Transforming Your Annual Report into An Asset
It has been 15 years since the Sarbanes-Oxley Act re-wrote the book on corporate financial reporting. Since Congress enacted the law, investors have benefited from measurable improvements in corporate financial transparency but much has been lost along the way. We will look at how the law impacted financial reporting, corporate communications, design, and branding; the gains and losses felt by key audiences; and, finally, the opportunity to make the annual report work harder for public companies.
Once Upon A Time
The Wyant Simboli Group has been producing annual reports for companies large and small for more than 25 years. We’ve always seen the annual report as a significant opportunity to update key stakeholders on the challenges and achievements a business experienced in the preceding year and, more importantly, as a vehicle for management to present these milestones within the context of their company’s story.
Since 2002, much has changed in the financial reporting industry. Not long ago producing an annual report was an immersive project where energetic clients and healthy budgets resulted in reports with refined messaging, pointed design, and carefully typeset financials. These reports aimed to both inform and inspire readers. In the 1990s, the medium challenged designers to experiment with specialty papers and advanced printing techniques to help their clients stand out. The idea that an elaborate and well-designed annual report projected an image of success and inspired shareholder confidence seemed to justify the expense. And it worked, for a time.
The Emperor’s New Clothes
In 2001 the lights went out. We learned that Enron, a $70B utility company, had been taking advantage of loose regulations to implement irregular accounting practices that fabricated profits through specially created entities that the company, itself, controlled. The scheme led to what was, at the time, the largest chapter 11 bankruptcy filing in history and to an unprecedented financial collapse.1
The fallout hit ordinary employees hardest. The New York Times reported “ ‘They kept telling us, “Don’t sell, don’t sell, it’s going to go up.” And they issued more options,’ Ms. Stone said of the stock. She said that Kenneth L. Lay, Enron’s chairman, once told employees, ‘ “In a year or two, we’ll be laughing at this.” No,’ she said, ‘we won’t.’ ”
Less than a year later, Worldcom, a $186B telecom company, filed an even larger bankruptcy after a small group of internal auditors “working often at night and secretly” revealed that top executives had employed fraudulent accounting to disguise lackluster earnings. Those responsible succeeded in artificially inflating Worldcom stock by approximately $11B.2
By July Congress reacted with the Sarbanes-Oxley Act of 2002. The 11 sections of the new law implemented a series of corporate accounting reforms. Specifically, Section 404 requires companies to disclose the scope and adequacy of internal control structures while section 303 requires that a company’s principal officers sign-off on the integrity of their financial reports.
The initial cost of compliance was steep. Public corporations were not only required to disclose significantly more information, but the new certification requirements meant that the processes used to generate the information had to be documented and standardized. The regulations also had a dramatic effect on companies involved in the production of annual reports. In 2003, IR Magazine stated, “according to some design consultants, the reports themselves have grown by 20-50 percent to include the new disclosure while their budgets have fallen by roughly the same proportion.” To balance the budget, managers slashed the editorial content of their annual reports and replaced typeset (read “readable”) financials with the standard 10K filling form. The days of specialty paper and expensive printing were over.
Financial reporting slowly started to improve. By 2006, Harvard Business Review was reporting on ‘The Unexpected Benefits of Sarbanes-Oxley’. While creating the systems necessary for compliance was expensive, companies that did so saw efficiency improvements and were beginning to generate a return on their investment. According to a survey conducted by Financial Executives International, the cost of compliance fell 23 percent between 2005 and 2006 to 0.036 percent of revenues. In 2006 the Lord & Benoit Report showed gains in share price for compliant companies outpaced the cost of compliance. Transparency also improved. After measuring the dispersion and accuracy of analyst forecasts for firms cross-listed in the US, European researchers concluded that companies that were required to comply with Sarbanes-Oxley were significantly more transparent.
The new regulations appeared to have worked as intended and produced valuable information for investors. However, not everything improved. The cost of compliance did decrease over time, but production budgets for annual reports did not come back. Many companies continued to publish a 10K wrap in place of a traditional annual report.
The 10K wrap cannot be considered an improvement for most key audiences. The standard form is, after all, a legal document required by the Securities and Exchange Commission. It lacks the editorial content of a traditional annual report and provides precious little context for retail investors and employees. The net benefit of a 10K wrap is questionable even for professional analysts since companies report financial performance quarterly and some of the most valuable information is already public knowledge. Additionally, the presentation itself is not particularly accessible; The American Enterprise Institute reported that most compensation statements ‘fail to even meet the readability standards that many US states require for insurance forms.’ The recognition that for both investors and employees, accuracy and transparency are simply not the same has been lost.
If We Wished Upon A Star
We believe there is an opportunity to move beyond mere compliance and improve accessibility for retail investors and employees while simultaneously providing context for these readers and professional investors alike. It begins with storytelling.
