The Yeezy standard for accounting

It was in December 1913, when Louis Brandeis, an American lawyer who was later appointed to the Supreme Court, stated in a now-famous essay that “sunlight is said to be the best of disinfectants”.

Focused on excessive fees charged to investors on financial markets at the time, he called for more transparency: “To be effective, knowledge of the facts must be actually brought home to the investor, and this can be best done by requiring the facts to be stated in good, large type in every notice, circular, letter and advertisement inviting the investor to purchase.”

Fast forward 110 years and Kanye West has provided an illustration of why “sunlight” is still important for investors.

German sportswear maker Adidas set up a partnership in 2015 with the rapper and fashion designer to produce Yeezy sneakers. While Adidas did not make a secret of the fact that the shoes, with their futuristic design and price tag of more than €230, were highly successful, it never disclosed the brand’s revenue and profits.

But investors belatedly learnt just how important Yeezy was when shares in Adidas tanked after the sportswear group pulled the plug on the partnership after a series of antisemitic remarks by West, also known as Ye. It was later disclosed that the shoes accounted for more than 5 per cent of the group’s overall revenue and about a quarter of its overall operating profit.

The episode has been painful for Adidas and its shareholders, but it also raises questions more broadly on just how much companies should disclose on the profitability of specific products, regions and brands.

Under global accounting standards, the relevant rule gives companies a lot of leeway. IFRS 8, which defines the guidelines for segment disclosure, follows the so-called “management approach”. It stipulates that a company’s external disclosure needs to follow its internal reporting lines.

As a result, “disclosures will not be consistent between entities, even those operating in similar industries”, warns Grant Thornton, an audit firm, in a note on the topic. And most listed companies keep their cards close to the chest. By doing this, they can at least partly hide highly profitable parts of the business from envious rivals while obscuring underperforming operations. “There is a common habit of combining strongly performing parts of the business with less successful ones,” a partner of a Big Four audit firm said.

There are several reasons why Adidas investors and analysts might have wanted to know about the scale and scope of Yeezy’s extraordinary performance well in advance. First, they might have asked inconvenient questions over the group’s growing dependency on the controversial, and unstable, Ye. Such questions were vented internally but brushed aside by the group’s management, as the Financial Times previously reported.

Second, and more important, shareholders would have wanted to know why the rest of the sportswear group’s empire was more lacklustre than the combined numbers suggested.

However, Adidas was far from alone in its approach. For example, German carmakers, which rely heavily on combustion engine vehicles and China for their profits, are reluctant to break out their profitability by region or drivetrain technology.

While tighter rules on better segment disclosure may be desirable, they seem difficult to implement as different industries are shaped by unique characteristics that change over time. Finding a better definition that works for fashion companies, global investment banks and carmakers all at the same time could be a stretch. And working out profitability within a division can be tricky given issues such as allocation of group costs.

A better, and more realistic lesson from Adidas’s Yeezy debacle is that investors should push individual companies much harder for meaningful disclosure of all aspects needed to fully comprehend the operations and risks a company is facing — be it the reliance on an erratic rapper or exposure to the Chinese car market. And companies need to ensure the narrative of their performance presented to the world is accurate, warts and all. Over the long term, this will be in the interest of executives, as more accountability is likely to lead to better decisions and superior performance. Companies that consistently shy away from sunlight deserve to trade on a shadow discount.

olaf.storbeck@ft.com