Post Enron World

7/28/2019 Post Enron World

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Introduction

After Enron, few people would question the need to re-examine thequality and rigour of financial reporting. It may be true that, thanksto Sir David Tweedies efforts at the helm of the Accounting Standards

Board (ASB), UK GAAP rules would have made it difficult for Enron to

transfer debt off its balance sheet by using a network of affiliates.

However, the recent report from the Treasury Select Committee

warned that it would be dangerously complacent to assume that this

type of failure is inherently less likely to happen here. Obscure report-

ing practices have been bringing down share prices. The belief in thesoundness of financial reporting has taken a knock.

The biggest driver for transparency used to be the European compa-nies push to access the US capital markets and the desire to beseen as progressive. However, in the wake of the recent accounting

scandals, investors are becoming hypersensitive to the reliability of

published accounts and suspicious of the possibility of inflated earn-

ings. The slightest hint of wrongdoing now has the potential to deflate

investor confidence and bring share prices down.

In other words, the drive has become more urgent and more desperate asthe investors fearing another case of enronitis steer clear of compa-nies with opaque business reporting systems. Transparency is becoming amatter of survival rather than choice and people are beginning to remem-

ber that the rules of financial reporting have never been an exact science

immune from interpretation or indeed human error.

When Enron failed to make new deals, it allegedly changed thevaluation assumptions that determined current-day recognition infinancial statements. In this way, it was able to report profits despite the

rising debt and what it did still has to be proved illegal. Companies

such as IBM have started providing additional financial information in

the light of concerns about the reliability and comprehensiveness of its

figures for example, its rival, Siebel Systems, accused IBM of peddling

accounting fiction. GE has also been under pressure to modify its

reporting practices. In its annual report published in 2002, it boasted that

the financial results section was some 30 per cent bigger than before yet

it still came under criticism for failing to provide its investors with ade-

quate information. Of course, better disclosure does not necessarily

mean more disclosure, particularly given the pressure on investors time.

RESTORING TRUST IN CAPITAL MARKETSAUGUST

200210

Business Transparency in a

PostEnron WorldIN THIS BRIEFING...

I Introduction

I Reasons for change

I Transparency

I More reasons for

change

I Why do companies

continue to play

accounting games?

I Risks and barriers tobetter disclosure

I Benefits of increased

transparency

I A framework for

better reporting

PwC ValueReporting

I SEM

I Technological changes

I International

Accounting Standards

I Company Law Review

I Global Reporting

Initiative

I Sustainabledevelopment

I Investor relations

I Conclusion

I References and

further reading

For further information

please contact:

Technical Services:

Tel: +44 (0)20 7663 5441Fax: +44 (0)20 8849 2468

technical.services@

cimaglobal.com

Executive

Briefing


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EXECUTIVE BRIEFING BUSINESS TRANSPARENCY IN A POST-ENRON WORLD

2

So what should companies do to achieve better disclosure? The aim of this briefing is toprovide the broad outlines of the problem and suggest some possible ways of moving for-ward. We hope to sketch out some ideas about what constitutes best practice. The primary aim,

however, is an awareness-raising exercise, as the only way corporate reporting is going to move

forward is through a deeper understanding of the issue and a commitment to improvement by

everyone involved.

In that sense, this is a guide for anyone concerned about what their companies should bedoing. Some of what is said in this briefing can be found elsewhere but the aim here is tobring the diverse strands of the transparency agenda together in one place. In any case, we

make no apology for repetition despite the professional bodies interest and the various books

and articles published in the last few years, corporate failures of which Enron is a spectacular

example continue to happen.

Chief executive officers, finance directors and auditors should start to understand that thisissue does not just affect their individual operations but capital markets as a whole. If theconfidence in markets is missing, capital to finance day-to-day business and longer-term invest-

ment funds will be less forthcoming and more expensive as higher rates of return and greater

security are sought to offset the perceived risks involved. And that confidence will depend onthe quality of reporting by listed companies.

The proposed mandatory Operating and Financial Review which will require directors to give aqualitative as well as a financial evaluation of performance should go some way in broaden-ing the scope of business reporting. But there still needs to be an extensive programme of educa-

tion of everyone involved in order to change perceptions and engender a wider cultural change.

So what is wrong with the reporting framework? Put bluntly, the current system of businessreporting cannot meet all the needs of the modern economy. There is a whole host of inter-related factors that expose its shortcomings.

First, it is geared towards the production of historicalinformation. In the current environment, particularly inthose sectors characterised by extreme market volatility,it offers little basis on which to predict the future perfor-mance of companies. Accounting is accepted as a way ofverifying history. Considering the future is never thesame as the present, this offers little support for valuingcompanies beyond basic extrapolation. Historical perfor-

mance is not a reliable predictor of a companys future. Inaddition, as technology continues to lower the barriers tonew firms entering markets (as well as creating new mar-kets altogether), many of the companies the markets haveto value will have no history to speak of in any case.

Second, the system takes no account of the major intan-gible value drivers in companies. This has the most pro-nounced effect on knowledge-intensive companies whereintellectual capital makes up most of their market value.But the consequences are universal all companies haveknowledge, experience, customer relationships and so on

(expressed as brands, goodwill or competencies) that arecurrently unaccounted for.

(See CIMA Technical BriefingManaging the IntellectualCapital within Todays Knowledge-based Organisations forfurther information.)

The system is geared towards reporting only one dimen-sion of value the financial one. This inevitably meansthat a whole host of other factors that contribute to acompanys performance do not get communicatedthrough the public channels. A recent CIMA researchreport by John Holland showed how fund managers useprivate meetings with a companys managers to obtaininformation on:

qualitative, non-financial company variables such as

quality of management, strategy and its coherence,

investment and financing plans, recent changes in these and

in corporate succession and management style. Information

on competitors and the structure of the competition was also

very important. (Holland, 2002)

Admittedly, even with increased disclosure, fund man-agers would still be likely to favour private meetings inorder to probe a companys strategy in depth, to look into

the whites of the eyes of managers, as Holland says. Themain reason for the continuing importance of such meet-ings is that they provide a unique opportunity for ana-lysts to assess the strength of a companys managementand leadership.

Reasons for change


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It is interesting to note that, within the UK, there seems tobe a consensus that high-quality management and lead-ership skills are in short supply. In a summary report bythe Council for Excellence in Management andLeadership (CEML), appointed by the Secretaries of Statefor Education and Employment and for Trade andIndustry, one of the recommendations is to developmechanisms to track progress in the UKs managementand leadership capability.

The report in fact acknowledges the paucity of informa-tion which, as Holland shows, has to be supplementedfrom other sources and recommends voluntary corpo-rate reporting of management and leadership capabilityfor public and private sector organisations promotedthrough appropriate professional bodies. They acknowl-edge that this could become an element within a widerproposal for human capital accounting and reporting.

In a report commissioned by CEML, the authors from theCranfield School of Management argue that more formalreporting in the field of management and leadership isnot only desirable but is in fact inevitable. However, theirview is that a standardised reporting framework is notthe way forward as the choice of measures used by com-panies is context- and strategy-specific. Instead, they pro-pose a toolkit consisting of a standardised set of genericquestions that organisations can be expected to addressin their annual reports. The potential measures suggestedare grouped together under the following headings:

G morale;G motivation;G investment;G long-term development;G external perception.

Further details can be found at:www.managementandleadershipcouncil.org

CIMA believes that corporate reporting should provideusers with more forward-looking information aboutintangible assets and other drivers of shareholder value.

At present, such matters are covered by limited statutoryrequirements relating to the directors report and by non-mandatory ASB guidance published in 1993 on the oper-ating and financial reviews (OFRs) of listed companies.

The drive for transparency will inevitably have an effecton the board of directors, especially the audit committee.The audit committee exists to look after the companysfinancial wellbeing and this should include overseeing thequality of information released to external stakeholders.

