Recommendations on Disclosure of Nonfinancial Performance Measures

INTRODUCTION This article summarizes comments of the Financial Accounting Standards Committee of the American Accounting Association (hereafter the Committee) on issues related to disclosure of nonfinancial performance measures. At the Committee's May 2001 meeting with the FASB, some Board members stated that an evaluation of academic research related to nonfinancial performance measures could be useful in the Board's future deliberations on performance reporting. The Committee took up the challenge and offers this overview of relevant academic research along with some preliminary recommendations on disclosure of nonfinancial performance measures. Comments in this article reflect the views of the individuals on the Committee and not those of the American Accounting Association. REVIEW OF ACADEMIC LITERATURE RELATED TO NONFINANCIAL PERFORMANCE MEASURES The Committee believes that nonfinancial performance measures should be judged against the same criteria as financial performance measures, namely, the characteristics of relevance, reliability, and comparability espoused in Statement of Financial Accounting Concepts No. 2, Qualitative Characteristics of Accounting Information. Accordingly, we structure the discussion of academic research on nonfinancial performance measures along these three dimensions. Relevance Various individuals and groups have called for greater disclosure of nonfinancial information by corporations (AICPA 1994; Boulton et al. 2000; Norton 2000; Eccles et al. 2001; Lev 2001). These individuals and groups argue that traditional financial measures have diminished relevance due to changes in business models said to reflect the "new economy. " Additionally, critics raise concerns about the backward-looking nature of financial measures and suggest that financial measures provide little insight into a company's future performance. (1) The demand for external reporting of nonfinancial performance measures also has been driven by companies' adoption of internal performance evaluation frameworks that incorporate nonfinancial measures, such as the Balanced Scorecard (Kaplan and Norton 1996). Investors have asked that external reporting include performance evaluation metrics used internally and that these measures be integrated into a discussion of the company's strategy. Frameworks such as PricewaterhouseCo opers' ValueReporting[TM] model (Eccles et al. 2001) exemplify such an approach. There is abundant anecdotal evidence that some firms disclose nonfinancial performance information on a voluntary basis (see Eccles et al. [2001] and Upton [2001] for examples). In addition, professional financial analysts refer to nonfinancial measures in their company reports (Previts et al. 1994) and maintain that they use these measures to evaluate the long-term performance of a firm (Dempsey et al. 1997). Nonetheless, these results do not provide evidence on the underlying linkages between nonfinancial data, future financial performance, and equity values. Studies take two approaches to examine these linkages and document the relevance of nonfinancial information: (1) establish a direct link between nonfinancial measures and equity values and (2) demonstrate a link between current nonfinancial measures and future financial information, indicating that nonfinancial information should be useful to investors and creditors. The first category typically is referred to as value relevance tests, while the second category is termed predictive ability tests. By necessity, value relevance and predictive ability studies examine industries in which nonfinancial performance measures are publicly available, which can raise concerns over small sample or self-selection biases. Research in this area, however, examines the relevance of a fairly diverse set of industries and nonfinancial measures, including measures related to airline performance statistics, customer satisfaction, air pollution, patents, quality, and market growth/penetration. …