Worthy ideas to improve business reporting must be translated into action or they create no public benefit. Such action depends on many factors ; the whole set of attitudes, rules, customs, institutions, and practices that affect the information companies provide to users. The factors can be more or less hospitable to improvements. This chapter presents the Committee's recommendations for improving the factors pertaining to the institutional processes that can create improvements.
National and international standard setters and regulators should increase their focus on the information needs of users, and users should be encouraged to work with standard setters to increase the level of their involvement in the standardsetting process. There should be little debate in the United States over the foundation role of the information needs of users in business reporting. The FASB early in its history put users' information needs at the center of its conceptual framework, and the rhetoric of standard setting for years has featured the information needs of users. The purpose of business reporting is to provide useful information to users. And because the process is designed to serve their needs, users can be particularly helpful to standard setters in:
Unfortunately, there has long been a contrast between the known importance of users' needs and the relative absence in the standardsetting process of either reliable data about those needs or sufficient input from users. This is true of all standardsetting bodies, from the FASB to AcSEC and the IASC. The FASB typically receives hundreds of letters commenting on its proposed position on a major issue, but most come from preparers and auditors, with only a handful from users. Few users testify at public hearings or participate in field tests.
Over the years neither the FASB nor FASAC, the FASB's advisory council, has had a notable proportion of members with backgrounds as fulltime users. AcSEC, the AICPA's fifteenmember senior technical body on accounting, has no users, and very few users serve on its related committees. The IASC, the board responsible for international standards, also claims few users, either on the board or its advisory group, and it receives relatively few letters from users commenting on its proposals.
User participation in the standardsetting process should be brought up to the level of the standard setters' other constituents. However, getting more user involvement in the standardsetting process will be difficult. Standard setters have encouraged user participation in the past with only limited success. Users may not be motivated to participate because they see little personal benefit from doing so or they may be uncomfortable in analyzing accounting issues with people who do so for a living. Despite the obstacles, however, user participation can and should increase. Business reporting and all those affected by it are not well served by the current limited level of user participation.
Those responsible for standardsetting processes, such as the Financial Accounting Foundation, the FASB's parent organization, and standard setters themselves should more effectively recruit users for service on standardsetting boards, advisory councils, and task forces. They should encourage users to write more comment letters and to participate in public hearings and field tests. But encouragement alone may not be enough. Those responsible for standardsetting processes should seek formal commitments to increase user participation from institutions representing users, such as the Association of Investment Management and Research and the Robert Morris Associates, or major institutional investors and other organizations. They should also consider novel means to get qualified users to focus exclusively on users' needs for the benefit of the standardsetting process (for example, focus groups and task forces made up of recently retired users).
Highquality research on users' needs for information has been limited. Much of what is written about users' needs for information is speculative ; that is, the author speculates about what would or would not be useful to users, not testing the speculative ideas with empirical data or with direct observations or otherwise working with users. Most of the empirical research on users' needs that has been done is not intended to support standardsetting activity and, as a result, is too broad or narrow to be helpful to standard setters. The Committee decided to conduct and sponsor new research because of the scarcity of relevant research.
Standard setters have sponsored and undertaken some research that has helped develop standards consistent with users' needs for information and have used other research produced by academics. The FASB, for example, considered findings from capital markets research in making decisions on Statement 33 ( Financial Reporting and Changing Prices) disclosures, marketable securities, and postretirement benefits other than pensions. However, standard setters should more aggressively search for, sponsor, and undertake research about how users make decisions and about the relative usefulness of various types of information in their decisionmaking processes. What has been done in the past is not enough. There is no substitute for reliable data on which to base decisions. The research should involve a wide range of projects that search for users' needs for information from a variety of perspectives. Examples of the types of research that would be helpful are listed in chapter 5.
To help motivate competent researchers to undertake the right kinds of research, standard setters should become more active in helping steer research programs into areas that are relevant to the standardsetting process. For example, standard setters could become more involved in advisory boards at universities and with research foundations. They could also increase the frequency with which they jointly sponsor research with other organizations, such as the Financial Executives Research Foundation, the Institute of Management Accountants' Foundation for Applied Research, and the AIMR.
U.S. standard setters and regulators should continue to work with their nonU.S. counterparts and international standard setters to develop international accounting standards, provided the resulting standards meet users' needs for information.
This recommendation recognizes both that developing international accounting standards is a worthy goal and that their development should be consistent with the current U.S. commitment to base accounting standards on users' information needs. The alternative is to give the development of international standards priority over the fundamental purposes of business reporting, a course that could result in lowestcommondenominator standards. Such a priority is evident whenever international standards result in a net loss of useful information, whether through less stringent requirements or through the variety or effects of accounting alternatives. The Committee rejects any approach that would sacrifice users' needs for information to the goal of creating international standards.
