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June 15, 2012
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Analyst and investor perspectives on financial communication
On May 29, 2012, Midwest Audit Committee Network members convened in Chicago for a discussion on
financial communication with Heather Brilliant, vice president of global equity and credit research for
Morningstar; Nathan Partain, president and chief investment officer at Duff & Phelps Investment
Management Company; and Ralph Schackart, partner and digital media and Internet analyst for William
Blair & Company. This document synthesizes the key insights from the discussion.1 For a list of participants,
please see Appendix 1 on page 10.
Executive summary
Financial reporting 2 is a challenging issue for audit committee members and investors alike. Businesses and
capital markets have become more complex, yielding new sources of risk and uncertainty that investors need
to understand. Accounting and audit regulators are trying to keep up, but in the process, standards and rules
have also become more complex. As a result, companies and their auditors expend an extraordinary amount
of effort complying with financial reporting rules and producing disclosures of ever-increasing length.
Members and analysts acknowledged a trend toward longer financial reports that may be of less value to
investors given investors’ increased reliance on non-financial and other sources of information. In the
meeting, members and analysts discussed these challenges and ways that the company could better
communicate its story to investors.
The themes that emerged from the discussion are outlined below and discussed in greater detail on the
following pages:
 Analysts seek a comprehensive, consistent story about company performance (Page 2)
Analysts seek data from a variety of sources in an attempt to build a comprehensive model that reflects an
accurate valuation of a company. Generally Accepted Accounting Principles (GAAP) serve as a
benchmark for the company’s financial health, but analysts are increasingly basing their models and
forecasts on the management discussion and analysis (MD&A) and non-GAAP measures that drive longterm value creation. To round out the story, analysts assess the impact that the company’s corporate
governance policies have on performance and scrutinize capital allocation decisions. Analysts value direct
interaction with management, discussions with other analysts, and use scenario analyses as mechanisms to
interpret their data and build their valuation models.
1
VantagePoint reflects the network’s use of a modified version of the Chatham House Rule whereby names of members and their company
affiliations are a matter of public record, but comments made during the meetings are not attributed to individuals or corporations. Quotes in italics
are drawn directly from comments made by members and guests before, during, and after the meeting. Other unitalicized, unattributed quotations
are drawn from audit committee chairs of other networks.
2
For the purposes of this discussion, “financial reporting” includes audited financial statements, press releases, analysts’ presentations, and other
supplemental information (financial and non-financial in nature) that the company provides to shareholders and the public.
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 Directors can help oversee communication of the company’s story to investors (Page 6)
Members said it is the board’s responsibility to ensure that the investment community has the most
accurate portrayal of the company’s performance. Members and analysts considered options that the audit
committee could take to support effective communications to the market. These include ensuring
consistent messaging through more robust oversight of communications such as press releases and scrutiny
of the earnings call script; expanding the scope of the audit; and broadening oversight of key performance
indicators (KPIs) and internal controls around financial communication, including the processes through
which the company communicates to the financial community.
 Directors are wary of increasing engagement with analysts and shareholders (Page 7)
One analyst suggested that boards might engage more with their companies’ largest shareholders, and
members said they are willing to meet with certain shareholders around specific governance issues when
the general counsel or other members of management are present. However, members said they do not
want to confuse the market with “too many voices,” and expressed concerns about a more robust
engagement platform because of Regulation Fair Disclosure (Reg FD). Members said enhanced
communication with shareholders increases the risk of director liability and could set a precedent that
would invite a flood of requests from shareholders.
For a list of questions for audit committee members to consider, please see Appendix 2 on page 11.
The unique roles of buy-side, sell-side, and independent analysts
Members were joined by a buy-side, a sell-side, and an independent analyst, each with a distinct role
to play in forecasting and impacting share-price performance:
 Sell-side analysts work for brokerage houses, investment banks, or research organizations,
providing insight and advice to buy-side analysts and investors. Sell-side analysts publish research
reports that are widely disseminated.
 Buy-side analysts work directly for investment decision-makers, such as pension-fund, hedge-fund,
and asset managers, serving as the research function for their organizations by providing insight
and advice exclusively for their use. Buy-side analysts often use the analyses produced by sell-side
analysts as they develop their own recommendations.
 Independent analysts offer independent stock advice and analysis to individual investors,
institutional investors, and financial advisors.
