This article orginally appeared in our July 2016 issue.
This issue features our annual coverage of Baruch College’s Financial Reporting Conference. Each year, leading regulators, issuers, auditors, and users discuss the most pressing issues on their agendas. The current focus was on the new rules, standards, and developments at the SEC, FASB, and PCAOB, as well the relevance and value of financial reporting on investors’ decision making.
A New Perspective
Entering the debate over the relevance of financial statements is a new book, The End of Accounting and the Path Forward for Investors and Managers, by Baruch Lev and Feng Gu, two professors from NYU Stern and the University at Buffalo. To be published this month, it marks the culmination of three years of research. One aspect focused on the decision-relevance of information in financial reports by comparing them to alternative sources of information. Their conclusion is either surprising or depressing: corporate quarterly and annual reports currently contribute only 5–6% [!] of the total information used by investors (p. 45). “Financial (accounting) information is losing ground to its more timely and relevant competitors,” they declared. This is an unintended result of the proliferation of standards; corporate managers, realizing the deterioration in usefulness, have responded by expanding voluntary disclosure of non-GAAP accounting information. The prevalence of pro forma, non-GAAP earnings releases doubled from 2003 to 2013, reaching over 40% (p. xvi).
Lev and Gu also report on a study by leading accounting researchers, who examined the impact of all guidance issued by FASB from its inception through 2009—a staggering 147 standards—and found that 75% had no effect on the shareholders of the impacted companies and that 13% actually detracted from shareholder value. Only 12% of the standards were found to have benefited investors. The authors attribute the SEC’s new initiative on “disclosure effectiveness” to a high-level concern over this issue.
Finally, Lev and Gu studied companies’ market values (stock prices) over a 60-year period to determine how much could be attributed to corporate earnings (i.e., net income) and book value or equity (i.e., balance sheet assets minus liabilities). They concluded that, during the 1950s and 1960s, roughly 80–90% could be attributed to corporate earnings and book value. Today, however, that figure has fallen to only 50% (p. 33).
The debate over the relevance of financial statements would be incomplete without a discussion of the integrated reporting movement—the subject of our June cover story, “The First Annual NYSSCPA–Hedge Fund Roundtable Sustainability Investment Leadership Conference.” The “integrated thinkers” at this conference gave their opinions on what constitutes useful information in light of the way corporations are valued today. Many global leaders in integrated reporting have concluded that country-specific and global standards are “irrelevant and meaningless” given that intangibles constitute over 84% of the value of today’s international corporations. “Do you think doing your financial statements according to FASB and not applying your mind to what is critical or relevant or material to your business from an ESG [environmental, social, governance] point of view is going to lead to a different result?” argued Mervyn King, former chair of the International Integrated Reporting Council and the Global Reporting Initiative.
Jane Gleeson-White, author of Six Capitals, or Can Accountants Save the Planet?, argued that substantial portions of the six capitals are not measured in the financials—despite making up the most significant share of an enterprise’s value today. These include reputations and brand equity (intellectual capital); employees (human capital); supply chains and goods subcontracted from vendors (manufactured capital); biodiversity and sustainable harvesting practices (natural capital); communities, infrastructure, and governments (social capital); and others.
What kind of information do financial statement users find relevant? And what kind of information are CPAs capable of measuring and providing assurance on?
The opinions expressed here are my own and do not reflect those of the NYSSCPA, its management, or its staff.