Corporate governance has come to the head of the international agenda. Public and private sector agencies have put the issue centre stage as the importance of corporate governance has been recognised as critical to both business and economic agendas. Intergovernmental organisations have made corporate governance a centre piece of their policy work, beginning with the OECD’s decision in 1998 to develop a set of principles that would set out the essential framework for corporate governance for its 39 member countries in the industrialised world.
As the Asia crisis brought chaos to the developing world just as these principles were being agreed, the World Bank was urged by the G7 to promulgate improved standards throughout the developing world. Corporate governance moved from being an issue of discussion and debate on Wall Street and the City of London, to a national reform priority in markets across the world. The OECD Principles drew upon a report from a Business Sector Advisory Group which brought together leaders from five countries, chaired by Ira Millstein, drawing upon the pioneering work of Sir Adrian Cadbury’s Committee on the Financial Aspects of Corporate Governance in the UK. Their advice to the OECD became the global standard, and now over 70 countries followed the powerful example of Cadbury, and developed their own national codes of best practice amplified by the OECD advice.
Although the reform efforts of the US with Sarbanes-Oxley and the European Commission with its Action Plan, may have caught the headlines, countries as diverse as Brazil, South Africa, China, even Kyrgystan, where the President has sponsored a national corporate governance centre and Rwanda which appointed a Minister for Corporate Governance, have shown that the corporate governance agenda has resonance in every region. The reasons are simple. The international corporate governance movement has grown to fill vacuum. It is a simply a movement which is seeking to ensure accountability for the exercise of power, a notion well understood in the international movements to promote democracy, but just as important in the economic realm as the political.
The corporation, put simply, has never been more important to the economic health and social fabric of the international community. Not only are we dependent upon companies for goods and services, employment, taxes to fund the public purse, with attendant concerns about their role in society on ethical, social and environmental grounds, but also the bulk of their shareholders represent the collective savings of the wider community for retirement, home purchase and welfare. Much of the regulatory debate and effort is focused upon attempting to balance private interest with the public good.
The drivers for this burgeoning interest in corporate governance were the privatisations of the 1980s (over $800bn according to OECD figures), liberalisation of capital markets which led over a decade to global flows from the private sector coming to represent five times the stagnated sums of public lending and investment. Critically, the bulk of the money available for domestic and cross border equity investment has come from the rapid growth in the assets of the public’s savings, channelled to pension funds, insurance and mutuals.
Those who view the long list of corporate scandals and collapses of recent years may feel justified in complaining that the reform agenda in governance has been a rehearsal of the obvious, by the politically correct. But cynicism is premature. There has been real progress over a relatively short period of time, and clearly still some important areas on which progress has barely begun, or where different ideas about solutions still compete. What though are the areas of progress?
The first cannot be underestimated in a global market. We have consensus internationally that convergence should be around function not form – we’re no longer arguing about which system works better. Remember the arguments about the Anglo-American versus its alleged alternative the German-Japanese bank financed, long term relationships model. Now – transparency, accountability are the understood principles. Remember discussions on disclosure – Vienot arguing to OECD this was voyeurism.
Are you ready for non-financial reporting?
Mark Hynes assesses the requirements of non-financial methods of reporting and asks whether UK companies are prepared for them.
Adding “real shareholder value” has long been a key focus for the directors of public companies. It has come to encapsulate all the measures of success, from free cash-flow to non-material assets of the business. Yet non-material assets have traditionally been harder to define, report and measure and have thus not been a substantive part of a company’s overall valuation. But pressure from investors is poised to change this.
Accounting standards such as IFRS have no means of recognising the worth of non-material assets such as experienced employees, customer loyalty, corporate strategy, market growth, product innovation and demographic change. Yet IFRS is what many companies think of as ‘corporate reporting.’
National Australia Bank finance director Michael Ullmer said recently, “I think you’d find around the world at the moment that boards are probably spending more time reviewing regulatory and compliance issues than looking at growing shareholder value.”
Further, many boards of directors and senior management have a difficult time identifying non-material performance measures and monitoring their impact.
A survey conducted on behalf of Deloitte Touche Tohmatsu by the Economist Intelligence Unit in October 2004 supports this. Of 249 board members and top executives polled, only about one third (34 percent) said their companies are proficient at monitoring critical non-financial indicators of corporate performance. Those surveyed blamed this on “the absence of developed tools for analysing non-financial measures, and scepticism that such measures directly impact the bottom line.”
