The ValueReporting Revolution: Moving Beyond the Earnings Game

ADVANCE PRAISE FOR THE VALUEREPORTING REVOLUTION

“Those of us with responsibility for reporting corporate performance in its broadest sense must look beyond the rules and regulations to ensure we effectively communicate the most useful information. This excellent book raises many issues and challenges and offers a range of solutions for improving how and what we report.”–John D. Coombe Finance Director, GlaxoWellcome plc

“With greater corporate transparency–the rallying cry of ValueReporting–investors, both institutional and individual, can gain a much deeper under-standing of how companies create and realize value. This is precisely the kind of information they are aggressively seeking to optimize their long-term investment decisions.”–Harold D. Kahn Financial Officer, Scudder Kemper Investments

“While it may take a while to get to a better system of corporate reporting, this book leaves few doubts that the journey will be worthwhile for both companies and the capital markets as a whole.”–Steven M. H. Wallman Commissioner, Securities and Exchange Commission (1994-1997) Founder and CEO, FOLIOfn, an innovative online financial services company

ROBERT G. ECCELES Dr. Eccles is a founder and President of Advisory Capital Partners, Inc. and a Senior Fellow of PricewaterhouseCoopers. He was a tenured professor at the Harvard Business School, where he served on the faculty for 14 years. While there, one of his major research interests was performance measurement and reporting. Dr. Eccles received his undergraduate degrees from the Massachusetts Institute of Technology and his Ph.D. from Harvard University. ROBERT H. HERZ A partner with PricewaterhouseCoopers, Robert Herz is the firm’s North America Leader of Professional, Technical, Risk, and Quality. His professional service includes positions on the FASB’s Emerging Issues and Financial Instruments Task Forces, the Financial Accounting Standards Committee of the American Accounting Association, and chair of the SEC Regulations Committee of the AICPA. He is a U.S. Certified Public Accountant and a U.K. Chartered Accountant. E. MARY KEEGAN Mary Keegan coauthored this book as Head of the Global Corporate Reporting Group of PricewaterhouseCoopers, where she specialized in international corporate governance and reporting. She has also served as Vice President of the Federation des Experts Comptables Europeens and as a member of the IASC’s Standing Interpretations Committee. She is now the Chairman of the U.K. Accounting Standards Board. DAVID M. H. PHILLIPS David Phillips is a partner with PricewaterhouseCoopers in the Assurance/Business Advisory Services practice in the United Kingdom and serves as the European Leader of ValueReporting. He is a graduate of Nottingham University, where he read Industrial Economics, and is a U.K. CharteredAccountant.

This book sends a wake-up call–to executives, securities analysts, market regulators, investors, and, not least of all, to accountants: The world of external corporate reporting is ripe for a revolution. And all have a vital interest in making it happen.

When I joined the accounting profession 20 years ago, stock ownership in my country, the United States, was largely limited to a small fraction of upper-income households. At that time, those with the resources to do so typically made investment decisions after scrutinizing a company’s quarterly and annual corporate reports, consulting with a broker, and perhaps trotting off to the local library to do a bit of research on their own. Once they acquired stock in a company, they usually held it for years–even decades. In most other developed countries, all but the most affluent had about as much exposure to equity investing as they did to quantum physics.

Things have changed. For better and for worse, the common man and woman have evolved into Homo investus. In the United States, more than half of the adult population now owns stock, directly or indirectly through pension and mutual funds. In the United Kingdom, the number is 25 percent, and in Europe it’s more than 12 percent and growing rapidly.

In many developed countries, stock market capitalization–the market value of all listed companies–now rivals or exceeds the size of the domestic economy. Initial public offerings (IPOs) and market gyrations are the stuff of everyday conversations. Electronic chat rooms ply us with investment advice. Stock alert pagers keep us constantly in touch. And after-hours trading keeps us buying and selling into the night.

It’s not just investor behavior that has changed; the ways in which businesses compete and create value have changed, too. These days, many companies measure their worth in “clicks” rather than “bricks,” while others possess assets–like an outstanding work force, a commanding market share, or instant brand recognition–that provide value far in excess of their tangible assets. Certainly, the market recognizes these “soft” assets and, to widely varying degrees of accuracy, factors them into projections of cash flow and then prices shares accordingly.

Technology–most spectacularly evidenced by the Internet–has changed the investment world, too. Today, information travels unconstrained by time and distance. With a click of a mouse, investors can have immediate delivery of a mind-boggling array of investment data and advice. All too often, it’s the sort that’s worth exactly what they pay for it–next to nothing.

But the kinds of information that companies regularly report, and that firms like mine audit and assure, simply do not serve today’s investors well. While technologies are emerging to support assured, data-rich, online, real-time corporate reporting, it’s fair to state that the accounting profession has yet to deliver on the promise of the Information Age.

Likewise, despite great strides in the development of internal performance measurement systems, the kinds of information that business executives report to the market–and the means by which they do so–have changed hardly at all in the past 100 years.

Let’s face it: When it comes to corporate reporting, our mental models have not kept pace with change. Certainly, traditional financial statements, designed to the requirements of an industrialized age, have lagged far behind the evolution of our knowledge-and-network economy. They do not speak to the interests of stakeholders beyond the finite circle of a company’s shareholders. An historical reporting perspective alone seems totally inappropriate to a world living on Internet time.

Nevertheless, once standards, regulations, and mental models are set, they become very hard to alter. The fear of harming our respective national reporting systems–which up to this point have worked pretty well–has held many of us back from trying something new.

Nature abhors a vacuum, in this case an information vacuum. To fill it, in have stepped analysts and advisors of every stripe. Good, bad, or indifferent, most don’t understand how to test and validate their opinions, and they seldom expect to be held accountable for their judgments. The worst of them go so far as to try to manipulate markets.

While I don’t believe in a divine right to existence for accounting firms, I do believe that firms like mine are distinguished by their responsibility to further the public’s vital interest in having someone ensure that objective and relevant corporate information is made available. If the information needs of investors aren’t being served, it’s time to set things right. As a start, I think all can agree that too little of the information that really matters finds its way to the marketplace.

Clearly, we need a more expansive, flexible approach to corporate reporting and auditing. One that acknowledges that the world has grown more complex and demanding. One that recognizes that in today’s world, aggregative, reductive methods alone do not impart a solid understanding of value, opportunity, and risk.

A new approach must be forged through creative discussion and intense debate among all parties involved, worldwide. Doing that will require leadership. I contend that no organization is better qualified to lead on these matters than mine.

So, consider this book an opening shot across the bow. Not everyone will agree with the views expressed herein. Indeed, some may feel discomfort or even anger at what they read here. This book will certainly raise tough questions for members of the accounting profession and for my own firm. But if it succeeds in stirring further thought and action, it will have served a good purpose.

To the authors–Bob Eccles, Bob Herz, Mary Keegan, and David Phillips–I offer my personal appreciation for their unwavering enthusiasm for spreading the gospel of quality, relevancy, and transparency and for fanning the flames of the ValueReporting Revolution…

J. Frank Brown Global Leader, Assurance and Business Advisory Services PricewaterhouseCoopers