Corporate America needs to do a much better job of communicating with shareholders, a senior Treasury official has warned.

“To improve corporate behavior and to reward corporate performance, companies must improve the quality and utility of the information that all corporations disclose to investors,” said Peter R. Fisher, Under Secretary for Domestic Finance, in a speech earlier this week at an American Enterprise Institute conference. “Our existing disclosure framework is not adequate.”

Fisher expressed his hope that nonfinancial indicators of business performance can succeed in providing investors the information they need and deserve, where GAAP has failed. But he said it is just as important to improve the state of financial disclosure and, by doing so, provide stronger incentives for companies to disclose business performance measures.

“To succeed, I believe that we must acknowledge the insufficiency of the accountant’s mindset, which animates our existing disclosure framework, and focuses on identifying facts (about the past) that are precisely comparable between firms,” he elaborated. “Investors have a different mindset and focus on comprehending the probabilities of likely and unlikely future deviations from particular desired or expected outcomes. We need to remedy this mismatch between what investors are looking for and what our disclosure regime provides.”

Fisher also called for resolving the historical imbalance between the information available to corporate insiders and to outside investors. He added that this gulf widened in the past two decades due to the computing, communications, and data management revolution, which has given insiders access to timely and detailed data about near-term company prospects in customer order flow, cost management, revenues, and other indicators of performance.

“This information needs to be organized and presented to investors on a systematic basis,” he insisted. “Some companies are doing this. More need to do this. To provide stronger incentives for companies to make these business value disclosures we need to improve the clarity of financial disclosures.”

How can this be accomplished? Fisher said we need to move beyond what he calls a false dichotomy between on-balance-sheet and off-balance-sheet.

“Shareholders and creditors need to know the real economic leverage being employed, whether through on- or off-balance devices,” he elaborated. “We need a measure of all the contractually obligated liabilities — both on and off-balance sheet — and a parallel measure of all of the firm’s contractually obligated revenues. Tying these together will give us the firm’s contractually-obligated net-present value, a true indictor of the firm’s leverage.” (Read more in our January special report on off-balance-sheet financing.)

Clearly disclosing this number — which will not include hoped-for or anticipated revenues, but only those for which there is a customer contract — would create a strong incentive for companies to disclose more clearly how they plan to generate the cash flow to close the gap between expenses and revenues, added Fisher, and to disclose the measures of business performance that will indicate the extent of their plan’s success.

To move in this direction, Fisher maintained that there are two challenges deserving attention. One, “the nonlinear nature of contingent claims, particularly reflected in options, poses a significant but manageable technical problem for financial disclosures. A more general challenge, affecting both financial and non-financial disclosures, is to squarely confront the subjective nature of risk,” he added.

“To measure accurately the present value of the future contractually obligated cash flows we need to deal with the contingent nature of various assets and liabilities, particularly options exposures,” he continued. “Simply put, investors need different facts about an option at different stages in an option’s life cycle. This does not come naturally to the accountant’s mindset — of looking for discrete facts directly comparable between firms — but properly understood it need not be at odds with it either. However, this information is vital for investors.” (Find out more in CFO magazine’s May cover story “Better Options.”)

Default Rate Rises for Speculative-Grade Corporate Bonds

There’s a reason they call it “junk.”

While many signs point to a gradually improving economy, last month the global speculative-grade corporate-bond default rate increased, month over month, for the first time in more than a year, according to Moody’s Investors Service. The default rate rose to 6 percent, up from 5.8 percent in July.

In August, eight corporate bond issuers defaulted on a total of $2 billion in debt; since January, 73 issuers have defaulted on a total of $38 billion. Compare that, though, with the 108 defaults on $120 billion over the same period in 2002.

U.S.-based issuers accounted for seven of last month’s eight defaults. The largest: Horizon PCS Inc. — $470 million.

