Annual reports (... who reads them?).

Annual reports, the 'Rodney Dangerfields' of corporate communication, earn surprising respect from institutional investors.

'THE RODNEY DANGERFIELDS of corporate communication," wrote one seasoned investor relations professional describing annual reports. "An ego trip for self-centered corporate CEOs," said another. One believer in the futility of annual reports was especially adamant. "Most corporate executives would be fired," he wrote, "if they ran their businesses the way they put out the annual reports."

As long as anyone can remember, no single element of the modern corporation's financial communication program has been the butt of more sarcasm and criticism than the annual report.

Today, more than 11,000 corporate annual reports are produced in the U.S. -- not to mention thousands of annuals published by government agencies, nonprofits and other private groups. Is the abuse justified?

A new survey of two of the annuals' principal players -- the institutional investor and the corporate financial officer (CFO) -- strongly suggests that perhaps all the howling is unfair and unfounded. Equally important, these two key annual report principals said there has been noticeable improvement over the past five years in the informational value of the annual to institutional investors.

Survey focuses on institutionals

As a veteran corporate annual report producer, I posed this basic research question: Is the corporate annual report meeting the information requirements of the institutional investor?

I chose institutional investors as the primary research audience because of their significant impact on equity markets and share prices. For years, professional communicators and investors trumpeted the coming of the institutional investor as the dominant player on Wall Street. Companies were warned to beef-up their financial communication techniques, such as the annual report, to better respond to the institutional investor's growing information appetite.

The warnings were not unfounded. Institutions currently hold more than half of corporate America's common stock outstanding, are responsible for about two-thirds of daily stock trading, and play a major role in the U.S. $30 billion invested annually in stocks and bonds. They have become the principal users and demanders of corporate information.

I also included the viewpoints of corporate chief financial officers. Because the CFO is such a major influence on the annual report product itself, and on the company's dealing with the investment community, CFOs were added to gain their views for comparison with those of institutional investors.

In early 1994, comparable three-part questionnaires were mailed to 300 institutional fund/portfolio managers and 300 corporate CFOs. Institutional investors were randomly selected from "Nelson's 1993 Money Market Directory of Investment Managers." To assure respondents represented institutions with significant corporate exposure, only institutions with more than $500 million in investments were chosen. CFOs were randomly chosen from "Nelson's 1993 Money Market Directory of Investment Managers." To assure respondents represented companies with substantial institutional stock ownership, only companies with more than 30 percent of their common stock held by institutions were chosen.

Ninety six institutional investors, or 32 percent, and 112 CFOs, or 37 percent, responded. Given the extremely demanding time constraints of both groups, the return rates were considered more than acceptable for this type of study. Contributing, perhaps, to the higher interest level by CFOs was the timing of the study -- the peak of the annual report production season.

Study posed three hypotheses

Using personal intuition/experience and the findings from an assortment of mostly critical literature reviews on the annual report, I crafted three hypotheses:

1) As a financial information tool for the institutional investor, the annual report is the least useful and least informative tool within the company's financial communication program.

2) As for content, the information value of the annual report's three major sections -- chairman's letter, management discussion & analysis (MD&A), and the financial section -- does not meet the requirements of the institutional investor.

3) The annual is of little or no use to the institutional investor in making an investment decision involving an existing or potential portfolio company.

Despite the fact that almost everything published on the annual report over the past decade has been negative, my research found that institutional investors' respect for the informational value of the annual is much higher than the "Rodney Dangerfield" perception held by many communicators. In fact, institutional investors failed to support any of the study's three hypotheses and, together with corporate CFOs, agreed that the annual's information content has, indeed, improved over the past five years.

Annual ranked most informative source

Specifically, more than half (51 percent) of institutional investor respondents ranked the annual as the most useful and informative of five distinct information sources within a company's financial program. The other four sources were the investor relations officer, the chief executive officer, the chief financial officer and electronic information databases, such as Dow Jones and Bloomberg financial wires.

Moreover, institutional investors displayed a much higher appreciation for the information value of the annual's three major sections than argued by annual report critics. For example, only 10 percent of respondents dismissed the informational value of the financial section and just eight percent said they felt the same way about the MD&A. The low unfavorable ratings demonstrated across-the-board support for the annual's information content.

Particularly noteworthy, and again contrary to professional opinion, 62 percent of institutional investor respondents agreed that the annual is as relevant for large institutionals as it is for small mom-and-pop investors.

On the usefulness issue, institutional investors again expressed greater appreciation for the annual than my expectations, as 52 percent agreed that the annual is informative in helping the institutional investor determine the investment value of a particular company.

CFOs view issues differently

Turning to attitudes of CFOs about the annual report, this study found that their views clearly differed from institutional investors in most major study areas.

For whatever reasons, defensive or otherwise, CFOs saw themselves and their senior management associates as much more important than the annual report as an information source for the institutional investor. For example, of the five primary sources of information available to the institutional investor, CFOs rated themselves the highest in importance at 57 percent and the annual report second at 52 percent. Surprisingly, electronic databases, such as the Dow Jones and Bloomberg financial wires, essentially were dismissed by CFOs as a good information source for institutional investors; 56 percent disagreed that their value was important. Institutional investors, on the other hand, put electronic databases in importance right behind the annual report. The wide disparity begs the question: Are CFOs really in tune with the investment community's growing dependence on the information superhighway?

