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The new New Economy Analyst
Report – September 22, 2002
Juergen Daum’s new New
Economy Best Practice service
©2002 Juergen Daum. All rights reserved.
The book of the month: “Building
Public Trust: The Future of Corporate Reporting” by Samuel A. DiPiazza Jr. and
Robert G. Eccles
News categories: Intellectual
capital management, Finance and Accounting, Performance management, Investor
and stakeholder relationship management
“There is a time to stand up and be counted – to stand
up and offer one’s best. Hence this book, addressing a topic that has been
forcibly brought to the world’s attention: the future of corporate reporting in
a time when major business failures and a stiff critique of the practices of
auditors and influential securities analysts have shaken the public trust. […]
Crisis is opportunity. Virtually every participant in what we have called the
Corporate Reporting Supply Chain is looking for new answers, new ways to assure
investors and other stakeholders that the information they are receiving
enables them to understand companies in detail and in depth. We hope that this
book stimulates dialogue among all of us who are responsible for building
public trust in the markets, on which the progress of society in all parts of
the world depends."
Samuel A. DiPiazza Jr. and Robert G.
Eccles
§
A new
model for corporate reporting based on three tiers that ensure full
transparency
§
The need for
Global GAAP: Tier-One
§
The need for
supplemental financial and non-financial industry specific information:
Tier-Two
§
The need
for information about good or bad enterprise management: Tier-Three
§
Confronting the
Corporate Reporting Challenge: The ValueReportingTM Framework
§
Digitizing the
Corporate Reporting Supply Chain: XBRL
§
Future
Audits: The role of independent auditors and the new Corporate Transparency
Model
§
How does corporate
reporting look like in ten years after Enron?
§
Summary
The
strongest cries for reform of corporate reporting have come from the United
States in the wake of the largest bankruptcy in the country’s history, the
abrupt and unanticipated failure of Enron. Not surprisingly, many accusations
are being made, many lawsuits have been filed, and proposals for new
regulations and laws are under review in many countries. While the debate about
a reform of corporate reporting is not new and many bright people have been
working on proposals for a new corporate reporting model (such as in an
SEC-inspired task force, which came up with their report “Strengthening
Financials Markets” in May 2001, the Danish Agency for Trade and Industry’s
research project that culminated in it’s November 2000 publication “A Guideline for Intellectual
Capital Statements” – about both I have reported earlier several times on
this website - or in the “Business Reporting Research Project”
of the U.S. FASB that released it’s report on January 2001), this has not led
to fundamental change initiatives by regulatory bodies yet – until now.
The
awakening brought about by the Enron disaster and by others that followed it is
the proverbial straw that broke the camel’s back. After other business failures
in a number of countries and after the burst of the Internet bubble it was
Enron, which was the last straw. Because of the Enron case, public trust has
been shaken in the institutions on which the global capital markets depend for
getting the information needed to make a wide range of investment decisions.
But the two authors believe, that the Enron bankruptcy is not the most
important issue. Instead, it is how the aftermath of this business failure can
serve as a lens to sharpen our collective focus on the key elements that create
public trust in markets and, therefore, allows those markets to allocate
capital efficiently.
Building
Public trust is a call to institute the necessary reforms to
ensure that public trust does not disappear. And DiPiazza and Eccles believe
that the foundation for those reforms lies in corporate reporting. Therefore
they propose to re-examine the Corporate Reporting Supply Chain, how they call
it. It begins with the corporate executives, who prepare the financials
statements that are reported to investors and other stakeholders. These
financial statements are approved by an independent board of directors,
attested by an independent auditing firm, analysed by sell-side analysts, and
broadcasts by information distributors, including data vendors and the news
media.
A new model for corporate reporting based on
three tiers that ensure full transparency
The
book offers a vision of the future of corporate reporting – a vision based on a
revised model of corporate disclosure, a fresh view of the responsibilities of
every participant in the corporate Reporting Supply Chain, and suggestions
about technologies, such as Extensible Business Reporting Language (XBRL), that
can help make the vision to become reality. The intention of the two authors
with this book is, to spur action towards the reforms that will build up public
trust and initiate a dialogue among all participants of the Corporate Reporting
Supply Chain to make that happen.