An article in theFinancial Times (10 June 2002) claimed

that the role of audit committees as it is currently definedis too narrow and too technical to achieve this. It goes asfar as calling for them to be renamed transparency com-mittees, in charge of assessing the effectiveness and dis-closure of the companys main performance indicators.This would mean that they are in charge of monitoring

both the statutory reports as well as the investor relationsstrategy. It is too early to say whether the change will beas far-reaching as that but there is no doubt that Enronhas provoked a whole-scale investigation of what consti-tutes good corporate governance.

Judging by their reporting practices, companies appearmore worried about the cosmetics of value streams thanlong-term value generation. The metrics used to reportperformance continue to be largely financial ones such asearnings per share (EPS), even in companies evangelicalabout stakeholder management.

In fact, part of the reason for Enrons spectacular down-fall has been its insistence that it was laser focused onEPS. As a number, EPS is relatively easy to manipulate.Struggling to meet their quarterly targets and City expec-tations means that managers often make short-term deci-

sions that can lead to destruction of shareholder value.When asked if this is true, most managers deny that theywould ever behave in this manner but unsurprisingly think that managers of other companies do so (Eccles andMavrinac, 1995).

As far back as 1995, Eccles and Mavrinac reported on theshortcomings of capital markets. Their survey of corpo-rate managers, financial analysts, portfolio managers andinvestors found that 87 per cent of all respondents agreedthat the markets are short-term oriented. In the last sevenyears, things could have only got worse due to, for exam-

ple, the proliferation of knowledge-intensive companieswith long-term R&D projects.

The current system has also become increasingly compli-cated. All this creates a gap between what the equityinvestors and analysts need and what the companies pro-vide and how they provide it. Put simply, the result of allthese inefficiencies is that markets are not getting the infor-mation they need. Instead, rumours and gossip proliferate.

Take Enron again part of the reason why such a hugeand seemingly profitable company collapsed in whatseems like such a short period of time is partly due to the

fact that few people apparently understood exactly whatit did. Its accounting practices and its network of partner-ships were so complicated that the black hole in itsaccounts was spotted far too late by the outside world. Ofcourse, one also has to question the diligence and inde-pendence of the analysts and stockbrokers involved.

Transparency

The way to address at least some of the inefficiencies

mentioned above is to advocate more transparency infinancial reporting. This essentially means that compa-nies would start providing all the information the marketconsiders relevant rather than simply fulfilling theirmandatory regulatory requirements.


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Transparency in this context means that there should belittle difference between the performance measures usedinternally and those reported to external stakeholders essentially, what is measured internally and reportedexternally should be the main value drivers of the com-pany. At the moment, management accountants may useone set of measures that gets converted into another setwhen reported externally. Instead, they would have todevelop internal control systems closely aligned with thestrategic direction of the company and forge much closerlinks with finance professionals in charge of both report-ing and auditing.

However, achieving total transparency is far from easy,and some of the problems associated with it will be dis-cussed later in this briefing.

More reasons for change

The paucity of relevant information can result in all sortsof anomalous behaviour. For example, ordinaryinvestors currently lack sufficient information uponwhich to judge a companys current or future perfor-mance. It follows that insiders with access to privilegedor exclusive information, including unreported intangiblevalue drivers could be in a much better position toinvest and trade in a companys shares.

As already mentioned, this vacuum created by the lack ofrelevant information soon gets filled with gossip andrumours that can generate market volatility. It can harmcompanies more than it can help them it is more likelyto distort performance downwards than it is to overvalueit. The purpose of financial statements was to provideuseable and comparable information to external financialstakeholders. This function should not be superseded byinsinuations and gossip that favour insider trading orspeculation.

In fact, various research projects have shown that man-agers believe their companies are on the whole underval-

ued (with the lucky few thinking they are overvalued!).Apart from the obvious company bias, the other likelyreason for this is that the information that managers useinternally is not the same as that reported externally.

Why do companies continueto play accounting games?

What is the motivation behind such behaviour? Why

would managers deliberately provide less informationthan is needed for their company to be valued accu-rately? Why do they continue to play accounting games,despite the potentially disastrous consequences? Theanswer has as much to do with behavioural and cultural

issues as it does with hard metrics. After the Enron col-lapse, it was said that its aggressive culture led to aggres-sive accounting. It was the arrogance that led itsmanagers and Board to believe they could get away withit and that no one would notice the hidden losses.

But it is also about expectations on both sides and thebehaviour resulting from those expectations. The com-ments one hears now are that sell-side analysts working incorporate banks may end up compromising their positionthrough fear of alienating clients who bring in the money.Auditors may earn much more from consulting than theydo from auditing. Non-executive directors can suffer froma conflict of interest or a lack of time through too manydirectorships and are not sufficiently accountable for inad-equate reporting. Fear of losing the large fees involvedmay also reduce their willingness to challenge manage-ments presentation of results. Managers motivation is

manifold most frequently, it is cited as being pure greed they expect big bonuses that are tied to the companysshare price performance. Admittedly, this only applies tosenior managers ambition is probably the biggest moti-vator and, at junior level, fear undoubtedly plays a part.Managers are also driven by personal pride on the onehand and a sense of responsibility for the employees onthe other. Many of the profit-earning and save-as-you-earnschemes aimed at employees are tied in with the com-panys market performance. But, knowingly or not, every-one can be involved in massaging figures for the marketand real accountability is frequently what is missing.

If managers perceive that the market does not value, forexample, their long-term investments, they will conducttheir business accordingly. Eccles and Mavrinac reportthat typically this results in three kinds of responses some managers accept the realities of the market andstop investing in long-term projects, some work harder atcommunicating their strategy and some limit communi-cations with analysts and investors altogether. Clearly,two of these responses can be seen as unsatisfactory.

Part of the reason also lies in the way that companiesstructure their reward policies. A research report by

CIMA (Cooper et al., 2001) found that, in most companiesinvestigated, the basis for determining rewards is the effectof performance upon the share price. Interestingly, thiswas the case in most companies, regardless of their perfor-mance philosophy. In other words, even those companiesthat are explicitly dedicated to a stakeholder approachtend to focus primarily on measures such as EPS.

Rewarding performance solely on the basis of meeting theshort-term earnings targets inevitably pushes the man-agers into short-term decision-making. By the time thevalue of a long-term investment is realised, the executive is

probably no longer with the company. Their time at thetop is limited so they quite naturally strive for immediate,short-term impacts. Companies are becoming increasinglyaware of this and more and more are offering long-termincentive plans as a way of providing a balance. However,


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Risks and barriers tobetter disclosure

It is important to emphasise that the change does not nec-essarily have to be a regulatory one. It is about theprocess of disclosure, about how value is communicatedto the market. But, if everyone else is already playing thenumbers game, what is the advantage of sticking oneshead above the metaphorical parapet? Surely it will notonly be costly to gather more information to disclose butcompanies are potentially risking their commercial sensi-tivity for little more than a promise of a higher shareprice? Arent you opening yourself up to being takenhostage to fortune, especially when things are goingbadly? Wont the markets, being efficient, eventuallycorrect any anomalies without interventions? Isnt this

just a huge gamble that only a few companies can afford?

Post-Enron, the obvious reason for reviewing reportingpractices is the danger of crossing the line betweenearnings management and fraud. There are plenty ofopportunities for companies to exploit the inherent scopeto exercise judgement when deciding on accounting treat-ments for a particular transaction, some of which could belabelled aggressive earnings management. There is also anincreased feeling of insecurity managers and employeesall over the world are scrutinising their own companiesaccounting practices. This is especially important in times

of economic downturn when more managers are temptedto massage the figures in order to inflate their earningsand meet their targets. Boards of directors need to be moreaccountable for their figures. The problem can only betackled through the combined efforts of the accountingprofession as a whole regulators, the professional bodies,the reporting businesses and users of accounts such asanalysts and institutional investors.

Related to this is the reputational risk that such dubious,albeit legal, practices might carry. If a companys earn-ings management tactics are uncovered and publicised,investor confidence will disappear overnight and the

share price can go into freefall. We are already beginningto see the same thing happening to companies unwillingto be open with their financial data.