The focus on users' needs recommended in the passage above offers a common framework for standard setters in all countries. Under this approach, users' information needs, proactively determined by research and the participation of users, would be the basis for international accounting standards. This approach, which is different from attempting to reconcile differences among the standards of different countries, should enable international standard setters to arrive at standards that serve the information needs of users. It should also allow standard setters to identify instances, if there are any, where international standards are not possible because information needs among different groups of users are incompatible.
Differences in economies, regulations, culture, and standardsetting objectives have led to the diverse reporting practices now in place in the international community. The diversity is extensive. Some countries do not recognize assets and liabilities that others do. Measurements of financial statement items differ. There are also differences in display practices and varying levels and types of disclosure.
Differences among nations' business reporting practices are the basis for the strong arguments in favor of international standards. The differences make intercompany comparisons more difficult and add risk to decisions on allocating capital among companies located in different countries. Uniform standards would facilitate securities registrations by foreign companies. It is typically more costly for a U.S. company to prepare disclosures under the more comprehensive U.S. requirements than for a foreign company to comply with the disclosure requirements in its home country. U.S. companies suffer competitive disadvantage when entities in countries with relatively limited disclosure requirements have access to the fuller disclosure required in the United States. Multinational companies are faced with the cost of complying with different national standards, and the difficulties can inhibit their access to foreign capital markets.
These arguments are a powerful incentive to work for highquality, effective international standards. But the arguments do not justify sacrificing users' needs for information to the goal of international standards. Past international standards have permitted wide flexibility or have reduced information requirements in order to obtain agreement among countries participating in the standardsetting process. However, international standard setters are working to reduce that flexibility and improve disclosures. Focusing on users' needs for information would facilitate that important process.
Business report users in the United States have expressed concern that international standards often result in reporting that is less useful to them. Although most favor a single set of accounting standards, if forced to choose, users prefer diversity when international standards result in a net loss of useful information. They generally believe their needs are best met by U.S. reporting standards.
An alternative to international standards is the policy of mutual recognition, under which two or more countries agree to accept, for purposes of registering foreign company securities in their capital markets, compliance with countryoforigin disclosure standards. Both mutual recognition and uniform international standards facilitate securities registrations by foreign companies, but the approaches are otherwise very different. Mutual recognition accepts differences among disclosure presentations. Such differences hinder intercompany comparisons by users and create competitive disadvantages for disclosing companies, disadvantages that international standards are, ideally, supposed to eliminate. In these ways, mutual recognition can sacrifice users' needs. Finally, mutual recognition can inhibit future efforts to develop international standards, because those who support that development primarily for purposes of encouraging foreign registrations will have lost their motive for continued support.
Users are particularly concerned about the loss of information that may result under mutual recognition. The Committee recognizes that mutual recognition would do no disservice to users' needs whenever the differences among disclosure presentations are immaterial. Apart from those circumstances, however, the Committee opposes mutual recognition.
Lawmakers, regulators, and standard setters should develop more effective deterrents to unwarranted litigation that discourages companies from disclosing forwardlooking information. The Committee's research shows that the current litigation environment has had a dampening effect on the disclosure of forwardlooking information. Moreover, because of that environment, the Committee was constrained to qualify its recommendation on enhanced disclosures of forwardlooking information, holding it in abeyance until the threat of unwarranted litigation is reduced. The followon recommendation here is that steps should be taken to reduce unwarranted litigation that makes disclosures of forwardlooking information inordinately risky.
The reduction must be sufficient to ameliorate the unreasonable threat of litigation costs incurred for competently prepared, goodfaith disclosure of forwardlooking information that serves the interests of users.Meritless litigation is certainly unwarranted. In the typical meritless suit, a drop in a company's stock price triggers a suit alleging fraudulently misleading disclosure, or lack of disclosure, and a favorite allegation is that predictive information was misleading, not having been borne out by events. The cost of defending those suits is very high ; so high that exoneration can be more expensive than settling. In addition, the risk of losing the suits is always a possibility accompanying the defense costs, despite the suits' lack of merit. As a result, settlements can be sensible business decisions, and they are typical. The transfer of wealth from the settlements makes additional meritless suits more likely.
All of this is well known. It has been discussed in congressional hearings, and the dampening effect of meritless suits on voluntary disclosure is common knowledge. Companies, well aware of the risks of meritless suits, have been reluctant to make forwardlooking disclosures. This reaction is an understandable defensive measure to reduce litigation risk, but its consequence is to deprive users of information and inhibit the progress in business reporting that comes from experience with voluntary disclosure. Users are concerned with the effect that meritless litigation is having on business reporting. There are three sources of potential relief from the problem of meritless suits over forward-looking disclosures ; lawmakers, regulators, and standard setters. Legislators and regulators can create more effective safe harbors and can adopt other measures that discourage unwarranted litigation. The antimeritlesssuit provisions in the legislation introduced in 1994 by Senators Christopher J. Dodd and Pete V. Domenici are examples of the latter.
