Explain Yourself: How corporate reporting really can engender trust by Joel Feyerherm

Tags: Corporate governance

Richard Moriarty, CEO of the Financial Reporting Council, used his IBE lecture this year to explore the intertwined nature of ethics and corporate governance.

Refreshingly, Moriarty did not profess to know all the answers. Still just a few months into his role, he was not afraid to say “I don’t know”. In fact, he posed more questions than provided answers.

That seems appropriate for a regulator. Rather than tell companies what they should be saying, a regulator should ask the questions and then listen.

It’s an approach that the FRC is finding is not always well received. “Boards should think for themselves”, Moriarty said. To which some businesspeople have responded, “What does that mean?”.

In a world in which business failures are often met with more prescriptive regulation requiring more reporting, it’s not surprising that businesspeople should seek to know what is expected of them.

In fact, the UK Corporate Governance Code, full of provisions to which companies must “comply or explain”, would seem on the surface to encourage a tick-box response.

However, “comply or explain” is not like “trick or treat”. You really can choose not to comply with a provision of the UK Corporate Governance Code, so long as you explain your decision.

As Moriarty pointed out, drawing on his experience running the Civil Aviation Authority, a clear and cogent statement explaining why a company has chosen not to comply with a provision can foster more trust than a quiet tick in the box of compliance. It demonstrates that the board considered the issue carefully.

So explaining is every bit as important as complying.

There is another set of standards hosted by the FRC that can shed some further light here, a code where there are no provisions against which one must comply or explain: the Wates Principles, developed by a coalition of organisations including the IBE and published in December 2018.

Since 2019, large private companies (those with more than 2,000 employees or with £2bn on the balance sheet and £200m in turnover) have had to state in their annual reports whether they follow a corporate governance code. Many have been using the Wates Principles to guide their reporting.

Then-Secretary of State for Business Greg Clark gave the Wates Principles his sign of approval, meaning it’s the only government-recognised set of standards specifically aimed at helping large private companies report on their governance.

There is no option to “comply” with the Wates Principles, as there are no provisions in it. There are only six principles, covering basic areas of governance – purpose and leadership, board composition, director responsibilities, opportunity and risk, remuneration, and stakeholder relationships.

The guidance for the Wates Principles suggests that companies apply all six principles and then explain.

It’s a fairly blank slate, though the guidance notes do provide some questions and more specific topics to consider. The FRC also provides broader guidance on good reporting, such as in its publication, What Makes a Good Annual Report and Accounts.

In that publication, the FRC advises companies not just to employ good corporate governance principles, but also the 4Cs of effective communication:

• Company-specific
• Clear, concise and understandable
• Clutter-free and relevant
• Comparable.

Which makes perfect sense, though putting those 4Cs into action is a good deal more complicated. Boards may consist of a diverse collection of individuals with strong opinions on complex topics and decisions.

In that context, it is too easy to resort to generalities and boilerplate text in the annual report.

Which is why we see statements in corporate governance reports like this one:

We adopt the highest standards of professionalism and ethical behaviour throughout the Group.

It may not come as a surprise that the example above comes from the annual report of a certain ferry company that, in the year following that report, made a large tranche of employees redundant and replaced them with overseas agency staff.

The boilerplate text feels hollow and doesn’t fool anyone.

Contrast that with a statement like this:

We remain family-owned and free to forge our own path. We are curious and excited by the unknown. Not restricted by conventional thinking, we discover and learn for ourselves.

Some may consider that simply a different style of corporate-speak. Still, at least it conveys a personality and reflects the essence of an electronic goods manufacturer with a well-earned reputation for innovation. It feels genuine.

So the Wates Principles, as a framework that allows considerable freedom for companies to apply and explain, may provide some hope for better governance reporting that reflects boards actually thinking for themselves.

Please note that the FRC is currently updating its research on company reporting against the Wates Principles and we expect a report to be published by the FRC soon.

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