Gamestop and the gap between companies and shareholders

The Gamestop story is fascinating for a variety of reasons but one issue that it illustrates is the disconnect between investors and companies. The underlying story of Gamestop is almost entirely irrelevant to the trading in its shares. None of the frantic market activity has anything to do with company resources.

When our current corporate reporting framework was established in the nineteenth century, it had a clear purpose: it allowed creditors and those buying company shares to see what had happened to the resources they had provided and to hold those managing those resources to account.

The economic and social environment of the twenty-first century is very different. The development of institutional shareholders and the complex array of investment intermediaries has fragmented that original direct relationship and obscured accountability relationships. Corporate reporting has not kept up with this. Periodically the flaws in the reporting model become too obvious to ignore but the solutions have been pragmatic and politically expedient, rather than based on a reconsideration of the fundamental assumptions on which the model is based.

For example, financial scandals in the 1960s prompted the accountancy profession to establish accounting standards. At the time, Professor Will Baxter outlined the possible consequences of this. He was especially prescient with regard to the impact of standards on education and the potential stifling of original thought about the role of accounting in society.

This avoidance of revisiting basic assumptions is very apparent in the recent discussion paper issued by the FRC which seems to be little more than an attempt to reconfigure the presentation of corporate information without providing any fundamental reflection on the role of corporate reports. It is worth comparing this attempt with the 1975 discussion paper The Corporate Report and the 1988 publication Making Corporate Reports Valuable, both of which tried to assess the underlying purpose of reporting before offering innovative ways to achieve this. Sadly, accounting history does not feature prominently in accounting education. 

The FRC discussion paper claims to offer a "stakeholder neutral" approach to the content of corporate reports. Is this logical? Surely the audience for corporate reports is corporate stakeholders, however they may be defined? "Neutral" may be intended to indicate that no particular stakeholder group will be given prominence but it is surely impossible to decide on the content of reports without considering the information requirements of the audience and the very act of considering these must involve some kind of ordering. 

A narrow shareholder focus for reporting is presumably no longer deemed appropriate. Certainly the reporting framework seems to assume that shareholders are a homogenous group with common interests which is clearly not the case now, if it ever was. The Gamestop story again illustrates that. But shareholders in the original joint stock companies were more likely to be providing resources directly to the company than they are today. 

A more radical approach to corporate reporting could begin by identifying those who provide the resources which enable companies to operate. Assessing their information needs could redefine the context and communication of corporate reporting within a clear framework of accountability and assurance which could underpin a reassessment of the role of audit and the necessary corporate governance mechanisms.

Conventional wisdom

I am increasingly irritated by those who respond to every business issue by pointing out that the board involved is dysfunctional because it is not diverse.

Aston Martin is in the news today. There are no women on its board. More interesting to me is that there is a preponderance of chartered accountants and the issue that has arisen relates to accounting. The company web site is not very informative about the current board but, although it has gone through a major shake up recently, two of the board members - described as shareholder representatives (aren't all board members shareholder representatives?) - have been directors within the group for a while and are CPAs. Asleep at the wheel?

J K Galbraith defined conventional wisdom in "The Affluent Society":

It will be convenient to have a name for the ideas which are esteemed at any time for their acceptability, and it should be a term that emphasises this predictability. I shall refer to these ideas henceforth as the conventional wisdom.

The idea that diversity is a remedy for the poor outcomes of groupthink has become conventional wisdom in the board diversity discourse: one could even argue that it is the result of groupthink among those promoting it.

But it is worth reminding ourselves that no board or committee can operate effectively without consensus: finding a way to reconcile challenge and arrive at consensus is the job of an effective chairman but board meetings take place behind closed doors and minutes provide little insight into how consensus is arrived at. Even personal reports of meetings can vary among attendees. And, of course, there is no guarantee that consensus will lead to good business decisions. How can we distinguish between groupthink and negotiated consensus?

Tracing the history of UK corporate governance regulation suggests that there seems to be an implicit acceptance that NEDs provide insufficient challenge: it was first assumed that the reason for this lay in their lack of independence and this underpinned the approach of Cadbury Code. As a result, the balance of board membership between executive and non-executive changed and boards became more measurably independent from management. There is little evidence that this has improved corporate governance, however you choose to measure such potential improvement, a challenge in itself. And it is telling that the annual Grant Thornton corporate governance analyses show repeatedly that the area of least code compliance is that relating to NED numbers. Research into this issue would be useful but I'm not aware of any. And a moment's thought might lead one to reflect that the change from a situation when the entire board sat round the same table to a situation where contact between NEDs and the full group of EDs can only take place under different circumstances might have had unforeseen consequences with regard to effective communication. Again, this could be a useful research area.

