9: The Downside of Disclosure
Gibboney Huske is a pro when it comes to sifting through corporate reports. As an analyst at Credit Suisse First Boston (CSR ), she covers 11 companies in the imaging industry and is regularly recognized as one of the top interpreters of the field. She's a certified financial analyst, has a staff who works with her, and has access to state-of-the-art technology. So if anyone was up to tackling the 1,000-page Xerox Corp. (XRX ) annual report issued on June 28, it was Huske. Yet, two weeks later, having worked both weekends, Huske and her staff were still analyzing the massive document.
If a professional stock analyst has that much trouble getting her arms around a company's financials, what hope is there for the average investor? True, Xerox had an extraordinary amount to explain--including a restatement of five years of numbers required by the Securities & Exchange Commission. But almost every company is putting out longer, more complicated reports these days. Even those with far less complex finances are weighing in with a mind-bending 500 pages plus.
Driving this corporate loquaciousness is a rising demand for increased disclosure following this year's string of corporate frauds and accounting misbehavior. Everyone from the SEC to President George W. Bush has demanded that investors be given more information. And faster. The SEC has proposed cutting the time allotted for filing quarterly reports to 30 days after the end of the period from 45. Annual reports will have to be mailed in 60 days, down from 90. But while outraged politicians and regulators demand more, one vital point goes ignored. Investors don't just want more information--they want better information. "I thought in this climate companies would be bending over backwards to do the right thing," says Charles L. Hill, director of research at Thomson Financial/First Call, which tracks Wall Street earnings estimates. "But of the 900 pages of a filing, probably 899 of them are ginned up by the lawyers to cover their butt."
Too much disclosure may indeed prove to be a very bad thing, if the ton of chaff makes it impossible to find the kernels of truth. The best hope for investors is that the current uproar will provide fuel for a second phase of reform, one in which disclosure is fundamentally restructured to make it more useful.
Since communicating a company's relevant information to investors is the whole idea behind filing quarterly and annual reports, it's a serious problem that these documents are becoming nearly impenetrable. It's particularly troubling because there's some early evidence that companies are not interested in improving the quality of their reports. Case in point: the SEC's demand in December that companies provide a clear explanation of how pro-forma earnings numbers were calculated and how they relate to earnings as calculated under generally accepted accounting principles (GAAP). Sadly, little has improved since. Companies like Solectron Corp. (SLR ), which immediately vowed to stop issuing pro-forma figures, are back at it. And that reconciliation of GAAP with pro forma? Very hard to find.
Overwhelmed by this flood of useless data, investors are increasingly relying on intermediaries to interpret what it all means--an ironic turn, given that the ethics and veracity of Wall Street analysts are under fire. "Without spending literally hours studying the financials, the notes to the financials, the management discussion and analysis, it's increasingly impossible to analyze a company," says Steven M.H. Wallman, founder of FolioFn Inc., a Web-based investing service, and a former SEC commissioner.
If that cry gains enough momentum, there is hope that real change can still come. Samuel A. DiPiazza Jr., chairman of PricewaterhouseCoopers, proposes a three-step reform in a book he co-authored, Building Public Trust: The Future of Corporate Reporting. He advocates using a less technical approach to auditing similar to the current European system, rather than the detailed rules of the GAAP. The hope is that this would make management both responsible and accountable for choosing the accounting method that best reflects the economics of the business rather than hiding behind detailed rules.
He wants disclosure of half a dozen or so benchmarks that can be used to measure financial and nonfinancial performance in each specific industry, with all such companies following the same rules. And he would include a discussion about issues of great importance to each specific company. "That's much better disclosure," says DiPiazza, "because it would truly help investors make better judgments."
Even without such fundamental change, there are steps that could be taken to greatly improve the usefulness of corporate information. One idea that has gained momentum in the past two years with Nasdaq, as well as the International Accounting Standards Board and major corporations such as Microsoft Corp. (MSFT ), is to create a technical standard that would be used to "tag" basic categories of financial information in corporate reports. The same standard would then be embedded in software programs used by investors and regulators. Advocates say that Extensible Business Reporting Language (XBRL) would make it much easier for almost anyone to wade through voluminous disclosures, via computer, for the numbers they need to analyze a company's performance.
The bust-up of the go-go '90s has exacted an enormous price--in the markets, in the reputation of executives, and in the trust in Wall Street analysts and corporate auditors. One beneficial legacy of such an era of pain would be if corporations could give us a clearer picture of their performance. But for disclosure to be valuable, it has to be aimed at informing investors on the issues they truly care about and presented in a way they can understand. If regulators lose sight of that in their push for change, they may have missed their best shot at true long-term reform.
By Nanette Byrnes