Thursday, September 21, 2023

Studies show that the usefulness of public companies’ annual reports has been consistently declining. In the past, financial metrics disclosed in regulated financial statements, such as a company’s book value or operating income (GAAP metrics), provided a meaningful explanation of stock prices and thus allowed for an efficient marketbased allocation of capital among publicly traded firms as well as the economy at large. Disturbingly, GAAP metrics no longer provide a strong correlation with stock prices or with the economy at large. While enjoying a booming economy, nearly half of all U.S. public companies reported losses in their pre-Covid financial statements. Meanwhile, publicly traded companies have been increasing disclosures of alternative metrics—i.e., newly-created adjustments to GAAP metrics (non-GAAPs) appearing in press releases and in formats other than audited statements—thereby exacerbating the potential for opportunistic and misleading reporting by managers. The reporting and content of non-GAAPs are carried out at the discretion of management alone, do not follow any consensually binding practices, and are not the result of negotiations with stakeholders. Not surprisingly, findings show managers opportunistically disclose non-GAAP earnings to conceal reported losses and meet or beat analysts’ expectations. When faced with deficiencies in regulated financial disclosure, private parties can negotiate alternative novel metrics that substitute the use of GAAP metrics in contractual arrangements. Executives of publicly traded firms act alike and use tailor-made financial indicators in compensation schemes. Investors in publicly traded companies, however, do not enjoy similar privileges, cannot negotiate the financial metrics disclosed, and remain bound to a flawed generic financial disclosure regime. Juxtaposing private parties’ negotiation over the financial metrics used in voluntary contracts with the limitations investors in public companies face, this Article proposes a novel approach for financial disclosure regulation—a Voting on Reporting regime under which companies, after gaining the consent of their shareholders, are allowed to report alternative but audited financial metrics that replace GAAP metrics and better fit their shareholders’ information needs. Currently, financial metrics disclosed by publicly traded companies are either dictated by the regulator (GAAP) or opportunistically used and governed by managers alone (non-GAAPs). By allowing shareholders to participate in devising and regulating a company’s financial reporting, the new regime could kill two birds with one stone: (i) it would allow financial statements to better cater to investors’ interests and information needs; and (ii) it would curtail managers’ opportunistic reporting of non-GAAPs.


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