Our current emphasis on the non-financial drivers of a company's or director's performance involves too much crystal ball-gazing, suggests Jane Fuller
This article was first published in the November/December 2017 UK edition of Accounting and Business magazine.
In a perfect world, stakeholders would have crystal balls and know whether or not the company they own, work for or supply will make sustainable profits – and ensure they are paid for ever. The performance of companies and directors would be continually evaluated and acted upon by diligent shareholders, and there would be no need for crude backward-looking numbers.
We can but dream. Clearly we do not live in a perfect world, but sometimes it sounds as though we think we do. The current focus on the non-financial drivers of company performance assumes a chain of causality stretching into the future.
If a company ‘invests’ in its workforce (spends more on training and wages), this will deliver higher productivity and push up sales as they delight customers. If it reduces emissions, it will not only earn a return on the kit installed to achieve that, but also cut the risk of paying fines for pollution.
If it gets involved in community activities, it will improve its image and sell more. In fact, none of these is certain. As Hans Hoogervorst, chairman of the International Accounting Standards Board, said in September, it is precisely because financial reporting is primarily backward-looking that it ‘offers the most concrete evidence of the performance of a company’.
Hard numbers matter, and so do the triggers to look at them. One example, as the UK reviews its Corporate Governance Code, is the independence of non-executive directors. These days, shareholders of FTSE 350 companies vote on their re-election every year, so surely they can assess them on individual merit? Why would a director suddenly cease to have an independent mind after nine years, the cut-off point in the code’s definition?
The answer is that we cannot read their minds, but it is reasonable to believe that long tenure breeds cost relationships. Similar reasoning supports the rotation of a company’s auditor after 10 years. We can only hope that the new ratio of CEO pay to average pay will focus minds on the question of whether the former are paid too much.
Yes, these are crude numbers, but in practice they are a good way to prompt effective scrutiny.
Even when the figures before us have contentious elements, as in accounting for defined benefit pension schemes, they are much better than having nothing at all.
Academics are up in arms over the doubling of the deficit in the Universities’ Superannuation Scheme to more than £12bn. It is a somewhat crude number and so is the (currently very low) discount rate that is used to calculate liabilities.
But if people are living longer and future investment returns may be less than historic, something has to give. Better to have a prompt to act now than to pretend it will all work out fine in the future.
Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council
"Even when the figures before us have contentious elements, they are better than having nothing at all"