8.4 THE ROLE OF ACCOUNTING INFORMATION IN TRANSNATIONAL ANALYSIS
8.4.2 Versions of the annual report used in foreign company analysis
Depending on the size, listing status and domicile of the company being analysed, analysts and fund managers have at their disposal various versions of the annual report and financial statements. In particular, many large com- panies translate their annual reports into English (where applicable), and
Table 8.4 Number of annual reports studied per year†
Fund managers Investment analysts Total
UK Foreign UK Foreign UK Foreign
reports reports reports reports reports reports
Mean 79 64 62 27 72 50
Median 50 45 35 20 50 30
Standard Deviation 71.0 68.6 107.26 34 86.9 60.1
†Based on the responses from 260 fund managers and 120 investment analysts.
Table 8.5 Use of annual reports in local and English language†
Never Sometimes Always Total
No. % No. % No. % No.
Foreign language version of annual report
182 58.3 94 30.1 36 11.5 312
English language version of annual report
10 2.4 88 21.4 313 76.2 411
†Based on the responses from the 155 analysts involved in transnational analysis.
sometimes prepare translations of financial statements into ‘more familiar’
accounting standards and currencies. Tables 8.5 and 8.6 show investment analysts’ and fund managers’ preferences of linguistic and presentational formats of the annual report and financial statements.
8.4.2.1 Language of annual reports
Table 8.5 shows that there is an overwhelming preference for the English language version of the annual report and, similarly, limited use of the foreign language versions. The foreign language version is always used by only 11.5%, yet the English language version (where available) is always used by 76%.
Analysts and fund managers therefore appear to be heavily reliant upon the translation of annual reports. An interesting question is to what extent the absence of an English version of the annual report results in UK-based analysts and fund managers avoiding companies. The results in Table 8.5 suggest that the absence of an English translation in non-English speaking countries may well deter analysts and fund managers from investigating certain overseas companies further.
8.4.2.2 Use of local and translated financial statements
Table 8.6 shows that financial statements prepared under local accounting standards are the most widely used in transnational analysis. There is also relatively little use of financial statements translated to UK GAAP. This is likely to be a reflection of the lack of availability of such translations, as the London Stock Exchange does not require companies to translate or reconcile their accounts to UK GAAP.4Consistent with the prominence of SEC Form 20-F in Table 8.1, US GAAP translations are more widespread, which may
4Provided companies meet minimum disclosure requirements and comply with certain accounting conventions (e.g., consolidated accounts).
Table 8.6 Accounting standards used†
Never Sometimes Always Total
No. % No. % No. % No.
Financial statements using domestic GAAP
16 4.3 165 44.8 187 50.8 368
Financial statements translated to UK GAAP
160 54.6 113 38.6 20 6.8 293
Financial statements translated to US GAAP
58 16.6 243 69.4 49 14.0 385
Financial statements translated to International Accounting Standards
77 22.5 220 64.3 45 13.2 342
†Based on the responses from the 155 analysts involved in transnational analysis.
be related to such financial statements being more widely available, due to the stringent SEC reconciliation and disclosure requirements.
Interestingly, local accounting standards are most popular; over 50% of analysts and fund managers in Table 8.6 always use financial statements prepared under domestic (local) accounting standards, yet only 14% and 13.2% always use those under US GAAP and IAS respectively. This is also likely to reflect the relative availability of the different versions of financial statements, i.e., local statements will always be available (provided the annual report is available), whereas IAS or US GAAP-based statements will not. This is particularly the case where the relevant overseas companies are not listed on a major stock market that requires reconciliations to US or IAS accounting principles.
It is also noteworthy that little difference exists between the prevalence of US GAAP and IAS – both are used by a large proportion of analysts and fund managers. Almost 85% use financial statements translated to US GAAP at least sometimes; the corresponding figure for IAS is 78%. The popularity of recognisable accounting standards may result from demand for comparable information between companies from different countries, or a lack of familiarity with local accounting standards.
8.4.2.3 How the annual report is used in transnational equity analysis
The decision-making processes of analysts and fund managers involved in foreign company analysis revealed that accounting information in general, and the annual report in particular, play an important role in various stages
of the investment decision. As noted in Chapter 7, fund managers’ initial screening stage often involves accounting variables – either absolute levels or financial ratios and multiples. Moreover, the comprehensive fundamental analysis undertaken by analysts and fund managers also involves rigorous analysis of financial statements and ratios. Discussions with analysts and fund mangers revealed that the annual report is a primary information source in its own right, but it also fulfils various other roles, particularly as an in- troduction to a company and as a source of questioning management in meetings. Significantly, the annual report plays an essential part in transna- tional investment decisions as a confirmatory device.
For fund managers, the annual report is a useful means of making initial enquiries about specific firms, particularly if limited analysts’ research in- formation is available. Fund Manager 6 stated that while the annual report is one of many information sources
it is your legally accurate and audited source of information – it’s the bottom line. If you want to go back to the basic level, the annual report has to always be there.
The various types of information published in the annual report make it a useful research tool in its own right, and for further, more comprehensive analysis. Fund Manager 7 stated that ‘the annual report is useful for making sure what we are putting down in our books is genuine, or as near as we can get to it’. As is the case in domestic decisions, however, the annual report is not the only source used, and fund managers stated it is used as a means of devising questions for other sell-side analysts or company management.
Fund Manager 12 noted ‘if one were to go to a meeting with only one piece of data it would invariably be the annual report’. The annual report is also used to acquire information on continuing company performance, after the investment has been made. For example, Fund Manager 18 stated that the annual report is required as soon as it is available for companies that are owned, to update spreadsheets, and to check the company is continuing to perform well.
Investment analysts also use the annual report as a device for further ques- tioning. However, due to the closer relationship between analysts and the companies they cover, the annual report is used more as a basis for forecast- ing financial information for companies with which they are already famil- iar. Comments from analysts reinforced the questionnaire result that the an- nual report is an essential information source. Analyst 2, for example, stated:
The annual report is very important. It is the most information in any one place, whether you get it from the internet, whether you have it in written form, or whether they send it to you on a disk. I would not go and see a company if I had not read the annual report. If I get an idea, the first place I go is to the annual report. It is essential.
Although it was viewed as a useful benchmark document, the annual report also attracted a degree of criticism, relating primarily to the lack of timeliness and the lack of forward-looking information, both of which have been identified in domestic based research. Overall, however, it was clear from the interviews that the annual report is of critical importance in transnational analysis. It represents a useful information source in itself; and for fund managers, it supplements and helps verify information acquired from the two other main information sources, company management and investment analysts.