The UK’s Big Innovation Centre recently released a Policy Report resulting from its “The Purposeful Company” project.
The background to the report is as follows: “The Task Force is a consortium of FTSE companies, investment houses, business schools, business consultancy firms and policy makers. It has been examining how the governance and capital markets environment in the UK could be enhanced to support the development of value generating companies, acting with purpose to the long-term benefit of all stakeholders.” The report sets out 22 main recommendations, some of which include simplifying pay with a focus on long-term equity and enhancing the disclosure and “say on pay” regime; requiring consideration and reporting by directors on how they fulfil their obligations under UK corporate law to ‘have regard’ to all stakeholders; and taking steps to encourage a greater flow of equity investment toward “purposeful” companies. Among other follow-up steps, the Task Force plans to “publish an annual Acceleration Report each year over the next three years to highlight that business can deliver greater productivity, competitiveness and success without sacrificing sustainability or the public good.”
Given the focus of this blog, I’ll focus in particular on the main recommendation set out in its “Accounting for Purpose” section:
- Traditional methods of reporting are now no longer enough for many leading companies if they are effectively to communicate their strategic intent and value to key stakeholders. In 1975, when the principles of modern corporate accounting were established, physical and financially accountable assets were the primary balance sheet components. In the past 30 years, tangible assets have reduced to comprise less than 50% of the true value of the average company, reflecting the new importance of knowledge, IP and data in company business models. Against the backdrop of these fundamental shifts in value creation, the IFRS has focused extensively on global standardization but failed to address the changing shape of value. The absence of a pro-active intervention has resulted in multiple confusing initiatives in company law, sustainability reporting and strategic reporting. This has left many long-term investors with a series of proxies but little trusted information beyond the financial information. However, investors still rely on this value as a proxy for total value, driving increasingly short term behaviour. Investors, stakeholders and companies need a common language to articulate how both tangible and intangible assets are being used to create value. At a national level, we also need productivity measures to be re-defined properly to take intangibles into account.
- Urgent reform is needed, and we call on (government) to investigate this with all relevant parties and propose a way forward… Company reporting should be overhauled so that intangible assets – including purpose – are properly valued, at both a company and national level supported by better mechanisms to value intangibles objectively. This will increase both companies’ incentives to invest and transparency around the issues that matter to investors, employees, customers, suppliers, and society. Such a solution should be piloted alongside existing accounting standards but with the ultimate aim of replacing them.
It’s not a new observation (for instance, I referred to the concept here in passing), but that hardly undermines its validity. Various related thoughts come to mind. Such a step presumably ought to coincide with a broader movement toward fair value accounting generally, which would certainly simplify some aspects of financial reporting (mixed measurement models for financial instruments for instance) while increasing the importance of disclosures about valuation methodologies, ranges of uncertainty and so forth. And such a movement would increase the demands on investors and other users. But that wouldn’t be a bad thing, to the extent that users currently tend to reduce the information in the statements to a few key performance measures that drive their short-termism. On the other hand, the recommendations in the report wouldn’t necessarily change that fundamentally, in that the maestros of non-GAAP measures might simply adapt to adding back different non-cash items.
Some other aspects of the report have a strong overlap with integrated reporting – for instance in proposing that “the entity should be clear about its purpose, strategy and business model and this should be reflected in the reporting.” Of course, such concepts have circulated for some time now without necessarily becoming mainstream expectations. Perhaps the report is correct that this will need a further step – that such information, and any more advanced quantitative reporting on value creation that flows from it, “should be assured to the same level of rigour as today’s financial reporting. The biggest criticism of alternative reporting methods today from the investor and employee stakeholder groups is that the information is not assured and it is being used as a public relations exercise, rather than something that can be trusted.” Although I take the point, I’ve never been convinced that bringing MD&A and other reporting within the scope of an auditor’s report would be entirely beneficial…
As I wrote recently, you can argue that a short-term orientation isn’t necessarily a wrong-headed approach to every investment decision; some companies don’t have more than that to give. But it’s also painfully clear, as the report discusses, that capitalism in its current form is severely challenged to deliver an economy that “works for all.” Plainly, the Purposeful Company report doesn’t have a fix for all of that. Perhaps the grimly pressing question is whether, even if all its recommendations were implemented tomorrow, it would contribute to a meaningful turnaround, or would simply provide a clearer window on a decline which is ultimately beyond arresting…
The opinions expressed are solely those of the author