Ironically, in order to limit the exposure to such risk,many companies attempt to restrict or manipulate theamount of information provided. However, the entireinformation paradigm has changed, mainly thanks tonew technology we expect the information now and,importantly, we expect it for free. If a company fails toprovide it, someone else will almost certainly be happyto oblige. It is in a companys own interest to abandon

defensive disclosure strategies and PR gloss in favour ofproviding timely, relevant and comparable information.

Cynics would say that there is indeed a danger that anyadditional information provided will be little more than a


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with the average executive contract in the FTSE 100 beingno more than a year (Financial Times, 20 April 2002) and anaverage tenure only four (Guardian, 5 September 2001), it ishard to see an immediate change.

For anything to be different, the whole culture of capitalmarkets will have to change. CIMA research (Cooper etal., 2001) has shown that there are usually three main rea-sons why companies choose to stick with the tried andtested accounting measures of performance. Firstly, it isbecause they consider the techniques to be perfectly ade-quate, especially when tied in with the development ofother internal measures such as the balanced scorecard.Secondly, the measures used were seen as appropriate fortheir major stakeholders and sufficient to measure perfor-mance accurately. But the companies interviewed alsoadded that City pressure and external expectations werepart of the reason they still focus on financial measures of

performance. The third reason cited was that theythought the culture of their organisation would not beconducive to a different approach. They believed theywould lack the support to adopt and implement any ofthe new measures. This normally equates with a lack ofcommitment at the senior level.

Many companies publish more than one EPS figure in anattempt to communicate their results. This allows them toemphasise or de-emphasise particular issues. Ironically,analysts usually convert those EPS figures into nor-malised earnings, for example, as well as looking for

additional soft information that will further elucidate acompanys performance. This can only be done properlythrough an honest stakeholder dialogue and a sea changein reporting practices. If more and more big companiesstart communicating value to the market in a different,more transparent manner, smaller companies will follow.

It is worth remembering that, although the trend for bet-ter disclosure is becoming apparent in large businesses,what happens in the top echelons of the FTSE 100 is noindication of what the rest of the listed companies arepractising. Hence the need to raise awareness of the sub-ject among the business community.

As the Enron case highlighted, it is not just the accoun-tants or impersonal market forces that are responsible forcorporate failures. The press has singled out the roleplayed by Enrons auditors and the shredding fiasco. Butthe role of boards and the issue of corporate governancealso deserve closer inspection (see the section onCompany Law below). In addition, analysts themselvesshould come under closer scrutiny the recent case ofMerrill Lynch being asked by the New York StateAttorney to disclose more information to investors comesafter the company was accused of providing misleading

stock recommendations in an attempt to secure contractsfor its investment banking services.


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public relations exercise. If individual companies are leftin charge of choosing what they disclose, the informationcan suffer from a considerable company bias. Comparingcompanies would become increasingly difficult as aresult, yet the other equally unwelcome extreme is theenforcement of rigid prescriptive rules and a tick-boxapproach. In fact, comparing like with like is one of thefactors in the continuing resiliency of the current system.In the words of Simon London (Financial Times, 16 January),asking a company to put a dollar value on its accumu-lated research and development spend or any otherintangible asset is like asking a kleptomaniac to countdiamonds. Guidelines defining terms such as researchand development and similar expenditure categoriesthat create long-term value are needed.

In the absence of agreed standards or at least a consensuson the measures used, asking companies to add more

detailed information to an already complex reportingsystem will raise doubts about the comparability andtherefore trustworthiness of their published results. Inaddition, there will be concerns about auditing the infor-mation provided in this manner. CIMA has no illusionsabout how difficult this process will be in practice.Building up data on historical trends is not enough what the market needs is cross-company comparability.CIMA is currently in the process of initiating research inthis area that will contribute to the debate.

New models and standards are emerging all the time

for example, the Financial Accounting Standards Board(FASB) in the USA has announced that it is preparing anew accounting standard that will require companies todisclose information on intangible assets such as brandnames, customer lists and patented technology. The expo-sure draft is expected to be published by this autumn.

The third objection to transparency is usually related tocommercial confidentiality. The complaint is, to a certainextent, unjustified no company will ever be expected topart with truly sensitive information. However, the defin-ition of what may be commercially sensitive has changed.As Nordberg says (Nordberg, 2001), the duration of the

value curve has shortened. In todays volatile markets,the more rapidly market conditions change, the morequickly hard-won market intelligence loses its value. Andfrom the company perspective, the faster the pace ofchange, the faster the decline in the value of maintainingconfidentiality of information.

Benefits ofincreased transparency

So what are the benefits? For a start, investor confidencewill improve with the increase in relevant information.This will in turn lead to more long-term investors. Ascompanies become more open with their strategy, the

quality of the management, the value of their assets andthe risks they face, they will become a less risky proposi-tion for investors. In this virtuous cycle, they would thenhave access to cheaper capital. Markets will eventuallyreward better disclosure and penalise opaque practices.Miller (2001) says:

First, the lack of useful information in a companys financial

statements may cause the markets to pursue other

investment opportunities. If so, the resulting diminished

demand for its securities creates lower prices and higher

capital costs. Second, the markets may decide that the

companys investment potential is great, even though the

reported information is inadequate. If so, they may invest, but

only after taking into consideration the resulting higher

degree of uncertainty and insisting on a higher expected rate

of return which will depress the securities prices and

increase the cost of capital. Again, this typical minimumreporting strategy doesnt advance the stakeholders

interests. Third, sophisticated investors and creditors will turn

elsewhere for private information thats more useful than

GAAP financial statements.

Despite all the potential benefits, many are still scepticalabout the practicality of total transparency. For many com-panies, especially the first movers, the shift will not beeasy. The biggest obstacle is the fear that the companiescould end up being held hostage to fortune. In addition,there will be concerns about the reliability of what the

companies disclose. As already mentioned, some kind ofexternal verification and/or auditing will be necessary.The cost of providing more information might prove tobe a significant barrier, especially for smaller companies.Some may have already developed leading performanceindicators for internal use or they may soon be requiredto do so by either the general trends in the businessworld or market pressures. Switching to increased disclo-sure should be the next step. But starting off with aredesign of management accounting information canprove to be a valuable and cost-effective exercise as it willhelp companies identify the main assets and activitiesthat really drive value in their companies.

There have been some attempts to develop systems ofreporting that would enable companies to address alldimensions of value and report on all the relevant driversof value generation. For example, Total Value Creationclaims to use methods that measure and report event-based future financial and non-financial value streamsand assess value creation performance for multiplestakeholders from a variety of perspectives. Furtherdetails can be found at:www.totalvaluecreation.com

Another framework entitled ValueReportingTM

has beendeveloped by PricewaterhouseCoopers and is outlinedbelow.


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Even before the Enron saga unfolded, companies'external reporting was already a focus of fiercedebate among the accounting community, and of sig-nificant ongoing change at the regulatory level. In apost-Enron world the issues are being played out ona wider stage amid the glare of media interest.

The need for a new framework

While we believe that historical financial statementsremain a key component of the financial reportingmodel, we recognise that they do not meet the needsof all a companys stakeholders in todays world.

With share price valuations increasingly determinedby expectations of future cash flows, investors aredemanding a better analysis of risk, more forward-looking and non-financial information. Theseinclude lead indicators such as customer andemployee satisfaction, levels of innovation, throughto the impact of environmental issues.

As well as underpinning a company's performance,these forward-looking factors are pivotal to the cre-ation of value. When a company reports on these inan open and transparent way, it is giving investors

and analysts additional information they need toassess its true value. At the same time it is reinforc-ing the credibility of management. The best-in-classperformers have realised they must eventuallydevelop new market-driven reporting frameworks,enabling targeted transparency across the full rangeof corporate information. And post-Enron, investorswill inevitably be focusing to a greater extent thanever before on transparency.

The ValueReporting framework

With developments such as these in mind,

PricewaterhouseCoopers set out some years ago todevelop a market-driven reporting frameworkspecifically to close the gaps between the informa-tion companies currently report, and the informa-tion the markets want and need. Since then, ourextensive research in the capital markets worldwidehas enabled us to develop a framework calledValueReporting that we believe provides a compre-hensive view of the critical value-relevant informa-tion, and how it can be presented in a cohesive andlogical way. The research and findings are encapsu-lated in a book published in 2001, The Value

Reporting Revolution: Beyond the Earnings Game.

