Stakeholders that provide resources to firms, whether they are shareholders, banks, or suppliers, rely on financial accounting information to support their decisions. To find out how different types of stakeholders use and value financial statement information, Stefano Cascino and five other researchers from across the UK and the EU designed a series of innovative survey experiments. Their results helped to shape international standards for financial reporting.
We don’t know enough about how financial reporting information is used
Financial statements provide essential information about a firm’s performance. However, users of financial statements don’t all necessarily need the same type of information as their objectives may be different.
“The same financial statements that are published by a corporation are used at the same time by shareholders, creditors, suppliers, and other stakeholders of the firm. All of these parties might have different objectives. They might use the very same piece of information for different purposes,” explains Dr Cascino.
“For example, a shareholder is interested in accounting information that is useful to predict the timing, amount, and risk of future cash flows and thus to support the estimation of the value of the firm. In contrast, a supplier would want financial information that is useful to understand whether the firm will be able to pay back the resources acquired.”
“There are certainly commonalities among the desired properties of financial accounting information. For example, if a firm reports an increase in profitability, this is good news for both an equity investor, who cares about the stock price, and a supplier, who gains confidence in the firm’s ability to pay for the resources it has acquired. However, certain properties of financial accounting information may satisfy the information needs of some stakeholders but not of others.”
For instance, financial accounting information that is relevant for firm valuation may not be as useful for managerial performance assessment. For the latter, accounting information should enable users to assess whether rising profits result from the efforts of managers, external factors, or pure luck. In contrast, for the purpose of firm valuation, rising profits are a useful piece of information regardless of whether they are attributable to managerial effort. This tension highlights important trade-offs between two primary objectives of financial information: valuation and stewardship.
Cascino and his co-authors found that prior research exploring the effects of stakeholders’ objectives on how useful they rated accounting information was scant. They also found that research was limited on how accounting information fares in stakeholder evaluations in comparison to other sources of information about the firm and its management, information about the industry and competitors, and about product markets.
Accounting standards setters have frequently subsumed the two objectives of financial accounting information – that is, valuation and stewardship – into one. As Cascino and colleagues explain, standards setters rely on a single “‘decision usefulness’ objective, even though general purpose financial statements may not be capable of satisfying multiple objectives simultaneously.” The management oversight role has in the recent past been relegated in importance, including in the 2010 version of the International Accounting Standard Board’s Conceptual Framework.
Survey experiments show how investment professionals assess financial accounting information
To understand exactly how financial information is used, the research team designed two survey experiments. First, they conducted 81 face-to-face interviews with investment professionals across 16 countries.
Each participant was presented with the same set of abridged financial reports for a fictional firm and asked to evaluate their usefulness. Participants were randomly assigned the task of either valuing the company or assessing management performance. The researchers also varied whether or not participants were told that managerial compensation was tied to the company’s financial statements.
The results showed that, “overall, investment professionals assigned a firm valuation objective assess financial statements as significantly more relevant than those assigned a managerial performance evaluation objective.” However, in this and in a follow-up experiment, they also found that, as long as the firm’s corporate governance is strong, with checks and balances in place, there was no evidence of concern about managers using their discretion over reported information when their own remuneration was tied to the bottom line.
This research highlighted the potential shortcomings of assuming that a single set of financial information can serve multiple purposes. One size does not seem to fit all in financial reporting. Who is assessing the information – whether they are providing credit or equity and whether they are seeking to value the firm or to assess managerial performance – shapes how useful the information is for them.
Policy impact: restoring accounting standards’ focus on the stewardship objective
High-profile corporate failures highlight the importance of managerial accountability and effective stewardship as fundamental concerns for investors, accountants, and standard-setting bodies. The research by Cascino and his co-authors has helped to restore standards setters’ focus on the stewardship role of financial reporting. Their research has influenced the revised version of the International Accounting Standards Board’s 2018 Conceptual Framework for financial reporting, which effectively replaced the 2010 version. This newer version re-emphasised the stewardship objective of financial reporting, which has implications for the more than 50,000 companies in 166 countries that use the International Accounting Standards Board’s accounting standards to prepare their financial statements.
Stefano Cascino and his co-authors acknowledge the financial support of the Scottish Accountancy Trust for Education and Research, Institute of Chartered Accountants of Scotland (ICAS) and the European Financial Reporting Advisory Group (EFRAG)