Financial disclosures studied

A nine-year study of New Zealand listed company  chief executives’ market disclosures has raised concerns about "unusual financial disclosure strategies".

While no companies are named in the study, released today,  its findings are sure to court  controversy.

The study investigated whether highly-paid listed company chief executives were using non-standard financial reporting methods to help protect their own financial compensation, including bonuses.

It also considered whether non-standard reporting might detract from  scrutiny of poor financial results, according to the three co-authors from the University of Otago’s Department of Accountancy and Finance.

Dr Helen Roberts was contacted and said the study’s motivation was on behalf of company shareholders, as chief executives’ base salary could  be up to $1 million, plus potential bonuses  of  50% to 80% of the base. The study, Non-GAAP Disclosure and CEO Pay Levels, shone a light on the association between chief executives’ pay and unusual financial disclosure strategies, she said.

It found  higher levels of chief executive compensation were associated with a greater likelihood of  non-GAAP [Generally Accepted Accounting Principles] profit disclosures.

Non-GAAP disclosure meant companies had "adjusted" their earnings or profits,  which could potentially exclude items which may have a negative impact on the GAAP measure of earnings.

"A lack of reconciliation between GAAP and non-GAAP profits also has a direct relationship to chief executive cash compensation," she said.

Between 2004 and 2013, the trio scrutinised up to 60 NZX-only companies annually, compiling data on chief executives’ salaries and bonuses, and comparing their number of disclosures made to the NZX sharemarket.

In four studies based on company sizes, from small  to large, chief executives paid less than median salaries made fewer non-GAAP disclosures, while those paid above the median salary made the most. In the largest 25% of companies, underpaid chief executives made up 68% of non-standard disclosures, while  overpaid chief executives made up 87%.

Co-author Dr Dinithi Ranasinghe said the research prompted questions on the motivation for companies to use non-GAAP methods in their financial disclosures.

"The findings also show that managers are more likely to use these non-GAAP disclosures when their GAAP earnings benchmarks are missed," she said.

Prof  David Lont, head of the department of accountancy and finance and co-author, said shareholders needed to be wary of the practises under scrutiny in the study.

"A company may argue that their use of non-GAAP measures is to explain their performance better," he said.

However, if chief executives were highlighting selective profit metrics instead of the usual GAAP measures, "that should raise alarm bells".

He said a chief executive may have a desire to improve their compensation or disguise poorer performance, by painting a picture they want investors to see, while detracting from potential negative performances, Prof Lont said.

To ensure the data given to shareholders was accurate, Prof Lont said more regulation of New Zealand’s reporting of non-GAAP profit figures may be needed.

simon.hartley@odt.co.nz

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