Macroeconomic Variables and Corporate Performance

Increased economic and financial integration and substantial macroeconomic fluctuations require that corporate managers and investment analysts pay more attention than in the past to the link between the “noise” that these fluctuations represent and the company's performance—past and future. For many reasons, company managers must weed out the effects of the noise to obtain a clear picture of the company's intrinsic competitiveness and long-term sustainable profits. The question is: To what extent can outside shareholders and investment analysts adopt this approach to corporate performance? Current reporting practice does not provide these outsiders with an adequate idea of the character and magnitude of the impact of macroeconomic variables on the company. The recommendations of International Accounting Standard 1, Presentation of Financial Statements (as revised in 1997), however, offer an improvement in this important area. This article presents four levels of implementation of IAS 1 and what these levels mean in terms of relevant information transmitted to outsiders. Illustrations are provided of current practices in two global industries and of a release that would meet the informational demands of shareholders and analysts. Increased economic and financial integration and substantial macroeconomic fluctuations require that corporate managers and financial analysts pay attention to the link between the “noise” that these fluctuations represent and a company's intrinsic growth and development. No company can claim any longer to be unaffected by what is happening in the global arena. Yet, the external reporting of most companies does not indicate the extent to which profits are affected by fluctuations in the company's macroeconomic environment during the reporting period.Without this information, outside shareholders and analysts have no chance of figuring out what has happened to the company's sustainable profits and, therefore, its intrinsic competitiveness. Consequently, as regards the effects of a volatile macroeconomic environment, current accounting practice is failing to achieve one of the fundamental goals of external reporting, namely, to provide information for evaluation purposes to shareholders and other stakeholders. Moreover, although the international standard-setting bodies support the notion of “decision relevance” for shareholders, no real progress has been made toward achieving the other fundamental goal of external reporting, namely, to provide shareholders with information about the future prospects of the company. However, International Accounting Standard (IAS) 1, Presentation of Financial Statements (as revised in 1997), indicates that an improvement in this important area may be in the offing.Corporate managers must weed out the effects of noisy macroeconomic factors to obtain a clear picture of the company's long-term sustainable profits and thus the company's intrinsic competitiveness. The question is: How far should this “revised” picture of corporate performance and expectations be extended to outside shareholders and investment analysts? I discuss the ways in which, despite IAS 1, corporate information on the impact of macroeconomic fluctuations that is supplied to outside users of financial statements does not meet their needs for such information. I go on to show how MUST-type analysis (MUST stands for “macroeconomic uncertainty strategy”), which was developed as a management tool, can also be used to report the effects of the macroeconomic environment on the company in the past, expected effects, and the company's strategy for combating adverse effects.If a report about the impact of macroeconomic variables on corporate performance is to be informative, the company has to have made and continue to make systematic analyses of this impact. Powerful outside forces—of which the one exerted by financial analysts may be the strongest—should be at work to increase company managers' interest in discerning to what extent the company's profits stem from its intrinsic competitiveness and to what extent they stem from changes in the macroeconomic environment. This information is needed to decide future strategy, set bonuses, and evaluate subsidiary managers. A MUST-type analysis filters out the (temporary) macroeconomic noise from corporate profits as a first step. After this filtering, an apparently favorable result may be transformed into a strong signal about reduced competitiveness and a “leading indicator” of the need to change product/service or production/distribution strategy. The second step is to formulate a risk management strategy for the future. Does the company need to handle the risks generated by future macroeconomic fluctuations, and if so, how? For companies that handle these steps intelligently, the final step is to communicate this valuable information to the company's outside shareholders and other stakeholders.The article discusses whether IAS 1, as it is likely to be interpreted and implemented, helps outside shareholders understand the impact of macroeconomic fluctuations on the company's performance and recognize the magnitude of macroeconomic risks. Four levels of response to IAS 1 are described in terms of how much and what kind of information is transmitted to outsider shareholders. For illustration, I categorize the annual reports of companies in the global automotive industry and paper/pulp industry for the fiscal years after the IAS 1 recommendations came into force. My conclusion is that at the end of the 1990s, no company in these industries included information in its external reporting that would enable outside shareholders or financial analysts to understand the extent of macroeconomic influences on corporate performance. I illustrate how valuable the information can be. Although technical and other barriers to publishing the output of a MUST-type analysis exist, I list seven compelling reasons that such releases will begin to appear in the not-too-distant future.