It may not be appropriate to jud
ge a book by its cover, but relying on the narrative content of some annual reports can cause investors and analysts to make ill-advised decisions. The problem, according to industry body the Institute of Practitioners in Advertising (IPA), is the lack of clarity among companies in their understanding of and preparations for the enhanced business review (the replacement for the operating and financial review), which comes into force on October 1. It will dramatically increase companies’ narrative reporting (or disclosure) obligations, and executive directors of firms that fail to meet these new requirements could be fined or disqualified.
In a study of the narrative content of the annual reports of FTSE 350 companies, the IPA has sought to identify best practice and highlight areas that need to be addressed to comply with the impending review. The study, which was the basis of the selection process for the best narrative reporting category at the IR Magazine UK Awards 2007, considered 10 categories. These ranged from concise (how accessible and well communicated the narrative is) to strategic (the identification of key drivers of – and risks to – long-term value) to balance (emphasizing success while admitting non-performance). Companies were awarded a maximum of three points per category.
The results indicate that FTSE 250 companies have a greater range of overall quality than their FTSE 100 counterparts. The larger companies among the FTSE 250, which were either previously FTSE 100 companies or could become one in the near future, have the best disclosure standards of all.
Defining terms
But the study also finds that companies have interpreted the review in different ways. For example, four FTSE 100 companies produce 10 pages or fewer of narrative content, while two provide over 100 pages. Similarly, 8 percent of companies do not provide forwardlooking information, while across the board there is a distinct lack of information about resources or the assets from which they will derive value in the future.
The better reports include an assessment of five or six key performance indicators (KPIs) of relevance to their business and 10 to 15 principal risks and uncertainties. But most reports fail to focus on issues identified as material in the chairman’s statement.
Nearly every chairman identifies people as the company’s most important asset, but a mere handful of reports include substantial human capital sections. This oversight is important because the IPA’s research has determined that 62 percent of a company’s value is now intangible.
Few all-rounders
The IPA notes, however, that few annual reports score well across all 10 categories. For example, while most companies find it relatively easy to set out their current and future strategies and provide comprehensive reports on performance, they nevertheless struggle to explain and verify both financial and non-financial KPIs. This is particularly true among FTSE 250 companies.
Few companies manage to link strategy, objectives, risk and performance in a comprehensive fashion and provide the narrative to support the numbers. Perhaps unsurprisingly, general financial and life insurance businesses perform well in this category.
The study finds 15 percent of reports fail to provide a sector comparison to enable investors to judge firms against their peers. This category poses a challenge for boards, which consider the disclosure of comparative data potentially sensitive or, often, do not have the information at all.
The best reports provide extensive market share data, drawn from external information services, or describe the market forces in which they operate. Some reports also include information on the regulatory context of their market. British Sky Broadcasting, which recently entered a very public battle with rival Virgin Media, is the only company to excel in this area. It provides considerable information on both competitors and its regulatory environment.
There are some stand-out reports, however. Banking group HBOS scores highly across the board, and was named the top FTSE 100 company for narrative reporting at the IR Magazine UK Awards. The IPA awarded HBOS 26 points out of a possible 30; it averaged 2.6 points across the range of 10 categories, against a banking sector average of 1.2.
HBOS’ annual report provides exceptionally detailed information in a comprehensive manner, with historic information across a broad range of business areas. It also provides market share information, with comparison to the big four competitor banks. Each section is introduced with KPIs, and relevant risks to each business division are highlighted.