Put simply, ValueReporting advocates starting froma position of complete transparency, with whateverfinancial and non-financial information the manage-

ment uses to run the company becoming the basis ofwhat it reports to the marketplace. Clearly, compa-nies need to make adjustments to deal with sensitivecompetitive information or unreliable performancemeasures but these decisions will depend on theperceived costs and the benefits of making enhancedinformation available to investors.

Of course, financial information remains very impor-tant, and ValueReporting does not replace it. Instead,it looks to augment it in several crucial ways.Investors and other stakeholders want more, andbetter, information about the factors that effect value

creation in a company: market dynamics, corporatestrategy and the intangible assets and non-financialmeasures that are leading indicators of future finan-cial performance. And that information simply doesnot appear in traditional financial statements.

Research findings

The research that laid the groundwork forValueReporting is still continuing. Our initial capitalmarkets research, covering institutional investors andsell-side analysts in the USA, the UK and 12 other

countries, showed overwhelming consensus on ninemeasures (out of a total list of 21) considered to beespecially important to sound investment decisions:

G Earnings;G Cash flow;G Costs;G Capital expenditure;G R&D investment;G Segment performance;G Statements of strategic goals;G New product development;G Market share.

This list includes financial and non-financial infor-mation some relevant to past and near-future per-formance, other more relevant to longer-termprospects. Both investors and analysts generallyreported higher levels of satisfaction with the qual-ity of financial information than non-financial infor-mation reported by management.

Our research has subsequently concentrated on spe-cific industries, evaluating the tailored informationand metrics specifically important to companies and

the market, the quality of this information, how wellmanagers think they are communicating information,and the markets level of satisfaction with the qualityand quantity of information it receives. To date, wehave conducted global surveys in banking, insurance,

ValueReportingTM: a road map to greater transparency

David Phillips, European leader of ValueReporting, PricewaterhouseCoopers


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. by closing the communications gapsThe overall message is that the Value Gap is openedup by mismatches between the information thatcompanies report and the information that investorswant. Our research has revealed three crucial ele-ments:

G The Information GapThis is defined as the difference between theimportance attached to a measure by analysts andinvestors, and their satisfaction with the informa-tion actually received from companies.

G The Reporting GapThis gap comes from the managements perspec-tive, and occurs when management says thatalthough certain information is important in run-

ning the business, they fail to make it available tothe marketplace. One reason for this could be thatthe companys data is not sufficiently reliable toreport publicly.

G The Quality GapThe difference between the importance executivesattach to information and the reliability of theirinternal systems when it comes to generating thatinformation.

ValueReporting in practice:

The ValueReporting FrameworkValueReporting, properly implemented, bridgesthese three gaps, bringing clear benefits to compa-nies and investors. Companies get increased man-agement credibility; more long-term investors;lower cost of capital; improved access to new capi-tal; and higher share values. For investors, betterdisclosure provides more relevant information formaking sound investment decisions, as well as bet-ter risk-adjusted returns.

To help companies put this into practice, we have

developed the ValueReporting Framework, an over-all approach for measuring and managing corporateperformance and structuring communications aboutthat performance (see Figure 3). The Framework istailored to match the performance dimensions ofspecific industries, enabling companies to commu-nicate their value in a language that investors willunderstand.

The Framework is built, above all else, on trans-parency. It assumes that shareholders come first,while recognising that long-term sustainable value

can only be realised if the needs of all stakeholdersare also included. Companies should make all infor-mation available unless they have a good reasonnot to do so.

high technology, consumer products, retail and phar-maceuticals, with several more planned.

This industry-specific research indicates that differ-ent reporting models are relevant on a sectoral basis and even from company to company within thesame sector, depending on their strategy and corpo-rate objectives. However, some of the basic findingsare consistent across industries, including the viewthat companies' corporate disclosure practices areoften inadequate and that there are significant per-ceived benefits to improving them.

Closing the 'Value Gap'..

One of our most significant findings is that more andmore companies face a 'Value Gap' the difference

between managements perception of their company'svalue, and the value placed on its securities in thecapital markets. Figure 1 below shows that the execu-tives surveyed tend to see themselves as relativelyproactive in how they report to the market. Investorsstrongly disagreed, however, showing market dissat-isfaction with companies reporting methods.

Figure 1: Perceptions of corporate disclosure

However, the potential for narrowing the mismatchbetween the perceptions of management andinvestors is underlined by their agreement over whichof the performance measures are most important for

creating value. As Figure 2 indicates, in every indus-try both executives and investors placed a greaternumber of non-traditional measures than traditionalfinancial in their lists of the most important measures.

Figure 2: The most important measures executives/investors

C I C I C I C I C I C I C = Companies

I = Investors

0

5

10

15

Banking Insurance Pharma-ceuticals

H ig h Tech R et ai l Consumerproducts

Traditional financial measures

Non-traditional measures

0

1

Minimal Proactive

2

3

4

5

Companies

Investors


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Figure 3: The ValueReporting Framework

The Framework addresses four principal categories:

G Market overview:the managements perspective on industrydynamics and market positioning.

G Value strategy:depth and clarity of strategy.

G Managing for value:how companies manage their financial resourcesfrom an economic and risks perspective.

G Value platform:critical investment in the activities/relationshipsthat underpin value creation.

If a company is to project a coherent picture of itsbusiness, management needs to provide significantinformation in all four categories.

Getting started

The real challenge for most companies looking atmoving to ValueReporting lies in identifying the cur-rent gaps in their own information and putting theright framework of information together. A furthercrucial element is linking the distinct building blocksof information to create a coherent overall picture.

The key to achieving this is not to try to cherry-pickthe right information. This approach helps no oneand would act against creating the transparencywhich will ultimately benefit everyone. Instead, thecompany should set itself a long-term objective ofprogressively narrowing the reporting gap betweenits internally used management information, and theinformation disclosed externally. This process isillustrated in Figure 4.

The implications of ValueReporting do not end withcompanies, but also extend to the role of accountants.

Should the accounting function expand to absorb andintegrate the new measures and information that arebeing reported? Or should traditional financialaccounting be kept separate from the increasinglyimportant and influential non-financial measures?

Figure 4: Narrowing the 'Reporting Gap'

In our view, the only practical way forward is inte-gration. Financial and non-financial informationboth feed into the same decisions, whether it is man-agement or investors who are taking them. The logi-cal conclusion from this is that ValueReporting is all

about breaking down silos and creating a commonbridge linking management accounting, financialreporting and investor analysis.

The breaking down of silos and the creation of acommon bridge linking management accounting,financial reporting and investor analysis isinevitable, as the information that is important tounderstand value creation needs to be at the heart ofall three elements of measurement and analysis.Perhaps the key is to remove the word accountingfrom the discussion. The focus has to be on informa-

tion, whether it be financial or non-financial. Theend-game is the creation by a company of a compre-hensive set of performance information and metrics,reflecting the shape of information in theValueReporting Framework, which is used to man-age the company, is used to drive external reporting,and which, for the investor, provides the majority ofinformation required to make an objectiveinvestment decision. Today the three elements areunaligned and each element omits key elements ofinformation, with perhaps the financial reportingmodel being the element most out of line.

Put another way, investors want to know whatinformation management use to manage the busi-ness. Our research shows that there is a good deal ofalignment between the views of investors and man-agement as to what is important information inunderstanding value creation. A significant issue,however, for many companies today is that they donot have the information, or if they do they admit itis unreliable. At the end of the day, assisted by theimpact of technology such as XBRL, we will face theworld where companies have one database of infor-mation, carefully and coherently constructed, which

is used to both run the business and communicate toall stakeholders. The only external reporting issuethat management will have to decide is where theydraw the line of transparency across this informa-tion set.

