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Corporate governance: Safety first

Who would have thought it. Certainly not the boards of most companies a mere
few months ago. The early days of any year-end wrap up of the report and
accounts is going to have to concentrate solidly on whether or not the
enterprise is a going concern (as discussed in last month’s accounting column).
A going concern? Any time in the last 20 years and this bit of the routine would
have been skimmed over. Of course we are a going concern ­ – even if there is a
bit of local difficulty, bankers and shareholders would quietly sort it out.

Now it is a less safe assumption. You may be a going concern on Friday, but
who knows what may happen by Tuesday? Suddenly, the directors’ mind is
concentrated as it has not been for a generation.

As the Financial Reporting Council, somewhat understatedly, advised them
recently: “The difficult economic conditions being faced by many companies will
necessitate careful consideration by directors when assessing whether it is
reasonable for them to use the going concern basis of accounting, and whether
adequate disclosure has been given of going concern risks and other
uncertainties. Addressing these challenges well before the preparation of annual
reports and accounts may help avoid a last-minute problem that might unsettle
investors and lenders unnecessarily.”

So what companies need to do first is mind their backs. This means an
inordinate amount of paperwork showing just how exhaustively everyone has worked
to reach a decision about whether or not the business is a going concern. This
has two benefits. If everything goes to hell in a handcart, directors will have
roomfuls of paper to wave at enraged and possibly litigious stakeholders and,
who knows, the exercise itself might focus directors’ minds even more sharply
than before.

The FRC underlines this need for documentation. “The general economic
situation at the present time does not of itself necessarily mean a material
uncertainty exists about a company’s ability to continue as a going concern,” it
suggests. “However, it is important that annual accounts contain appropriate
disclosure of liquidity risk and uncertainties as such are necessary in order to
give a true and fair view.” In other words, book those lawyers now and just grin
and bear it when you estimate the fees they will cost you.

It needs no urging from me to suggest that your bankers now need looking
after like no other time in our living memory. Despite their protestations to
the contrary, banks still do not really want to have too much risk anywhere. Now
that they view all companies as risks above and beyond what they would prefer,
that means everyone. The FRC issued a warning about this reluctance. “In the
present economic environment bankers may be reluctant to provide positive
confirmations to the directors that facilities will continue to be available,”
it says. “This reluctance may extend to companies with a profitable business and
relatively small borrowing requirements.” That means any business in the
country.

One way to alleviate your pain could be to play the audit committee card.
This is precisely the time when they can assume the role of fall guy. Or, if you
prefer to put it another way, they can really earn their crust. The FRC has
already put audit committees on notice. In another piece of advice, late last
year it said: “Audit committees are likely to examine in more detail the rigour
with which the analysis supporting the going concern judgment has been made and
the integrity of the disclosures about going concern in the financial statements
and other market communications”. Note the use of “are likely” there. The
translation: “They will ­ – or they will be dead in the water and sued blind.”

If you are a finance director, any other director, or a member of an audit
committee, you would be well advised to cancel that skiing holiday. The next few
months will require an astonishing amount of grinding work and time spent doing
routine, but now vitally important things. Remember the days when you earned
your bonus by hitting a fairly easy share price target? Hopefully, you salted
those gains away so they can act as balm now. Because from here on in, it will
be awful.

In the meantime here is a footnote. Journalists often get it in the neck for
failing to warn their audience of impending doom. So here, at the outset of
2009, I thought it worth checking back what had been said in the recent past.
And I make no apologies for quoting the last paragraph of this column in January
2008, on incentive payments, or bonuses, built into the remuneration structure.

Here we go: “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.”

And so it was.

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