Article

Question 1

1. How has the IASB responded to the discussions regarding a financial reporting problem?

Answer 1

The IASB has responded to these discussions in several ways. A paper discussing a number of possible changes to its current Conceptual Framework, including two chapters relating to disclosure and presentation issues, was published in July 2013 (IASB 2013b). A short-term project to amend IAS 1, Presentation of Financial Statements, has been initiated and there are plans to start a short-term project considering how to provide further guidance on the application of materiality and a medium-term project exploring whether a set of present standards should be replaced with a single standard on presentation and disclosure. There are also plans to review disclosure requirements in existing standards.

Question 2

2. Which are the four areas in which AIMR discovered room for improvements.

Answer 2

(1) segments/disaggregate data, (2) forward looking information (strategic and business plans, forecasts), (3) off-balance sheet assets and liabilities and (4) extraordinary, unusual, non-recurring charges (including restructuring).

Question 3

3. What was the conclusion from the 2012 survey IASB conducted, regarding the “disclosure problem”?

Answer 3

Those preparers who responded to the survey viewed the disclosure problem as prima- rily one of disclosure overload. Many users who responded saw disclosure overload as an annoyance rather than as a barrier to understanding the financial statements. Overall, users who responded focused on poor communication and a lack of relevant information to describe the disclosure problem (IASB 2013a, p. 36)

Question 4

1. What was the conclusion in a study by Baker and Imam 2008, regarding the perception of earnings? Which where the two key-factors in this classification?

Answer 4

respondents expressed a focus on ascertaining core earnings. This translated into a concern with the persistence and predictability of future operating earnings. These findings echo the outcome of previous research, which also suggests that a focus on earnings and cash flow is a common feature of all categories of capital market actors and highlight the importance of different valuation models for making predictions of future profitability.

Question 5

2. Which are the two dominant valuation models for sell-side analysts, found in research by Barker 1999?

Answer 5

In contrast to the normative prescription of finance theory, which privileges dis- counted cash flow (DCF) as the basis for equity valuation13, these studies have found that the comparatively unsophisticated price earnings (PE) multiple is the dominant valuation model, followed by DCF

Question 6

3. Research by Bence (1995) has shown that sell-side analysts and institutional investors rank the importance of information from the companies differently. Which were the three top ranked factors by sell-side analysts?

Answer 6

They found that while both sell-side analysts and investors used information from a range of sources, they ranked these sources differently. Sell-side analysts ranked the preliminary statements, interim statements, personal interviews, annual reports and company presentations highest. In compar- ison, the four highest-rated sources of information from the point of view of institu- tional investors were company visits, personal interviews, the company annual report and company presentations.

Question 7

In the research by HHS, which where the dominant user group in the study?

Answer 7

Owing to a combined consideration of identification and access possibilities, and the need to delimit the study, we chose to focus on professional equity and credit market actors.

Question 8

According to the HHS study, why is the interim report important to sell-side analysts, but not as important to fund managers?

Answer 8

while sell-side equity analysts were expected to provide rapid reactions to new information (e.g. interim reports), several fund-managers commented that they typically did not act on new information due to a long investment horizon and/or lack of sufficient liquidity.

Question 9

Name two reasons to why the number of companies covered, differed between an equity analyst and a credit analyst.

Answer 9

Availability of resources for information search and analysis also influenced how information was used. As one sell-side credit analyst noted: “If we had endless resources, then we could follow all companies to support our customers” Access to resources related, to a large extent, to the organizational setting. Notably, we found considerable differences in the number of companies covered by each inter- viewee.

Question 10

The coverage of companies differs between an equity analyst and a fund manager – how?

Answer 10

Unsurprisingly, buy-side actors with more generalist roles indicated that they did not have the possibility to undertake detailed analysis of individual company reports. As discussed further below, they described relying on in-house buy-side analysts and/or external information intermediaries to undertake such analysis.

Question 11

What is a “company thesis”?

Answer 11

Interviewees referred to such a company thesis in terms of unique reasons to hold (or divest) a company. In part, the company thesis was related to how a com- pany was viewed in comparison to the ‘market view’

Question 12

Why is the company thesis important when processing information about a company?

Answer 12

Interviewees indicated that once such a thesis was established, information that was linked to thesis-based drivers was prioritized. Several interviewees described how they purposefully searched for specific data in both interim and annual reports which they had identified a priori as the most relevant for that specific company

Question 13

In what way does expectations affect the way information is processed?

Answer 13

Most interviewees also described a process whereby they form expectations of key parameters prior to new information being released to the market and then searching for deviations from these forecasts:

Question 14

How does valuation models affect the information collecting process?

Answer 14

A clear majority of the interviewees also told us that their use of financial reporting information was directed in part towards updating their spreadsheets with various items from the financial reports. The level of detail in the models varied considerably. Sell-side analysts tended to describe more elaborated models requiring more data points to be updated.

Question 15

What is the draw-back with conference calls subsequent to the report?

Answer 15

A draw-back with these calls, however, was that they required additional time.

Question 16

Explain what is characterized as a “useful sense check”. How does it work?

Answer 16

Different actors appeared to rely on other actors to a various degrees. For example, one buy-side analyst characterized sell-side analysts as providing a useful sense check on his analysis: Because of the reliance of the capital market on sell-side analysts’ analyses, one fund manager somewhat provocatively referred to them as sanitation workers:

Question 17

Which of the information from the company was regularly used by most of the interviews?

Answer 17

With few exceptions, all interviewees not only said that they had read the most recent interim report from the relevant case company but also that they routinely read interim reports from the company on a timely basis.