Numbers, particularly large sets of tabular data, and dry factual narratives are not the most effective way to communicate with real people. Anecdotally this seems obvious, but we don’t have to rely on anecdotal evidence as scientists have shown that humans have a measurably better response to stories.
For example, we know that information presented in the form of a story is more likely to be remembered. According to a Lifehacker article “If we listen to a powerpoint presentation with boring bullet points … it hits the language processing parts of the brain, where we decode word into meaning” and that’s all. However, when we convey the same information in the form of a story “not only are the language processing parts of the brain activated, but any other area of our brain that we would use when experiencing the events in the story are too”. So, while a standard business writing is merely absorbed, a relatable story is ‘experienced’. We don’t need to actively memorize stories precisely because they are memorable. In a Harvard Business Review article, the prominent American neuroeconomist Paul J. Zak noted that his “experiments show that character-driven stories with emotional content result in better understanding of the key points a speaker wishes to make and enable better recall of these points weeks later.”
In corporate communications, better understanding and increased recall would be achievements in and of themselves but the most applicable part of the current research is based not on what happens in the brain but, rather, why it happens. Relatable stories result in improved recall because they create empathy. As social creatures, we need to establish trust in order to facilitate cooperation and advance the common good. Storytelling helps us to build trust. ‘Experiencing’ the events described in a story activates a chemical reaction in the brain that results in feelings of empathy. Professor Zak’s research showed that the amount of empathy produced “predicted how much people were willing to help others; for example, donating money to a charity associated with the narrative.” In other words, when we present information in the form of a story, the points are better understood, more likely to be remembered and also more likely to instigate action.
So what kind of story can or should corporate communicators tell, specifically in an annual report to shareholders?
Since antiquity, authors and philosophers have suspected that there are a limited number of story types, albeit with infinite possible variations. Kurt Vonnegut explains the idea with some humor in his lecture on the shapes of stories. Until recently there was little consensus on exactly how many story arcs there are; however, in July of 2016 MIT Technology Review reported that researchers from the University of Vermont had analyzed the emotional arc of 1,700 narratives from Project Guttenberg and derived the first measurable answer, six.
Since there aren’t that many types of story to tell, what counts is that we tell character-driven stories, including real named people, and provide the reader with relatable emotional content. For example, Linkdex described Google’s reverse turn on emotional storytelling between two ad campaigns for their Chrome browser that ran less than a year apart. The first is a conceptually compelling series of ads that describe product features one by one. Whereas, in the second campaign, the product features are shown but not highlighted. The newer ad records a new father’s writing a series of emails to his young daughter over a period of years. The products quietly facilitate an emotional story that the father is writing for his daughter to read one day. Both campaigns are skillfully produced, but the emotional campaign is clearly more memorable. An article published in Psychology Today seems to support the second approach. The study showed that positive emotions toward a brand have far greater influence on consumer loyalty than trust and judgments based on a brand’s attributes.
By including storytelling in our year-end reports, we can provide context and establish a company vision that readers are more likely to engage with and better able to remember, which represents a significant improvement on the standard form 10K.
Enter the Fairy Godmother
How could we deliver this new and improved annual report? You guessed it, the interwebs – everybody’s favorite answer to everything. Back in 2003-03 discussion of the internet as a potential solution to the production of post-Sarbanes-Oxley annual reports was stunted by the limitations of a 56Kbs modem. Wider access to broadband internet fundamentally changed the situation. Moreover, the prevalence of tablets and mobile devices (Apple only introduced the first iPhone in 2007) in combinations with techniques like responsive design allow us to reach more people in more places by optimizing the same content for a user’s preferred device.
Widening the tubes that make up the internet was also a boon to video as a communications tool. Paul J. Zak’s research also showed that messages delivered as a video produced the same chemical reaction as those delivered face-to-face. In other words, to inspire empathy and reap all of the benefits of good storytelling in corporate communications we needn’t go out and meet each and every shareholder individually.
Viewers don’t have to sit through an entire video for in order to absorb its message. A study commissioned by Facebook Business found that 74 percent of video campaign value (as measured by change in brand awareness) came from people who watched less than 10 seconds of a video.
Numbers still have a place too. Researchers from Cornell University found that presenting a scientific claim alongside a graph increased the reader’s confidence from 68-97 percent. Not to be outdone, researchers from Harvard and MIT studied 5,000 examples of data visualization and concluded that those which included graphic embellishments, more color, higher visual densities, and recognizably human elements were the most memorable. So data presented alongside a narrative increase credibility and, further, well-designed visualizations increase memorability.
Happily Ever After
In marketing communications repetition is key. We believe that the annual report presents companies with a uniquely regular opportunity to reach out to key stakeholders. The best way to produce an annual report today is to take advantage of current technology to tell a compelling story that will engage readers, create empathy and be remembered. If you have the option to increase financial transparency and accessibility all while achieving a material benefit to your corporate brand, the real question is “why would you publish a 10K wrap?”