Their
basic recipe for a new corporate reporting model is, in order to improve the
information corporate reports provide to investors and thus increase their
trust in corporations and in the capital markets at large, to significantly
broaden the scope of corporate reports. With Building Public Trust,
DiPiazza and Eccles are introducing a three tier model for corporate
transparency:
§
Tier 1: A set of
truly global generally accepted accounting principles (Global GAAP)
§
Tier 2: Standards
for measuring and reporting information that are industry-specific,
consistently applied, and developed by the industries themselves.
§
Tier 3: Guidelines
for company-specific information such as strategy, plans, risk management
practices, compensation policies, corporate governance, and performance
measures unique to the company.
Why
a three tier model?
Much
is being done today to improve corporate reporting. But each group involved has
its own goals and its own rather narrow view of what will make things better.
Therefore many of these different initiatives focus on one of these tiers. But
the authors state, that the market requires a larger organizing framework that
will focus all of these efforts to become part of one integrated model that can
ensure that investors and other stakeholders get the information they need to
make appropriate decisions. And investors will benefit fully only if companies
communicate the information in each tier in an integrated fashion that provides
a holistic view of the enterprise – its marketplace opportunities, its
strategies and their implementation, its value drivers, and its financial
outcomes.
The need for Global GAAP: Tier-One
At
the foundation of DiPiazza’s and Eccles’s Three-Tier Model of Corporate
Transparency is the existence of Global GAAP, a set of accounting standards for
reporting a company’s financial performance for a defined period. Only Global
GAAP can provide the information that investors need, to compare financial
performance of companies from different countries. Just as markets for tangible
products have become global, so have the capital markets. Investors want to
invest around the world, just as companies want access to capital around the
world. But the vast differences that exist among national and international
accounting standards, and in the levels of transparency they create, impair the
ability of investors to compare the financial performance of companies that
report according to different sets of standards. The resulting uncertainty
about the reliability of reported financial information can be reflected in a
higher cost of capital through a lower share price. Conversely, if Global GAAP
existed, investors could much more easily and accurately compare the
performance of any company, in any country, in any industry.
But
the lack of a global GAAP standard is not perceived as the only shortcoming of
the current GAAP practice. Criticism about GAAP worldwide includes also that
GAAP focus too much on short term earnings, thus fostering the so called
earnings game. In addition, GAAP based financial reports do not account for or
disclose certain types of information about intangible assets, and do not
communicate adequate information about value creation. DiPiazza and Eccles
believe that most of these problems can be resolved by adding additional
information to the GAAP based financial numbers at Tier 2 and Tier 3 of their
model. But the biggest problem at Tier 1 remains the lack of a Global GAAP
standard. But we may be close to a solution. The authors name the efforts of
the IASB (International Accounting Standards Board) that established the
International Financial Reporting Standards (IFRS – before called the
International Accounting Standards – IAS). While IFRS will become the standard
in the European Union in 2005, where it will apply to companies that represent
25 percent of the world’s total market capitalization, the adoption in the
U.S., with approximately 52 percent of the world’s market capitalization, will
represent the decisive milestone for its global success.
The need for supplemental financial and non-financial
industry specific information: Tier-Two
But
what drives value, dramatically differs across industries. DiPiazza and Eccles
are demonstrating that by comparing the pharmaceutical industry, where value
creation is mainly driven by product innovation, with the telecommunication
industry, which creates value mainly through marketing, customer retention,
competitive pricing and other market related activities.
In
order to compare one company’s performance to that of its industry competitors,
investors need, in addition Global GAAP based figures, which provide a
foundation, supplemental industry specific information, both financial and
non-financial, to gain a more complete view of a company’s past performance and
to make inferences about its future prospects. Because the competitive dynamics
of specific industries, how those industries create value for shareholders, and
what other stakeholders want to know (for example environmental and social
NGO’s want different type of information depending on the industry) vary widely
across industries, investors and other stakeholders require, in addition to
tier 1 information (Global GAAP based), information about industry specific
value drivers. This is called Tier-Two information by the authors.
To
make such industry-specific information truly useful to both investors and
companies, standards are needed, otherwise a company’s set of numbers could not
be compared with those of other companies of the same industry. But how to
create these standards?
DiPiazza
and Eccles believe, that a few pioneering industries can lay the foundation for
developing Tier-Two standards across many other industries. This requires a few
pioneer companies within such an industry, that make a start in publishing
corporate reports that include Tier-Two figures.
