Management Discussion & Analysis: Its Genesis and Importance?

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Management Discussion & Analysis: Its Genesis and Importance?

Management Discussion and Analysis or MDNA as it is popularly called is a relatively new addition to the corporate annual reports, making its debut only in the 1970s. Despite its recent entry, MDNA has a key role in corporate communications, especially for its value to indicate future trends of financial performance by sharing the second level details and the context in which this performance is delivered.

Equity analysts and serious investors look to MDNA for it not only provides the building blocks of the past financial performance, but also reveal the leading indicators on how the company could be expected to perform going ahead.

Like good knives, which are sharp and cut with precision, good MDNA’s too are expected to be insightful and incisive by providing the reader with valuable insights. MDNA too like blunt knives can be ineffective, if its purpose is not fully understood. Given this context, it is essential to know the genesis and the purpose for mandating MDNA.

The Concept

Scorecards, commentators and experts sharing their views on a cricket match is illuminating. However, the views of the Man of the Match and the captains of the two teams reveal a lot more insights and capture what their thinking was, which cannot be provided by others.

Like scorecards, financial statements are only a dry trail of the journey completed. The Management team, like players in a cricket match can provide interesting insights of what transpired. Management Discussion and Analysis is the management’s point of view of its performance.  A well-crafted MDNA provides substantial insights into the business and increases the level of transparency, which cannot be achieved through any other means.

The First of First

In the face of stock market turbulence in mid-1960s, the SEC in 1968 required the management of the US listed companies to discuss and share views on unusual and non-recurring items in their earnings statement so that the investors would not be misled by it. This requirement for a narrative from the management to explain a part of the financial statement seeded the MDNA section we see today in Annual reports.

A year later in 1969 based on the recommendation of security analysts, SEC set up a Disclosure Policy Group, also known as Wheat Commission to study disclosure issues, including the question ‘should companies be permitted to make forward looking statements in their SEC filing?’ The Commission concluded that forward looking statements are critical for making future estimates. However, this can be costly due to potential litigation, onerous requirements to update, and undue reliance placed by the investors on these statements.

In parallel attempts to make financial statements meaningful continued. In 1974, SEC expanded the narrative disclosures by requiring the management to discuss operational trends. But this additional requirement did not add much value, as in most companies, financial ratios were discussed with an arithmetic bent, without going into the business reasons for the change in ratios over the years.

After much deliberations and work by a committee appointed for this purpose, SEC brought in the Safe Harbour rule in 1979, to protect companies and encourage them to discuss trends in their financial performance with a prospective flavour of what was to come.

The Safe Harbour rule provided protection to the management for making specific forward-looking statements that had a reasonable basis and were made in good faith. With the Safe Harbour rule in place, on September 2nd, 1980, SEC expanded the disclosures required. Companies were now required to discuss their business from their individual viewpoint in the industry and not take a generic view. In specific it required a discussion on the Results of Operations, Financial conditions, and Liquidity and capital resources, thus fleshing out the MDNA in full.

The expanded requirement of MDNA was to provide an opportunity for the users of financial statements to see the company operations through the eyes of the management, to supplement the quantitative ‘dry’ financial statements.

MDNA, first introduced in the United States soon spread to the rest of the world. On a non-mandatory basis, it was introduced in England initially in 1992 for large companies and renamed as the Operational and Financial Review. India too followed suit in the year 2000 requiring all the listed companies to have a MDNA section, specified in Clause 49 of the listing agreement.

MDNA in India

Regulation 34 2 (e) of LODR, 2015 requires every listed company to include management and discussion analysis report in its annual report. Neither the Companies Act nor SEBI’s LODR define the contents of MDNA. The only guidance, if any, that is available on MDNA in India is in ICSI’s Referencer on Board’s Report, which is a crisp gist of the MDNA requirements specified by the SEC.

Many MDNA’s seen today in India are ritualistic compliance fulfilling the regulatory requirement but fail to serve their intended purpose. Exceptions are companies that are listed in the US or companies that are followed by the global analysts, which provide more information makings their MDNA purposeful.

By | 2019-05-06T12:30:04+00:00 May 6th, 2019|First of First|0 Comments

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