Corporate governance: Tall story

Over the past few years we have seen a trend towards many
different ways of measuring corporate success. At the heart has been the view
that, with pure financial reporting figures becoming ever more complex, the
story of corporate performance should be told just as much through narrative
reporting and through the use of intangible issues.

This is an excellent trend. Telling the corporate story from an ever-growing
number of sources within the organisation has to help to give a more useful
picture to stakeholders and investors alike. The trend is also growing. The
recent report from the Prince of Wales Accounting for Sustainability project
makes the point that only if sustainability issues are connected to the more
traditional financial reporting issues will their true effects be properly
measured. By doing so the real effect of sustainability issues on the business
will become apparent for the first time and so start to influence performance
and strategy. Anything that gives both management and outsiders better
information on which to base their decisions must be good.

But there is a downside. Widening the range of measures which are perceived
as significant can produce other effects along the way. Take the latest report
from Deloitte on narrative reporting in annual reports. Its title, Written to
Order, tells you the story. What the firm found in its annual survey of this
area was that companies were not using the opportunity to explain, but were
instead sticking closely to whatever formula they were comfortable with. In
part, it blames it on companies following the pro-forma model reports that firms
like Deloitte have produced for clients in the past. And, bravely, Deloitte has
dropped such models from this year’s report.

It is an old story. Guidance on financial reporting is changed in the hope
that companies will strike out on their own and in an original fashion. Some do.
But the majority seek comfort and retreat into formula. Not much changes.

And there is another pitfall. And it is made plain in the recent report on
remuneration issues released by PricewaterhouseCoopers. In the firm’s review of
2007 in the remuneration field similar problems are highlighted. The review is
an exhaustive survey of an area where much is changing. The variants in the
elements in a remuneration package would have the traditional senior director or
employee from even a decade ago baffled at the sheer variety.

Remuneration has moved from a solid lump of pay allied to a scattering of
fringe benefits to an astonishing array of remuneration calculations based on a
drive for incentives. Some might say that the growth in this field owes more to
the rapacious greed of remuneration consultants than to the perceived refusal of
executives to perform without a range of incentives dangled before them. And
that is undoubtedly true.

Another part of the business world has become impossibly, and probably
unnecessarily, complex. But there is little that can be done about that now,
though a good solid downturn through 2008 might have executives racing back to
the comfort zone of a simple salary. Performance incentives are great when
without too much of a touch on the tiller the business is going to roar ahead
regardless.

Where PwC sees a real problem is in the distortion that all this creates.
Once upon a time, company chairmen insisted that only shareholder value
mattered. These days it is different. “Factors such as employee engagement and
customer satisfaction are proven leading indicators of future financial
success,” says PwC. “No organisation acting rationally in the interests of its
shareholders can afford to ignore these. So from a variety of motivations,
companies are increasingly looking beyond the purely financial measures of their
performance.” Linking remuneration to all of this is fine, says one part of the
argument. It is the old cliché of what gets measured, gets done. But, as PwC
points out, there is another side to the argument. “The opposing school takes
the view that such a linkage will lead to dysfunctional behaviour,” it says. It
can be that the very act of using a metric reduces its effectiveness.

It cites the National Health Service as living proof of this. As it points
out: “It is often possible to achieve a specific numerical target in a way that
was not envisaged – with unintended consequences.” And there is another simple
consequence of all this. The sheer complexity of the measurement, the measures
themselves, the timing concerned and the calculations mean that any transparency
which might be desirable has gone out of the window. This is probably no bad
thing for the employees, directors and staff involved. The more opaque the
process the more they can defend their remuneration.

The recent Little Blue Book of Governance Pitfalls published by Independent
Audit, has a simple risk at the top of its list for the remuneration committee.
“Weak alignment with strategy,” it says, “triggering the wrong behaviour.” And
wrong behaviour in 2008 is going to be punished much more severely by economic
circumstances than it was in 2007.