Analysts seek a comprehensive, consistent story about company performance
One analyst said, “We are trying to assess [a company’s] consistency over a long period of time. We want
industry perspectives on the company; we want to understand management’s thinking and judgment; and, of
course, we have to know the fundamentals of the company.” Analysts shared the ways in which they gather
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information that determines the valuations they place on companies, including GAAP and non-GAAP
information, management performance, and corporate governance.
GAAP information provides a benchmark for a company’s financial health
Analysts view the audited information provided in financial statements as a critical building block for their
analyses: “Analysts and investors use this information to build their own models for tracking business
performance and highly value the fact that it is independently verified and generally consistent between
periods and across companies.” 3 A guest analyst at a recent meeting of another network noted the value of
audited information as an important counterbalance to management’s natural exuberance and optimistic bias,
a deterrent to fraudulent reporting, a means of ensuring compliance with standards, and a promoter of
internal controls. 4 One analyst said, “The financials are the foundation upon which we build our models.”
However, to meet the demands of their investors – “to generate alpha” – the analysts said audited financials
are insufficient because they have natural limitations. They are inherently retrospective, yet analysts want to
understand the company’s future. They are intended to promote comparability across companies, but what
is most important for a particular company may be idiosyncratic. They are based on standards developed
through a well-articulated decision-making process, but those standards may lag industry and business
developments. One analyst said, “GAAP has become so formulaic, so you have to ask, ‘Is this really giving
me the best information about the company that I need to generate [market-beating returns]?’”
Analysts are increasingly relying on non-GAAP information
Because of the limitations of audited financials, analysts are increasingly relying on operational and other
metrics that drive long-term valuation. One analyst said, “I want to know what drives the business. What
are the key performance indicators?” Another analyst remarked, “Give me your operational measures, and
we will be evaluating the consistency of those measures over time.” A third analyst reported gleaning
immense value from segment reporting, which breaks down the performance of business units: “Segment
reporting was one of the best accounting changes in recent years.”
Analysts also value management’s ability to place the numbers into a meaningful narrative about the
company’s strategy and performance – one that helps connect the dots, even if this narrative is partly a sales
pitch. 5 All three analysts agreed with one who said, “You can get some great information if you read the
footnotes and the MD&A.” However, another analyst remarked, “There is still too much information there.
For example, the compensation tables in the [Compensation Discussion & Analysis] don’t tie to anything.”
Members said that while there are elaborate mechanisms to oversee GAAP measures, there is a lack of rigor
around non-GAAP disclosures. One member said, “Things like backlog and production efficiency can sneak
through without getting challenged. In some companies, internal audit is charged with getting
documentation and in challenging reasonableness of these measures.” Another member said, “I am always
Ernst & Young and Tapestry Networks, “The Financial Communication Challenge,” InSights, November 2009, 4.
Audit Committee Leadership Network, “Investors’ Perspectives on Financial Reporting,” ViewPoints, November 3, 2011.
5
Ernst & Young and Tapestry Networks, “The Financial Communication Challenge,” 6.
3
4
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looking for an overabundance of non-GAAP measures. I don’t want to see a lot of them. I am always
cautioning, ‘How many ways do we really need to say this?’ I also find it useful to put things in tabular
form, so it’s clear to the reader – here’s GAAP, here’s non-GAAP.”
The analysts outlined several other important factors that they incorporate into their company valuations:
 Management consistency. Analysts value meetings with senior management as a way to understand
management’s grasp on the company’s strategy and performance outlook. Above all, analysts are looking
for consistency and predictability from management. One analyst said, “From management, we are
looking for the consistency of the story. When we meet with management, we will pull out notes from
our conversations two years ago, and compare the notes with what they are telling us.”
 Capital allocation decisions. One analyst remarked, “We look at how management allocates capital.
We are looking for a history of behavior that demonstrates that management is allocating capital in a way
that increases value for the shareholder.” The analysts used mergers and acquisitions decisions as an
example of how they evaluate companies on their capital allocation decisions. One said, “When a
company undertakes a major acquisition, they strip out their [net present value] in the bidding process.”
Another analyst added, “When I hear, ‘This acquisition is going to be accretive in three years,’ that’s
when I get out of a stock.’”
