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Creative Performance Assessment

In a NYT Business Day article of June 18, 2015 RE: Exclusion of costs in assessing executive performance, I became reminded of the hazards of self-reporting, including agency and asymmetry of information costs. While the article does not allude to anything illegal (i.e., the costs, including stock-based compensation costs, forming the subject matter of the lament were apparently disclosed in regulatory filings), it illustrates indirectly how performance assessment has become divorced from what really matters in the context of publicly traded corporations; i.e., the commercial practice of producing goods / services of value to buyers at a fair price. This has become secondary to performance measures such as the closing price of the corporation’s equity, which is more readily subject to manipulation than the buyers’ appreciation of goods / services, assuming these outputs are not controlled by monopoly, oligopoly, or other unfair / deceptive trading practices that improperly inflate the prices paid by buyers.

The article notes that some corporations, explicitly Apple and Netflix, do not report non-GAAP financial measures, but it does not intimate the root / common cause of the comparatively uncomplicated financial reporting of these public corporations. Perhaps, controlling persons (e.g., officers of corporations) not under the strain and stress of appearing to look good where GAAP performance metrics do not directly support such a glowing appearance are content with GAAP, where others are left to their imaginative devices, including the preparation of non-GAAP measures. These non-GAAP measures may become acceptable not only within the industry but also the SEC (e.g., real estate investment trusts’ use of funds from operations).

The apparent failure of GAAP to function as a one-size-fits-all, sufficient measure of financial performance illustrates the superseding importance of critical thinking in analysis of performance, financial and non-financial. Neither the external analyst nor the independent registered public accountant will suffice. Risks inherent in the use of manipulative devices such as gaming (and the NYT article only focuses on publicly reported metrics – the risk of the undisclosed may trump this – but that’s a theme for another day) are not mitigated by buy / hold / sell recommendations or expert opinions on GAAP performance. However, as the article indicates, this may be a stakeholder risk the cost of which is borne by the other guy, until the music stops.