But now it seems that the reason for imputed lack of challenge in the boardroom has more to do with lack of diversity. Both independence and diversity are measurable substitutes for that which cannot be measured - the independent and diverse thought and behaviour which are seen as desirable in board members. But without sound evidence that the prescription of board composition improves corporate governance, boards are likely to be further hamstrung by imposed requirements, especially if all aspects of diversity are to be addressed.

The debate about the purpose of the corporation is welcome. When corporate purpose is substantively and transparently addressed, accountability processes can then be designed appropriately. Do we need boards? Read this and ponder.

Wirecard: some reflections

I trained in audit in the late 1960s, when internal control questionnaires were new and plastic flowchart templates represented the cutting edge of technology. I know that it's all different now but, even so, I am somewhat bemused by reports that Wirecard's auditors didn't get independent confirmation of bank balances.

Checking the existence of balance sheet items used to be a very basic audit task. We pursued written confirmation from banks and debtors. We supervised stocktaking - sometimes we even had to count things ourselves (carcasses at Smithfield Market, ugh!). We even went to look at items of plant and machinery to confirm that they existed.

I was also taught to be sceptical. I learned to quickly scan the papers on a desk, to read upside down and to sense if someone might, for whatever reason, be trying to divert my attention. (Sometimes the men were just having a little game to test out the only female member of the audit team...)

We tried to pass on this critical scepticism in our module on Audit Practice which involved role play. Students conducting the audit of a fictitious client were provided with accounting information and duly met up with relevant employees, played by lecturers. The students collected information from them all but few really questioned what they were told until they encountered me, the crooked CEO, who contradicted what they had been told, refused to answer questions, and ended up by shouting at them and sending them away. Great fun! I wish that we had followed up those who went on to accountancy training to find out if it had been a useful experience.

But the fundamental audit problem of independent authentication of information is rarely addressed. The continuing discussion about the independent status of auditors tends to obscure this.  Some years ago Peter Wolnizer wrote a very interesting book about this entitled "Auditing as Independent Authentication". He argued that accounts "must be descriptions of empirical phenomena, the veracity of which must be ascertained by recourse to evidence which is beyond the control and influence of those who prepare them." (p5)  Follow this link to read the first few pages of the book, which gives a sense of his argument.

It's a book that should be required reading for every auditor and regulator.

Oliver Williamson

Sad to hear that Oliver Williamson has died. 

In 2002, the book based on my PhD was published. I had met a rep from a very small publisher at a conference and she had asked to see the manuscript.  Knowing nothing about academic publishing, I was thrilled when it was accepted - no changes needed but they did want camera-ready copy which in those far-off days was quite a hassle to produce. I think they printed 50 copies. Sales never reached the point of generating royalties, the company was absorbed into a much larger publisher, my contact moved on and the book sank without trace. But my mum was quite impressed and it looked good on my CV.

In 2003, when Google was still something of a novelty, in an idle moment late on a Friday afternoon, I googled my own name. Glancing down the results, I noticed one hit in which my name appeared together with that of Oliver Williamson. Odd, I thought. Isn't he a famous American economist? A click brought up a pdf which looked like a book chapter, with the title: " Organization Theory. Lessons for the Lens of Contract/Governance". 

Searching the text, I found this: 

"Laura Spira's ethnographical examination of role of audit committees in corporate governance is what I would refer to as a precious jewel. Rather than address the issues in a normative way, she examines the practice. Her main finding is that (2002, p. 165): 'an important and unacknowledged role of the audit committee is the provision of comfort, through a process of ceremonial performance.. The comfort thus generated supports claims to organizational legitimacy and facilitates resource access. The study offers a possible explanation for the popularity of audit committees despite their apparent lack of effectiveness in improving corporate governance standards.' 

The comfort benefit is that audit committees enable companies to present a concern over high standards of corporate governance, whereupon added legitimacy and better access to financial resources result (Spira, 2002, p. 169).

In the wake of Enron and other accounting scandals, the idea that the auditing committee is a legitimating façade, maybe even a scam, is hard to resist. Spira does not purport to settle these matters definitively, but her treatment suggests that the audit committee is more form than substance. That has lessons for corporate governance reformers: do not mindlessly proliferate new rules, the observance of which serves ceremonial purposes and deflects attention from serious underlying concerns."

Wow! No-one had reviewed my book and I didn't even think any copies had been sold. And now a Nobel Laureate economist had called my book "a precious jewel"! To be honest, the excitement of that moment has never died. 

Husband arrived home from work expecting dinner. No chance. I was far too busy composing an email to the great man asking how he had discovered my book. Husband, with an undergraduate degree in economics, had never heard of Professor Williamson and was not impressed. 

