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Corporate governance – A little bit of knowledge

There are many frustrations in being a financial director. One of the greatest is being lambasted in the newspapers for the share price dithering as a result of a perceived lack of clarity about what the company is up to. Sometimes the reason for this is that the financial director concerned has got something badly wrong. But mostly it is because the established channels of communication between the company and the markets have not been working smoothly.

The key is analysts. There are lots of good ones around. At conferences and public meetings they are snappy, sharp and talk the talk. What everyone forgets is that these are the best ones. Underneath that slice of strata there lurk a large number of people who know how to keep their bosses happy but are, in every other respect, off the pace.

Throughout the long period of time as the spectre of international financial reporting standards approached, analysts were pushing back the day when they would have to deal with it. Every time you made a polite enquiry they would say they were actually frightfully busy on something else. The latest flurry of interim results was upon them. But they knew something big was on its way and would turn their attention to it in due course.

What they were doing is what their job forces them to do. They were firefighting. Information lands on them in an avalanche. They have every intention of sitting down in a quiet time and mugging up on changes ahead. But, as every good student of firefighting as a management culture knows, that period of quiet time never comes.

So, currently, they are all scrambling around trying to cope with international financial reporting standards. And we all know what happens if there is a bit of an emergency on. Something else comes along to catch you off-balance. And so it is with the analysts. That something is Sarbanes-Oxley. For most of us this cloud has long moved from the horizon to a point where its lowering detail obscures the midday sun. But for the analysts it has yet to appear on their weather chart.

Take the latest research from PricewaterhouseCoopers, for example. We all know that surveys can come up with all manner of whatever you might need to back up your sales story. And it would not be in PwC’s interests if a survey on Sarbanes-Oxley showed that everything was going fine and that companies had no need to buy additional advisory services to deal with any problems. But this survey is really disquieting.

It covered analysts, investors and credit rating agencies around the world, roughly a third Asia-Pacific, a third Europe, and a third the Americas. Asked what, if anything, they knew about the infamous section 404 of the Sarbanes-Oxley legislation, the section which is at the heart of certifying that a company’s corporate reporting can be relied upon, only 4% bravely said they knew a great deal. From that high point it is all downhill: 18% said they had never heard of it; a further 22% said they had heard of it but knew nothing about it; and a hesitant 38% said they knew a little about it.

As you might expect, these low levels of understanding have worrying implications for what will happen when investor information containing less than fully positive details emerge. When the survey asked the respondents whether they would mark down or sell shares on seeing that the auditors had issued a negative section 404 report, the answers were straightforward: 50% said they were fairly likely and another 22% said they were very likely to either mark down the shares or sell them in such circumstances. Another 3% said they were ‘certain’ to take such action.

So financial directors are faced with a situation where the people who move the markets have little knowledge of an extremely important, if tiresome, chunk of legislation and 75% of them are likely to dump stock because of it. Not surprisingly, the survey goes on to show that any negative section 404 disclosures would have a substantial impact on a company’s valuation.

So what should the much put-upon FD do? Railing against the inadequacies of the analyst community would be an understandable first step. But in the end it is all down to stepping up the efforts at communication. And instead of dumping the whole problem on the investor relations department it might also be useful to include the non-executive directors and the audit committee in this.

It is likely to be a long, hard and dispiriting slog. But the benefits of doing it effectively will be great.

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