What is the brand new management hype? Real-time reporting of financial information is certainly close to the top of that list. Calls for more frequent reporting of financial information suggest that quarterly or semi-annual reports come too late for investors. The argument goes that more frequent reporting will decrease cost of capital and improve corporate management, through better monitoring by investors. However, this argument lacks solid scholarly support. There is no research to support the position that increasing reporting frequency, beyond quarterly reporting, to daily or real-time basis has a significant impact on cost of capital. Research that tests for the effect of increased speed of information dissemination finds a negligible impact, if any, on cost of capital. Moreover, as Brian Bushee, of University of Pennsylvania, has shown, monitoring is performed by long-term investors, not investors that trade on the basis of short-term information.
Furthermore, there is a dark side to frequent reporting and it can vastly offset any benefits. Investors make decisions based on their expectations about the future cash flows of a company. The more frequently those expectations are revised and the more short-term the metrics they are based on, the more trading we will see in markets. Trading on next day’s sales numbers will lead to short-term speculation, higher trading commissions, and higher transaction costs. Robin Greenwood and David Scharfstein, of Harvard Business School, documented that in 2007 total outputs from the securities industry in the US was $676 billion, a three-fold increase in just ten years, with almost half of them coming from asset management fees. Is this money well spent by asset owners? I doubt it. Especially when most active fund managers fail to even match their benchmark after accounting for fees charged.
But here is the larger problem. More short-term trading can induce more short-term corporate management. In research that I have conducted with Francois Brochet and Maria Loumioti, of University of Southern California, we have shown that a more short-term oriented investor base leads to more short-term oriented management practices and vice versa. Firms with a short-term orientation tend to engage in suboptimal actions, such as cutting R&D expenses when they are about to miss analyst consensus forecasts. They also report accounting numbers that raise a number of red flags, such as abnormally large discretionary accruals and a propensity to just beat analyst forecasts or just avoid violating accounting covenants. A vicious cycle of short-termism is created that can lead to organizational disasters, threatening the competitiveness of our economies.
So how can we benefit from innovations in information technology, if not by increasing frequency of reporting? The answer lies in re-conceptualizing reporting from a one-way communication channel to a two-way. Integrated Reporting is a significant step in this direction. Moving from talking to listening, from lecturing to discussing. Providing information but also including tools for analyzing this information and gathering feedback from users about the company’s performance and reporting practices and getting suggestions for improvement. Websites, social media platforms and other information platforms can serve as mediums for a company to engage with its stakeholders and understand their expectations. A better understanding of those expectations is the key to higher customer satisfaction and loyalty, employee engagement, better community relations, and a more robust supply chain. As my colleague Bob Eccles and I have shown companies that successfully use these engagement platforms are able to innovate in processes, products, and business models and execute on a sustainable strategy, a strategy that drives long-term financial performance for shareholders while minimizing negative externalities, leading to market outperformance. The Brazilian cosmetics company Natura is one of the leading companies that have embraced this expanded vision for reporting, but other companies like industrial giant Philips and consumer products icon Nike are now realizing the benefits as well.
The German technology firm SAP is another good example of a company that utilizes innovations in information technology productively. On SAP’s website a five-year summary of key financial and nonfinancial indicators is provided, there is a chart generator for the last five years of performance for different classes of metrics (e.g., revenues and income, employees, and environment), technical terms in the text are defined with little boxes that hover over the word, the user can provide feedback to SAP on the report, individual names of employees in investor relations are given for answering questions (vs. the more typical “Investor Relations” box), webcasts are made available, concrete examples citing specific companies and people are included to bring to life performance metrics. All these features help interested parties, including investors, assess SAP’s long-term performance in the context of its strategy.
Advancements in information technology can improve corporate communication with shareholders, but not through incessant data dumps. Instead, companies will more likely be poised for continued success if they use digital platforms for long-term oriented engagement and communication in the context of our changing global economy. This is characterized by increased demand for corporate transparency, heightened global competition leading to customer mobility, and resource scarcity that raises the importance of innovation in sourcing, production, and delivery processes. Quality of communication, not quantity will yield important benefits.