Question 18

within what time frame does a sell-side analyst normally react on an interim report?

Answer 18

Typically within minutes after a results release, we publish our initial impressions on our Bloomberg chat

Question 19

Explain how the interim report and the company thesis fit together?

Answer 19

Many of the interviewees talked about the interim reports as containing new infor- mation to the market. More specifically interim reports were seen to provide an update about recent developments. This information was used to assess if these deve- lopments affected their general or specific expectations (the company thesis and the line item forecasts)

Question 20

How is the interim report read by a sell-side analyst?

Answer 20

In line with this, many interviewees described how they routinely read interim reports with a clear purpose, more or less immediately searching for predetermined and specific information deemed relevant for the specific company at that specific point in time

Question 21

What is a “bridge”?

Answer 21

Several interviewees spoke especially about the usefulness of a ‘bridge’ explaining the difference between the outcomes of two periods in terms of the effects of acquisitions, foreign exchange and so on

Question 22

Is there specific a data point that most analysts look at when an interim report is released? If there is – which?

Answer 22

In general, interviewees told us that they tended to focus on forward-looking infor- mation such as outlook statements and orders, in addition to revenue (sales) and operating income measures.

Question 23

What is the reason the annual report is not as important as the interim report, to the analysts?

Answer 23

This was because they had already developed a company thesis and because they had read the interim reports.
In line with this, interviewees noted that the importance of the annual report varied with the quality of the interim reporting. Simply put: the better the interim reports, the less important the annual reports.

Question 24

How is the annual report commonly used compared to interim reports, among analysts?

Answer 24

1) updating specific metrics not found in interim reports, 2) as a general update and 3) as a reference book. In addition, the interviewees spoke of having relied extensively on annual reports when they were first getting to know the company.

Question 25

Describe how the footnotes in the annual report are used in relation to the company thesis.

Answer 25

Usually there’s very little incremental information that’s out there and part of me reading that in the footnotes is not because I think it can really give me an edge, I just don’t want to be in a situation where something blows up and for no reason I didn’t see footnote seventeen which basically made it quite clear that here’s a big yellow flag that I ignored

Question 26

What is the first data point to be analysed in a financial report and how is this analysis normally conducted?

Answer 26

Many interviewees mentioned sales and/or operating income as one of the first data points to be identified and compared with own and the market expectations.

Question 27

What is meant by “quality” in reported numbers and how is it often tested?

Answer 27

Several interviewees spoke explicitly about wanting to understand the quality of the revenue/operating income. In this context ‘quality’ seemed to translate to ‘sustaina- bility’ and to be related to the objective of forecasting the future. To understand the sustainability of sales and/or operating income, interviewees highlighted the need to evaluate several dimensions.

Question 28

There are four factors important to test the quality in the numbers – which?

Answer 28

(1) differentiating earnings growth in different segments and regions, (2) consi- dering the impact of organic growth and (3) evaluating the impact of items affecting comparability. And, sometimes, considering operating expenses… (opex)

Question 29

Which item of comparability (and whether it should be excluded) is often regarded as ambivalent in the analysis?

Answer 29

Another is the problem of knowing what to regard as items affecting comparability and not, restructuring items often being commented as ambivalent in this regard: I never take them (restructuring charges) away. I always.. in [ComponentCo] they are part of ordinary earnings (Sell-side Equity Analyst)

Question 30

What was the reason the interviewees paid little attention to the financial net and taxes?

Answer 30

In part this was justified based on perceptions that such items are not generally possible to forecasts. Many interviewees said that they thus limit themselves to entering reported figures in their spreadsheets. Some suggested, however, that it would be useful if companies provided guidance on these items.

Question 31

Discuss how the information in the OCI was used.

Answer 31

Most interviewees then told us that they did not make use of any OCI information. At the most, they might have looked at it. Some said that they might have dug deeper if the reported num- bers had been material. Only a few suggested that they included OCI items in their spreadsheets.

Question 32

How is the cash flow statement used equity analysts in relation to the income statement? What was the most common analysis?

Answer 32

In general, the interviewees did not talk about cash flows to the same extent as they talked about income. Nevertheless, most interviewees did indicate that they regularly, and at an early stage, look through the statement of cash flows to ascertain that
the income was being translated to cash flows. Cash flows would thus seem to be another dimension of gauging the quality of reported income:

Question 33

Describe the difference between a credit analysts use of the cash flow statement compared to an equity analyst.

Answer 33

As a credit analyst, I mostly look at the cash flow statement and balance sheet to assess whether a company can repay its debt maturities with internal cash flow. The income sta- tement is useful to assess the ability of the company to service debt but we don’t look too much at the income statement, because we’re more interested in cash flow from operations….

Question 34

Which factor was considered the most important among the interviewees relating to the balance sheet? How did the analysis of this factor differ between credit and equity analysts?

Answer 34

In general, however, many interviewees mentioned keeping an eye on one item related to the balance sheet: net debt. This was tracked to make sure that there were no major and unexpected changes. In general, interviewees did not turn to the statement of financial position for this figure (trusted reported measure). Credit side interviewees, however, said that they generally try to calculate their own net debt figure based on established practices of credit rating agencies using the avail- able information.

Question 35

There are five factors that constitutes “decision useful” information – which?

Answer 35

1. Information about past performance is decision useful
2. Information about past cash conversion patterns is decision useful
3. Information that explains the variability of outcomes is decision useful
4. Forecastability is an enhancing characteristic of decision useful information
5. Disclosure is more important than presentation