And yet, research shows that regulatory financial reporting alone is failing to meet the needs of investors. For example, in interviews with over 1,800 managers and investment professionals across 16 industries, PricewaterhouseCoopers’ Value Reporting have consistently found that only 25% of the measures cited as critical for understanding a company in a given industry are covered by the regulatory reporting model – 75% lie outside the regulatory reporting framework.
Chief investment officers are increasingly looking for metrics beyond typical financial indicators to provide a more robust view of a company upon which to base their valuations, giving rise to a number of initiatives aimed at addressing this issue. In Europe, the Enhanced Analytics Initiative comes from a group of asset managers and asset owners with assets under management totalling over 380 billion euros, who actively support better sell-side research on “extra-financial” issues.
Putting their money where their mouths are, these fund managers are dedicating brokerage commissions to analysts who produce research on “fundamentals that have the potential to impact on companies’ financial performance or reputation in a material way, yet are generally not part of traditional fundamental analysis.” This has already led to new, fundamental research.
However, creating the research and analysis of the ‘extra-financial’ issues solves only one part of the problem; the format in which it is delivered is crucial. In financial reporting, a new standard, eXtensible Business Reporting Language (XBRL), is expected to change the useability of data. XBRL is a language for the electronic communication of business and financial data.
By providing a computer-readable identifying tag for each individual item of data, XBRL benefits both the preparers and users of financial information. This helps automate the analysis, giving advantages of speed, accuracy and cost savings.
To date, no such reporting framework exists for non-financial information. However, the not-for-profit Enhanced Business Reporting Consortium is taking a lead in creating one. Their aim is to define and build XBRL taxonomies for different sectors, which would allow businesses to report on their non-financial assets, in a way that is easy for investors and stakeholders to use and compare.
And finally, a key piece of the jigsaw is the wide communication of this non-financial information. The information used to value a company, whether material or non-material, is worthless if it doesn’t reach the widest audience possible.
As financial information is fed through the media, such as news agencies, newspapers, radio, TV and the internet, businesses can expect that the news disseminators are there to help ensure that their non-financial information, comparable and measurable in easy-to-use formats, is distributed to the widest possible investor audience.
True transparency in all aspects of corporate reporting is within sight.
For further information on the Investor Relations Society visit www.irs.org.uk
For further information on the Enhanced Business Reporting Consortium please visit www.er360.org
Sarbanes-Oxley reforms ‘go too far’, says author
One of the architects of the controversial US Sarbanes-Oxley legislation admitted yesterday that some of the reforms were “excessive” and could have been introduced more “responsibly”.
Congressman Michael Oxley told a London conference that the legislation “was not a perfect document” because it had been rushed through in the “hothouse atmosphere” following the collapse of WorldCom.
However, he defended the right of federal lawmakers to push through investor-friendly reforms, deflecting accusations made this week that Congress was usurping the role of individual states to draw up corporation laws.
The Sarbanes-Oxley legislation, based on bills introduced by Mr Oxley and Paul Sarbanes in 2002, sought to clean up corporate America following the spectacular financial scandals that engulfed Enron and WorldCom and which cost investors billions of dollars.
Sarbanes-Oxley requirements, such as the need for companies to test their internal financial controls against fraud, have angered members of the US business lobby, who claim it has led to big rises in compliance costs.
Small- and medium-sized corporations are also critical of the legislation because it makes no exemptions for the size of a business.
Oxley told the International Corporate Governance Network annual conference: “After WorldCom happened it was difficult to legislate responsibly in that type of hot-house atmosphere. But I am proud of the bill. Compliance [with it] is an investment in the strength of the US capital markets.”
Speaking to the Financial Times before his speech, Oxley said: “If I had another crack at it, I would have provided a bit more flexibility for small- and medium-sized companies.”
However, Mr Oxley app-eared to quash hopes that smaller companies would gain concessions as a result of the Securities and Exchange Commission considering whether they should abide by a different set of accounting and governance requirements compared with larger ones, to reduce costs. He said: “Congress will not re-visit this issue. The SEC reform [on smaller companies] is not going to happen either.”