Financial Reporting Brief January 2018

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Financial Reporting Brief

January 2018

This month’s article 'Financial Reporting – Importance of Corporate Culture' considers the fundamental importance of corporate culture and how this is reflected in financial reporting with Brendan Sheridan commenting on some relevant developments recently including those on integrated reporting and corporate governance.

Financial Reporting – Importance of Corporate Culture

Almost two thirds of European company directors work on boards that either fall short of giving corporate culture significant attention, or fail to include it in their formal risk management systems. Sixty three per cent either work on boards that exclude culture from formal risk considerations, or fail to routinely assess the risks associated with their own corporate cultures.

These were some of the major findings in a survey recently carried out which gathered the views of 435 board members across Europe.

There is growing awareness of the need to recognise and focus on the changing business environment and the different demands that arise. Some of the fundamental movements in this regard are:

  • Integrated reporting - the chance to make a difference; integrated reporting enhances the way organisations think, plan and report;
  • Financial Reporting Council (FRC) proposals for a revised UK Corporate Governance Code to reflect the changing business environment and help UK companies achieve the highest levels of governance;
  • FRC Financial Reporting Lab – seeking to understand how companies can better inform investors on the risks they face and their viability – with the Lab project report ‘Risk and Viability Reporting’.

The question of whether financial reporting is achieving its purpose remains in question. Investors need to understand a company’s business model and its strategy for long-term value creation which reflects on the culture of an entity to achieve sustainability.

Integrated Reporting
The results from the first worldwide consultation on how companies are adopting integrated reporting show how the focus has moved from one of initial acceptance to progress in actual implementation. Over 1,500 businesses in 62 countries globally are now integrating the goals of sustainable development and financial stability to support their reporting, which has been identified across the world as the future ‘norm’ for corporate reporting.

At a time when companies are under pressure to think more about the long-term in how they are creating value - the multi-capital approach (core to Integrated Reporting) – provides a framework for communicating more broadly how an organisation’s social and environmental impact has been threaded into strategic thinking, while remaining focused on information material to investors.

The full impact of what integrated thinking requires of organisations and the way integrated reporting dovetails with governance methodologies needs to be considered. Governance primarily addresses the way the leaders of organisations wield their power, and inculcate the culture of the organisation into its activities.

UK Corporate Governance Code – Proposals
The proposals for a revised UK Corporate Governance Code focuses on the importance of long-term success and sustainability and they address issues of public trust in business and aim to ensure the attractiveness of the UK capital market to global investors through Brexit and beyond. The revised Code sets out good practice so that the boards of companies can:

  • Establish a company’s purpose, strategy and values, and satisfy themselves that these and their culture are aligned;
  • Undertake effective engagement with wider stakeholders, to improve trust and achieve mutual benefit, and to have regard to wider society;
  • Gather views of the workforce;
  • Ensure appointments to boards and succession plans are based on merit and objective criteria to avoid group think, and to promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths;
  • Be more specific about actions when they encounter significant shareholder opposition on any resolution, including those on executive pay policies and awards;
  • Give remuneration committees broader responsibility and discretion for overseeing how remuneration and workforce policies align with strategic objectives.

Financial Reporting Lab – Risk and Viability Reporting
In a recent report the Lab is seeking to ascertain how companies can better inform investors on the risks they face and their viability. The Lab has found that companies have in recent years had better engagement with investors on how they are managing risks. To support this, it provides guidance and practical examples on how companies can find a balance between reporting that is specific, whilst not revealing commercially sensitive information.

Investors are unanimous that understanding the principal risks faced by a company is important both before making an investment and during the holding of the investment. There has been an increased focus on risk management, and the reporting of principal risks has become more comprehensive and more deeply embedded in any business model reporting.

Investors find it helpful when the links between such reporting and other parts of the annual report are clear and that changes in a company’s strategy since the last annual report are clearly explained in the report.

The Lab calls on companies to be bolder with their viability report disclosures to ensure that they provide investors with better information on the company’s longevity and relevance in the market. 

Conclusion
It is recognised that stakeholders are increasingly interested in a broader view – a more holistic story about how we are creating value over time and the opportunities and challenges impacting our future. The narrow focus on financial reporting has got to move forward to a report with an Annual Review which should ideally provide not just broader detail about performance but also the sustainability of that performance with incisive insights into how the company interacts with its customers, its people and the community.

The report published by the UK Government ‘Growing a Culture of Social Impact Investing in the UK’ focuses on how savings and investment funds are challenged into social impact investment, but such investments are scarce and difficult to identify. Explaining the fundamentals of social impact investment can be challenging for investors who think more in financial terms. Consistent measurement of track record and non-financial returns are still a work in progress.

Failing to realise the importance of culture is a frequent mistake that boards make. They often dismiss it as something vague and just tick a few boxes for the company’s report, without recognising that culture must be at the core of the company’s values and behaviour for long-term survival and success.

When things go wrong and the culture of a company is shown to be defective, boards may misjudge public and investor anger. Boards often overlook how valuable trust and confidence are and, once broken, how difficult it is to rebuild them.
 

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