Some hours later a puzzled reply arrived. "I have no recollection of this piece, could you remind me?" Slightly deflated - was this a forgery? was the author a different and less illustrious Oliver Williamson? - I sent him the URL. 

"Ah" he replied, "I must have found your book on a shelf in the library at Berkeley." My book had found its way to a library in California - that was astonishing enough but to then be taken off the shelf by an eminent scholar in a random moment - what are the chances?  

He said that he had written the chapter for his students and had no current plans to publish it but I was welcome to quote his comment. Which I did. Often. Whenever an opportunity arose. In job applications, grant applications, annual appraisals...Of course, I had to explain who Oliver Williamson was to my mum ....and sometimes to other people... even, occasionally, to economists...

Some years later Professor Williamson came to the UK to give the annual Malthus lecture at the university of Hertfordshire. After his lecture - which, I confess, I barely understood -  he was surrounded by a crowd of people asking him what were no doubt penetrating questions about the arguments he had presented. I shouldered my way through to thank him for his kind words which had given a huge boost of confidence to someone in the early stages of an academic career. Of course, he had no idea what I was talking about but he smiled benignly.

The book wasn't that good. (I've written better stuff since.) It wasn't ethnographic, it was just based on a bunch of interviews. I think he was intrigued because it was an unusual approach to the subject at that time. But his comments made me believe that, in my fifties, I had become a proper academic and that my thoughts might be considered worthwhile.

Negative reviews have never bothered me since. And, paying it forward, I always frame the reviews I write as positively as I can. Although, sadly, I've never come across anything I would describe as a precious jewel.

Sir Donald Brydon's report on the quality and effectiveness of audit

This report is, in two respects, a model of its kind. It draws extensively on relevant academic research and it engages directly with those who responded to the Call for Views. Both of these features are unusual in this type of review: academic research is often cherry-picked simply to provide evidence for assertions of the authors and there is rarely any indication of how consultation responses have fed into the thinking behind the report.

I would have liked to have seen more general reflection on the role of audit in the structure of accountability. The report emphasises the role of audit in the supply of confidence (and I'm now wondering how confidence is related to what I termed comfort in my work on audit committees) but does not explore where audit sits in the investment intermediary chain, where confidence is crucial but accountability is blurred.

Another area which deserves exploration is the challenge of getting shareholders to engage: the owners/traders issue is relevant to the role of audit.

It would also have been useful to see some discussion of audit evidence: the work of Peter Wolnizer on auditing as independent authentication has been unjustly neglected.

The idea of an audit profession which recognises audit beyond the financial is interesting: this could usefully clarify the boundaries of financial audit. I remember engaging in heated discussions about the meaning of the word audit with the senior management at my university when the term "quality audit" crept into their discourse, before the publication of Michael Power's "The Audit Society". Multidisciplinary training for this new breed of auditors would indeed be essential.

The comments on the audit committee were also interesting. It is a long time since I interviewed AC members but it is clear that the demanding role placed on members has increased greatly. I remain baffled as to how anyone can chair, or even be a member of, more than one large and complex plc AC. The proposal that membership should be broadened away from those with a purely financial background is important but more needs to be understood about AC dynamics before further requirements about membership are introduced. The suggestion that NEDs don't fully understand the role of external audit is worrying.

I found this interesting:

"10.2.2 A simple mechanism to enable the workforce to raise issues around risks and assurance should be developed in each company, so that the designated director (or other mechanism) be the recipient of those inputs. The company should then have an obligation to respond to the workforce as to the way in which it has reacted to their requests."

I remember interviewing internal auditors in the 1990s about the processes underpinning risk reporting: at least one FTSE 100 company at that time had such a system and based its determination of its risk universe on feedback from employees. 

Two parts of the report made me cheer.

"18.0.3 In essence, it can be argued that there are no correct values as these all depend on informed estimates about the future of one kind or another." If only this was more widely recognised!

Numbers carry a misleading aura of certainty: Ted Porter analysed this effect in "Trust in Numbers" but it is rarely explicitly discussed in the context of financial reporting.

And this:

"26.1.5 It is too seductive for people to retreat behind a best practice defence of their actions. What matters is that the right practice has been followed and that may well be different in different companies and at different times. What matters is what is right for a particular company, with its particular problems and its particular management at this particular moment given its particular circumstances. Best practice concepts drive out innovation as it is always safer to go with the herd and claim that an action is best practice rather than take a bolder and individual step. Best practice defences are based on backward looking analysis. Of course, good practice must be faithful to an enduring set of principles. "

I have long believed that the words "best practice" are very misleading. Who decides what best practice actually is? 

