GETTING PERSONAL: Controversy Brews Over Mkt Volatility

By LYNNETTE KHALFANI

   A Dow Jones Newswires Column

NEW YORK -- Could stock market volatility be reduced if publicly-traded companies had better disclosure practices?

That is what a growing number of experts say, though their views are controversial in many circles.

In particular, some noted thinkers suggest that U.S. businesses should focus less on earnings reporting and more on non-financial measures of a company's health. The non-economic details that should be divulged, proponents say, include information about employees and intellectual capital, brand development and supply-chain management.

Among those advocating increased disclosure of these so-called intangible performance yardsticks are former Securities and Exchange Commissioner Steven Wallman, noted New York University professor Baruch Lev and Margaret Blair, a project director at the Washington, D.C.-based Brookings Institution, which even has a task force on "Understanding Intangible Sources of Value."

Meanwhile, the belief that investors need to know much more than a company's sales and profits is also taking root closer to Wall Street.

A group of partners at PricewaterhouseCoopers, the Big Five consulting firm, is backing the merits of enhanced non-financial disclosure. The partners have penned a just-published book on the topic in which they say stock market gyrations result, in part, because companies dole out data on "the bottom line and a few other key financial measures, but on little else that really matters."

"We're not discounting the financials. We just think volatility would be reduced if investors had a richer data set on which to evaluate a company's performance," says Robert Herz, one of the authors of "The ValueReporting Revolution: Moving Beyond The Earnings Game."

Herz adds that volatility won't disappear, even in an environment where investors have perfect knowledge about a company. But he says more information would make businesses less subject to market sell-offs, for example, in the event they missed earnings expectations by a penny a share - a common occurrence in today's market climate.

Some observers, however, see a danger in the growth of non-financial reporting. They say intangible measurements, which have been dubbed "the new metrics," ignore well-established valuation methods, such as price-to-earnings ratios, in a bid to justify the lofty stock values given some New Economy companies.

"New metrics are not new - just foolish," wrote PaineWebber investment strategist Edward Kerschner, in a March 2000 report entitled "New Economy: Yes, New Metrics: No."

Other veteran Wall Street watchers agree with the theory behind non-financial reporting, though they note that it has shortcomings.

"It does appear to be true that if there is a dearth of information, that tends to create trading swings," says First Albany market strategist Hugh Johnson. He points to emerging markets such as Indonesia, where there is little or no transparency, and very high volatility.

Still, Johnson worries about information overkill.

"You can also say that too much information becomes useless and doesn't help the investment decision-making process," he says. "But who knows where that line is and is that best left to the SEC or to companies?"

   Phases Of Value Creation

According to Lev, a professor of accounting at NYU's Stern School of Management, two primary factors influence volatility: technology and information. But the problem with the information in the current model of financial reporting is that it is driven by accounting standards.

"It's important to understand the limitations of accounting," says Lev. "Accounting is based only on transactions, where sales and purchases are recorded by the system."

Increasingly, though, corporate value is created or destroyed well before a transaction occurs, Lev argues. He identifies three phases where companies can create value: the discovery phase, when new products, ideas and services are born; the implementation stage, when initiatives like beta tests are conducted; and the commercialization stage, when companies finally sell their goods and services.

Lev cites the case of a pharmaceutical concern that wins Food and Drug Administration approval for a new drug. The regulatory go-ahead is a huge event that can create value in the marketplace even though no transaction has occurred. Yet, if the company later successfully marketed its drug, that wouldn't be reflected in the company's accounting for perhaps three years or more down the road, the professor notes.

Non-financial reporting, then, "tries to capture value creation...and early positive or negative warnings before the accounting system does," Lev concludes.

   Reg FD And Other Causes Of Volatility

Some say heightened stock market volatility is a result of recent regulatory changes, namely the SEC's Regulation FD, for fair disclosure. The rule bars companies from engaging in the long-standing practice of disclosing to analysts and other members of Wall Street material information, unless that information is also simultaneously revealed to the general investing public.

In a survey released last week by the Charlottesville, Va.-based Association for Investment Management and Research, 57% of analysts and portfolio managers said the volume of substantive information released by public companies they research has decreased since Reg FD took effect in October.

Additionally, 71% of those surveyed said Reg FD has contributed to market volatility. "Many respondents commented that this increased volatility is due to a lessening of earnings guidance and consequently more earnings surprises," the AIMR member study states.

What may be going on is that different people are interpreting the new SEC rule in different ways. For example, Reg FD only prohibits selective disclosure or private communication of material, non-public information.

So far, though, there's no clear consensus about what constitutes "material" information. In the AIMR study, for example, 84% of respondents agreed with the statement: "Now that Reg. FD has taken effect, corporate managements need a clearer understanding of what constitutes 'materiality'." Furthermore, another 77% of those polled said that in the wake of Reg FD, "regulators and the investment industry need to develop a more precise legal definition of materiality."

Of course, the notion that increased disclosure might reduce stock-market volatility is just one theory about the causes of Wall Street's frequent ups and downs.

In a recent research paper, executives at Neuberger Berman cite six reasons about the likely roots of volatility: the "democratization" of the markets, technology's effect on trading, increasing performance pressure on portfolio managers, excess leverage in the market, starkly conflicting views about the market's direction, and sector rotation in the market.

The latter reason certainly helps explain the topsy-turvy phenomenon of one sector being hot, then suddenly falling out of favor. A case in point is what happened to technology and utility stocks in 1999 and 2000.

The S&P Technology sector surged 75% in 1999, then plunged 39% in 2000. Meanwhile, utilities declined 9% in 1999 and rose 59% in 2000, notes Michelle Stein, a Neuberger Berman money manager.

-By Lynnette Khalfani, Dow Jones Newswires; 201-938-4381; lynnette.khalfani@dowjones.com