Communicating the value drivers for the long-term in a biased short-term environment

18. Dez 2018

Communicating the value drivers for the long-term in a biased short-term environment By Dr. Martin Steinbach, Head of IPO and listing services, EY

Dr. Martin Steinbach

In the digital space of the 24-hour real-time newsflow and high-speed trading, with the rise of activist investors, interim financial reports on quarterly performance and the rapid digital evolution of the business landscape, the boardroom is under increasing short-term pressure. Boards and their investor relations (IR) officers are challenged more and more to communicate the long-term value creation for all stakeholders.

 

Shape of value is changing

Due to innovation, digitilalization and fast growth in a disruptive environment, an increasing proportion of a company’s value lies in its intangible assets but traditional financial reporting metrics were not designed to measure them. All over the world investors count on regular disclosures in annual and interim financial statements based on international reporting standards.This financial reporting system was created in an industrial age - a time when physical assets made up the core of a company’s balance sheet. Todays company’s value lies in its intangible assets such as its brand, talent, research and development and intellectual property. Surveys1 show that intangible assets represented 17% of market value in 1975 and by 2015 have risen in some sectors to 82% and 52% of market value is based on intangibles on average. So how can we build on existing financial reporting frameworks and develop standard metrics to better communicate to the capital markets on how long-term value is created?

Short-term – long-term disconnect

Issuers are with the current financial reporting system skewed towards short-term financial performance, which doesn’t help to communicate how they’re creating value for the long-term. With the pressure performing on the short-term, it potentially comes at the expense of the success in the future. In many cases the alignment of the time period for executive performance measurement in relation to the need and obligations of entities is out of step. Also the need for accountability and a lack of information on which to value long-term investments encourages a focus on short-term financial metrics by managers. In turn, managers are required to deliver according to the mandates, which are often articulated around short-term financials. On the other hand information publically available provides a rich source of data, which can be mined to help build a better understanding of intangible assets such as: the brand perception, market share, costumer base and loyality, talent and workforce, ability to innovate and corporate culture2.

Value drivers for the long-term

Investors are also no longer limited to the information available in the annual report and increasingly prepared to make their own judgements, based on the information from a range of resources. Without the full picture of a business’s performance, investors and other stakeholders tend to focus on the part to which they have access. This contributes to an investment chain that tends to focus on the short-term despite the desire to create value in the long-term. In addition, performance pressures on fund managers can also sometimes drive a short-term focus and disconnect with the long-term aims of the actual shareholders. Boards and IR-Officers are therefore challenged communicating their long-term value and performance, and stakeholders are lacking the information to truly understand the business’s future potential for value creation. Investors need comparable verified outcome metrics to evaluate which companies are positioned well for real long-term success. Missing standards and consensus, inconsistency in models and metrics, inhibits their ability to use the information. However, building consensus and trust between listed companies and investors on all the measures that matter remains a challenge.

Measures that matter for a standard metrics

Listed companies as well as large cap investors recognize the importance of creating long term value. Issuers pro-actively started already to use in IR- communication non-GAAP measures to better adress measures that matter for their sector specific value creation. Additionally CSR-reporting became part of financial disclosures in regulated markets. Taking a deeper look at the non-financial metrics that will be of value to investors represent human-, customer-, brand- or societal-value. Communicating these will increase transparency in the investment value chain which will help companies to more effectively articulate how they create value for their stakeholders and reduce the pressure to make short-term trade-offs. A consistent set of agreed outcome metrics would provide an insightful indication of long-term value creation. However, it is crucial that investors buy into the validation of these measures. Critical is confidence in the robustness of information disclosed and the links to value creation with more reliable, comparable and certifiable information that more fully captures a company’s long-term profitability. Important in this context are: the purpose, strategy and governance the organisation needs to deliver to its stakeholders, the types of value the organisation creates and the types of risks and threats the organisation manages to protect value2.

IR function to communicate long-term value

Ultimately it is about to deliver trusted, relevant information to the key IR stakeholders and help improve the allocation of capital for the long-term. The ability of IR to analyse data and draw insights especially on intangible assets will be a key enabler in the long-term value journey. A standard metrics of long-term value drivers can support IR to measure and express the value of their intangible assets. One of the projects around the world focussing on long-term value and concept is the “Embankment Project for Inclusive Capitalism”3. Aim is to develope a measurable, comparable and meaningful way for companies to better articulate to the financial markets how they create value for their stakeholders and how their strategic resources and capabilities are contributing to the protection and growth of future cash-flows.

IR is best positioned to use this framwork as an example, to serve the boardroom with a long-term mindset and to shorten the gap between the net book value of assets on the balance sheet and the market capitalization. In capital markets that are changing in the digital era faster than ever before, intangible assets have become more important than ever as a key driver and determinant for business success. In many sectors the majority of companys value is now reflected in intangible aspects of the business model. Good reasons to better implement reliably measured long-term value drivers in IR communication as part of a sustainable and compelling equity story.

Sources:
1  ICAEW, Intangible Assets: the Achilles heel of financial reporting, 2017 and Global Intangible Finance Tracker, 2017
2  EY, Is everything that counts being counted?, 2018
3  EPIC, Embankment Project for Inclusive Capitalism, 2018