ValueReportingTM Framework

External Internal

MarketOverview

CompetitiveEnvironment

RegulatoryEnvironment

Macro-economicEnvironment

ValueStrategy

Goals andObjectives

OrganisationalDesign

Governance

Managingfor Value

Economic Performance

Financial Position

Risk Management

Segmental Performance

ValuePlatform

Innovation

Brands

Customers

Supply Chain

People

CorporateReputation

Information

Internal

Information

ReportedInformation

1

4

3

2

Time

Index

1. Quality and breadthof internal information.

2. Information reportedexternally.

3. Vision of futureexternal reporting.

4. Enhancement tointernal reportingsystems.

Reporting Gap


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So how can change occur? First, all accountantsneed to be trained to understand the critical linkagebetween internal and external reporting, and raisetheir knowledge of what drives value (the valueplatform) and how it can be measured, monitoredand managed. Second, the external reporting modelhas to be better aligned to the information usedinternally by management to manage the business this is the heart of ValueReporting. Finally, manage-ment need to reassess whether they really under-stand what drives value, and whether the internalprocesses and metrics generate the information theyand investors need to understand the future poten-tial of the business.

About ValueReportingTM

ValueReportingTM (www.valuereporting.com) wasdeveloped to help companies realise their full valuein capital markets and to give investors and otherstakeholders the information they need to makefully informed decisions about how a company isperforming. The best value creation efforts of manycompanies often go unreported and unappreciatedby the marketplace. After all, investors cannot valuewhat they cannot see.

The ValueReporting Framework enables a companyto communicate its value in a language that

investors understand. This includes managementsview of the marketplace, its strategy for competing,its targets and objectives, and the assets bothfinancial and non-financial the company considersmost critical to its success.

ValueReporting in action: its use so farIn our experience to date, it is fair to say that no sin-gle company yet embodies all the elements of thefull ValueReporting Framework in its corporatereporting model. But, as our ValueReporting Forecast2002 clearly shows, every aspect of what wedescribe as 'important information' is being reportedsomewhere by one or more companies. This meansthat best practice is already starting to emerge in theapplication of ValueReportingTM in the real world.

In terms of theMarket Overview quadrant, one of thebest examples we have seen is the Bank of Montreal'sreporting on the macroeconomic environment, plac-ing the outlook for its own business in the context ofthe Canadian, US and world economy.

In the area ofValue Strategy, Boots plcs AnnualReport and Accounts 2001 describes the linkbetween shareholder value creation and executiveremuneration through the use of a shareholdervalue metric total shareholder return (TSR) as akey performance measure.

In terms ofManaging for Value, Barclays Bank describesits use of value-based management (VBM) relative toits commitment to shareholder value creation.

And in the Value Platform arena, Ford Motor Company

describes its commitment and approach to reducing itsenvironmental footprint, and communicates itsadherence to global reporting initiative (GRI) guide-lines.

All these case studies, and many more, are explainedand illustrated in: PricewaterhouseCoopers0ValueReporting Forecast 2002

The impetus for better disclosure is partly driven by thechange in technology that supports financial operations.Sophisticated software has automated and integrated a lotof routine processing and ERP systems are designed to:

G provide a better understanding of the businessG increase accuracy of information and speed of deliv-

ery

However, ERP implementation in itself does not provide

improved decision making and strategic managementprocesses in an organisation. This can only be achieved bytaking a strategic enterprise management approach thatallows the best companies to sustain competitive advan-tage through a superior strategic management process.

The technologies that enable SEM which are beingoffered by the big software vendors will continue toevolve and it is likely that the next two years will see agrowing number of ERP vendors and niche softwarefirms offering SEM capability. In the long term, CIMAbelieves that sustainable competitive advantage fromSEM will arise neither from the adoption of widely avail-able software nor from techniques. More important willbe each management teams success in adapting the tech-nologies and techniques to the unique operating environ-

ment and decision-making culture of their ownorganisation.

The CIMA SEM project is about organisations improvingthe quality and effectiveness of their strategic manage-

Strategic Enterprise Management (SEM)

This article is reproduced by permission ofPricewaterhouseCoopers who retain copyright.


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ment processes to secure a sustained advantage overcompetitors. Evidence to date suggests that successfulcorporations have in common a superior strategic man-agement process. This involves not just business perfor-mance management, but also the more proactive areas ofbusiness problem solving, business learning, and busi-ness direction setting. It is only when this capability is inplace that an organisation can begin to develop and sus-tain competitive advantage by enhancing decision mak-ing in important areas such as its:

G Choice of marketG ArchitectureG CultureG Value chainG Strategic resources

Success in adopting a SEM approach can be measured

broadly in two ways:

1. by how well senior executives feel they are able toempower their employees to run an organisation asefficiently as it can be run in the present day;

2. by having the necessary space themselves and theright information to develop a superior strategic man-agement process that can take the company forwardin the medium to long term.

In an SEM approach, the finance function can bridge the

gap between strategy and operations by making share-holder value the key criteria in decision making and byproviding the tools and information to support a SVMapproach. This involves helping executives operationaliseSEM by informing them what factors drive value andwhere value is created or destroyed. Improving the effec-tiveness of strategic management processes in terms ofexecuting and adapting strategy is achieved by providingbetter business intelligence capability in the form of infor-mation captured from within the organisation and fromthe external environment in which it operates.

SEM also helps management monitor and communicate

strategic and operational objectives by providing a real-time measurement of value drivers and reporting on theirimpact on organisational performance. It is an approachwhich will therefore aid transparency with all stakeholdersand provide the basis for improved reporting externally.

CIMA is leading the thinking in this emerging area via itsRound Table of CFOs, consultants and academics. Aswell as providing various opportunities for the partici-pants, particularly in terms of learning through sharedexperiences and case studies, CIMA is using this forumto promote the advantages of a SEM approach and good

practice in this field. For more information and resourceson SEM, please see:

www.cimaglobal.com/main/resources/developments/sem/

Technological changes

Fast closingThe impact of new technology has been pervasive inother areas. Speed itself has become a source of competi-tive advantage technological innovation is shorteningproduct life and capital investment cycles. Indeed, speedto market has become crucial. Thanks to web-enabledtools, industry leaders such as Cisco have pioneered dif-ferent ways of getting information out in as little as a day.

Fast closing is not an end in itself. Instead, it should becomean opportunity to sort out all the inefficiencies that makethe month-end close such a drudgery for finance profes-sionals. Put simply, there is little point in embarking on acomplex programme of change to achieve a fast close if the

underlying process is flawed to start with. Fast closingshould be about reliability and relevance as well as speed.Fixing the basics will increase management confidence inthe numbers produced both for internal reporting needs aswell as for current and potential investors. Companies will-ing to undertake comprehensive albeit costly reviews oftheir processes will inevitably be seen as more proactiveand better managed and controlled than their competitors.This is no small advantage in an environment where strat-egy and the quality of management rather than the tangibleassets can distinguish a company and attract investors.

Although apparently a purely operational issue, fast clos-ing can clearly generate benefits on a more strategic level.It will in effect mean that key financial information willbe available on a timely basis. This should, in turn,improve forward planning, decision-making and externalreporting. Problems can be spotted and rectified before itis too late, and up-to-date information will allow moreinformed decision-making. The emergence of best prac-tice can also be observed in the way many companies arenow beginning to narrow the gap between the time ofclose and the time of reporting to markets.

Web-enabled technologies, the unprecedented speed and

ubiquitous nature of the Internet, have forced many busi-nesses to become 24/7 operations transcending distanceand time differences. The Internet has made informationwidely available, easily accessible and most impor-tantly cheap.

Although many members of the investment communitystill expect a glossy annual report, more and more com-panies are using their websites to communicate with themarket. A convenient and cost-effective communicationtool, a company website can include not only the latestaccounts or financial reports but also interactive web-

casts, videos and so on. For example, the preliminaryresults for 2001 from WPP Group plc on a websitedevoted exclusively to investor relations include not onlythe main text and the relevant tables but also an audiopresentation with synchronised slides and a pdf presen-tation document (www.wppinvestor.com). There are,


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however, some remaining concerns about the reliabilityof online accounts, as it is technically possible to alterthem after they have been audited.

A research report by ICAS entitled Business Reporting:Harnessing the Power of the Internet for Users (2002) high-lighted the fact that, although the Internet is becomingaccepted as a medium for delivering financial data, it isunlikely to replace human interaction.

