Governance up the agenda for IR teams

“Governance” and “interesting” used to be contradictory terms for most IR people. However earlier this week, I went to a private lunch hosted by Tomorrows Company and Radley Yeldar (see my bio) which managed to combine both.

The point of the event was to allow a high quality group to debate the ‘stewardship’ of companies, and a potential disconnect of interests between ownership and the long term success of the company.

Tomorrows Company had produced an interesting perspective which graded degrees of stewardship, from the original founders of businesses with the highest degree of stewardship instincts, to speculators – members of the ‘casino’ economy, rather than the real one. The use of derivatives by these speculators to leverage investment without transparency has been an important contributor to this disconnect.

One of the key discussions centred around engagement with companies by (institutional) investors. We have recently seen cases of noted activists such as Knight Vinke joining up with traditional long investors to raise concerns with the companies in which they invest. However this is far from the norm.

Since few investors proactively seek to engage regularly with the companies they own, the discussion developed of how to communicate the governance values that companies subscribe to. Regulation is certainly not the answer, according to those at the lunch. And yet there is coming a need to defend comply or explain. The so-called Lecce framework – potential governance rules for companies across the EU – are due to be debated at the next G8 summit. And many other regulators are looking at their own codes, including the Walker Review, the FRC review of the Combined Code, the new Belgian Code, the PIRC calls for radical overhaul, the new Institutional Shareholder Committee governance recommendations....the list goes on.

However, in the meantime, how companies communicate their governance ambitions and culture is important. And difficult. One attendee told me that she was responsible for the governance section of her annual report, and that she had wanted to enhance it well beyond a simple set of compliance statements. However the company wanted to balance the information provided with the risk of “over complicating” their governance discussions with investors - and their proxy advisors.

By observation, many (most?) annual reports’ governance sections are formulaic and uninformative. A new best practice should evolve, which explains not only the compliance with the codes, but also the culture of governance within the company.

Corporate reporting is about ‘cutting out the clutter’.

The preparers of annual and other reports have always had to balance between compliance and communication. Traditional wisdom has it that so much of what the ‘rules’ say should be reported is of no interest to anyone, and is simply there for compliance sake.
Well now there is support for the view that reporting should be more about principles of good communication.

2 years ago, the Financial Reporting Council launched its project to review the complexity and relevance of current corporate reporting requirements. This week, it published Louder than Words: principles and actions for making corporate reports less complex and more relevant.
The discussion paper looks like a first step along a long road of change to what companies tell the market. Probably the most important conclusion to be drawn from it is that the FRC thinks that reporting should be more principles based. Indeed it lays down a series of communication principles. They are hard to argue with – motherhood and apple pie and all that – but the fact the FRC says them is helpful.

The report also makes 5 ‘calls for action’. In these days of focus on survival, the first call for action – to provide better information on cash flow and net debt – is vital. Pulling out and explaining key metrics used by investors such as debt ratios (gearing, interest and dividend cover), debt maturity profile, and contractual obligations will assist analysts relying only on the notes to the accounts.

So far so good. There are 2 areas where I am tempted to disagree.

First the title. We know that well over 50% of a company’s valuation does not lie on the balance sheet but in assets like management skill, technology, brands, patents etc. It would be unfortunate if some read the title as meaning that the narrative in annual reports – words after all – somehow mattered less.

The second is the statement about the intended audience for reporting. It says “One widely acknowledged problem is that reports currently aim to please too many types of user. There is a need to refocus them on their primary purpose: providing investors with information that is useful for making their resource allocation decisions and assessing management’s stewardship. We suggest that regulators and companies should reconsider how they address the needs of other stakeholders – for example, those with specialist interests in environmental and employee diversity issues.”

Environmental and employee issues absolutely deserve equal consideration with financial issues, and should be of interest to investors as well as wider stakeholders. They are part of the equity story, and should not be shunted into another report.