The measure of success: what do investors really need to know?
Despite the UK’s biggest institutional investors calling for companies to stop quarterly reporting now it is no longer mandatory, it seems that big businesses are reluctant to kick the habit. According to the Investment Association (IA) although several FTSE 100 companies, including Unilever and Legal & General, have put an end to quarterly reporting, the vast majority continue to publish financial information every three months.
The quarterly report (QR) was designed to improve transparency between companies and shareholders by providing information about company activity that would help guard against corporate failure, yet scandals such as Toshiba, VW and Tesco continued to emerge. Not only that, evidence suggests that QRs drive businesses towards short-term decisions which can compromise long-term development and prosperity. According to Unilver’s Paul Polman “Before I came, we were making a lot of short-term decisions to make the quarterly numbers, [and these decisions were] actually driving the company, over time, downwards.”
So if we are serious both about preventing corporate failure and ensuring long-term value creation, what should boards be looking at and what do investors need to know?
Clearly a meaningful measurement of profit is still required and shareholders need this information regularly. But an annual update should suffice, avoiding short-term decision-making and encouraging long-term business development. However, what investors are increasingly calling for are real indicators of long-term viability. This has been underlined in the 2014 UK Governance Code which asks boards to provide investors with a ‘viability statement’ comprising an improved and broader assessment of an organisation’s long-term business prospects.
An essential component of any viability statement should be an assessment of ethical culture and corporate behaviour, both strong indicators of stability and long-term prospects. Corporate misconduct damages organisations significantly and has done so repeatedly, denting public trust as well as corporate performance. Investors and boards need to know that their organisations have a clearly defined and robust corporate culture that lowers the risk of failure.
Such a culture needs to be set at board level and aligned with the values and purpose of the organisation, ensuring that business goals and the behaviours needed to achieve them are in line with expected corporate conduct.
This goes beyond the development of a code of conduct that stipulates desired behaviour. Businesses need to assess, embed and monitor their corporate culture, reporting back to boards and investors on this activity as a key part of demonstrating long-term viability. While this may present challenges, measuring and benchmarking ethical conduct is achievable once the right indicators have been identified.
Over the last 16 years, GoodCorporation has developed a methodology to do this, offering high-level reviews of ethical culture and measuring corporate behaviour and ethical conduct on a company-wide basis. High-level reviews comprise an assessment of the code of conduct and its key requirements in terms of ethical behaviour. These behaviours can be readily translated into measurable statements and ‘audited’. The key to any auditing activity is to include independent interviews with employees, customers, suppliers, regulators and other stakeholders to understand how the company’s culture works in reality. Listening carefully to these stakeholders is crucial to understanding if a company’s culture is threatening the long term viability of the organisation.
“One of the perennial challenges is to create a quantifiable measurement, avoiding ‘flabby’ reports of people saying that they are happy or not happy. In our methodology we address this by starting with concrete statements taken from the Code of Conduct. Take as an example “the company ensures that customer complaints are handled well”. This statement can be audited by looking at the company’s procedures to manage complaints, combined with interviews with customers who have actually complained. This gives an incredibly powerful insight into a key area of risk in terms of culture.
This type of analysis can then be turned into a ‘grade’ and GoodCorporation uses a five-point scale from ‘commendation’ where the policies and systems are working extremely well to a ‘non-compliance’ where the policy and system are largely not working or have broken down. By matching the evidence from the audit with this type of statement, the audit can turn the evidence found into a ‘grade’ for each of the practices that are reviewed.
The grades can be used to measure and assess performance against the GoodCorporation Business Ethics Benchmark of over 500 such assessments, providing an indicator of relative performance, which can be tracked over time to show improvement, providing the board with crucial insight into the company’s culture and its position relative to other companies.
Boards looking to provide investors with meaningful information about ethical values and culture can use these results to support their organisation’s long-term viability. This is clearly an area that businesses find challenging. A report by the Chartered Institute of Internal Auditors (IIA) earlier this year revealed that while 94 FTSE 100 companies mentioned ethics in their 2014 annual reports, just 23 had ways of measuring whether they were behaving ethically.
Boards need this type of information in order to make informed decisions and to protect the long-term viability of shareholders investments. Dropping quarterly reports is just one small part of the fundamental change that is needed in helping boards to maximise long term returns and to protect against corporate failure.
October 2016