Standard setters can reduce the threat of unwarranted litigation by developing provisions for forwardlooking disclosures that enable companies to demonstrate compliance. The incidence of meritless suits over forwardlooking disclosures should be dampened if companies can demonstrate that although results differed from forwardlooking disclosures, the disclosures had been competently prepared in good faith in compliance with authoritatively established standards. Taking as an example the forwardlooking disclosures in the Committee's reporting model (see chapter 5), the standards could be more or less openended. If the issue was risks, specific risk types characteristic of particular industries could be identified for companies in each industry to disclose. Compliance would then be far more easily demonstrated than by following a blanket obligation applicable to all companies to disclose all material risks. The former approach to disclosure is far less open to accusations of inadequacy in light of subsequent events.
It is often argued that litigation over disclosure serves a valuable social function: It provides recompense to the defrauded, and the desire to avoid litigation promotes care by companies in the discharge of their accountability obligations and vigilance by auditors in examining financial statements. These arguments apply only to legitimate claims of fraudulent disclosure. They do not apply to meritless suits. In a meritless suit there are no defrauded victims, and there is no inadequate care by companies or by auditors. The only suits targeted by this recommendation are meritless suits. Measures can diminish them without weakening mechanisms to redress legitimate claims.
Companies should be encouraged to experiment voluntarily with ways to improve the usefulness of reporting consistent with the Committee's model. Standard setters and regulators should consider allowing companies that experiment to substitute information specified by the model for information currently required. Standard setters, regulators, and users should encourage companies to experiment voluntarily with improved reporting based on the Committee's model. The experimental presentations can be supplementary to what is now required, but with the cooperation of standard setters and regulators, they can also take the form of replacing currently required presentations or parts of them. In that case, standard setters and regulators would have to grant participating companies permission to substitute items from the model for required items. For example, under current rules, companies cannot separately display the effects of core and noncore activities and events. Permission would have to be granted in order for the model's core-noncore approach to replace what is currently required.
Some voluntary efforts to improve reporting have met with success. For example, companies participating in FASB field tests over the years have provided valuable information for standard setting. Voluntary reporting has been stimulated by cooperation between companies and analysts. The interaction of the AIMR Corporate Information Committee and companies evaluated in its annual rankings of corporate reporting has encouraged many initiatives, including presentations of quarterly segment data and nonfinancial operating data. Corporate factbooks are another example of voluntary corporate disclosure that has matured from the interaction between disclosing companies and investment analysts.
Experimentation could provide information about costs and benefits, generate insights to refine ideas, and in other ways give standard setters and regulators a better baseline from which to consider the Committee's recommendations. Successful experiments that demonstrate that practical, costeffective improvements are possible would both accelerate improvements and help avoid pitfalls.
Standard setters should adopt a longer term focus by developing a vision of the future business environment and users' needs for information in that environment. Standards should be consistent directionally with that longterm vision.
The relevance of the information businesses report to users is affected by a constantly changing environment. Economic and technological change occurs swiftly, and the changes affect the needs of users of business information. Standard setters should have some systematic approach to awareness of the likely importance of these changes for business reporting so that agenda priorities are well chosen, resources effectively deployed, and standards appropriate to the environment in which they are to be applied.
No one can have detailed, accurate knowledge of the future, but developing such knowledge is not the aim of this recommendation. The aim is to identify enough of the broad outline of the future to improve planning and facilitate a strategic approach to standardsetting tasks. Responding to problems as they arise ensures that reporting standards will always lag behind users' needs for information. Even if the problemsolving approach was once suitable, it will not suffice in the rapidly evolving era we have entered.
The kind of vision called for by this recommendation embraces broad questions. What, for example, will be the relationships among the parties to the business reporting process in the future? Who will those parties be? Will customers, suppliers, and employees, for instance, take their places beside investors and creditors as focalpoint users of business reports? How will companies' affiliations with other companies change and what are the implications of those changes for the reporting entity of the future? How will technology affect the capacity of reporting entities to provide information and the capacity of users to analyze it? How will technology and changing patterns of producing goods and services change the types of information collected and used for managerial purposes? In what ways will the factors of production change? How will the background, capabilities, and other characteristics of users change? And what are the implications of the answers to the whole range of such questions for the information needs of business report users?
Arriving at answers to such questions will require consideration of the broad trends affecting the reporting environment. The inquiry could include the likely influence of demographics, media penetration, and regulatory activism on accountability obligations; how the mechanisms by which finance is conducted will change; and whether institutions now widely relied on in the business world will gain or lose roles or indeed be supplanted by different institutions. The context could embrace changes in relationships among institutions and their constituents, including changes in the concept of sovereignty and in the future relationships between competing interests, such as between the right to know and the right to confidentiality.
