The Financial Reporting Lab (“the Lab”) seeks to improve the effectiveness of corporate reporting in the UK. It does this by working with companies, investors and others on topics that matter. Lab reports explore innovative reporting solutions that better meet the needs of companies and investors, by speaking to them about a topic and publishing reports that represent their views and highlight best practice reporting.
The Lab has carried out a series of projects on narrative reporting topics. It previously published reports on business models and risk and viability reporting. This project, on performance metrics, explores how companies report performance against their strategic objectives. Its report, published in June, provides an investor view on performance metrics.
The reporting of performance continues to be of substantial interest and it is clear that it is central to how companies demonstrate the value they create and how investors value companies. It is also clear that not all company reporting is meeting investor needs, and the Financial Reporting Lab (“the Lab”) therefore spoke to investors to see if they could identify a set of principles for companies to consider when deciding on the performance metrics that they report.
There has been a great deal of change recently in the reporting of performance metrics. European initiatives and regulation such as the European Union’s Non-Financial Reporting Directive, the Commission’s Action Plan on Sustainable Finance, and the European Securities and Markets Association (ESMA) Guidelines on Alternative Performance Measures (APMs) are changing how companies think about and report on their performance. The reporting of performance metrics is also being considered internationally, with the Canadian Accounting Standards Board, the Securities and Exchange Commission, the Task Force on Climate-Related Financial Disclosure, the Sustainability Accounting Standards Board and others all working on aspects of the reporting of metrics, whether financial or wider metrics.
Given these recent changes, the Lab sought to gather an investor view on the disclosure of performance metrics and the report published in June sets out the views the Lab heard from 38 members of the investment community.
When discussing performance metrics, the project addressed all metrics, including GAAP, non-GAAP and wider metrics. This broad scope was reflected throughout our investor discussions, as they use all information that might help them build a picture about management credibility and the company’s performance, position and prospects. Important in understanding issues of performance is that the metrics reported externally are those being monitored and managed internally. Investors seek to understand performance through the eyes of management, and the metrics being used internally are instructive for them in assessing what management is focusing on and trying to achieve.
The report identifies five principles. Investors want performance metrics to be: aligned to strategy; transparent; in context; reliable; and consistent. Within these high-level principles, there are some more specific expectations about the level of detail and explanation investors would like to see.
For metrics aligned to strategy, investors seek disclosure
of metrics that provide insight into the company’s business model, strategy and competitive advantage and measure its success
of metrics that demonstrate how the company creates long-term value
of the metrics used internally to make business decisions and to manage, monitor and incentivise the achievement of the business strategy
For transparent metrics, investors seek disclosure
that provides transparency on how metrics are calculated and defined to help investors make their own assessments, with clear reconciliations from GAAP to non-GAAP metrics
that gives a clear explanation of why metrics have been used and, in the case of non-GAAP metrics, why management think these are a more faithful representation of the value that has been generated by the company’s business model than the GAAP metrics
In expecting metrics to be presented In Context, investors seek disclosure
that shows how a company has performed, with explanations where this is different from what it was trying to achieve, either good or bad
that explains the company’s position, for example, its balance sheet strength, liquidity and market position
that gives an indication of the company’s prospects within the context of the market and market changes. Longer-term objectives are often preferable.
In expecting reliable metrics, investors seek disclosure
that provides information to help investors gain confidence on the process of developing, monitoring and reporting reliable metrics, and whether there are appropriate controls in place
that provides clarity over the level of scrutiny that metrics are subject to (including Board, Audit Committee, internal and external assurance processes) and the boundary of the information
In expecting consistent metrics, investors seek disclosure
of metrics that are calculated consistently year on year and also presented consistently across reporting formats (annual report, investor presentation, sustainability reports, press releases, etc.)
that provides a track record, preferably over five years
that provides enough detail to allow effective comparisons of similar companies, either at a business model or sector level
There are some good examples of reporting, but there are also a range of areas which investors highlighted for improvement. Investors stressed how important performance metrics are for their assessment of management credibility. So to assist companies when assessing their own reporting against the investor expectations, the Lab identified a range of questions for companies and boards to ask themselves. These questions, which flow from the principles, can be found in the full report.
The next phase of the project, including examples of reporting against these principles, will be published in the autumn.
About the author
Hannah Armitage is a Project Manager in the Financial Reporting Lab. Hannah joined the lab in 2017 when she moved from the FRC’s Corporate Governance Team, where she worked on the Stewardship Code and related issues and revisions to the UK Corporate Governance Code.
Hannah is a qualified lawyer and prior to joining the FRC worked in the Australian Department of the Treasury on corporations and corporate law policy.