In the movie Planes, Trains and Automobiles, John Candy plays a lovable loser with a habit of telling convoluted stories. In a fit of frustration, co-star Steve Martin shouts, ‘When you’re telling these little stories, have a point. It makes it so much more interesting for the listener!’
With investors’ interests in mind, the same message applies to companies preparing their management’s discussion and analysis (MD&A). In the post-Enron environment, disclosure documents like the MD&A are getting longer and the message, or the point, is becoming harder to decipher.
CEOs and CFOs increasingly view their target audience as those who can prosecute, not those who can purchase shares. As someone who has headed communications for a company operating under court protection, I can say these two audiences are very different.
It is the IRO’s job to defend the interests of investors and to keep the MD&A readable. First, find out what your shareholders want and need to know, and then provide that information in a clear and understandable way. Nothing is more uninviting than impersonal, boilerplate MD&A that reads like a prospectus.
Good MD&A answers the following questions.
Wazzup?
Forget the boring business overview. The MD&A introduction needs to deliver all the company’s key messages of performance, strategy and financial position. It’s the 30-second sound bite, which is often all the time an investor is willing to give.
What are you leveraging?
When investors buy your stock, they are gaining exposure to something. What is it? The MD&A should clearly discuss the factors that drive the company’s financial results and share price. Far too often, earnings’ sensitivities are buried deep in the risk section when they should be front and center.
Where are you taking the company?
US and Canadian regulators have called on issuers to present their MD&As ‘through the eyes of management’, focusing on long-term strategy and value creation. If more companies started doing this it would be one of the greatest breakthroughs in IR. Imagine watching Lord of the Rings without knowing what the ring is or that the overriding objective is to destroy it. That is what reading a typical MD&A is like for investors.
Given your strategy, how did you do?
With a focus on long-term strategy, the MD&A’s discussion of variances should not just include the traditional elevator analysis of results compared to the prior period (this went up, that went down). It should provide an assessment of performance relative to management’s expectations. Candor is a great way to build credibility.
Can you pay your bills?
Since Sarbanes-Oxley and subsequent SEC rules, companies must disclose all material off-balance sheet obligations, relationships with unconsolidated entities and key accounting estimates and assumptions. Heavy stuff, particularly with the continuing lack of clarity around the word ‘material’. Remember that most investors don’t care about accounting wizardry. They want to know what is likely to cost the company money and if you have the cash to pay for it. Focus on the exposure, not the complexities of the financial instrument or arrangement.
What keeps you awake at night?
The risks and uncertainties section of the MD&A can be boilerplate at the best of times. Management knows what they’re concerned about, and what risks are most often discussed at board meetings (helpful hint: get the minutes). By isolating these issues, IROs could, in many cases, cut risk sections in half and double the value.
What happens next?
The MD&A should give the reader an idea of how much further the company plans to progress with its strategy in the coming year. This is a totally different exercise than simply throwing out earnings guidance, which provides little value other than giving casino-minded investors and brokers a chance to place their bets.
Who’s calling the shots?
When reporting through the eyes of management, it helps to know whose eyes. Whether in the MD&A or elsewhere, disclosures about internal control structures, decision-making processes, and checks and balances within the company are all very important.
A scattergun approach to MD&A disclosure simply doesn’t provide value for the reader. What does lend insight to investors is an MD&A that, as Steve Martin suggests, gets straight to the point.
Mark Utting is a CFA and award-winning financial writer with experience writing MD&As and annual reports. [email protected]