We need to acknowledge the contextual nature of financial reporting and thus of audit. Standardisation implies homogeneity but companies are all different. Why shouldn't audit approaches differ too, depending on the context? 

And where does the role of judgement fit in? I have only looked at a few of the consultation responses so far but I was very struck by the one from Andrew Likierman in which he provides a very useful framework for the analysis of professional judgement.

It will be very interesting to see how this important report is taken forward. The demands placed on the future ARGA are very significant: ideally the design and constitution of ARGA will take these recommendations into account.

Professors of accounting

On Friday I attended the annual Conference of Professors of Accounting and Finance where there were two speakers who have recently written books which may be of interest.

Linda Evans is Professor of Education at the University of Manchester and her book is “Professors as Academic Leaders: Expectations, Enacted Professionalism and Evolving Roles”.   This is based on four extensive studies that she has undertaken, exploring the role of professors across all disciplines. Her conclusion is that the definition of “academic leadership” which underpins the role is poorly defined and thus problematic, leading to professors being stretched too thinly over a range of scholarly and administrative roles. She suggests that the professoriate in a university should be treated as a team with specialisms allowing all requirements across the university to be fulfilled but with professors able to contribute according to their strengths, in a manner similar to the canons at Westminster Abbey. This could then preserve space for research and scholarly activity which, she suggested, was under grave threat.

Michael Shattock has for many years been the guru of university governance and his new book is “Governance of British Higher Education: The Impact of Governmental, Financial and Market Pressures”. He presented an interesting historical analysis of university governance, arguing that boards of governors comprised of lay people cannot fulfil governance accountability requirements and that academics have been progressively side-lined from any influence on university strategy and need to take back control. The audience was a bit sceptical about this, having already spent the day listening to speakers who had painted a gloomy picture of the overstretched professoriate: Michael’s somewhat unsatisfactory response to this scepticism was to point to the enduring success of Oxbridge where senior academics take an active part in strategy development and manage to do everything very effectively.  No Oxbridge academics were present to comment on this.

I was particularly interested in the parallels with corporate governance in the private sector: the adoption in public sector institutions of mechanisms developed in the private sector has not been very successful in improving accountability – indeed, such mechanisms have largely failed in the private sector, too, where non-executive boards have been unable to deal effectively with issues such as CEO pay. The Shattock solution of including more academics on boards of governors is remarkably similar to Labour policy proposals to put employees on corporate boards.

Robert Caro

Until a few days ago I had never heard of Robert Caro but the title of his recently published book - "Working: Researching, Interviewing, Writing" - intrigued me. I've spent much of my working life doing those three things and I'm always interested to know how other people do them.

Caro is a highly respected journalist who, now in his eighties, is still working on the fifth volume of his biography of Lyndon Johnson and previously wrote a biography of Robert Moses. This book is a collection of pieces in which he describes the background to his writing - his motivation and the way he works.

Caro began by wanting to explore the nature of political power: he didn't set out to write biographies but saw this as the most interesting way to investigate this topic, focusing on the role of a single man who exercised great power, and considering its source. Not (yet) having read either biography, I can't assess how far he achieved this ambition but the diligence he exercised in his research is hugely impressive.

His account of working with documentary sources is amazing. His description of the Lyndon Johnson library and the colossal number of files held there is very vivid. The prospect of investigating them would be daunting for anyone less committed than Caro but with the help of his wife Ina he tackled the task. His research was meticulous. These days, when so many archives are available online, one might think it would be easier to do such work but Caro's description of working with documents illustrates the importance to a researcher of the feel and look of the originals. I noticed this myself when working on the Cadbury archive: looking at digitised documents is undoubtedly convenient but it is very different from holding the paper in your hands, seeing hand-written annotations, and this prompts different ways of thinking about the context in which the documents were produced and their meaning for those who produced them and read them.

His interviewing was equally diligent. Just tracking down the people who could provide him with the most useful insights took immense effort and great determination: researchers who complain about difficulties in accessing interviewees could learn a lot from Caro. And he is a very persistent interviewer, braving the irritation this caused to some of his influential interviewees.

Caro had no funding to do this work. He realised quite early on that working as a journalist and writing in his spare time was not an effective way to undertake such big projects. His first publisher made him a small advance but eventually his wife sold their house to support his work. It took a while before they were in position to feel more financially secure. This didn't prevent them from moving from New York to Texas to understand Johnson's background and to get closer to the people who could tell him about Johnson. This is an astonishing commitment to the project.

I found this book quite fascinating. Caro is a great storyteller and a fine researcher. Anyone interested in researching, interviewing and writing should read it.