 Corporate governance. The analysts said they review companies’ corporate governance policies and
procedures, such as those around the governance leadership structure and board composition, but
generally they view these corporate governance policies in the context of the company’s performance.
One analyst said, “We look at governance issues to the extent they impact company performance. We
don’t [make judgments about] the staggered board, the chairman/CEO split, or related-party transactions
unless it matters to the company’s performance.”
Quarterly earnings guidance has limited value to analysts and investors
The analysts agreed with one who said, “Quarterly earnings guidance is not very useful to me. Management
believes they know what will happen in the next quarter, and they have a great deal of control over earnings
guidance.” In addition, the analysts said that quarterly earnings guidance may reflect a temporary
improvement in performance that has little bearing on the company’s long-term outlook. One said, “We
believe one company is in serious decline. But they had a good quarter recently. That doesn’t change our
belief that the company is in decline, and that doesn’t change our valuation.” Another analyst said, “Annual
earnings guidance works just fine.”
The analysts’ perspectives echo an opinion set forth several years ago by a Merrill Lynch analyst, who argued
that the drawbacks of quarterly earnings guidance far outweigh the benefits: “The company’s goal is to
encourage the market’s acceptance of its self-defined measurement stick and then beat the resulting
consensus, thus proving that it is earning higher-than-expected returns and so worthy of further allocation of
investor capital. This process creates an echo chamber that drowns out investor debate and distils what
should be a complex message about a company’s operations and performance into a single number – dictated
by the company itself. At Merrill Lynch, analysts are advised not only to discount heavily and to question
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earnings guidance, but also to analyse what the guidance – and the way it is constructed – says about the
management.” 6
Indeed, one analyst at the meeting reported using quarterly earnings guidance only as a red flag: “If a
company misses two quarters in a row, I will downgrade them. Because earnings guidance is so wellmanaged by companies, if you miss twice, that’s a sign that management does not have a good grasp on the
company’s [performance].”
Analysts use additional inputs to hone their views about a company
In addition to GAAP and non-GAAP reporting, analysts mine a host of other sources to get a holistic view
of the company. Those other sources include the following:
 Certain investor conferences. One analyst remarked, “The company should poll their largest
shareholders and ask, ‘What are the best programs for investors?’ – then line up the calendar with the
most important events for the CFO and investor relations to attend.”
 Perspectives of other analysts. One analyst said, “We like to ask analysts, ‘Of all the companies you
cover, which ones are you most worried about falling off a cliff?’ They all have companies they worry
about.”
 Executives’ views on their competition. One analyst said, “I ask CFOs, ‘What do you think about
your competitors?’”
 Media reports. While there have always been plenty of outside sources of information about a
company (e.g., trade publications, government statistics, press articles, and reports by other analysts), the
online world has expanded access to these sources and created wholly new sources, such as blogs,
Twitter, Facebook, LinkedIn, and even YouTube. As U.S. News & World Report reported in January,
“Already, professional stock analysts and their amateur competition are regular fixtures on Facebook,
Twitter, Google+, InShare, and other real-time information outlets. Now, an increasing number of
investor relations departments are taking to social media to reach shareholders, sometimes smack in the
middle of an earnings briefing.” 7 In addition, some have observed that financial media has more
influence on analyst views during significant events, such as during a merger or acquisition. 8
 Scenario analyses. One analyst suggested that using information about a company to run scenario
analyses can provide insight into how the company might perform in reaction to stresses in the market:
“With all of the global variables now impacting company performance, we find it useful to run scenario
analyses. We ask, ‘What could go wrong? How prepared is the company if certain scenarios come to
fruition?’”
Candace Browning, “Companies Should Drop Quarterly Earnings Guidance,” Financial Times, March 19, 2006.
Rachel Koning Beals, “Investors Increasingly Tap Social Media for Stock Tips,” U.S. News & World Report, January 31, 2012.
8
Ibid., 7.
6
7
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Directors can help oversee communication of the company’s story to investors
Audit committees are responsible for reviewing the company’s public disclosures, but members and analysts
agreed that there are several ways the audit committee can help the company communicate more effectively
to investors. One member said, “As the audit committee chair, I have only one objective: to tell
shareholders – and by implication, other stakeholders – how it really is … How can we present the
information and communicate in a way that draws analysts’ attention to the most important issues?”
