Next time you see a member of the team that puts together your company's annual report, give that person a pat on the back. They'll need it this year. Coming fresh off 2002–a year in which corporate scandals and accounting shenanigans seemed almost daily revelations–regulators, and more importantly investors, are in no mood to be toyed with, let alone lied to. The premium in year-end wrap-ups must be on telling it straight and telling it simply. In other words, junk the footnotes.
It's all part of the so-called new age of financial disclosure. Executives must now swear to the veracity of financial statements. When trying to woo investors, using pro forma numbers instead of GAAP results can do as much harm as good. And even the proxy statements and lowly little annual reports have new bars to hurdle with respect to which pieces of information must be disclosed and how.
Companies that fall short of at least the appearance of full disclosure face not only harsher penalties from Washington, but also the unfettered wrath of a jittery investor community short on patience and trust. "We are all going to be looking, and those who don't come forward [with full disclosure] will pay dearly," says Nell Minow, a shareholder activist and editor of The Corporate Library, which researches corporate governance issues. "Their cost of capital will reflect the fact that investors don't believe what they say." As Ann Yerger, director of research at the Council of Institutional Investors in Washington, puts it, "full and fair disclosure is not that hard."
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Less Quantity, More Quality?
So should the financial community expect a marked improvement in annual reports and proxy statements? As many see it, these annual updates couldn't get any worse. Still, a look at early examples indicates that some companies are interpreting regulations so literally that the quantity of information appears to have declined even as the quality may or may not be increasing.
Sid Cato, editor of the Newsletter on Annual Reports, a monthly publication that examines annual report trends, claims that the annual report page-count study he conducts is showing that average page counts have actually fallen to 41.4 pages for reports released in connection with the end of the 2002 fiscal year, from 48.6 pages in 2001 and 53.4 pages in 2000. Apparently, though the government is mandating more information, many companies are opting for word economy in this new climate. "The annual report has become the whipping boy among corporations, which are saying, 'I think we put out too much information,'" even as Washington demands more disclosure, Cato says. In many ways, "Things are as bad as ever," he says.
Some business experts, however, claim that the regulations simply make companies defensive and actually end up inhibiting disclosure. A proxy statement "is a highly regulated document, and the form in which it's produced comes from regulation. Companies could always disclose more, but they are straightjacketed by a form set by the SEC," says Charles Elson, chairman of the Center for Corporate Governance at the University of Delaware's College of Business and Economics. "This year will be more concerned with Sarbanes-Oxley and certification rather than anything new. It will be more about meeting what is out there versus what should be out there."
Perhaps the operative word that Elson is using here is "could." Clearly, companies could disclose more, but even disclosing enough or being honest was obviously a concept lost on the management of companies like Enron, Tyco, Xerox, Adelphia, Global Crossing and WorldCom, to name a few of the more outrageous offenders.
Hence the regs. Sarbanes-Oxley mandates that proxy statements disclose more information about a company's audit committee, provide more detail about executive compensation and give greater transparency to conflicts of interest concerning management, among other things.
Though regulations are expected to produce improvements in key areas of proxy statement disclosure, a larger question looms over whether the impact will trickle down to annual reports, which many institutional investors these days deride as useless puffery that focuses less on the true direction and health of a company and more on pictures of smiling workers and an emphasis on the company's global presence. "Full-time investors and professional investors ignore the pictures of multiracial employees, test tubes and the letter from the CEO and flip right through to the back and read the numbers," Minow says. "Even individual investors don't look at it all."
Seize the Moment
In spite of that, Minow says corporations should not ignore an opportunity to make improvements that could turn an annual report into something useful. One option: Let the board of directors take over the issuing of the annual report. "It is very difficult for company management, which lives and breathes the company, to communicate with people who have other demands of their time," she says. "It might also be worthwhile to have a message from your outside directors, discussing who they are, how they look out for your investors and what they are doing to adhere to Sarbanes-Oxley and the NYSE rules." Minow also suggests that companies spend a little time at the beginning of the annual report explaining why readers should believe what is on the remaining pages, literally outlining the internal controls that have been put in place.
The good news is that there are companies out there getting the message. Cato points out that Ford Motor Co. and insurer Aflac Inc. are examples of companies whose annual reports feature strong writing, are externally focused and celebrate the work of employees from the line worker all the way up to the CEO. Tellabs Inc. is another company with a strong annual report. "They've taken a cognizance of the Internet and realized that length is not where it's at, substantive information is," he says, adding that the report is concise and to the point.
Elson calls for change beyond current regulation: Allow companies to collapse the annual report and proxy statement into a single document, much the way European companies do. "I look at the two documents as combined to form annual disclosure," he says. "The real action is where the proxy statement comes in because that's the governance statement."
That said, for this year, there is only one sure approach that will garner the most respect from investors and regulators: With gratitude to the 1970s, tell it like it is and not how you wish it were.
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