Financial disclosures studied

A NINEYEAR 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 highlypaid listed company chief executives were using nonstandard financial reporting methods to help protect their own financial compensation, including bonuses.

It also considered whether nonstandard reporting might detract from scrutiny of poor financial results, according to the three coauthors 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, NonGAAP 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 nonGAAP [Generally Accepted Accounting Principles] profit disclosures.

NonGAAP 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 nonGAAP profits also has a direct relation ship to chief executive cash compensation,’’ she said.

Between 2004 and 2013, the trio scrutinised up to 60 NZXonly 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 nonGAAP disclosures, while those paid above the median salary made the most.

In the largest 25% of companies, underpaid chief execu tives made up 68% of nonstandard disclosures, while overpaid chief executives made up 87%.

Coauthor Dr Dinithi Ranasinghe said the research prompted questions on the motivation for companies to use nonGAAP methods in their financial disclosures.

‘‘The findings also show that managers are more likely to use these nonGAAP disclosures when their GAAP earnings benchmarks are missed,’’ she said.

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

‘‘A company may argue that their use of nonGAAP 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 nonGAAP profit figures may be needed.

❛ A lack of reconciliation between GAAP and nonGAAP profits also has a direct relationship to chief executive cash compensation study coauthor Dr Helen Roberts