When the UK’s Department of Trade and Industry (DTI) released its consultation paper on the review of company law in February, it was at pains to stress the reasons for a rethink. With the bulk of UK company law relatively unchanged from the principles upon which it was founded last century, it was deemed high time for a fundamental rejig. And financial reporting is one of the key issues up for intense scrutiny.
As the consultative period draws to an end, it is clear that the DTI’s initiative has raised the level of debate on a whole host of corporate reporting issues. The purpose of preparing annual accounts and a report to provide a ‘stewardship report by directors to shareholders’ has not changed. But much has changed in the nature of company assets, the expectations of transparency and performance since the original legislation. Further, the wider concerns about the social role of business has developed into a ‘stakeholder’ debate about the interests of employees, suppliers, creditors and the environment.
According to Professor Hugh Davidson of Cranfield University’s School of Management ‘The company report should not now be only built on historical results and tangible assets but on future prospects and intangibles.’ His views are echoed by many in the investment community including Gervaise Williams, a fund manager on the smaller companies desk at Gartmore Investment Management in London. He favors a much fuller ‘statement of prospects’ in company reporting. And brand consultants Interbrand calculate that 70 percent of the total value of companies in the FTSE 350 is attributable to intangibles.
So what can the analyst or investor depend upon to predict future trends in a business and so be confident to invest for increased value? The obvious touchstones are projections based on more frequent and regular historic reporting, such as quarterly numbers or regular management accounts.
Davidson identifies five principal, forward looking, non-financial measures companies should report publicly in, say, five years:
- market trend – the way their market is likely to develop;
- market share – what share they can realistically expect;
- new product performance – how much future income can be expected to arise from new products;
- investment in the future – how much they will invest in areas like technology, new expertise, enhancing the skills of staff, etc;
- customer retention – how good is the company’s record on this.
Davidson recognizes however that the targets for company reporting can and perhaps should be more than the investment community. So should revised reporting requirements be based on ‘enlightened shareholder value (ESV)’ or on a ‘pluralist’ approach?
The ESV view is that the chief objective of companies is to generate maximum value for shareholders and that this is the best means of achieving wider prosperity and welfare across society. The pluralist approach is that company law should be modified to incorporate wider objectives, requiring companies to acknowledge and serve a broader range of social interests.
The Institute of Chartered Accountants of England and Wales (ICAEW) takes the ESV line, adding, ‘it should be supported by non-statutory clarification’ of what companies’ directors should do. And ‘Section 309 of the Companies Act 1985 which obliges directors to have regard to the interests of the company’s employees in general as well as the interests of its members should be repealed.’ The ICAEW says the pluralist approach would give rise to difficult questions of competing interests and put directors ‘in an untenable position.’
Venture view
3i, the UK’s largest corporate and development capital group with investments in a great many smaller and growing businesses, also favors an ESV view. ‘Shareholder value is the key concept,’ it says. ‘What is good for a company’s shareholders is likely to be good for all.’ The group also favors the wider use of the internet in disseminating information to those interested in what companies are doing.
Stuart Bell, research director of Pensions and Investments Research Consultants ‘Pirc’, the independent research consultancy specializing in corporate governance is in favor of more quality reporting. ‘Accountability is going to be necessary if companies are going to be assuming greater power in society,’ he says. For Bell. legislation is only the basic standard and simply complying with legal requirements is not enough. He favors best practice models, although he does not think that the UK should follow some US companies which tend to stuff their reporting with information to act as shields against risks of future litigation. ‘If companies are to succeed in future they have to look after their stakeholders.’
The Industrial Society, the independent self-financing charity whose mission is to transform people’s working lives, wrote in its response to the DTI: ‘Standards of reporting should encourage the fullest disclosure without endangering competitiveness.’ It adds that the review should cover the ethical standards, best practice and reporting requirements appropriate to, among other things…the balance of boardroom power and responsibilities.’ It encourages the debate over stakeholders’ interests and notes that the form of future legislation should reflect the changing nature of companies into knowledge-based organizations whose intangible assets are their principal strengths.
Holding some of the most radical views and a key advocate of the pluralist approach is the Centre for Tomorrow’s Company, headed up by Mark Goyder. Its evidence to the DTI sets out this vision of the company of the future and its implicit reporting approach: ‘Our image of the company of the future owes more to biology than engineering…An adaptive organism with its thousands of individual cells collecting, sharing, storing and using information. It will increasingly control itself through networks rather than through hierarchy.’
In such an organism, failure to share information, to include stakeholders and to protect employees represents commercial suicide. They may simply walk away and share their skills and their knowledge to the benefit of others, including competitors.
But how far can you take such openness? Professor Davidson argues for a level playing field where all companies are prepared to divulge the true current position and future prospects of their businesses. But we are a long way from this. Many companies may not even tell you basic information about how many people work in their warehouse on the grounds it might be market sensitive.
Risky business
This raises the broader issue of risk. Should companies provide, as part of their regular reporting, detailed risk assessments of their businesses? These might sketch out threats from competition, product risks, market and economic perils facing them. Oil companies might reveal their environmental risks, tobacco firms the full consequences of litigation or construction companies the risk to their reputations should natural disasters destroy the buildings they have built.
Some steps in risk reporting are already being routinely taken, such as in provisioning for foreseeable events. But how far do you take it? For sure customers, suppliers, employees, shareholders and society at large can be affected by a range of company risks, but can companies afford to tell their stakeholders while their competitors may be listening?
Or might warts-and-all transparency help in retaining the loyalty of stakeholder groups? Research into investor attitudes by PricewaterhouseCoopers has revealed that investors would be more comfortable knowing bad news well in advance.
Key issues
All viewpoints are fighting for attention, then, but the key issues for the current review of company law are the following.
- How much can you require companies to report without imperilling competitiveness?
- How much do you legislate for?
- How much do you leave to other regulators to achieve in the way of fuller and more transparent, forward-looking reporting?
- Is self-regulation sufficient?
- Is competition and best-practice benchmarking likely to play an important role in forcing companies to tell more if they wish to retain stakeholder interest?
The ‘balance of competing interests’ and the role of directors are bound to be, as the ICAEW says, complex issues to legislate for. But company law in general and its requirements for reporting specifically are acknowledged by all to be in need of a fundamental rethink.
It is difficult to see how the UK can establish a unilateral policy of broad openness without prejudicing its corporate competitiveness in the short term. The outcome may be substantially left to individual companies to do as they think fit in reporting to wider stakeholder groups. And this could mean, in a knowledge-based future, that it will fall to corporate investor relations and public relations professionals to balance openness and discretion, in line with what they feel able to reveal about their businesses. It is certainly likely to be a reporting challenge.