Members and analysts identified several areas where the board could play a role in improving the company’
financial communications:
 Ensure consistent messaging to the market. When analysts come across conflicting information
from various company sources, it undermines their ability to appropriately value the company. Several
members said it is important to ensure that the company is communicating information in a consistent
manner. One member said, “The audit committee looks at the earnings call script prior to when it is
disseminated. We have to ensure that the message to the market is consistent.” Another member
remarked, “We bring in investor relations to review the press release with the audit committee.”
However, one analyst said some disclosures have less value because they have become “too boilerplate.
For example, the risk factors in the MD&A have become so formulaic that I don’t put a lot of value in
them.”
 Broaden oversight of communication to the market. An interviewee in an issue of InSights on
financial communication recommended that audit committees increase their oversight of KPIs: “Audit
committees should decide with management what are the few key performance indicators that talk to the
long-term value of the company, and they should see how management communicates them to the
market. For me, that includes reading the supplementary materials given to analysts and the presentations
given the rating agencies.” 9
Some members said they seek more insight into the interaction between the financial community and the
company, including the processes by which investor relations department (IR) professionals are educated
about liability concerns. One member said, “There should be more audit committee involvement in
looking at what gets said to whom, and when. Does everyone in the company know our processes about
Reg FD? There needs to be more discipline around the processes by which we communicate to
analysts.”
 Push for enhancements to investor relations. For the investment community, the primary contact
at a company is generally the head of IR, though it might also be the CFO. 10 Analysts and investors
often have strong opinions on specific IR practices, offering commentary on such aspects as access to
management, shareholder letters, and the IR website. 11 The three guest analysts agreed that the best IR
professionals are those who are “not career IR professionals; [rather,] they are the folks who are spending
9
Ernst & Young and Tapestry Networks, “The Financial Communication Challenge,” 12.
BNY Mellon, Global Trends in Investor Relations - Sixth Edition: A Survey Analysis of IR Practices Worldwide (New York: BNY Mellon,
2010), 55.
11
“Survey of IR Best Practice in the US,” Inside Investor Relations, 18 February 2011.
10
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a short time in IR but who grew up in the business and have a much better understanding of the
business.” Members said that great IR professionals “will have good insight into senior management and
a great understanding of the business – someone that the CEO and CFO really respect.” One member
identified opportunities to enhance IR through more frequent, informal communication with the audit
committee: “Investor relations is the main interface with the analyst community, yet [the audit
committee] does not have much contact with IR beyond formal, quarterly meetings.”
 Address “outlier analyst” misunderstandings. One member said, “Analyst misunderstandings about
your company, performance, forward-looking projections have a longer-term impact. Some
misconceptions take a longer time to overcome.” Members discussed the issue of an “outlier analyst”
who does not have a strong understanding of the company and as a result places valuations on the
company that are totally inconsistent with the valuation range of other analysts. As one member said,
“The issue that the audit committee is concerned with is what happens if one analyst gets out of line –
what if their model is way off track?” One analyst responded with a potential solution: “Have someone
from IR meet with the analyst and, over time, pose questions to that analyst that may lead the analyst to
think differently about how he or she is building their model.”
 Expand the audit scope. In its guidance on non-financial reporting, the International Corporate
Governance Network states, “Independent assurance about the extent to which non-financial business
reporting has followed established measurement and reporting standards can be useful to enhance the
credibility and reliability of the reported information.” 12 The Public Company Accounting Oversight
Board’s concept release on the auditor’s reporting model solicits feedback on whether auditors should
provide assurance on information outside the financial statements, such as the MD&A and non-GAAP
measures. 13 Some audit committees ask their audit firms to review KPIs that drive executive
compensation. One member explained, “External auditors review the non-GAAP measures that we use
to affect our bonuses. This is part of the new era – to understand judgment items and how they affect
compensation.”
Directors are wary of increasing board engagement with analysts and shareholders
Analysts and some members said they may get some value out of having a dialogue on an occasional basis.
One member said, “When we’ve brought analysts into the boardroom to get an industry perspective, it’s
always been helpful.” One analyst said, “The board can provide helpful [nuance] about the company.”
However, members and analysts agreed that neither directors nor analysts particularly desire regular meetings.