XBRL

The nature of the information contained in online finan-cial reports is likely to change, however, with the lan-guage used for Internet reporting. HTML or HypertextMark-up Language which tags every page in theInternet, provides a format in which relevant informationis displayed. Although it tags the information displayed

in the browser, the tags only serve to present the informa-tion in a certain way such as in italics or in tables. Itsimply displays the information without being able toread or make sense of it, so it does not allow it to beanalysed or compared in any way.

Enter XML Extensible Mark-up Language. It is an elec-tronic reporting language that functions across all softwareand technologies, including the Internet. Its advantage isthat it tags information in a way comparable to a bar codeso that each individual piece of data is described in a com-prehensive way, regardless of the format.

XBRL Extensible Business Reporting Language is anopen specification for the reporting of financial informa-tion in XML. Its primary aim is to enhance the trans-parency and usability of all financial data (and, at a laterstage, non-financial too) on a global scale. Its potential isbased on taxonomies XML-based data tags that describefinancial statements and are available for universal use byall members of the financial information supply chain.

It provides the financial community with a definedframework to prepare, publish, extract and automaticallyexchange financial statements. It is therefore about

changing the process of disclosure rather than establish-ing and enforcing new standards.

In March this year, Microsoft started reporting in XBRLfor the first time, claiming that it expects to see a quickreturn on its investment. Only Reuters and MorganStanley Dean Witter have so far published their financialdata in this way. However, XBRL has had enormousstakeholder support and international participation. AsBob Eccles, principal at Advisory Capital, a US consult-ing firm specialising in financial reporting, says in theFinancial Times (5 March 2002):

This is just like a fax machine. If only a few companies are

publishing in XBRL, it is not much use. We need a collective

movement to encourage companies to go with us.

XBRL has several key aims:

G To enable business reporting that leverages theInternet so that web browser searches are more effi-cient and relevant. An XBRL-based financial state-ment is a digitally enhanced version of a paper-basedone that includes the balance sheet, income statement,statement of equity, statement of cash flows and thenotes to the financial statements as well as the audi-tors report.

G Effective access and analysis of business reports forboth internal and external users. Computer programswill be able to easily extract every piece of informa-tion in a financial statement.

G Improve corporate communications with stakeholdersand enhance financial information through the supplychain.

In future, the aim is to develop business reporting forXBRL so that taxonomies carry non-financial data.

The envisaged benefits of XBRL to end-users include:

G Reduced cost of reporting and analysing financial andother information.

G Increased speed and efficiency of business decisions.G Enhancing the distribution and access of existing

financial statement information.G Increasing and enhancing analysis, i.e. investors, ana-

lysts, regulators and other users can spend more timeanalysing information rather than simply looking forit. Analysis can be automated and presented in differ-

ent formats. Nasdaq estimates (Financial Times, 5March 2002) that about 10,000 publicly listed compa-nies in the USA are not covered by Wall Street ana-lysts part of the reason for such a large gap must liein the forbidding cost of collecting information. XBRLshould make it easier and cheaper to do this.

G Increasing transparency and therefore accountabilityof financial reporting.

Its critics claim that, despite the alleged benefits, XBRLwill do nothing to actually improve the current system ofreporting. Electronically tagging financial informationdoes not necessarily lead to that information meaning

anything more. Some claim that XBRL could in fact makematters worse by enabling different companies to reportidentical items in more than one way. In addition, it maynot put any additional pressure on companies to disclosemeaningful information online the same accountinggames will continue to be played, only digitally.

Although some of the objections to XBRL may be con-strued as valid, they run the risk of divorcing style theformat in which the information is presented and con-tent in a very simplistic manner. Information is neverneutral it is always partly defined or constrained by the

way in which it is presented.

The international effort to create taxonomies and defineindividual data tags will have to start from some kind ofconsensus about what to call particular reporting items.


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There will always be room for deviation but it should beno worse than what is available at the moment. In fact,one can hope that the predicted mass move to XBRL (thelist of companies subscribed is impressive) will pushcompanies to first simplify and then standardise existingfinancial information. The increased speed and analyticalcapability should in turn lead to other improvements inthe content of the information that makes up financialstatements.

The impact of XBRL may initially be more evident ininternal reporting, say, between subsidiaries as they arelikely to use the same accounting policies. The prolifera-tion of new organisational forms based on partnershipsor networks and the global and fragmented nature ofmany of todays supply chains will play their part in themove towards consolidation.

Admittedly, XBRL cannot achieve this in isolation. Butalongside all the other drivers for change, it should playits part in revolutionising external reporting. Web-enabled technology has united traditional financialreporting and the Internet in a way that will increase thespeed and the accuracy of gathering and disseminatingrelevant financial information.

InternationalAccounting Standards

The push for more transparent and exhaustive reportinghas been partly driven by regulatory pressures. In the lasttwo years, several significant developments have takenplace in the realm of international accounting standardsand the harmonisation of financial reporting regimes:

G The International Accounting Standards Committeecompleted its programme of core standards(December 1999);

G The International Organisation of SecuritiesCommissions recommended that multinational enter-

prises should be able to use International AccountingStandards (IASs) for financial statements for cross-border listings and offerings (May 2000);

G The USAs Securities and Exchange Commission(SEC) is considering whether it will accept financialstatements in IASs from foreign registrants withoutrestatement or reconciliation to US GAAP (conceptrelease published February 2000);

G The EU proposal requiring all companies listed on aregulated market within the EU to prepare groupfinancial statements using International AccountingStandards in place of national standards was ratified

by the Council of Ministers (June 2002).

The most significant development, from the viewpoint ofUK listed companies, is the EU decision. It means a lot ofwork within a very tight timescale for standard-setters,preparers of the financial statements, auditors and users.

The deadline for the implementation of the EU regulationis January 2005. In addition to listed companies prepar-ing their accounts using IASs, the regulation gives mem-ber states the option to extend the requirement tounlisted companies as well as single entities. This mayencourage the total replacement of national standardswith IASs as many member states might wish to avoidhaving separate regimes for listed and unlisted compa-nies.

The intention behind the proposal is to make financialstatements of organisations from anywhere in the EU and hopefully the world comparable. This, in turn,would eliminate barriers to cross-border trading andreduce inequalities in the cost of raising capital. In fact,capital market efficiency and the consequent boost to theEU economy is the main driver behind the proposal. Inaddition, some envisage that it will improve shareholder

dialogue and the clarity of strategic direction for theorganisations directly affected by the requirements.

The points worth bearing in mind are:

G Enforcement mechanismA two-level mechanism is in place: an AccountingRegulatory Committee operating on a political level,which is supported by a technical committee, theEuropean Financial Reporting Advisory Group(EFRAG). This group is made up of representativesfrom the various constituencies with an interest in

financial reporting users and preparers of accounts,national standard-setters and the accounting profession.G Further EU regulation

The European Commission will continue its financialreporting work by modernising two of the existingAccounting Directives (the 4th Company LawDirective and the 7th Directive on consolidatedaccounts) over the next two years.

G IASB work programmeThe general consensus is that almost all the currentIASs will be revised over the next few years. The cur-rent agenda for the IASB was published on their web-site on 27 June 2002 with convergence a priority.

G ASB work programmeThe ASB itself acknowledges that this would not bethe right time to introduce new UK standards its pri-ority is to assist in the convergence programme. InMay, the ASB published for comment FinancialReporting Exposure Drafts of proposed UK account-ing standards, aligned with IAS: Foreign currency translations; Related-party disclosures; Earnings per share; Post balance sheet events; Inventories, construction and service contracts;

Tangible fixed assets; Financial instruments.

G Training and educationMore emphasis will need to be placed on InternationalAccounting Standards in the syllabi of all the profes-sional bodies. Accountants who qualified before these


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standards became relevant will need to ensure theyupdate their knowledge sufficiently to understandtheir application and interpretation. The ConvergenceHandbookis a useful starting point for UK accountants.

