Corporate governance: Law and order – lack of litigation bodes well for FRC

We are, of course, still in touch-and-go territory. The total corporate carnage many predicted has not come about ­ yet. But, increasingly, it is looking likely that the firestorm which would have left the corporate landscape a swathe of burned-out ruins was more a doom-laden vision of Jeremiahs than a practical assessment of the likely outcome of stricken credit markets. Fair enough, disasters have been anything but scarce. But often they have, like the demise of Woolworths and any number of leisure-related businesses, been business models which were moving toward their sell-by dates before the credit crunch provided the final push.

The corporate governance models seem to have held up remarkably well. And it is the explanation of why this has come about which is illuminating now. How have corporates escaped audit disaster? Was it down to smart and timely work by the regulators? Was it down to fancy footwork by the finance functions? Was it down to wary and careful auditors? And when is the wave of litigation going to start?

The answer to all but the last of those questions seems to be ‘probably’. The answer to the last may well be that the careful planting of good UK corporate governance over the past two decades and the emphasis on a very different model from the one which prevails in the US, may well have made all the difference.

In mid-April, those brave folk at PricewaterhouseCoopers released the findings of their own research on what had been happening among their biggest clients. They found that nearly all of them had managed clean audit opinions, nearly all of them had found the going concern issue the most challenging and they had nearly all done much more work on that challenge and disclosed much more information on the risks they face. These were the maturity of bank facilities and their renegotiation and covenant triggers.

All of this is rather disconcerting. After all, newspapers prefer the idea that businesses in the midst of a credit crunch behave like headless chickens. The word from inside the corporate village suggests people have tended to breathe deeply, draw up plans early and, mostly, act in a very practical way. We wait to see if this continues.

Certainly, regulators in the financial reporting world have helped. The early handing down of guidance on the issue of going concern by the Financial Reporting Council and its efforts to bang heads together at both audit firms and corporates very early in the reporting cycle, seems to have helped enormously.

“The lack of litigation is a feather in the cap of the FRC,” suggests Martyn Jones, national audit technical partner at Deloitte. “The work of the Financial Reporting Review Panel has paid off,” he says. “So far.”

The experts at PwC concur. “People started on this earlier,” says Andrew Ratcliffe, the audit partner in command of the research. “Managements realised they needed to. Some needed prompting by their non-executive directors and some by us, but they were in a minority.”

So people kept their heads and they are now working on sensible solutions to the different problems at this stage in the cycle of the credit crunch. They know that the issue of going concern is a rolling one. They may have got one set of figures away. But what happens when they reach the next hurdle, at the interim reporting stage, for example?
“The intelligent companies have had rights issues and have been talking to their banks over the past year,” says Ratcliffe. “There has been a lot of sensible treasury management. They have been looking ahead and trying to head off any other trouble which may be coming down the line.”

But the threat of litigation remains. The lack of litigation so far has been one of the many surprising aspects of recent months. Of course, people will try, suggests Ratcliffe, but it may be slightly different this time around. The greater emphasis that people have been placing on the issue of going concern, which was previously taken as a given in most large companies, may pay off. The greater thought and documentation of the decisions made this time around and what went into the best judgement at the time may leave a more solid defence than previously.

Also, litigation is seen as a US fashion. There, an entire industry built around class actions promotes it. The fostering of a corporate governance culture in the UK, which puts a premium on investors giving directors a hard time over financial reporting, rather than the US emphasis on investors trading shares and demanding compensation, may have made a difference. Financial directors will certainly be hoping so.