Corporate governance: Get on message

One of the keys to corporate governance is that it should all connect.
Information should make sense in the corporate context. Everything needs to be
in alignment, as the consultants would put it. But this is increasingly hard to
do. Corporate reporting is entering a period of unprecedented chaos. To the
casual observer there is no reason why this should be so. But anyone observing
the changes in the past few months knows exactly why it is so.

The large corporates have now settled into a routine with reporting under
international financial reporting standards. They now know several things for
sure. It has taken a huge amount of technical resource and effort. The result of
the process has integrity. There should not be huge difficulties in the
reporting process from hereon. Companies can cope. But, they also know that a
great shift has taken place.

Finance directors will think back fondly to their formative years when the
goal was somehow to have the external reporting aligned with the information
produced internally. A virtuous circle was always sought. The figures for the
outside world would be made up of the figures which the management of the
company used for their own internal purposes of driving the company forward and
forming the strategy to do so.

This is no longer the case. The common view is growing that the internal
figures and the external figures are now as far apart as anyone can remember.
Some FDs will tell you that the two have almost no connection to each other.
They also know that something has to be done about this. And they know that it
is down to them. If they are to explain what they are up to in a complex world
there is only one route they can take. And that has to be narrative reporting.
The finance function has to find another way of explaining what drives the
company and what makes it distinctive and likely to be ahead of the game in its
competitive sector.

But narrative reporting is hard to pin down. It is, mostly, not a mandatory
process. It is only codified through best practice and peer pressure. It can
seem to sprawl out of control through the annual report and accounts and other
investor relations publications. And, if it is not kept rigorously under control
it can fill page after page of an already overlarge publication. It will also
tend to be drawn from different criteria, company-to-company.

All this means that we are likely to see a steady movement towards an element
of standardisation of narrative reporting. Companies will simply pluck a good
idea from here and a thoughtful performance indicator from there. In five years’
time the whole process will be a settled one. At the moment it is not.

In April,
PricewaterhouseCoopers
produced a survey of the narrative reporting practices and patterns drawn from
the information put out to shareholders, investors and analysts by the Fortune
Global 500 companies. It provides a useful start. It finds that, for example,
narrative reporting is split equally between qualitative and quantitative
reporting. It finds that the majority of narrative reporting relates to
explaining performance outcomes. But it also shows that only 10% of quantified
narrative reporting relates to forward-looking information and only 15% of
companies report specific key performance indicators. Those figures will surely
rise in coming years.

One point that the survey emphasises is that the lack of such information may
be hampering the ability of companies to get across their message in such a way
that investors look to them as long-term opportunities rather than a short-term
punt. “It is interesting to speculate whether some of the current capital market
‘short-termism’ is, in part, driven by the current reporting model and the lack
of forward-looking information evident from this survey,” it says. “As things
stand,” it suggests, “some of the core components of revenue, operating profit
and sources of growth are invisible to investors. How much is due to organic
growth rather than acquisitions? Is organic growth a result of realising price
increases, or is it more to do with volume changes? Providing more granularity
in this critically important area would help investors better understand and
interpret the underlying economics of performance.”

It is this confusion that may be at the heart of so much dysfunctional
financial reporting. “Even the most technically able within the corporate and
investor communities are finding it difficult to decipher the performance
message of financial reports,” says the survey. “Further, the data required to
address the technical complexities of the external reporting model may not be
aligned with the information set being used to manage the business.
Sophisticated users of the current reporting model typically pay attention only
to parts of the information conveyed by companies and have little choice but to
turn to non-company sources to continue to populate their analytic models.”

This is what has to be addressed in the confusion ahead. The winners will be
the companies which can escape the tyranny of the figures and put the case for
their future success in narrative form.