Market analysis – Q1 2023
“Figures often beguile me,” Mark Twain wrote in Chapters from My Autobiography, published in the North American Review in 1907, “particularly when I have the arranging of them myself;”. As we approach the new reporting season following a difficult economic year, the temptation to fudge a company’s performance has never been so high.
Diplomatic doublespeak; fake news; and ‘my’ truth based on lived experience: by ‘changing the optics’ on events or facts our world leaders have inured us to misleading, obfuscating and dissembling statements. In a world in which everyone can choose the truth they want to believe, would it be a surprise if a company’s directors present an overly optimistic, alternative view of the facts relating its financial position?
The reality is that the majority of companies won’t have done as well last year as they would have wanted, which will put pressure on management teams to spin the facts of a lacklustre performance into a more compelling story for their investors. But it’s important to resist that temptation. Being transparent, up-front, open and honest about what’s going on in a business helps everybody, including the company itself which will need investors’ on-going support in these challenging times. That’s equally true for companies’ financial reporting, as well as those looking to IPO this year.
The over-riding problem is that management teams tend to take a too rosy a view of their business, which often means that they are not able to face-up to some of the issues that might be in front of them. How far they travel along the spectrum from presenting an overly optimistic picture, to outright dissembling and misrepresentation at the far end, depends on the ethics of the Board and how robustly the Non-Executive Directors and the Chairman, can show their teeth.
Beyond this issue, there are plenty of reasons for directors to want to over-egg the custard, but the main reason is to support the company’s share price and ensure the company doesn’t go into play i.e., become a takeover target. That’s a significant fear – a lot of UK companies are ripe for takeover. While the UK stock market has caught-up some of the trading discount with other major indexes, it is still looking cheaper than many other multiples:
it would immediately increase the value of a US company to buy a UK one! But there are other strong personal motivations to massage the facts, not least self-preservation of directors’ bonuses and share options.
Although the UK has managed to dodge the threat of a recession again for another quarter, trading conditions for many industry sectors have been brutal over the last year. But the challenges haven’t impacted all companies equally: the market is more nuanced and complex.
Some companies will have under-performed compared to previous years because of falling sales and rising costs; others will have stagnated, or achieved revenue growth only to have those gains eroded by increased costs. Others will have done much better at maintaining or increasing their margins over this period (only to be condemned in the media for their ‘mercenary’ actions to protect their shareholders).
Typical ways to pull the wool over investors’ eyes in the financial statements, include:
- Spin: painting a dismal picture in primary colours to disguise underwhelming performance;
- The illusory truth effect: taking a leaf out of the politicians’ play book to repeat something often enough that people will start to believe it’s true. For example, using the same boiler plate words in the Chairman’s Statement, the CEO’s Statement, and the CFO’s Statement, to say: ‘We’ve had a fantastic year!’. The FRC has recently highlighted this kind of repetition in the front-end of the financial statements as a problem; and
- Hiding in plain sight: The size of the financial statements has grown by 30 to 40 per cent in the last five years, mainly because the statements have become so complex and so big, that there’s no one person holding the pen: there is no ‘controlling mind’. As a result, directors and those preparing the accounts don’t knows what each other are saying, other than to repeat the corporate good news line. Either by accident, or design, it certainly helps to bamboozle the reader with an information overload.
Cut down the waffle
There’s a considerable amount of advice for Boards on how to make their financial statements more factual, informative and concise in the public domain from investment banks as well as the FRC, which exhorts companies to make sure that the front end and back end of their annual report and accounts tell the same story.
Boards need to get back to basics: be open and honest with a strong message and a clear focus. Two hundred pages of accounts isn’t exactly transparent!
The FRC has signalled its intention to focus on promoting better, clearer reporting processes with an attention on what matters, increasingly in future. There will undoubtedly be more guidance to come. Watch this space… But in the mean time, if you have disappointing results for investors, follow the PR mantra on how to break bad news: tell it all, tell it fast and tell the truth.
This article was originally published in the Q1 2023 Corporate Advisers Rankings Guide. For more information, please contact Mark Ling.