Some who have addressed these kinds of questions and subjects have painted a radically different business reporting environment early in the next century, one with realtime reporting, user access to entity databases, powerful software for users' analytical tasks, and much lower costs to prepare and disseminate information. Whether or not those predictions become parts of standard setters' fresh attempts at longterm visioning, they suggest that longterm changes could affect agenda priorities.
The examples just given of the type and breadth of questions that might be addressed in formulating a longterm vision, the forces for change that might be explored, and the dimensions of change that might be revealed are illustrative only. Defining the issues for inquiry obviously would be one of the initial tasks of those who develop the vision. And to ensure its perceptiveness and quality, standard setters should consider assistance from experts in various disciplines ; finance, accounting, economics, law, business strategy, behavioral science, and technology, for example.
Regulators should consider whether there are any alternatives to the current requirement that public companies make all disclosures publicly available. The inherent tension between a company's need for confidentiality and business report users' perceived right to know is an important issue to address in developing a longer term vision of business reporting. Many expect that tension to increase in the future. On the one hand, the increased availability of information, the increasing complexity of business transactions and relationships, and users' expectations for more information will provide pressure to disclose more information. On the other hand, competitors will enhance their power to learn from competitively sensitive information and draw advantages from it. This suggests that alternatives to the requirement that public companies make all disclosures publicly available would be relevant to serving the interests of investors and creditors and improving the allocation of capital.
Under the current requirement of fully public disclosure, all information that goes to users is available to the disclosing companies' competitors. Fully public disclosure is a valued ; even revered ; feature of the disclosure system, but it also constrains the types of information that are disclosed because competitive disadvantage is a cost. Yet much information that might cause competitive disadvantage when disclosed to competitors could assist users in their analytical and decision making tasks. The requirement for public distribution of all information thus prevents users from receiving competitively sensitive information that can help them reduce their risks of misallocated capital and improve the effectiveness of capital allocation in the country. A known benefit, the disclosure of useful information to users, is being sacrificed to avoid a known cost, the disclosing company's competitive disadvantage.
The Committee is not recommending that the fully public disclosure requirement be abandoned, only that regulators explore whether there are any alternatives. Regulators should consider whether the cost of reporting sensitive information to competitors could become an undesirable barrier to providing the most useful information to users and therefore to allocating capital effectively. If so, regulators should consider whether, given such circumstances, it would be in the interest of effective capital allocation for certain users, such as those who agree not to disclose the information, to have access to more extensive information.
The alternatives could be explored in two contexts. The first is the efficient markets theory. Given such markets, are there circumstances where no disservice would be done to the interests of individual investors by allowing professional investors access to more extensive information? Staying with the previous paragraph's example of confidentiality agreements with users, it would probably be impracticable to reach all users with confidentiality agreements. The most likely candidates for such agreements would be institutional investors, whose fulltime attention and transaction volume give them a claim to being the most influential securities price makers. They are far more likely to act rapidly on new information than individual investors. It therefore would be reasonable to inquire whether improved valuations of companies by institutional investors with access to the information under confidentiality agreements would do no disservice to individual investors and creditors, because the share price the individuals consider would reflect the additional information whether or not they had prior access to that information.
The second context for exploring alternatives to the "tell one, tell all" policy is the rapid, ongoing progress of information technology and its influence on the disclosure system. In time, corporate disclosure is likely to be online to users. Differential disclosure would then be able to benefit from encryption technology and other devices for selective access to information. There will be many new possibilities to consider, and some can be anticipated now.
The AICPA should establish a Coordinating Committee charged to ensure that the recommendations in this report are given adequate consideration by those who can act on them. Since the Committee formulated this recommendation, the AICPA Board of Directors has voted to establish a Coordinating Committee. According to the Committee's recommendation, the Coordinating Committee should:
These responsibilities should enable the Coordinating Committee to be a catalyst in bringing appropriate attention to bear on the Committee's recommendations.
The recommendations in this chapter are designed to better the conditions necessary to improve business reporting. As stated at the outset, there is far more to improving business reporting than worthy ideas. Good ideas need to be given force. They must attract attention and support and be differentiated from ideas that can provide no public benefit. They must be considered by those who can turn them into practices and into standards and otherwise implement them. Parties who can influence implementation must cooperate if the ideas are to yield their best results, and they must persevere until all the necessary work is done. Above all, the institutional processes by which improvements are developed and implemented must be effective ; oriented to the public interest, focused on the right objectives, open to new ideas, proactive in obtaining needed information, free of needless barriers to progress, and otherwise prepared to fulfill their missions.