What is a chartered accountant?

@TruenFairview has tweeted this which I really like. I'm parking it here to remember it for future use, although I have some misgivings about the way the verb "curate" is used these days.

Chartered accountants are curators of uncertainty. We can't make the uncertain certain but we can help you analyse it and prepare

Looking at evidence: the dog that didn't bark

The BEIS corporate governance inquiry report was published this week. I haven't yet had a chance to read it in detail but Alex Edmans, who gave both oral and written evidence has usefully summarised it here. He makes the very important point that evidence should be viewed with care and not cherry-picked, an issue that has plagued the debate on board gender diversity since Lord Davies' first report, which relied on a very selective review of the existing literature.

But taking a balanced view of available evidence also requires some thought about gaps. Conan Doyle and more recently Mark Haddon each constructed a plot on such a gap, the dog that didn't bark. While assisting ICAEW in providing a summary of the written consultation evidence to the committee, I noticed a significant absence of any comment from companies. Some reflection on this could be instructive. If corporate governance reform is to be effective, consensus has to be achieved not just among company stakeholders but with companies themselves: the process of building the Cadbury Code clearly demonstrated that. Stronger enforcement may not be the answer.

A fundamental review which addresses more directly the purpose of the corporate form is sorely needed. My letter on this appeared in the FT last Saturday.

Corporate governance: all talk, no action?

Today I attended a roundtable discussion billed as "Cadbury 25 Years On". I'm never sure what the purpose of a round table discussion is - indeed, the chair of this one in his closing remarks said "I'm not sure where we go from here." The panel of experts pontificated and various people offered questions and comments from the floor. The audience and panel were overwhelmingly male and middle-aged edging towards elderly, and the panel members and some of the audience who spoke were well known to each other and chuckled about their past connections in a frightfully British sort of elitist manner. It was in many ways rather old-fashioned which chimed well with the observations made that nothing seemed to have changed much since Cadbury.

Which of course isn't true and the lack of recognition of this is stultifying any sensible discussion of future corporate governance policy. Rehearsing yet again the problems of executive remuneration, shareholder engagement and the governance of the investment intermediary chain is not helpful. Companies are global, shareholders are not a homogenous group and not a major source of corporate finance. Corporate reporting needs to be broken out of its statutory shackles and done differently, in a way that makes it relevant to all those with an interest in company activity.  That can then lead to a proper review of corporate governance.

Not being a grandee or connected in any way with the big cheeses on the panel, I couldn't catch the chairman's eye and had to listen to a number of false statements about Cadbury pass uncorrected.

1. Cadbury failed to prevent corporate scandals. That was never the remit or intention of the Cadbury Committee.

2. The Cadbury Committee discussed and abandoned the financial bit of "the financial aspects of corporate governance". Given that a central recommendation was the establishment of audit committees, this seems a very strange assertion. What is the major concern of the audit committee if not financial? I don't think that the person who said this went on to explain what might follow from the assertion but I may have missed something by being cross.

3. The Cadbury Committee was only concerned with issues internal to the company. The whole point of "comply or explain" was to stimulate conversations about the explanations with those outside the company.

There are a great many of these events taking place at the moment, organised by different groups which don't seem to talk to each other and produce, in my view, very little of substance in the way of contributions to corporate governance policy change. The responses to the BEIS corporate governance inquiry were, with one or two notable exceptions, bland and boring. It will be interesting to see whether the Green Paper responses are any more radical but I'm not expecting anything surprising.

However, I have been very cheered by the publication this week of this from The Purposeful Corporation. I haven't yet had a chance to read the whole paper but it appears to take a holistic view, have some intellectual substance and it does make mention of the role of corporate reporting.

Looking round that room today, it occurred to me that we probably don't need more women on boards nearly as much as we need more women influencing corporate governance policy. I don't think an all female panel would have chuckled so much.

A radical approach to #corpgov?

John Kay’s submission to the BEIS inquiry made the very important point that businesses are financed differently from the way that they were when our legislative and regulatory regime was first constructed. We are locked into a nineteenth century framework of accountability that bears little resemblance to twenty first century business reality.

In the past the accountancy profession has led the way in radical thinking. The profession has struggled for many years with the idea that financial reports are not useful.  “The Corporate Report” was published by ICAEW in 1975, before the accounting standard setting behemoth had submerged corporate reporting and developed into a huge constraint on any form of constructive rethinking.

