Investors Value Fuller Disclosure
By Gayle Donohue 10 October, 2013
Gayle Donohue, of PwC, argues that fuller disclosure could translate into more BUY recommendations, Gayle Donohue, of PwC, argues that fuller disclosure could translate into more BUY recommendations, Gayle Donohue, of PwC, argues that fuller disclosure could translate into more BUY recommendations
We are all familiar with the importance of transparency and stakeholder focus in our external reporting but how many companies consider what messages the non-financial information they communicate, or omit, can convey to investors?
The rise of integrated reporting
At PwC we have been talking to our clients about good corporate reporting for many years and the current discussion around integrated reporting (IR) is really an extension of this. Business models have changed significantly over recent decades and will continue to do so at an even faster pace in future.
“The existing corporate reporting model is no longer considered fit for purpose and places undue focus on financial aspects of the business model without reflecting the value creation story of an organisation.”
The existing corporate reporting model is no longer considered fit for purpose and places undue focus on financial aspects of the business model without reflecting the value creation story of an organisation.
For example, if you look at the components of the S&P500’s market value in 1975, around 83% of the company’s value could be derived from physical assets in the company. By 2009 this figure was nearer 19% as the importance of areas such as intangibles, technology, brands, and human capital to a company’s value had increased.
IR attempts to address this by encouraging organisations to report on areas such as their strategy, governance, performance and prospects in a clear, concise and comparable format. This includes not only financial information but also environmental factors such as water usage and carbon emissions and social considerations around employees and other stakeholders.
“Some regulators, including the Stock Exchange of HK, have recommended that issuers include ESG information in their annual reporting.”
Some regulators, including the Stock Exchange of Hong Kong, have recommended that issuers include Environmental, Social, and Governance (ESG) information in their annual reporting and we are also starting to see investors asking questions about areas outside of the usual financial enquiries.
The pace of change differs by region, Europe is clearly leading, but many companies across Asia are now starting to pick up pace as IR gains momentum.
Benefits of ESG reporting – proof for investors
At this point many people ask us “so what?” What is the real benefit to the company of this reporting? Actually the internal benefits to corporates are reasonable well documented. The International Integrated Reporting Council (IIRC) and BlackSun published research in 2012 which showed that of the companies involved in the IIRC’s pilot scheme:
- 93% agreed that moving to Integrated Reporting leads to the development of improved cross-functional working processes, breaking down silos between teams
- 93% agreed that this leads to better quality data collection; in particular, non financial information is becoming more rigorous, comparable and robust, especially as more finance teams become involved in its collection
- 93% agree or strongly agree that this leads to greater focus by management on sustainability issues
- 95% agreed that the attention on reporting a greater range of KPIs is leading to an increased focus among the Board on exactly what the KPIs should be for the business
“Separately PwC have also performed research which indicated that corporate reports are more likely to generate rewards in the capital markets if the reader can visualise a link between strategy and areas such as employees, the environment and corporate performance. “
Separately PwC have also performed research which indicated that corporate reports are more likely to generate rewards in the capital markets if the reader can visualise a link between strategy and areas such as employees, the environment and corporate performance. So it is not only what you report but also how you do this which influences readers – integration can also improve communication with stakeholders.
A number of years ago, PwC approached Coloplast, a company recognised as a leader in corporate reporting, and asked them to take part in an experiment. A PwC corporate reporting specialist then dissected and edited the company’s accounts to create a version of it’s report which complied with regulatory accounting standards and included the narrative typically provided in the front end of the report but deliberately excluded the non-financial data.
Armed with two versions of Coloplast’s report and accounts – the original, complete document (including non-financial information) and the financially compliant document – the PwC team descended on the offices of Schroders, one of the UK’s most successful investment management houses. Each member of the research team was presented with one of the two versions of the report and asked to use the information provided to provide three things: develop a forecast of revenue and earnings for the next two years, provide a recommendation for the stock, and support that recommendation with the key reasons.
The findings were quite startling. The average revenue and earnings forecast prepared by the analysts with the full set of accounts were actually lower than those prepared by analysts who only had the financially based document. This may be a little discouraging for advocates of greater transparency were it not for the fact that despite the lower forecast, members of the group with the complete information set were overwhelmingly in favour of buying the stock, this stands in stark contrast to those with the less complete information set of whom nearly 80 percent recommended selling.
“… those with the full information set were more confident in their forecasts with the result that they awarded a higher valuation to the stock – hence the propensity towards “buy” recommendations”
When we look at the earnings estimates generated (see below) it is also clear that the users with the more complete picture of corporate performance generated a much tighter range of estimates than those just using financial performance. A closer examination of the findings and discussion with the investors revealed that those with the full information set were more confident in their forecasts with the result that they awarded a higher valuation to the stock – hence the propensity towards “buy” recommendations.
Therefore it appears that while models generated by investors may be geared towards exposing the future earnings potential of a company, the confidence they have in this forecast – and thus the value that they place upon the stock – is based upon a far richer set of data than merely financial.
DB Climate Change Advisors have also sought to understand the value of ESG factors for investors and companies in their 2012 literature review of over 100 studies in this area entitled “Sustainable Investing: Establishing Long-Term Value and Performance”. They found that:
- 100% of academic studies agreed that companies with high ratings for CSR and ESG factors have a lower cost of capital in terms of debt (loans and borrowings) and equity.
- 89% of the studies reviewed showed that companies with high ratings for ESG factors showed market based outperformance over the medium and long term.
- Governance was the most important factor, environment next, followed by social.
This was qualified with the observation that, while not loosing money, SRI funds have historically struggled to capture outperformance, albeit they highlight that these funds are historically based on exclusionary (or negative) as opposed to positive or best-in-class screening.
There appears then to be a compelling case, both for corporates and investors, to report non-financial as well as financial information to ensure that their own reporting provides a complete picture of the organisation and to support the continuing development of Integrated Reporting.
For more information on PwC & Integrated Reporting please click here, for PwC’s new report Measuring and Managing Total Impact: A New Language for Business Decisions.
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