While analysts said it is helpful to hear from directors from time to time, they prioritize meetings with
management to enhance their understanding of the company. For their part, members agreed with one who
said, “It is management’s job, not the board’s, to communicate with investors and especially analysts. The
board should not be communicating with analysts.” Another member added, “We don’t want to confuse
International Corporate Governance Network, ICGN Statement and Guidance on Non-financial Business Reporting (London: International
Corporate Governance Network, 2008), 10.
13
Public Company Accounting Oversight Board, Concept Release on Possible Revisions to PCAOB Standards Relating to Reports on Audited
Financial Statements (Washington, DC: Public Accounting Oversight Board, 2011), 26.
12
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the market with too many voices, and, clearly, management is better equipped to have these conversations
with the analyst community.”
Liability concerns discourage directors from enhancing engagement with shareholders
One analyst advocated that directors engage more with the company’s shareholders: “I would encourage you
to meet with your largest shareholders. Most of them are reasonable. It’s a dialogue that you are going to
have to have eventually, and you might as well get in front of it.” The analyst continued, “You would
rather have a discussion with your shareholders before the shareholders demand a meeting because they are
surprised by something that happened at the company.”
Members said they might be willing to meet with shareholders to discuss specific governance concerns, such
as executive compensation, if the general counsel or another member of the senior management team were
present. However, members said they are fearful about engaging in a more proactive, systematic dialogue
with shareholders because of liability concerns related to Regulation Fair Disclosure, which “provides that
when an issuer … discloses material nonpublic information to certain enumerated persons (in general,
securities market professionals and holders of the issuer's securities who may well trade on the basis of the
information), it must make public disclosure of that information.”14
One member said, “If there were no Reg FD, the board would communicate more with shareholders.”
Indeed, one director of a major global corporation said, “Boards use Reg FD as a crutch that prevents
directors from talking to investors.”15 However, regulators have made it clear that directors and investors
should be talking to one another: according to Securities and Exchange Commission Chair Mary Schapiro,
“Regulation FD does not restrict communications between companies and their investors” nor does it
“prevent companies from seeking out and listening to the views of investors.”16
In addition to liability concerns, members said enhancing dialogue with shareholders could present
challenges for the board. One said, “If you invite a dialogue with shareholders, it becomes a slippery slope.
Do you meet with the top 10? The top 20? If you meet with one shareholder, soon you could be meeting
with all of them. How do you put boundaries around it?”
One member pointed out that some boards are experimenting with different ways to communicate with
investors. For example, in April 2011, Occidental Petroleum hosted a “fifth analyst call” – that is, a call in
addition to the regular quarterly analyst calls, focused on corporate governance and hosted jointly by the
company, including at least one director, and a large investor. 17 Deborah Gilshan, corporate governance
counsel for Railpen Investments, a London-based pension fund spearheading an effort to encourage more
companies to use fifth analyst calls, said, “The point here is about board accountability. You get a better
14
Securities and Exchange Commission, “Final Rule: Selective Disclosure and Insider Trading,” October 23, 2000.
Tapestry Networks, “Advancing Board-Shareholder Engagement,” ViewPoints, May 30, 2012.
16
Deborah Gilshan and Elizabeth McGeveran, “The Fifth Analyst Call: Investors Seek Greater Communication with Directors,” Harvard Law
School Forum on Corporate Governance and Financial Regulation (blog), March 20, 2011.
17
John R. Engen, “Communicating with Shareholders,” Corporate Board Member, February 28, 2012; Deborah Gilshan and Elizabeth McGeveran,
“The Fifth Analyst Call: Investors Seek Greater Communication with Directors.”
15
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understanding of the board’s oversight approach when the message isn’t filtered by management.” 18 More
recently, representatives from four large investing institutions met with a group of experienced nonexecutive directors to discuss board-shareholder engagement, and concluded that “the time for enhanced
engagement between their two constituencies is at hand.” 19
Conclusion
The analysts said that GAAP financials, while fundamental to building their models, are only one part of the
story: they also rely heavily on non-GAAP information, meetings with management, and secondary sources
such as media reports to build a comprehensive view of a company’s outlook. As one analyst said, “We look
for sustainable competitive advantage through soup-to-nuts analysis.”
