By Nneoma Njoku
Nneoma Njoku (njoku.n@labrador-company.com) is the General Manager for Labrador U.S. in Atlanta, Georgia, USA.
Companies are well aware that over time rules and regulations regarding corporate financial disclosures are subject to change, whether it’s from the Securities and Exchange Commission (SEC) in the US or its counterpart in the European Union (EU). For example, environmental, social, and governance (ESG) reporting is imminent in the US, but currently there’s no standard. It’s already highly regulated in the EU. This lack of consistent framework on ESG topics can make it difficult for US investors to evaluate the risks in investing in a company. Hence, the rise in investor activism has increased the call for true transparency. Stakeholders seek to make informed decisions on the risks and rewards of the companies they do business with or invest into.
Today, companies must tell their whole story, good and bad, in a way that is easy to understand and doesn’t blur the facts. It’s important to generate trust with shareholders, the investment community, employees, and all stakeholders.
True transparency is the act of disclosing all relevant information to stakeholders in a clear and concise manner. The new focus on transparency puts more responsibility on corporations to be truthful and accessible to the public and asks them to consider including information that is not yet required.
Despite the growing demand for transparency, many companies continue to struggle with the concept. Concerns range from worries about sharing information with competitors and the fear that investors may misunderstand what is being published to how to build a compelling story and what to include.
The ninth annual US benchmark study of S&P 250 proxy statements by Labrador,1 a global corporate disclosure communications firm, points out that the SEC has reminded companies that many issues, whether currently regulated or not (e.g., ESG), may need to be disclosed under existing rules. As a result of the SEC reminder, S&P 250 executives are revisiting financial disclosures to ensure that they aren’t just including the bare minimum required by the SEC. The study cited more comprehensive and proactive corporate disclosures than in the past to comply with not only increased regulatory requirements, but also the greater scrutiny from stakeholders.
Seven tenets to transparency
Financial disclosure documents, especially the proxy statement, which is seen by all stakeholders, should be viewed as a powerful communication tool and a unique opportunity to create corporate value. While every company’s needs are different, heeding these seven best practices can improve transparency and understanding substantially.
- Ensure accuracy: Avoid creative accounting tactics and be truthful about your company’s performance. Investors need to trust that figures are accurate and reflective of the true financial landscape.
- Be clear and concise: Be honest, open, accountable, and willing to provide details. A lack of clarity can appear as if organizations have something to hide. When disclosures are too vague, it leads to a loss of investor confidence that can have serious financial consequences over time.
- Think sustainability: When companies fail to provide an overview of their long-term business strategy, it can be a significant red flag for investors. Investors want to see a long-term plan that demonstrates how the company will be successful in the future. Avoid overemphasizing one-time boosts or successes; instead focus on sustainable growth over time and on its vision and mission.
- Be accountable: Companies need to be accountable for their internal and external disclosures. Make sure everyone within the company knows what’s expected of them when it comes to disclosing information about their performance. Externally, work with investors directly to make sure they understand your business operations, as well as how you generate revenue from those operations.
- Enhance understanding: Balance readability and simplicity with compliance and accuracy to attract and build strong relationships with readers. Streamline the message using plain language to create reader-centric documents. Add a summary overview to ensure that even skimmers understand the information. Incorporating succinct quantitative and qualitative data also helps illustrate an organization’s story.
- Employ graphics: They say a picture is worth a thousand words. Employ easily understandable graphics and other visuals to communicate complex information in a digestible format. These will help draw readers’ attention to main ideas.
- Include ESG reporting: While the SEC has not yet issued any rules mandating ESG reports, many companies are voluntarily providing this information to their investors as a way of building trust. With the growing interest in this type of reporting, more companies are starting to include ESG metrics to differentiate themselves from their competitors. Many of the ESG reporting changes that are being considered by the SEC in the US have been in place in the EU for years. For instance, in 2014, Directive 2014/95/EU, also called the Non-Financial Reporting Directive, was passed.2 It incorporates rules on disclosure of nonfinancial and diversity information by certain large companies. In 2019, Europe’s Sustainable Finance Disclosure Regulation came into effect,3 requiring diversity and inclusion, greenhouse gas emissions, and pay equity data from publicly traded and private companies to be disclosed. And just this year, the European Commission’s adoption of the Taxonomy Climate Delegated Act became a mandate.4
Five unforeseen pitfalls
When writing financial disclosures, companies also need to be aware of mistakes that can thwart even best efforts to transparently share corporate information.
- Making assumptions: Many companies mistakenly believe their investors understand the business model behind their revenue sources and operations. They often do not provide a company overview or share strategy, losing the opportunity to reinforce the brand messaging and image. Be sure to include plenty of detail in your documents so that investors can understand how you operate and generate revenue.
- Underestimating uniqueness: Companies that only report the bare minimum in their financial disclosure documents as required by the SEC miss the opportunity to reinforce their unique story. In all disclosure documents, they should take the opportunity to reinforce competitive differentiators in the minds of stakeholders.
- Overpromising: When companies overpromise on future performance, they set themselves up to fail when their performance falls short of that promise. This can also negate the effectiveness and belief in the information provided across all corporate compliance and disclosure documents.
- Neglecting to educate: Use a frame of reference to help investors put drastic changes or dips in perspective. Especially if results are less than optimal, include information that speaks to the company’s strategy moving forward. Spell out why something happened and what it means to the company’s overall short- and long-term financial picture.
- Letting one department dictate: When discerning materiality, there are many departments that can provide insight into significant company issues. Cross-company collaboration with a coordinated team effort will yield a more robust, complete picture of the organization and ensure a quality product.
The case for increased transparency is strong. It leads to greater accountability, better governance practices, and creates a feeling of goodwill toward the company. Importantly, with a little guidance, companies can begin to create financial disclosures that are accessible and enhance investors’ trust, which is essential for a healthy, functioning relationship with all stakeholders.
Takeaways
- Many companies still struggle to be fully transparent in their disclosures, perhaps fearing that reporting true numbers can leave them vulnerable to competitors and investors.
- When writing financial disclosures, ensure they are clear, concise, and accurate. Focus on long-term growth and report the company’s ESG metrics to illustrate its sustainability.
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1 Labrador, 2020 Proxy Statement Trends and Analysis, December 2020, https://bit.ly/3Cd4Bqv.
2 Council Directive 2014/95/EU, 2014 O.J. (L 330), https://bit.ly/3ioiW8I.
3 “SFDR,” EUROSIF, accessed March 3, 2022, https://www.eurosif.org/policies/sfdr/.
4 “Introduction of the first two environmental objectives,” EU Taxonomy Info, accessed March 3, 2022, https://bit.ly/3K5vjE6.
Copyright 2022 Ethikos, a publication of the Society of Corporate Compliance and Ethics & Health Care Compliance Association (SCCE & HCCA).