The new forms of report proposed by this discussion paper were largely ignored, apart from the value added statement, although the statement of future prospects and the statement of corporate objectives have been revisited, with little acknowledgement of their history, in the integrated accounting project. The list of users and the description of their information needs has become received wisdom, repeated in financial accounting textbooks and firmly set in stone.

Thirteen years later ICAS published the discussion paper “Making Corporate Reports Valuable”.

This is much more radical in its approach, starting with a clean sheet and  thinking through accountability issues and how to address them. (It is notable that chapter 2 provides a corporate governance perspective: Scottish accountants had been reflecting on corporate governance for some time and were central to the establishment of the Cadbury Committee.)

MCRV reframed the list of users and directly addressed problematic areas of reporting. A detailed analysis of information needs led to precise suggestions for different reporting forms. This paper was followed in 1990 by a specimen set of accounts for a fictitious company, Melody plc, showing how the ideas could be applied in practice and in 1993 by a further feasibility study.

The two discussion papers bear rereading. While they were very much of their time, prompted by specific concerns such as the problem of accounting at a time of high levels of inflation, they represent a depth of thinking about reporting and accountability that has not been seen during the past twenty five years since the publication of the Cadbury Code. Corporate governance, financial reporting and audit are inextricably linked (yet surprisingly few corporate accounting textbooks – even those written by accountants – fully address this) as they form the framework within which accountability is expressed and achieved.  It would be encouraging to see the accountancy bodies once again grappling with these issues from a radical perspective, rather than offering further ideas for tinkering at the edges.

But the only recent instance of radical thinking on corporate governance that I have found is in this paper by a US legal scholar which argues that boards of directors are no longer essential.

It’s worth a read.

This week the FRC has announced a fundamental review of the UK Corporate Governance Code.

It remains to be seen how fundamental it will really be, in terms of addressing how corporate governance arrangements relate to modern business models and different funding patterns. And whether it will go back to first principles and pose unasked questions – for example, the unintended consequences of mandating board composition, which have not been widely discussed. Since Cadbury, board independence has been viewed as desirable but US evidence questioning this existed even before Cadbury*. Many large companies now have a hybrid form of two tier board: the board and the executive group do not sit around the table together and the link between the two is principally in the hands of the CEO. Which is ironic, given that corporate governance arrangements were largely intended to curb the power of the CEO.

Another useful set of questions might be: how do governance mechanisms operate within the public sector, where accountability structures are very different? Have boards of central government departments and of NHS Trusts simply replicated arrangements from within the private sector or have such arrangements been adapted? Is there anything that the private sector can learn from this?

The discussion paper published this week by ICSA is an interesting attempt to extend the debate, arguing that restoration of trust in business is not only the responsibility of listed companies and they cannot be expected to shoulder alone the task of achieving broad public policy objectives.  ICSA promises further papers and a radical approach. My breath is bated...

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* Baysinger, B.D and  and Butler, H.N (1985) Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition Journal of Law, Economics, & Organization, Vol. 1, No. 1 pp. 101-124;  see also Bhagat, S and Bernard Black, B (1999) The Uncertain Relationship Between Board Composition and Firm Performance The Business Lawyer Vol. 54, No. 3 pp. 921-963

Econocracy

I have yet to read "The Econocracy: The Perils of Leaving Economics to the Experts" by Joe Earle, Cahal Moran and Zach Ward-Perkins but I have been reading this review of the book by Aditya Chakrabortty and it has caused me to reflect further on my own experience of studying economics.

Like Earle, Moran and Ward-Perkins, I studied for an undergraduate economics degree at the University of Manchester. To me, in 1965, the course structure seemed fragmented: I had assumed that I would study mostly economics (although I had no idea what that involved and had chosen it for rebellious reasons).  I was puzzled by the requirement to study social anthropology (what did witchcraft among the Azande have to do with anything?) and politics, although I enjoyed both and found them much easier than my choice of option, accounting.

The course had in fact provided a very broad base of social science study, although the links between the different parts of the programme were not emphasised and it was not until I started my doctoral studies many years later that the links dawned on me. It was also many years before I realised that I had been taught by very distinguished scholars in politics (W.J.M.Mackenzie) and social anthropology (Max Gluckman).

