Philips' Survival As Industrial Giant by Financial Reporting & Disclosure Innovatio
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Innovation, Continuity and Governance: Philips’ survival as industrial giant by financial reporting & disclosure innovations (1912-2004) Paper to be presented on the twelfth Accounting and Management History Conference Lillie March 29th and 30th 2007 By Dr. Frans G. Volmer Maastricht Univerity (The Netherlands) March, 9 2007 Résumé Innovation, Continuation et Gouvernance: La survivance de Philips comme gérant industriel par les innovations comptables des rapports annuels (1912-2004) La question fondamentale à propos des rapports annuels comptables est de savoir quelle est la contribution des innovations des rapports annuels financière à la gouvernance d’entreprise et la gouvernance à long terme des industries existantes et renommées? Chatfield et Vangermeersch constataient déjà en 1996 que les rapports annuels de Philips SA donnaient une vue d’ensemble passionnante de nombreux problèmes de la comptabilité du vingtième siècle. Pour cette raison, les 92 rapports annuels financiers de Philips de 1912 (année de la fondation de la société anonyme) à 2004 ont été choisis pour l’étude. Cela représente une période de presque un siècle ; ce qui est exceptionnel pour la plupart des recherches comptables sur le court terme. Cette étude établit, en premier lieu, une liste des innovations comptables de Philips : chiffres d’affaires annuels, figures comparatives, comptes consolidés annuels, segmentations, coûts actuels, ressources humaines, flux de trésorerie, profits par action et charge. En second lieu, plusieurs modèles de rapports annuels ont été étudiés pour expliquer l’évolution des rapports annuels durant cette période. En troisième lieu, la question de recherche est: Philips stimulait-t-il systématiquement le financement interne par la non-répartition des profits? Lors de l’étude, aucun élément déterminant n’a été trouvé pour supporter cette hypothèse. Par contre, on a pu constater que les innovations comptables de Philips ont eu lieu dans une période de hauts profits (1950-1954). La dernière question est de savoir si le CEO (P.D.G.) a utilisé des pratiques comptables pour protégerer et consolider son pouvoir. Concernant l’hypothèse « big bath » (faire apparaître les résultats d’une façon qui les rendent pires qu’ils ne le sont) la conclusion est qu’en cas de succession du CEO (PDG) sans transfert de celui-ci vers le Conseil d’Administration, dans 8 des 12 successions, on a trouvé des éléments prouvant cette « big bath » hypothèse. Dans tous les cas , le nouveau CEO (PDG) a commencé avec une perte comptable. La conclusion concernant la période entière c’est que les innovations des rapports annuels peuvent être expliquées par l’hypothèse du financement interne et du nivellement des profits. Lors des années de crise se soldant par de faibles profits, la politique comptable de Philips adoptait une politique comptable tendant à gonfler les bénéfices et pocédait à l’inverse lors des années fastes Mots clés: comptabilité, histoire d’entreprises, innovation comptables, gouvernance d’entreprise Innovation, Continuity and Governance: Philips’ survival as industrial giant by financial reporting & disclosure innovations (1912-2004) Abstract The principal research question is “ How financial disclosure innovations contribute to corporate governance and the long term survival of well-known still existing industries?” Chatfield & Vangermeersch stated already in 1996 that the annual reports of Philips' Industries provide a fascinating panoramic view of many accounting issues of the twentieth century. Therefore 92 annual copies of Philips' financial reports since the start in 1912 (as former family business) up to 2004 were selected: nearly a century and that is exceptional in accounting research suffering on short-sighted. In this paper, firstly a list of (Philips') disclosure innovations was established: reporting about sales, comparative figures, consolidated accounts, segmentation, current cost, human resources, cash flows, earnings per share and taxation. Secondly, several financial reporting models were investigated to explain the evolution of Philips' disclosures during the period. Thirdly, the first empirical research question is: Does the financial disclosure policy of Philips stimulate systematically internal financing by retained earnings? No strong evidence was found for this hypothesis. However it was found that Philips' accounting innovations took place in high performance periods (1950-1959). Finally, the second empirical governance research question was investigated: Did the Philips' CEO use creative (big bath) accounting practices as a corporate governance practice in order to protect and consolidate his power? Regarding the big bath accounting