“The decline in the global default rate we’ve seen this year has been largely driven by a sharp fall in defaults outside the U.S., particularly in Europe,” said David T. Hamilton, director of Moody’s corporate bond default research, in a statement. “Although U.S. corporate credit quality is certainly improving, we’re still in the early stages of a credit recovery. It’s likely that the default rate for U.S. issuers will finish the year just slightly below where it began.”

Indeed, over the first eight months of 2003, there is little to get excited about. The U.S. speculative-grade default rate increased to 5.8 percent in August from 5.3 percent in July, and is just slightly below the January figure of 6 percent.

Keep in mind, however, that the junk default rate peaked at 11 percent in January 2002.

The picture is much brighter in the Europe, however. For a third straight month no European corporate bond issuers defaulted. The rate for that region fell to 7.5 percent last month, down sharply from the 9.4 percent in July and far below its January high of 19.2 percent.

For the year, Moody’s predicts that the global speculative-grade default rate will come in at 5.8 percent, slightly below the current level but down considerably from the 7.5 percent rate recorded in January.

Furthermore, Moody’s expects that the global default rate will decline even more quickly next year, reaching 4.6 percent by September 2004.

SEC Clears PolyMedica’s Accounting

Now here’s a refreshing twist.

After examining the accounting practices of PolyMedica Corp., a medical products company, the Securities and Exchange Commission has chosen to do nothing, thus giving its seal of approval.

As a result, the company won’t need to restate its financials despite an earlier warning.

PolyMedica, which makes diabetes test kits, said the regulatory agency has determined that it should continue to capitalize its direct-response advertising costs related to the acquisition of new customers, rather than expensing such costs as incurred.

As a result, the company will not restate its financial statements, which it had warned about in its annual report for the fiscal year ended March 2003.

“We are pleased that our accounting for direct response advertising costs has been reviewed by the highest levels of the SEC and that this issue has now been resolved,” said interim CEO Samuel L. Shanaman, in a statement.

“We have always believed that capitalization of our direct response advertising costs accurately reflects the underlying economics of our business,” he added. “However, some members of the investment community had expressed concerns about how we account for those costs, and so we wanted to explore whether going forward we would be able to adopt the more common method of expensing advertising costs as incurred, while remaining compliant with GAAP.”

Shanaman added that few companies qualify for capitalization of advertising costs because few have a business model with the same level of recurring revenue that PolyMedica does.

Since acquiring its Liberty unit in 1996, PolyMedica said, it has capitalized its direct-response advertising costs and amortized them, generally over two to four years, in accordance with the AICPA’s Statement of Position 93-7. That guideline provides for the capitalization of such costs when, among other things, the advertising elicits sales to customers who respond specifically to the advertisement, and the advertisement results in probable future benefit.

Short Takes

• Underfunded pension liabilities at troubled U.S. companies doubled this fiscal year, and could exceed $80 billion, according to Reuters, citing the Pension Benefit Guaranty Corp. Airlines are accounting for nearly a third of the deficit.

Also, the PBGC’s deficit has grown to $5.7 billion as of July 31. The deficit for the entire fiscal year ending September 30 last year was $3.6 billion, said the report.

• Delphi Corp. filed a shelf registration to periodically sell up to $1.5 billion in debt securities, common and preferred stock, and other securities. The auto-parts maker said it plans to use the net proceeds for general corporate purposes, including the repayment of existing debt and satisfaction of corporate obligations.

• Subsidiaries of Textron Inc. filed a shelf registration to sell up to $4 billion worth of debt securities and guarantees. Textron Financial and Textron Canada Funding said they plan to use proceeds for general corporate purposes such as debt repayment.

• The number of Americans making initial unemployment claims rose last week to the highest level in more than a month, according to the Labor Department. Jobless claims rose by 15,000 to 413,000 for the week ended Saturday from a revised 398,000. The four-week moving average rose to 401,500, above the 400,000 level that some analysts believe divides job-market expansion and job-market contraction.