The Convergence Handbook, prepared for the ASB by theICAEW, was published in November 2000. It comparesdifferent treatments for various issues under interna-tional and UK standards and suggests solutions for con-vergence. The solutions include the adoption of the bestof both UK and international standards.

TheHandbookwas originally a consultation document.CIMAs contribution, echoed by other contributors, was aplea not to worsen the impact of these changes by intro-ducing further changes to national standards that wouldhave a limited life before being overtaken by harmonisa-tion. Subsequently, the implementation of FRS 17 has

been delayed.

It is probably too early to judge whether the internation-alisation of accounting standards will in fact be worth theeffort on behalf of the standard-setters, the costs incurredby the business community and the investment in train-ing by professional bodies and individual accountants.The ultimate goal, of course, is transparency and compa-rability. At the moment, the case of Enron and the pre-scriptive US approach seem to have revealed thepotential benefits of replacing national standards withIASB ones and aiming for a principles-based approach. If

harmonisation can be achieved, it is ultimately worth theeffort, although there will inevitably be risks involved.

The Financial Accounting Standards Board in the USA iscurrently exploring the possibility of adopting standardsthat emphasise basic principles and objectives rather thandetailed rules, exceptions and alternatives to the underly-ing principles. Such standards would place the focus onaccounting for the substance of a transaction rather thanits form.

Although all the EU countries are involved in the pro-posed IAS changes, the effect on the UK is likely to be

unique. Not only does it have the highest number oflisted companies but arguably also has the best stan-dards in the EU.

Introducing IASs is a major step towards consistency andcomparability, but sceptics like to point out that culturaland language differences leave enough room for differentinterpretations, although they will be translated. There areother potential problems too for example, whether com-panies will be required to report quarterly, rather thanbiannually as at present. There will also be issues aboutspecific sector requirements.

Company Law Review

When British company law was created in the 19th century, it

was a source of competitive advantage. Now it has become

a competitive disadvantage. The law has become encrusted

with amendments and case law over generations. It has

failed to adapt to meet the changing role of small enterprises

Patricia Hewitts preface toModernising Company LawWhite Paper July 2002

In the UK, following three years of extensive consulta-tion, the Company Law Review has been completed andthe final draft submitted to the Secretary of State forTrade and Industry at the end of July 2001. Although thegovernment is not expected to table formal proposals

within the current parliamentary session, the develop-ments outlined in the report are likely to be included inthe updated Companies Act in 2003.

In July 2002, the Secretary of State for Trade and Industry,Patricia Hewitt, published a White Paper entitledModernising Company Law which invites comments onhow the recommendations of the Final Report are imple-mented. Responses should be sent by 29 November 2002.

The Strategic Framework(Company Law Review SteeringGroup, 1999) states:

Company accounting and reporting remains essentially

backward looking and based on financial indicators. There

are few statutory requirements to report on the main

qualitative factors which underlie past and future

performance (or for future performance, even financial

factors) in particular on strategy, prospects, opportunities

and risks; on intangible, and so-called 'soft', assets (which

may contribute significantly to success but are not well

captured in traditional financial statements); and on key

business and wider relationships. As a result, the information

provided is defective and directors do not have the discipline

of accounting for stewardship on some key responsibilities.

As the above quote illustrates, an important aspect of theCompany Law Review has been to reassess the structureand process of current financial reporting practices with aview to increase corporate responsiveness to wider inter-ests through transparency and accountability (StrategicFramework, 1999). It essentially acknowledges that theinformation currently provided by the majority of com-panies is not only backward looking (and thus gives noreal indication of future performance) but also fails torecognise that in the course of generating wealth compa-

nies may cause various kinds of external harm of whichsociety disapproves damage to health and safety, abu-sive employment or contracting practices, and environ-mental damage (ibid.). It therefore calls for companies toaddress the issue of transparency by disclosing more and


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better information about their performance and how itaffects a variety of stakeholders.

As they presently stand, directors statutory duties to oth-ers beyond the owners of the company are minimal.There have been proposals to redefine them along thelines of the so-called pluralist approach where compa-nies are required by law to serve a wider range of inter-ests not subordinate to, or as a means of achieving,shareholder value but as valid in their own right(ibid.). The companies would therefore have to juggle anumber of equally legitimate interests and seek suitabletrade-offs between them.

This approach was rejected as unfeasible companieswould in reality become accountable to everyone and noone at the same time. Instead, the change put forwardwas for a mandatory rather than voluntary Operating

and Financial Review (OFR). It would rectify the currentanomalies by redefining their duties to take into accountwider stakeholder interests while maintaining their legalaccountability to shareholders alone.

It goes some way to transforming both what and howcompanies report as their main measures of performance.Besides traditional financial measures, they will berequired to include an account of how the companysintangible assets contribute to overall value generationand how the conflicting stakeholder interests are balanced.

It must not end up being just a checklist, as boiler-platereporting will always be ineffective. It should containwhat the directors think is important.

The Final Report from the Company Law ReviewSteering Group (2001) specifies the areas to be covered inthe new OFR as the following:

Always required:

(i) The companys business and business objectives,strategy and principal drivers of performance.

(ii) A fair review of the development of the companys

and/or groups business over the year and positionat the end of it, including material post-year-endevents, operating performance and material changes.

(iii) Dynamics of the business i.e. known events, trends,uncertainties and other factors that might substan-tially affect future performance, including invest-ment programmes.

Required to the extent material:

(iv) Corporate governance values and structures.(v) An account of the companys key relationships, with

employees, customers, suppliers and others, onwhich its success depends.

(vi) Policies and performance on environmental, commu-nity, social, ethical and reputational issues, includingcompliance with relevant laws and regulations.

(vii) Receipts from and returns to shareholders.

It is clear from the above list that some of the informationprovided in this way will not be quantitative in fact, theFinal Report explicitly states that the OFR is a qualita-tive, as well as financial, evaluation of performance,trends and intentions, prepared by the directors fromtheir perspective as managers of the business.

Rather than issuing detailed mandatory requirements,the OFR focuses on directors judgement to provide a rel-evant account of their companies performance.

Corporate governance has been retained as a separateheading on the above list despite the fact that the report-ing of risk is in fact covered by items (i), (ii) and (iii). TheSteering Group stresses that the reason for this is thatitem (iv) is in fact concerned with controlling and focus-ing the powers of management and not with the specificrisks or ways to combat them.

There are, of course, problems with a forward-lookingOFR that requires companies to increase their disclosureon risk. According to the Gee Corporate GovernanceHandbook, when finance directors were asked about riskreporting, their main concern was being held hostage tofortune if suddenly faced by unexpected events. They alsoexpressed discomfort about being a what if company andworried that the premature announcement of a potentialrisk could damage their share price. In addition, theyclaimed that if the risks were becoming significant enough,they would not wait until the OFR to announce it.

As theHandbooksuggests, the OFR could become a vic-tim of its own versatility in a 1998 discussion paper, theICAEW called for a separate and specific statement ofrisk. Any further developments in this area will be crucialas the importance of disclosing risk moves higher up thecorporate agenda, thanks to Enron.

CIMA fully supports the OFR. We see it as a positive stepin improving transparency by enhancing public reportingto stakeholders on long-term issues. We are currently con-tributing to the debate on what the OFR should includethrough a research project and a planned response to the

White Paper.

The common complaint among companies is that it is dif-ficult to obtain, categorise and analyse non-financial data FEE (Fdration des Experts Comptables Europens European Federation of Accountants) states that itshould be recognised that the subject matter is often verysubjective and social accounting lacks the rigours offinancial accounting. For verification to be effective, thereshould be clearly defined guidelines for the preparers ofthe information reported (Response to the Green PaperPromoting a European Framework for Corporate Social

Responsibility, 2002).

The overall message of the Company Law Review hasbeen to get companies to consider their multiple account-abilities to a range of different stakeholders. CIMA


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FEE, in its response to the European Commissions GreenPaper Promoting a European Framework for Corporate SocialResponsibility, states that:

there is the business case for CSR (Corporate Social

Reporting) including sustainable development, risk, corporate

reputation and ultimately shareholder value, even though this

may often attract little attention in comparison with short-

term issues.