hypothesis, it was found that in the case of CEO succession -with no transfer of the former CEO to the Supervisory Board- 8 of the 12 successions provide evidence for big bath accounting. In all this cases the new CEO started with a accounting loss. The conclusion regarding the whole period is that the reporting innovations can be explained with a smoothing/internal financing hypothesis too: in years of crisis with bad performance the new adopted accounting policies tend to increase profits and in booming years the opposite turned out to be true. Keywords: financial accounting, business history, corporate governance, big bath accounting Contents 1. Introduction 2. Prior literature about reporting innovations 3. Financial reporting models and internal financing of the firm 4. Hypothesis development 5. Results and discussion 6. Conclusion 2 1. Introduction The objective of this paper is to discuss the evolution of Philips’ disclosure practices from 1912 to 2004, placed in the context of accounting history and related to its corporate governance by Philips’ CEO’s. This type of study is valuable considering the importance and size of Philips as an innovative multinational company (consumer electronics) and the fact that disclosure research provides insight in business’ areas of concern. The principal research question is how financial disclosure innovations contribute to corporate governance and the long term survival of well-known still existing industries? Chatfield & Vangermeersch stated in 1996 that “ the annual reports of Philips' Industries provide a panoramic view of many accounting issues of the twentieth century”. The above stated quote provides the ultimate argument to investigate almost a century of accounting disclosures of one of The Netherlands’ most important companies in depth. A very extensive descriptive research in Philips disclosures is provided in the empirical research section. In that part, disclosure size and reporting goals are discussed from 1912 until 2004.. Philips’accounting policies itself are investigated in depth by many researchers such as Vandermeersch (1983), Brink, (1992), Schattke & Vergoossen, (1996), so that these need not be the main focus of this research. The aim is to be able to provide an answer to the question: Was Philips a disclosure innovator and what were its motives? Several points of view are used in this research. Firstly by comparing the timing that individual disclosure items appeared in the annual reports to the timing that they were required by legislation. Second, a set of hypotheses will assess Philips innovativeness, for example based on the three ownership models (Traas, 1976). A comparison between the timing of the average company shift towards the different models and the timing of Philips’ shift is provided. Several advantages regarding agency theory have been identified in prior literature why a company should have a sound disclosure strategy. The third set of hypotheses relates to the above-mentioned ownership models and agency theory. Did Philips stimulated internal financing by retained earnings? Philips needed a lot of money for innovation and through gaining more trust by improved reporting disclosures new investors could be attracted and less dividends had to be distributed. The shift of governance models from proprietary to the closed (entity) model can be explained by the agency theory. Assertions will be made on whether innovations in disclosure are related to a company’s financial performance and whether dividend payouts are related to innovations in disclosure. Expected is that when information increases / improves lower risk premiums (dividends) have to be paid. There are considerable disadvantages to compensation plans that are performance related surrounding CEO turnovers. Taking into account that in the last three CEO successions (which were all non-routine turnovers with no transfer of the former CEO to the Supervisory Board) profits decreased in the transition year, especially the likelihood of big bath accounting seems high. By assessing mutations in the relating balance sheet / profit and loss account items concerning the CEO successions, evidence can be found whether Philips’ CEOs engaged in creative accounting and what were their motives. 3 Royal Philips: A short history1 The principles for what was to become one of the world's biggest electronics companies were laid in Eindhoven, the Netherlands, in 1891. Philips began by making carbon-filament lamps and, by the turn of the century, was one of the largest producers in Europe. As developments in new lighting technologies fueled a steady program of expansion, in 1914 it established a research laboratory to study physical and chemical phenomena and stimulate product innovation. In 1918, it introduced a medical X-ray tube. This marked the beginning of the