Alternative Performance Measures are a relevant aspect in today’s external and internal reporting. Two thirds of Switzerland’s 30 largest companies use them to provide an additional view on sustainable performance and bridge the information gap between investors and management. With regulation by SIX Swiss Exchange looming on the horizon, many listed companies will now need to think about their external reporting practices, internal policies and processes to be compliant and transparent.
Financial statements and key figures in accordance with internationally recognized accounting standards alone are rarely ideal to tell a company’s story holistically. This is why so-called Alternative Performance Measures (APMs) are often being additionally used to bridge the information gap between companies and investors. For this purpose, GAAP measures (e.g., net profit) are adjusted for certain items (e.g., one-off costs) and translated into non-GAAP measures (e.g., adjusted net profit).
APMs have become well established in financial reporting with two thirds of the companies in the Swiss Leader Index reporting non-GAAP earnings measures in the financial year 2016. But, APMs have been controversial for some time. On the one hand, non-GAAP measures are designed to better reflect the company’s actual performance than the associated GAAP measure and are meant to help analysts and investors gain a clearer picture on the company’s current and future performance.
On the other hand, adjusting GAAP KPIs also gives rise to suspicions that the company’s performance is being embellished or even of investor abuse, especially if the adjustments undertaken are dubious in character or have not been communicated transparently.
Given the above in combination with the prominence and prevalence of APMs it is not surprising that the Swiss regulator SIX Swiss Exchange (SIX) has taken action and published a draft directive on APMs to encourage their transparent use. The scope of the proposed directive are issuers whose equity securities are listed on SIX Swiss Exchange Ltd and whose registered office is in Switzerland. The scope of application extends to information which issuers publish periodically or on an event-related basis such as annual reports and press releases (Art. 4). Overall, SIX focuses on the following areas:
In view of the SIX regulation to be expected for issues in Switzerland, KPMG and the University of St. Gallen analysed to what degree the requirements of the draft directive have already been implemented in the current financial communication.
The study shows that APMs primarily result in improved results compared to GAAP numbers. In 85% of the investigated cases, the reported APM is higher than the associated GAAP item. This gives the impression that costs are more likely to be adjusted than income in order to embellish the company’s overall performance. On average, the reported APM was higher by 67.5% for absolute non-GAAP figures. These observations are sensitive taking into consideration that every third APM influences the level of management compensation.
As the results show, the majority of reporting companies are eager to provide transparency in regard to the adjustments made and even fully or partially follow the directive already. Nevertheless, as the table below depicts, there is still room for improvement and many companies have to rethink their current reporting to create the required transparency and comparability.
The action that should have the highest priority for the to-be-affected companies is transparent communication itself. Only 27% of the investigated APMs are reported with a clear definition of the adjustments performed. To conclude, only very few SLI-listed companies currently fully comply with the requirements of the proposed directive. In comparison to companies abroad (especially in the US and the EU), they will have to work hard to catch up.
Financial analysts and companies generally agree on the high importance of APMs and transparent communication. SIX’s attempt to regulate these is therefore consistently welcomed. This is also gratifying because the companies concerned are well aware that this is likely to lead to a need for action regarding their future reporting, guidelines and governance processes. The wish for a level playing field, i.e., comparability and confidence through transparency, is great.