But what about the economics courses? I remember that the main textbook was the first edition of An Introduction to Positive Economics by Richard Lipsey. I remember breathing in the smell of my brand new copy. I also remember reading the first chapter time after time in the hope that eventually I would understand it... We also used Samuelson's Economics (a book which gets its own Wikipedia entry) which I found much easier to understand. Or perhaps the diagrams were prettier. I remember that our classes were taught by two young men called David, Colman and Metcalf, who both went on to have very distinguished academic careers, although I didn't understand what they talked about.

My main problem with economics was the models. They required so many assumptions that I couldn't see how the abstractions helped with understanding the complexity of real life problems. I could - eventually - grasp the idea behind the trade-off between guns and butter but how exactly did this explain how decisions about national resources were actually made? What did the Phillips curve actually mean? This puzzlement extended into aspects of accounting: I shed tears over double entry bookkeeping for the whole of the first term until the penny dropped and I managed to produce a balance sheet that balanced.. but what exactly was the point? I hit this problem again when I began my PhD work and found that the corporate governance literature was largely predicated on principal-agent theory, the assumptions of which, to me, led to a very narrow analysis of my area of interest, board behaviour.* 

According to the book review, the Manchester students had a similar problem with abstract models and prompted by this review I look forward to reading their account. But Chakrabortty, as he makes clear, was closely involved with the students and the developments subsequent to their challenge to the Manchester curriculum and I'd like to hear other views - I'd particularly like to know how the Manchester lecturers dealt with the challenge.  Chakrabortty also states: "The authors analysed 174 economics modules for seven Russell Group universities, making this the most comprehensive curriculum review I know of." One could, of course, argue that Russell Group graduates are more likely to have significant future influence as economists than graduates from other universities but my former colleagues were certainly teaching heterodox economics long before the financial crisis which precipitated the story behind this book.

I like the idea of students challenging the curriculum, not because it's too challenging for them (not unusual among my accounting students over the years) but because it doesn't address real world problems. More power to their elbows!

*the late Sumantra Ghoshal, Professor of Strategic and International Management at the London business School, argued persuasively that the teaching of agency theory in business schools had very negative consequences on actual behaviour. The theory has been broadened more recently with scholars developing behavioural agency theory models.

Ghoshal, S (2005)  Bad Management Theories Are Destroying Good Management Practices Academy of Management Learning & Education, Vol. 4, No. 1, 75–91.

Random thoughts on the scope of corporate governance

I've been following tweets about the HBOS fraud from well-informed people and, not for the first time, I wonder how it is possible to distinguish between corporate governance failure, audit failure, poor business decisions and outright fraud. This distinction matters in placing blame - which may, of course, be shared - and in considering regulatory responses.

If corporate governance is about how companies are directed and controlled, any failure of direction or control could be deemed corporate governance failure. But businesses do fail, for all sorts of reasons, not all of which could be anticipated or managed.

Corporate governance failure implicates the board of directors. Audit failure implicates not only the auditor but also the wider profession. Poor business decisions may lie with the board and/or senior management: they could be the result of poor business strategy (the fault of the board?), poor operational implementation (the fault of management?) or lack of proper oversight by the board.

Experienced NEDs have told me anecdotes about feeling powerless in board situations where it was clear to them that decisions made would set the company on a downward path: the challenge for a NED is then whether to stay and continue to try to mitigate the negative outcome or to resign and possibly accentuate the difficulties, as the signal of company problems affects the share price. Would subsequent company failure in such circumstances be viewed as a corporate governance failure?

Fraud is surely a failure at an individual level. Does anyone ever explore the motivations of those convicted of fraud? The detection of fraud is not, as we know from the famous canine analogy (bloodhound not watchdog), necessarily down to the auditor.  But a recent shift in thinking seems to view the occurrence of fraud as a failure of company culture and thus a further area of board culpability.

And where do the regulators stand in all this? The FRC has been remarkably quiet on the HBOS scandal and a recent call for a new corporate governance regulator suggests that the present regime is inadequate.

Some radical thinking is needed. This paper by a US legal scholar deserves wider consideration.

It argues that "the board of directors in a large, public corporation is ineffective to perform the functions assigned to it and so should be eliminated in favor of a governance system that more accurately reflects corporate decision making."

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.