XBRL Meets Modern Investor Relations

Three years ago, the Securities and Exchange Commission introduced a financial reporting “tagging” concept called eXtensible Business Reporting Language (XBRL). Seventeen pioneers—including 3M Company, Altria Group, Microsoft, Pfizer, and Xerox—volunteered to file their financial statements using XBRL, to see what this new technology could do.

Fast forward to today. On May 14, the SEC voted to publish a proposed rule that would require companies to start filing financial statements tagged in XBRL as soon as next spring. First would be businesses using U.S. Generally Accepted Accounting Principles and carrying a worldwide public float of more than $5 billion (that is, the 500 or so largest public companies in the United States). The remaining companies using U.S. GAAP would be required to use XBRL over the next two years. Those using International Financial Reporting Standards would have until late 2010 to comply.

The XBRL mandate is a long time coming and one of the least surprising announcements the SEC has made in Chairman Christopher Cox’s tenure. Cox has touted XBRL at every opportunity for years; in 2006 at an American Enterprise Institute forum, he strongly urged more companies to file their financial reports in XBRL voluntarily and re-christened the technology as “interactive data,” an obvious effort to take the mystery out of the acronym.

Businesses, on the other hand, have been slower to climb aboard the bandwagon. Many have suspected XBRL is another costly SEC creation, and they are still reeling from the huge costs of implementing Section 404 of Sarbanes-Oxley. The voluntary filing program has now gone from 17 pioneers to 75 participants today, but that’s still well short of the thousands of companies that will be using XBRL in the very near future, like it or not.

That’s a shame, because XBRL stands to be a boon for investors and analysts. And if it’s going to transform how they do their jobs, it will transform how investor relations departments conduct themselves too.

Elmer Huh, an analyst at Morgan Stanley and a leader in the adopt-XBRL movement, spoke at a 2006 forum on XBRL and said the technology would allow analysts to compare specific financial data across a range of companies quickly and easily. Instead of manually creating spreadsheets for individual companies, XBRL would allow someone to create a single model for analyzing all the companies in a peer group. It would provide a convenient way to make “apples-to-apples” comparisons of many factors across specific industry sectors. For example, if you wanted to compare the real debt or credit risk of operating leases within a peer group, XBRL would let you do that with considerable ease.

Huh also emphasized that XBRL is about more than the numbers. Companies should try to put context around the numbers, to give investors perspective where and when it is needed.

I represented the corporate side at that 2006 conference. I urged companies to get with the program and adopt XBRL because it is a way to improve communications with stakeholders. It would clearly assist analysts and shareholders in conducting their analyses and reaching conclusions more efficiently using tagged information direct from the companies’ SEC filings. Analysts today use a variety of information sources to make recommendations: SEC filings, company Websites, data and information purchased from distributors, and talking with company representatives. This, however, can be a time-consuming, largely manual process.

Consider the process analysts use now. First, a report is published to the Web in HTML or PDF format. Second, the analyst manually transcribes numbers into his own spreadsheet model. Third, one must analyze the results quickly, because of the competitive pressure to publish a comment in short order. Do you, the company, really want analysts to take an approach so rife with the chance for error or misjudgment?

Now consider the XBRL-enabled future. A company publishes its financial reports in XBRL format, and the numbers can be automatically loaded into an analyst’s spreadsheet by an Excel add-in. This gives the analyst more time to analyze results, which gives him a higher degree of confidence before publishing a comment to Wall Street. This process also eliminates the need for a third party to repackage the company’s data and put his own spin on it. Everyone knows exactly what the company’s numbers are, because XBRL lets them flow automatically from company to analyst to, ultimately, investor. Which approach would you rather use?

One of the more exciting opportunities possible with XBRL is that companies can also tag non-financial information. These would be common factors within an industry group that are generally accepted value-drivers. Take the biotech industry, for example. Non-financial assets might include research and development expenditures; alliances and business relationships; specific product progress in the Food and Drug Administration approval process; FDA approvals; patents; intellectual property; and market size, growth, and share.

One common question in the wake of all this easy, automated disclosure is whether companies will be giving away too much intelligence to competitors—intelligence they would just as well keep to themselves. In my opinion, this issue is overblown. Given the volumes of information available in the public market already from a variety of sources, XBRL won’t be exposing that much more. And the benefits are well worth what little risk there is.

The biggest advantage of XBRL is its enhanced transparency and its broad availability to investors. It has the potential of creating a revolution in corporate valuation, where analysts can provide more value to investors by looking at longer-term corporate performance measures—away from the short-term focus on quarterly earnings that will be largely commoditized. A strong proponent of this approach is Robert Herz, chairman of the Financial Accounting Standards Board. Prior to taking on his present role, he co-authored a book titled “The Value Reporting Revolution: Moving Beyond the Earnings Game.”

Starting Down the Path

As with the introduction of any new concept, there may be unintended consequences. One could speculate that given: (1) the ease of accessing interactive data through the Internet, (2) the pressure on U.S.-based sell-side firms to cut research costs, and (3) the surging growth in the number of Chartered Financial Analysts and CFA candidates in countries like India, China, and Singapore, there is potential for moving a significant amount of analytical work offshore, where it can be done at lower costs.

From a corporate perspective, this could mean less interaction between company representatives and the overseas analysts. Yet it also has the potential of producing lower-cost research coverage of small to mid-cap companies that today have no sell-side coverage.

What should companies be doing at this time?

Read the proposed rule and comment on it as appropriate. The proposal was published May 30, so we are already halfway through the 60-day comment period. If you have something you want to say, pick up a pen soon.

Assume the rule will become final in some form, and start preparing to implement it. If your company falls below the implementation criteria, you may want to consider voluntarily filing your financial statements using XBRL, given the advantages the new system offers and the potential that using tagged interactive data might improve your chances of being selected for research coverage.

Investor relations officers should learn how analysts will use the tagged information and how peer companies will tag their information. IROs should also work with the finance team in determining how the company will tag its information, by providing input gleaned from the analysts, investors, and peer companies in how they will use it.

While the SEC does not require companies to issue an earnings release, the Commission asks for comment on whether the proposed rules should require interactive data submissions for a filer’s financial information provided under Form 8-K or 6-K, such as earnings releases or interim financial information. I believe the SEC should consider requiring companies that issue a news release or interim financial information to tag the interactive data and furnish it under a Form 8-K or 6-K . This would be a step forward in providing more transparent and more easily understood information for shareholders.

One need only reflect on the revolutionary changes that are taking place in our financial markets: expanded electronic trading, cross-border exchange mergers, derivatives and options products trading globally, and the growth of electronically traded funds, to name a few. XBRL is but one of the changes that companies are dealing with. But the rate of change does not allow companies the luxury of taking a “wait and see” attitude. Those companies in the forefront of adapting to change will reap the rewards of that decision.