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Corporate governance: Private matters

Robert Bruce

‘Sell in May and go away’ used to be the mantra of a more leisurely class of
stockbrokers. It probably doesn’t work now. And another mantra that works even
less is predicting the direction in which the business world may move across
this new year.

But there are two themes which people ought to have uppermost in their minds
as the year and their business prospects unfold. The first is the dilemma posed
by private equity. In the first half of 2006, there were more funds raised
through private equity than through IPOs and the public markets. Now we all know
why this is.

It is argued that it is much easier to pull value out of a wayward company if
you can do it, as it were, behind closed doors. And all the support can be
rejuvenated. As one venture capitalist often boasts, he can get the auditors in
and tell them that what they did last time was a disgrace and can they, for
gratis, do it again, only effectively this time round.

The issue is partly one of whether it is good for the economy generally and
for the wider ranks of stakeholders, and even pension holders, to have
enterprises taken off the public markets and for public disclosure of
information to vanish.

This is now seen as a real threat to the markets. In November, a consortium
of interested parties produced a new approach to the disclosure model. They
called it Report Leadership and they produced a number of ways in which existing
internal information could be disclosed and provided a pro-forma set of accounts
showing how it would work. The consortium consisted of the management
accountancy body, CIMA, accounting firm PricewaterhouseCoopers, design house
Radley Yeldar and the engineering group Tomkins.

It was the finance director at Tomkins, Ken Lever, who linked the
consortium’s efforts to the non-disclosure of private equity information. Lever
also represents the influential Hundred Group of Finance Directors and runs its
financial reporting committee. He saw the proposed system as bridging the
disclosure gap between private equity and public companies. The useful
information which drives private equity investment is there, obviously, in
public companies. It just isn’t made available to investors.

“This new system tries to create, for the public market, the information
available to private equity,” he said. A proper debate between investors and
owners could ensue. “In private equity you have that discussion,” he said. “In
public companies you can’t have that discussion for regulatory reasons. This new
system helps towards that.”

Anything that promotes the idea of companies making more of the internal
information available to investors will help. And, as there is perceived to be
an increasing divide between what is seen as impenetrable accounting information
and accessible narrative information, this trend will continue. This is where
public companies find themselves currently under performance pressure from
privately held companies. That pressure can only put more information of a
useful – non-accounting – sort into standard corporate disclosures. It is an
obvious way for public companies to level their wildly askew playing field in
the investor arena.

The second theme, which should gain more support through the coming year, is
a fundamental view of corporate governance. No one could deny that corporate
governance has transformed the security and stability of the UK corporate sector
and of similarly enlightened corporate sectors around the world.

What is sometimes denied is that it is not all upside. The rise of corporate
governance has also created a side-effect, which people need to be watchful
about. There is a tendency among the investment community not to value good
corporate governance just for the stability it fosters, but also for the simpler
quality of seeming to lock stability into the corporate model. In other words,
the investment community also wants corporate governance to be strong because
that way it covers its back. Lawyers love it.

This has a knock-on effect. Some companies can overreact. The result is that
they think the share price is best protected by avoiding disaster rather than
necessarily going for growth. It is a difficult balance at the best of times.
But following the corporate governance theme too slavishly can start to do
damage to companies. Playing terribly safe may protect a share price. But in the
long term, it is not going to do investors any favours. Corporate strengths have
as much to do with products and services as they do with ensuring that an
organisation is effectively run.

And finally, as we look ahead to the new year, all financial directors can
look forward to one bonus. The tide is turning when it comes to international
financial reporting standards versus intangible items such as key performance
indicators. And it is running one way only for the year ahead. With all the
steady rubbishing of international financial reporting standards and the
comeback of narrative reporting, it will be much easier to create a smokescreen,
which means that investors think one thing while the FD knows another.

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