However, there is plenty of evidence that companies arealready treating the corporate social reporting and sus-tainability agenda as an important part of their competi-tive strategy. They can gain market advantage throughgreen products, ethical investment and so on. This has inturn led to the creation and adoption of voluntary stan-dards. The ones currently tested in UK companies are:

G AA 1000:developed by the Institute for Social and EthicalAccountability;

G The Global Reporting Initiative:developed by a wide range of international organisa-tions;

G ISO 14001:developed by the International Standards Organisation;

G Project Sigma:

a sustainability management standard under develop-ment by the British Standards Institution, Forum forthe Future and others.

Global Reporting Initiative

Global reporting initiative (GRI) is a long-term, multi-stakeholder, international undertaking whose mission isto develop and disseminate globally applicable sustain-able reporting guidelines for voluntary use by organisa-

tions reporting on the economic, environmental andsocial dimensions of their activities, products and ser-vices (www.globalreporting.org). It arose from the needto address the failure of the current governance struc-tures to respond to changes in the global economy.

In June 2000, GRI published a set of sustainability report-ing guidelines. It envisaged them to be used as a decisiontool in three ways:

G At the level of the governing body, the guidelines pro-vide an internal vehicle for evaluating the consistency

between the organisations economic, environmentaland social policy and its actual performance. Theincreased uniformity in reporting facilitated by theguidelines will help reporting organisations to com-pare themselves with others and to recogniseimproved performance.


16

research on shareholder or stakeholder value shows thateven those companies that explicitly subscribe to Value-based Management (which advocates the primacy ofshareholders interests), nevertheless recognise theimportance of at least three primary stakeholders share-holders, customers and employees (Cooper et al., 2001).The researchers go on to say:

we see that all are treated as important to the business

and their interests balanced out, although there is a tendency

to treat shareholders as more important and hence have

more attention paid to them than the other stakeholders

whatever philosophy of performance management has been

adopted.

They cite the almost universal adoption of some form of abalanced scorecard technique as evidence of the compa-nies attempt to balance various stakeholder interests.

The discourse of financial reporting has in fact been shift-ing for some time from an economic view of corporateperformance measurement to an informational perspec-tive with a recognition of the social implications of anorganisations activities (Beaver, 1998, quoted in Cooperet al., 2001). The pioneers of corporate social reportingwould like the companies to go even further in theirpractices they call for reporting that would reflect thecompanys impact on societies, communities and theenvironment in which they operate in pursuit of share-holder value.

This represents the so-called triple bottom line wherecompanies would have to relinquish their traditionalfocus on financial bottom line and consider the impact oftheir performance on environmental quality and socialjustice.

Sceptics say that the only way the environmentallyfriendly and socially responsible practices and the moretransparent reporting frameworks will become wide-spread is if they are accompanied by a big regulatorystick. FEE believes, as do many other commentators, thatcorporate social reporting should be left to develop in a

voluntary setting, stimulated by market forces.

But it is worth bearing in mind the potential conse-quences of ignoring the current trend. Even if the govern-ment does not intervene (as it did when it introduced theLandfill Tax or the Climate Change Levy), companies arefacing serious reputational risks where they could bepenalised by customers for failing to be leaders in thefield. The whole concept of corporate risk will probablyhave to be redefined.

This process is already under way. In 1997, the Hampel

Committee suggested that directors should be maderesponsible for monitoring non-financial risks and con-trols, as well as traditional financial ones. In 1999, theTurnbull Committee confirmed that company boardsshould consider all relevant risks, including environmen-tal ones.


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G At the operational level, the guidelines provide a logi-cal structure for applying sustainability concepts tothe organisations operations, services and products.They also help guide the development of data andinformation systems for setting and tracking progresstowards economic, environmental and social goals.

G From a communications standpoint, the guidelinesprovide a framework for effectively sharing and pro-moting dialogue with internal and external stakehold-ers regarding the organisations accomplishments andchallenges in achieving its goals.

The guidelines are based on several detailed underlyingprinciples such as that of reporting entity, reporting scopeand period, conservatism, materiality and so on. Theyclassify the performance reporting elements into:

G categories (the broad areas of concern to stakeholders,e.g. air, energy, etc.);

G aspects (general types of information related to a spe-cific category such as child labour practices); and

G indicators (specific measurement of an individualaspect that can be used to track and demonstrate per-formance).

The indicators themselves are divided into:

G environmental (generally applicable and organisation-specific);

G

economic;G social;G integrated (systemic linking performance at the

micro-level with economic, environmental or socialconditions at the macro-level and cross-cutting bridging information across two or more of the threesustainability elements of an organisations perfor-mance).

For example, the indicators for social performance aresplit in the following manner:

WorkplaceQuality of managementG Employee retention rates.G Ratio of jobs offered to jobs accepted.G Evidence of employee orientation to organisational

vision.G Evidence of employee engagement in shaping man-

agement decision making.G Ranking of the organisation as an employer in internal

and external surveys.G Job satisfaction levels.

Health and safetyG Reportable cases (including subcontracted workers).G Standard injury, lost day and absentee rates (including

subcontracted workers).G Investment per worker in illness and injury prevention.

Wages and benefitsG Ratio of lowest wage to national legal minimum.G Ratio of lowest wage to local cost of living.G Health and pension benefits provided to employers.

Non-discriminationG Percentage of women in senior executive and senior

and middle-management ranks.G Discrimination-related litigation frequency and type;G Mentoring programmes for minorities.

Training/educationG Ratio of training budget to annual operating costs.G Programmes to foster worker participation in deci-

sion-making.G Changes in average years of education of workforce.

Incorporate achievement associated with training pro-grammes.

Child labourG Verified indices of non-compliance with child-labour

laws.G Third-party recognition/awards for child labour prac-

tices.

Forced labourG Number of recorded grievances by employees.G Incidents identified through organisations auditing of

suppliers.

Freedom of associationG Staff forums and grievance procedures in place per-

centage of facilities and countries of operation.G Numbers and types of legal actions concerning anti-

union practices.G Organisational responses to organising at non-union

facilities or subsidiaries.

Human rights

GeneralG Demonstrated application of human rights screens in

investment.G Evidence of systematic monitoring of organisational

practices.G Number and type of alleged violations, and organisa-

tional position and response.

Indigenous rightsG Evidence of indigenous representation in decision-

making in geographic areas containing indigenouspeoples.

G Number and cause of protests.

Security

G Examples incorporating security and human rightsinto country risk assessment and facility planning.

G Remuneration/rehabilitation of victims of securityforce action.


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SuppliersG Performance of supplier relative to social components

of programmes and procedures described above.G Number and type of incidents of non-compliance with

prevailing national or international standards.G Frequency of monitoring of contractors regarding

labour conditions.

Products and services

Major social issues and impacts associated with the useof principal products and services. Include qualitativeand quantitative estimates of such impacts, where applic-able.

Customer satisfaction levelsAs is obvious from the above examples, the GRI guide-lines prescribe the use of quantitative data. They encour-

age reporters to express the information as ratios as wellas providing absolute values, as this makes the informa-tion easier to interpret and understand.

However, GRI also suggests the use of qualitative criteriathat would enhance the credibility of reported data.They consider the main qualitative characteristics to be:

G relevance;G reliability;G clarity;G comparability;G

timeliness; andG verifiability.

More and more companies are beginning to use theframework for performance measurement and reporting,and in April this year, the GRI was officially inauguratedas a global institution at a launch in New York. For fur-ther details check www.globalreporting.org.

Sustainable development

In its response to the aforementioned Green Paper on cor-porate social responsibility, the European Federation ofAccountants noted that the term triple bottom line itself isno longer up to date and the use of the terms sustainabilityor value reporting is preferred. They add that corporatesocial reporting needs to be approached within the totalframework of corporate governance within which eachstakeholder should assume responsibility.

Sustainable development is a key concept that informsmuch of the current discussion around social reporting.The World Commission on Environment and

Development defines it as:

Development which meets the needs of the present without

compromising the ability of future generations to meet their

own needs.

Any mention

Documents

Post Enron World