As such, questions remained about the audit committee’s role in overseeing financial communication to the
market. Members were wary of increased engagement with shareholders, but said there are other ways that
directors could help their companies communicate to the market, such as increasing communication with
investor relations, looking more closely at non-GAAP information, and ensuring consistent messaging to the
market. One member asked, “If we lived in a different world, with different rules and regulations … how
would you communicate with shareholders and other stakeholders?” Members agreed that, for now, an
expanded role in reviewing public disclosures would be a poor use of the board’s time. One member said,
“We should be focusing on the company’s strategy, succession planning, and other big-picture items. We
shouldn’t spend more time on the stock price.”
About this document
The Midwest Audit Committee Network is a group of audit committee chairs drawn from leading companies committed to
improving the performance of audit committees and enhancing trust in financial markets. The network is organized and led by
Tapestry Networks with the support of Ernst & Young as part of its continuing commitment to board effectiveness and good
governance.
VantagePoint is produced by Tapestry Networks to stimulate timely, substantive board discussions about the choices
confronting audit committee members, management, and their advisers as they endeavor to fulfill their respective
responsibilities to the investing public. The ultimate value of VantagePoint lies in its power to help all constituencies develop
their own informed points of view on these important issues. Anyone who receives VantagePoint may share it with those in
their own network. The more board members, members of management, and advisers who become systematically engaged in
this dialogue, the more value will be created for all.
The perspectives presented in this document are the sole responsibility of Tapestry Networks and do not necessarily reflect the views of network
members or participants, their affiliated organizations, or Ernst & Young. Please consult your counselors for specific advice. Ernst & Young refers to
all members of the global Ernst & Young organization. This material is prepared and copyrighted by Tapestry Networks with all rights reserved. It
may be reproduced and redistributed, but only in its entirety, including all copyright and trademark legends. Tapestry Networks and the associated
logos are trademarks of Tapestry Networks, Inc. and Ernst & Young and the associated logos are trademarks of EYGS LLP.
18
19
John R. Engen, “Communicating with Shareholders.”
Tapestry Networks, “Advancing Board-Shareholder Engagement.”
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Appendix 1: network meeting participants
The following network members participated in the meeting:
 Dave Burritt, Audit Committee Chair, Lockheed Martin
 Howard Carver, Audit Committee Chair, Assurant
 Blake Devitt, Audit Committee Chair, Baxter
 Cheryl Francis, Audit Committee Chair, Morningstar
 Sandy Helton, Audit Committee Chair, Covance
 Olivia Kirtley, Audit Committee Chair, U.S. Bancorp
 David Landsittel, Audit Committee Chair, Molex
 Richard Roedel, Audit Committee Chair, Lorillard
 David Schwartz, Audit Committee Chair, Walgreen
 John Shuey, Audit Committee Chair, Cooper Tire & Rubber Company
 Al Smith, Audit Committee Chair, Simon Property Group
 Steve Wilkinson, Audit Committee Chair, Entergy
 Donna Zarcone, Audit Committee Chair, CIGNA
The following network members took part in pre- and post-meeting calls:
 Cindy Lucchese, Audit Committee Chair, BrightPoint
 Laurette Koellner, Audit Committee Chair, Sara Lee
 Mike Monahan, Audit Committee Chair, CMS Energy
 George Off, Audit Committee Chair, Telephone and Data Systems
The following Ernst & Young partners participated in the meeting:
 Rick Fezell, Midwest Area Managing Partner
 Jim Logothetis, Midwest Assurance Partner
 Rich Bonahoom, Midwest Accounts and Business Development Leader
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Appendix 2: discussion questions for audit committees
? What information do the analysts following your company value, and where do they obtain this
information? Has this influenced your company’s IR strategy?
? What concerns you about analysts’ current use of financial reports? How do you feel about the balance
between audited and non-audited information being used?
? What additional information do you think analysts need? Should that information be provided in the
audited financial statements?
? What format or style changes can your company make to its financial reports that would help analysts?
? Do you believe the scope of the audit should be expanded, given the increasing use of non-GAAP
financial information and other management information?
? Do you feel the audit committee should review a broader range of reported information?
? Does the audit committee provide any oversight of internal controls over non-financial information? If
not, should this be addressed, and how?
? What kind of relationship do you have with the head of IR and other IR staff? How does the
relationship need to evolve?
? How does the audit committee determine what analysts need? Should the audit committee go beyond
IR to explore investor needs?
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