The need for information about good or bad enterprise
management: Tier-Three
Assuming
that both Global GAAP and global industry standards existed for all key
financial and non-financial measures, investors and other stakeholders would
still need a great deal of information specific to an individual company. In
order to be able to assess the success of management, they need information
about management’s strategy, identified risks, risk management and compliance,
compensation policies, corporate governance, and company-specific performance
measures on key value drivers. DiPiazza and Eccles state, that to report
publicly and completely on these value drivers, within the bound of competitive
good sense, is the very meaning of transparency.
Management
turns its commitment to transparency into action by making its holistic value
proposition understandable to stakeholders. Holistic here means how all things
within the company, and between the company and its markets, are linked. By
demonstrating to stakeholders the links between marketplace opportunities and
strategy, between value drivers and measured results, and between management
decisions and value creation, the company will deserve confidence of investors
and all stakeholders in its performance. Good management and good reporting at
Tier Three produces good results at Tier-One and Tier-Two. But this requires
that management knows, how value is created, what the true risks and
opportunities of the business are, and that it shares at least a portion of
this insight with stakeholders and with the company’s board. It requires that
management has a good performance management system in place (consisting of an
appropriate performance measurement system and the right management processes1)
and that the company has implemented a good corporate governance system.
Confronting the Corporate Reporting Challenge: The
ValueReportingTM Framework
The
authors are admitting, that the corporate reporting of few, if any, companies
today provides the disclosure contemplated by the Three-Tier Model of Corporate
Transparency and, within that model, the information requirements of Tiers Two
and Three. But this is not surprising. Corporate commitment to greater
transparency is still in its infancy, although it is maturing rapidly. DiPiazza
and Eccles list five major challenges management must confront in order to
practice greater transparency:
§
Model external reporting on internal reporting (eliminating
of reporting gaps in external reporting: reporting externally on all issues
that management find important for running the company)
§
Determine the information that stakeholders need
in a systematic way (closing information gaps: disclosing information that
investors and other stakeholders think is important for them)
§
Report relevant information from external
sources (adding information that shows, how a company is performing against
industry trends, such as competitor benchmarks)
§
Report on the real economic entity (report on
the broader ecosystem of the company that may include subcontractors and how
they behave from a social and environmental perspective)
§
Weigh the risks and costs against the benefits (identify
and exclude information from the corporate reporting process that might put the
company at a competitive disadvantage, is misleading, unreliable, too detailed
to be clarifying, or to costly to assemble)
In
order to report to shareholders and stakeholders in a logical and organized way
all the information it has decided to disclose, the authors present the
ValueReportingTM Framework. The ValueReportingTM
Framework offers a solution that companies can use for organizing the
information they report to stakeholders. Developed on the basis of
PricewaterhouseCoopers’ capital market research, it should provide a comprehensive
means of structuring internal and external reporting. The framework presents
four basic categories of information. Together they create a coherent and
complete medium-term picture of a business, against which short-term
performance can be explained. The four categories link to and build on one
another:
The
ValueReportingTM Framework:
Market
Overview:
Competive environement, Regulatory environement, Macro-economic environement
Value
Strategy:
Goals and objectives, Organizational design, Governance
Managing
for Value:
Economic performance, Financial position, Risk management, Segmental reporting
Value
Platform:
Innovation, Brands, Customers, Supply Chain, People, Corporate reputation
The
framework should not be viewed as a static medium for presenting discrete bits
of information. Used properly and intergrated into internal management
processes, it becomes a dynamic tool for assessing and monitoring all key
aspects of performance and for communicating publicly their contribution to
value creation.
Digitizing the Corporate Reporting Supply Chain: XBRL
Paper
based communication formats will not be superseded any time soon for a wide
range of purposes they serve effectively. But corporate information, in all its
growing quantity and complexity, can be and must be communicated more
effectively with the use of new technology. The authors believe, that reported
information needs to break away from the constraints of paper-based formats.
Even with today’s electronic technology, most content is still reported in
formats that are very little more than electronic versions of paper, for
example, the pdf format for annual reports found on Web sites. Transferring
content to a spreadsheet for analysis for instance, almost always requires
manually transferring of date to another format. This is labour intensive and
time-consuming. In addition users get little or no help in analysing and
understanding such an electronic document’s full content or in verifying its
accuracy and authenticity.
