John Kay hits the spot

Although I have spent the last few weeks studying the responses to the BEIS inquiry into corporate governance, John Kay's submission has only just been posted on the web site.  I wanted to cheer when I read it. He has expressed my own thoughts very cogently. Here are my favourite bits:

"Public policy discussion, and in particular our regulatory structures, demonstrate very little recognition of … changes in the nature of capital, business and the relationship between the two."

"...the existing structure of financial reporting must come into question.  There are wide differences across industries and activities in the relevant metrics of performance and the appropriate time frame for these  metrics  The attempt to impose a standard reporting template across the whole corporate sector has led in practice to very lengthy corporate reports, much of which consists of boiler plate, and which often conceal rather that highlight relevant information.  The recent emphasis on narrative reporting is a helpful step away from this, but there is  difficulty in ensuring that such reporting is substantive rather than platitudinous.  The accounting firms and accounting standards bodies have a principal role to play in elaborating what is good and bad in narrative reporting, but such material is by its nature subjective and qualitative, and not readily amenable to prescriptive regulation."

"The wider issue here is that corporate reporting should increasingly be – as it now is in private equity – a matter for negotiation between investors and companies, with an eye on key performance indicators, rather than the subject of one-size-fits-all regulatory prescription.  The traditional function of formal financial reporting to Companies House – to provide a check on the honesty of the directors and executives and give potential creditors the information they need before they decide to do business with a company – remains, but has become confused with the provision of the, necessarily company specific, data needed to attempt a valuation of the company and assess its investment potential.  The move to ‘fair value accounting’ is a reflection of such confusion of functions.

The Annual Report has naturally been the company’s principal means of communication with the wider public.  That most large companies produce other documents with this aim is an indicator that the doorstop Annual Report no longer serves this purpose.  In practice, most companies now communicate with the public through their website, and some such websites are well constructed and informative.

We have not rethought financial reporting for a world in which the internet is a primary vehicle of communication, in which the typical large business is no longer a manufacturing business but a knowledge factory, and in which the structure of asset ownership is increasingly dominated by a few large intermediaries.  Instead, we have bolted on new requirements to an existing structure, creating a clumsy framework which does not serve any of its underlying functions well."

Root and branch reform of financial reporting is needed, paying close attention to how business activities can best be communicated and reflecting that regulatory requirements need to be sufficiently flexible to accommodate the wide variety of such activities and the organisations in which they take place. This could present a new approach to thinking about the relationships between corporate governance, corporate reporting and the role and practice of auditing. The idea that corporate reporting should be negotiated between investors and companies echoes the Cadbury Committee's idea that corporate governance disclosures should be the basis of a conversation between the same parties. 

It would be greatly to the advantage of the accountancy profession to lead such thinking.