Performance metrics play an increasingly important role in company valuations, but what should be reported, and how?
A company’s management, staff and other members of the workforce are an important part of the success of that company. Investors increasingly seek information on how the directors have had regard to their stakeholders and as a result, metrics on workforce issues are becoming more important.
The Financial Reporting Council’s Financial Reporting Lab has spoken to companies and investors about their approaches to reporting, monitoring and using performance metrics. Not surprisingly, these conversations highlighted that wider metrics – standardised or company-specific metrics expressed in non-monetary units (for example, customer satisfaction scores and environmental measures) – are increasingly important.
Performance metrics are central to questions of value creation and, ultimately, to an investor’s valuation of a company. When they are presented in a fair, balanced and understandable way, they can be key to the communication between companies and investors about a company’s performance. All metrics can help indicate levels of performance, including wider metrics such as those regarding the workforce.
Depending on an investor’s investment style, position in the investment chain, place in the market and personal approach, there will always be some difference in the approach to performance metrics. However, the Lab’s project found much consistency in the investor view. Wider metrics, including those relating to the workforce, were considered useful by both companies and investors, but they also shared concerns about their reliability and whether there was a clear link between the reported metric and the company’s strategy. However, just because companies and investors find this information useful does not mean that questions around materiality, reliability and the presentation of information on workforce issues can be easily overcome.
Performance metric disclosures
The first phase of the Lab’s project on performance metrics culminated in the publication last June of an investor perspective on such reporting. The project initially gathered a predominantly investor-focused view of reporting because of the numerous recent changes in national and international regulation and market initiatives surrounding this reporting.
Investor demand for performance data leads to strongly held views about the use and presentation of metrics. In choosing which metrics to report, companies must select those that investors would find most helpful. The Lab’s first report on performance metrics can help companies decide which metrics to report, and how to do so.
Five investor principles
The Lab consolidated investor views into a set of five succinct principles that capture the type of information investors wish to see when analysing performance metrics. The framework, which is expanded on below, notes that investors want performance metric disclosures that are:
- Aligned to strategy: in asking for metrics that are aligned to strategy, investors want to see metrics that are managed and monitored internally. They also want metrics that provide indicators of the sources of long-term value to give them an insight into the company’s performance and strategy;
- Transparent: investors expect metrics to be reported with clear definitions and calculations. For non-GAAP metrics, they seek clear explanations and reconciliations to GAAP measures;
- In context: providing context is a key element of presenting performance. This includes explaining the company’s goals and what it has achieved, with explanations for where this is good or poor. It also includes the company’s position and prospects in the market and its longer-term objectives. Targets are considered helpful, with longer-term ranges appropriate in some circumstances;
- Reliable: to understand the reliability of metrics, investors want detail around the level of governance and oversight over those metrics. They expect the board and audit committee to address the relevance and reliability of metrics on a consistent basis; and
- Consistent: investors expect metrics to be presented consistently across formats and across time. Detail that allows for the comparison of similar companies is also welcome.
These five investor principles were complemented by a series of questions for company management and boards to ask themselves when assessing whether their performance metrics meet the needs of their investors. The questions flow from the investor principles and cover items like the materiality of disclosure, the disclosure of oversight of the reliability of metrics, the level of balance in the reporting of metrics and how consistently metrics are presented.
Practical application
The Lab’s second report, published in November, provides practical examples of how the investor principles can be applied in light of the challenges faced by companies when seeking to meet those expectations and the requirements of the regulatory framework. The report also expands on the investor views, which informed the five principles, to provide a high-level overview of how investors use metrics.
A range of companies include workforce metrics in their reporting. Which metrics make the most sense for a business will depend on its size, sector and complexity, but employee metrics reported by companies tend to focus on workforce composition, engagement or welfare. This information is sometimes reported with explanations about the importance of the workforce, or why the specific level of performance has been achieved. The Lab found that investors sought further information around how these metrics are linked to a company’s strategy and the level of assurance over the metrics to enable them to assess their reliability.
New Lab project
Following on from this report and the Lab’s other work on business models and risk and viability reporting, the Lab recently launched a project to look at corporate reporting practice in relation to workforce issues. The Lab’s report on business model disclosure established that good business models provide the foundation for the strategic report as a whole. Its subsequent report on risk and viability reporting explored how a company’s principal risks and assessment of viability could be reported in a way that best meets investor needs. These findings, coupled with our report on performance metrics, show that there is already a lot happening in the reporting of wider metrics, including a range of market initiatives, with which both companies and investors are grappling.
The Lab’s project will highlight and reference relevant initiatives and frameworks that are supported by company and investor participants. The workforce reporting project will expand on the input gathered from company and investor participants in the previous three projects to inform our discussions about how those insights, views and principles can be applied to ensure effective workforce reporting.
Despite the challenges of reporting, as we work towards a better understanding of the future of work, understanding the needs of the workforce becomes more important. In this context, it becomes even more important for companies to tell investors and others about the work they are doing to attract and retain one of their most important assets. How they can do that most effectively will be the focus of the Lab’s work.
If you are interested in getting involved in the Lab’s project on workforce reporting, we would love to hear from you. Please contact us via financialreportinglab@frc.org.uk
Phil Fitz-Gerald is a Director at the Financial Reporting Lab.
What is 'the lab'?
Over the last seven years, the Financial Reporting Lab has sought to improve the effectiveness of corporate reporting in the UK.
It does so by working with companies, investors and others on topics that matter. Lab reports explore innovative reporting solutions that better meet the needs of companies and investors by speaking to them about a topic and publishing reports that represent their views.
Lab reports do not form new reporting requirements, but do seek to highlight best practice and thought leadership. Our published reports can be found on the FRC’s website, www.frc.org.uk/lab