In
contrast, Extensible Business Reporting Language (XBRL) with its ability to
“tag” any individual piece of information with a precise contextual
description, facilitates the access and use of information by investors. The
authors therefore introduce XBRL as the possible solution and next step to
facilitate the Corporate Reporting Supply Chain and to make it more efficient
and effective. When information is tagged in XBRL, stakeholders can simply make
an information request from within their analytical software and in seconds the
information or data they want will be incorporated into their analysis. As an
example DiPiazza and Eccles quote that such tools can quickly find and extract
information – for example, a company’s revenue recognition policy, buried in
the footnotes of a 100-page annual report – and present only the specific
information that the investor wants to analyse. In addition XBRL can also speed
the company’s access to its own information by reducing internal barriers to
consolidation information, thus making information sharing among disparate
internal data warehouses much easier.
XBRL
is not limited to the financial information at Tier-One of the Three-Tier Model
of Corporate Transparency. It can tag virtually any type of information,
including the non-financial, industry-specific, and company-specific
information at Tiers-Two and -Three. It can also be used to collect relevant
performance-related information from sources external to the company, such as
benchmarking information on customer satisfaction levels, that originate from
independent industry association’s customer satisfaction survey data or from a
customer complaint database maintained by a third party, thus offering
previously unattainable benefits to the Corporate Reporting Supply Chain.
But
realizing the benefits that XBRL promises requires a much closer integration of
all the Corporate Reporting Supply Chain participants. They must adopt it as
the standard in business reporting. But XBRL is only as good as the quality of
the information on which it is based. This is why the assurance function,
according to the authors, plays such a critical role in building public
trust.
Future Audits: The role of independent auditors and
the new Corporate Transparency Model
Enron
is just one example of a recent spate of business failures that occurred with
virtually no prior public expression of concern over the reliability of the
company’s financial reporting on the part of the independent auditing firm. The
public outcry after the Enron crisis has struck the auditing industry at the
heart of its professional values: objectivity, independence, and integrity.
DiPiazza and Eccles therefore think, that auditing firms must address the
questions raised about the quality and relevance of their work and quickly so,
because public trust is fragile – easy to loose and hard to regain.
One
of the central propositions of the authors in their book is that when investors
have access to more reliable and more timely information about company
performance, that is in large measures, the information that executives use to
run their business, better investment decisions will be possible. If markets
begin to reward companies that swiftly, fully, and accurately describe their
performance, the pressure to play the earnings game – and for auditors to
acquiesce in it – will be relieved. The Three-Tier Model of Corporate
Transparency provides the information that is relevant to investors and other
stakeholders for the decisions they must make. The reliability of this
information is assured by subjecting it to an audit by an independent and
objective third party. It will require auditors to better respond to the
market’s demand for audit opinions that say more about the information on the
health of the business – especially in the U.S..
In
the future, the authors believe, the role of independent auditors will be
refocused to give investors and other stakeholders assurance on a much broader
range of information as embodied in the Three-Tier Model of Corporate
Transparency. At all three tiers, management will prepare the information, the
board will approve it, and an independent auditing firm will provide assurance
on it. Providing assurance an a broader range of relevant information will make
the audit opinion itself more relevant.
How does corporate reporting look like in ten years
after Enron?
In
their epilogue, the two authors present three different scenarios that may
emerge in ten years after Enron:
Scenario
1 - Disorder: All efforts to achieve significant and broad
reform of corporate reporting have long since foundered. One version of GAAP is
pitched against another, and informed access to global capital has become
prohibitively cumbersome and expensive, except for the very few. Companies
publish more data than ever on their Web sites, more pages of number and text.
But the meaning of what they publish has become more impenetrable than ever. In
this disordered future, corporate mistakes are often hidden until revealed by
journalists. The markets have become a
global casino, fortunes won and lost on a single roll.
Scenario
2 - Bureaucracy: The regulators are now firmly in charge. The
fear of chaos in the capital markets and of flawed corporate reporting proved
to be so great that the capital markets gradually became national and regional fortresses
overseen by powerful agencies whose primary interest is making and enforcing
rules. Closed borders prevent access to foreign capital, and investors have no
option but to invest at home. The quality of assurance is only as high and
delivered only as fast as can be expected from government work. Rather than
moving toward daily closing of the corporate books, the pace has slowed. As a
result, the only publicly reported news is old news. Meanwhile analysts have
gone underground, and black market research abounds. The earnings game plays
on, but now behind tightly closed doors.
