning out the Augean stables of UK financial reporting.
These days we are many heaps of ordure down the line. Sir David’s efforts mean that, as of this year, all listed companies in Europe and many others around the world will be reporting under the same set of international financial reporting rules. Come next spring, the first full company results under this regime will start to appear – and that is when the ordure will next hit the fan.
In the latest issue of Corporate Financier, the magazine of the corporate finance faculty of the ICAEW, Smith returns to the fray. He makes it plain that Tweedie has done a tremendous job in clearing away the creative accounting that bedevilled the early 1990s. But he says that the problem now is that companies have no need for creative accounting. The analysts, in effect, do it for them.
His view is that analysts now are so lazy and gullible that companies no longer have to be devious. “Analysts are sent the numbers in a press release, and none ever read a profit and loss account.” Spin has taken over from creative accounting.
The one thing on which everyone is agreed about corporate results under the new financial reporting regime is that they will be more volatile and will need to be explained carefully. If Smith is right, the analysts are not up to it, with some honourable exceptions, of course. KPMG has just published a collection of interviews, International Financial Reporting Standards – The Challenges Facing Business, with the main players in the financial reporting field, and the same message comes over loud and clear. Jan Hommen, CFO at Philips, said: “Analysts know they understand little about international accounting standards. So they are not ready to see the changes that are coming.”
Jon Symonds, CFO at AstraZeneca and chairman of the 100 Group of Finance Directors, said: “The issue that concerns me is not that companies will do a good job communicating their results, but what will the recipients of hundreds of restated accounts make of it? I am not sure the investment community really has its mind around what the changes mean. Will there be a knee-jerk reaction on the stock market?”
Putting those feelings, which are widespread in the CFO community, together with Smith’s views on the quality and motivation of many of the analysts, you can see where the link is going to break. It could even take the financial reporting community back to the arguments of the late 1960s. Then, before UK accounting standards had been created, it was down to the auditing firms to interpret and rule on the true and fair nature of a company’s accounting policies. In a takeover tussle between AEI and GEC in 1967, the very different profit figures produced by two companies’ audit firms became a cause celebre in the tactics of the takeover. But the argument in the public arena was a basic one, and it was over how several apparently conflicting figures could all add up to the same thing.
By next spring, there will be many people from both companies and the financial reporting community explaining what it all means. And the difficulties may be alleviated by comparisons across sectors that should show similar movements and changes. But it is the analyst community which has been forgotten in all this.
In the KPMG study, global head of regulatory issues Neil Lerner put the issue succinctly: “The analysts who use the figures probably don’t want to spend time to understand them to a great level of sophistication,” he said.
The great issue in the corporate governance world over the next few months is to try to ensure that when the financial reporting revolution does take place, its benefits are clearly understood by everyone who needs them.