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Corporate governance: Flying a kite

The pursuit of simplicity is a wonderfully liberating discipline. It has been
at the heart of arguments over the communication of financial reporting and
corporate governance for years.

The idea of stripping everything back so that almost anybody with a grasp of
basic business could understand what has happened and what is likely to happen
is enormously attractive.

So why, with the best business brains on the planet working on the idea, are
we still so far from it being achieved? The answer comes in one word. Lawyers.
Saying something very simple doesn’t earn them fees. And, sadly, saying
something very simple gives them the chance to thunder in with schedule after
schedule of very expensive ‘what ifs’.

The latest plea for simplicity came from John Griffith-Jones, chairman and
senior partner of KPMG. He was giving the annual Aileen Beattie memorial lecture
under the auspices of the Institute of Chartered Accountants of Scotland. In a
wide-ranging examination of the accounting profession, he homed in on audit. At
the heart of his ideas was the concept that if you bought, for example, a toy,
it would have a kite-mark on it which would provide all the assurance you
require. Why should there not be a similar kite-mark – a very simple audit
statement – on the annual report and accounts? When you buy a toy, as he said,
“you do not expect to have to read a page of small print describing all the
remoter possibilities of danger that the kite-mark does not cover.”

Yet the audit and business world has progressively moved in the opposite

Griffith-Jones made the point that a good audit spurred a company to do a
decent and thorough job in the first place and reduced the chance of errors
getting into the final figures.

But, as he pointed out, audits reduce, but do not absolutely eliminate
errors. Introducing new rules doesn’t produce the desired perfection, and much
of the effectiveness of an audit depends on the quality of the people conducting
it. As a result, you end up with an expectation gap: people feel an audit should
deliver perfection – but it can’t. And in striving to explain this problem, the
audit report grows ever wordier.

Griffith-Jones held up two documents at this point. One was the latest audit
report for ICI, and the other was its 1968 audit report. He read the latter out.
“To the members of Imperial Chemical Industries Limited,” it started. “We have
examined the accounts set on pages 26 to 33. In our opinion, the accounts comply
with the Companies Acts 1948 and 1967 and give a true and fair view of the state
of affairs of the company and, so far as concerns the members, of the state of
affairs and profit of the group.”

And that was it. Quite apart from the idea that the accounts only stretched
across seven pages, it is a startlingly simple statement. Griffith-Jones had no
intention of reading out the most recent and voluminous report. “Every word and
every paragraph added over the past forty years was agreed by very eminent
people on very eminent committees, in the sincere belief that each would add a
new level of clarity to the world at large about what an audit was – and was
not,” he said.

The reason for this was, as so often is the case, the lawyers. “I fear the
real raison d’être for those lengthy opinions is to offer the auditor some legal
protection,” he said. “It’s not really been about providing society with a more
reliable kite-mark. It’s as much about protecting people like me and my firm
from being put out of business by a successful claim for negligence.”

He didn’t think this was sensible. It only made the relationship between
auditor and society at large more difficult. What he thought was needed was an
understanding by society that the audit process did not guarantee perfection,
nor eliminate the possibility that a rogue director had committed a fraud.

So he proposed a short wording which would effectively become the kite-mark.
And, equally important, it would highlight where responsibility for fraud lay.
“I believe the kite-mark that the profession and society should agree to work
towards could be summarised in vernacular as ‘These accounts are about right,
unless management have deliberately conspired to falsify them.’”

It is an endearing concept. Personally, I think it could be reduced still
further. A set of accounts would bear the auditor’s name or logo on the front
page and be accompanied by a ‘thumbs-up’ sign; or, when things have gone wrong,
a ‘thumbs-down’ sign. Reducing the opinion to one small sign would make life
wonderfully simple for the investor and shareholder. And the prospect of a
thumbs-down sign would equally wonderfully concentrate the minds of the finance
director and their team.

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