Scenario
3 – Transparency: The future of corporate reporting is now
firmly in place, the Three-Tier Model has become a reality, powered by XBRL,
auditors have both the appearance and the reality of practicing at the highest
level of professional skills, ethics, and independence. As a result, capital is
being allocated more efficiently all over the world and the overall cost of
capital has come down. Innovation flourishes wherever bright minds and the
entrepreneurial spirit converge.
DiPiazza’s
and Eccles book was published at the right moment. The time is ripe for new
corporate reporting concepts that replace the traditional model focuses solely
on financial earnings and balance sheet figures that capture only 20 percent of
a company’s economic reality today and does not reflect any more the value
creation model of today’s enterprises. Samuel A. DiPiazza Jr. and Robert G.
Eccles and their co-workers at PricewaterhouseCoopers did an outstanding job in
bringing the different concepts that had been developed so far and the results
of many different research work together into their Three-Tier Model. Building
Public Trust: The Future of Corporate Reporting is clearly a must read for
everyone interested in corporate reporting, investing, and corporate
performance management. The book continues and deepens thinking first presented
in another book: The
ValueReporting Revolution: Moving Beyond the Earnings Game, by Robert
G. Eccles, Robert H. Herz, E. Mary Keegan, and David M.H. Phillips.
Samuel
A DiPiazza Jr. is the CEO of PricewaterhouseCoopers. He has
enjoyed a long career with PricewaterhouseCoopers, which he joined 1973. He
most recently served as Senior Partner and Chairman of the U.S. firm with
executive responsibility for U.S. operations.
Robert
G. Eccles is founder and President of Advisiory Capital
Partners, Inc. (ACP), and a Senior Fellow of PricewaterhouseCoopers. Prior to
founding ACP, Dr. Eccles was a full professor at Harvard Business School, where
he was a faculty member for fourteen years, receiving tenure in 1989.
Building
Public Trust: The Future of Corporate Reporting
by Samuel
A. DiPiazza Jr. and Robert G. Eccles
Hardcover - 188
pages (July 2002)
John Wiley & Sons Inc; ISBN: 0471261513
1 for the concept of a new
performance management systems that is suited for today’s companies see also: Juergen H. Daum, “Intangible
Assets and Value Creation”, John Wiley & Sons Ltd. Chichester, 2002 (German Version: Juergen H. Daum, Intangible Assets oder die Kunst Mehrwert
zu schaffen, Galileo Press Bonn, 2002)
A revolution in
stakeholder oriented corporate disclosure – case study: The Shell Report by Juergen Daum
eXtensible Business
Reporting Language (XBRL) is moving forward by Juergen Daum
Approaching the next
level of shareholder value management (part 1) by Juergen Daum
Interview with Baruch
Lev: Accounting, Reporting and Intangible Assets by Juergen Daum
The book of the month:
“Intangibles: Management, Measurement, and Reporting” by Baruch Lev
Intangible
Assets and Value Creation, a book by Juergen H. Daum, which focuses on the
new accounting, measurement and management system companies require to thrive
in the knowledge economy of today
Intangible Assets: a
central topic at the mySAP Financials conference in Strasbourg by Juergen Daum
Performance
Management and Business Controlling in the 21st Century Presentation held by Juergen Daum at SAP's European mySAP
Financials Conference, June 2001, Strassbourg / France
Interview mit David P.
Norton: Intangible Assets und die Balanced Scorecard by Juergen Daum
Intangible
Assets: The Art of Creating Value – Interview with Juergen Daum by sapinfo.net
Performance Management
Beyond Budgeting: Why you should consider it, How it works, and Who should
contribute to make it happen
by
Juergen Daum
Corporate Performance
Management: Managing profitability and growth in the new environment – article by Juergen Daum
Interview with Leif
Edvinsson: Intellectual Capital: the new wealth of corporations
The new FASB rules for
reporting on Intangible Asset - The U.S. versus the European way by
Juergen Daum
How accounting gets more
radical in measuring what really matters to investors – article by Juergen Daum
Today’s #1 management
challenge: How to better exploit intangible assets to create value –
article by Juergen Daum
Can corporations protect
their investors against fake news stories ?
by Juergen Daum
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