Cost effectiveness also explored

While I had the attention of these two key annual report players, I went beyond the three major study areas and explored several other sensitive annual report issues, such as cost effectiveness.

Chase Manhattan's corporate communication director, Steve Rautenber, best expressed the sentiment of many professional investors and communicators when he likened the typical annual to the old Ed Sullivan Show: "A comedian for mom and pop, a rock band for the teens, an accordion player for granny, and Topo Gigio, the Italian mouse, for the kiddies." Rautenber argued that the variety show approach to annual reports had become outdated. "Consequently," he said, "the vast majority of today's annual reports are a big, fat waste of money."

Billions spent on annuals

It's a legitimate issue. A staggering amount of time, energy and money are invested in annual reports -- more than $5 billion every year in the U.S. Unquestionably the most expensive and management-intensive tool within the typical financial communication program, today's average 32-page report costs in excess of $500,000 to produce, or as much as $8 per copy.

In one of their rare moments of agreement, institutional investors and CFOs were together on the need for corporations to get a better grip on annual report glitz and spending. No legal requirement exists for annual reports to have become the showpiece publications they are today. The landmark Securities and Exchange Act of 1934 specified only that publicly held companies make full financial disclosure of details relevant to the current and future value of the company to shareholders on a yearly basis.

Yet, since the birth of modern graphics for annual reports in the 1940s, the corporate penchant to "make it pretty" has been an irritant to large and small investors alike. In this study only 15 percent of institutional investors and 32 percent of CFOs felt that the amounts of time and money invested in graphics and editorial content were appropriate, strongly suggesting that, despite decades of criticism, old habits are hard to break.

Summary reports not popular

Another controversial tool, summary annual reports, failed to generate much support from either institutional investors or CFOs. Summary annual reports, or SARs, strip the annual report document of the lengthy financial notes at the back of the book, replacing the turgid legal prose with brief, clearly written summations. The required information then often is printed on less expensive paper, typically in the proxy statement, which is issued to shareholders at the same time as the annual report.

Institutional investors and CFOs both expressed strong doubts about the SAR meeting the information requirements of the institutional investor. Only 19 percent of institutional investors and less than 16 percent of CFOs agreed that the SAR meets information requirements as well as the traditional annual report. Since McKesson Corp. pioneered the SAR in 1987, few companies have adopted the tighter format. Study findings suggest the SAR has not grown, nor can it be expected to grow soon, in popularity.

Respect for annual is real

Are today's annual reports meeting the information requirements of the institutional investor? The short answer coming out of this study is "yes." A longer answer includes some qualifiers that deserve further analysis, such as what is the annual's role in relation to other primary required and voluntary financial communication vehicles? The fact, however, that institutional investors failed to support any of this study's three hypotheses, and agreed that the annual has improved over the past five years, is, indeed, enlightening.

Annual reports historically have suffered a stormy evolution. Even today many communication scholars and investment professionals still believe something is not quite right in the world of corporate annual reports. Considering the significant impact institutions have on equity markets, there is value in continuing to examine corporate communication with this powerful audience, particularly in respect to the role of the most expensive and debatable element, the annual report. Such effort would help build on the improvements already acknowledged in this study. More importantly it may lead to erasing the disconcerting "Rodney Dangerfield" perception held by many corporate managers and investors.

EXCEPT FOR U.K. STUDIES, LITTLE RESEARCH WAS FOUND ON THE IMPORTANCE OF ANNUALS TO INSTITUTIONAL INVESTORS OUTSIDE THE U.S.

A major frustration encountered during the research phase of this study was finding a surprising dearth of research or literature on the usefulness of the annual report to the institutional investor.

Much "how-to" information has been written by communication scholars and financial communication professionals on annual reports. Literature ranges from how to write a more "ethical" report to the intricacies of producing a video annual report. Some literature addressed the usefulness of the annual report to particular segments of the individual investor group. Yet, despite the importance of the institutional investor, there is a conspicuous lack of research on the usefulness of the annual to the institutional investor.

Equally surprising, from the handful of pertinent research pieces turned up, the key works were published in the United Kingdom. In the U.K.'s Accounting and Business Research Journal Autumn 1982 issue, for example, R.D. Hines suggested that the annual has little, if any, effect on the actual market value of a company's stock. The focus of Hines' investigation was an apparent anomaly between shareholder surveys and what he described as Efficient Markets Hypotheses (EMH). In simpler terms, Hines maintained that annual reports are issued too late to be of use to shareholders, particularly large institutionals; the information they contain has been disseminated and absorbed by investors before the annuals are published.

Another major U.K. financial journal, Accountancy specifically addressed the challenge of communicating with institutional investors in its May 1990 issue. Authors Alexander Prexis and Veerle Berbers reinforced the influence that key investor relations tools, such as the annual report, have on institutional investors. At the same time, however, they cautioned their corporate readers that analysts and institutional fund managers are able to make faster and more-informed decisions based on the real-time information gained from their computer screens.

A year later, Accountancy's August 1991 issue took and other look at the annual report and its informational value to shareholders, particularly institutionals. Authors Sid Gray, Clare Roberts and Paul Gordon argued that while some U.K. companies are now providing information on "corporate systems," a major failing of most reports is that they still give little or no quantified information about future prospects, a key information need of institutional investors.

H.R. Hutchins is secretary and education grants officer of the Shell Oil Company, Houston, Texas. He will lead a session on annual reports at IABC's 1995 international conference, June 11-14, in Toronto.