If reports are to earn the trust of their company’s stakeholders, and become widely used as credible sources of useful information, what should corporate South Africa be doing differently? This article calls for corporate leadership to do the right thing and say it like it is.
In her final column for the Business Report, Ann Crotty tackled the subject of annual reporting credibility with comment on Caxton’s recently released 2013 Annual Report. She begins: “You should know that when Caxton’s annual report can be considered as one of the best to be produced by a JSE-listed company, something has gone horribly wrong with the whole concept of corporate disclosure.”
After debating whether the report is “on the money” or not, she notes that it is a truly wonderful thing that you, the reader, have to trip through only 64 pages to “get the misleading impression that you know something about Caxton”. Meanwhile, “other companies will force you to wade through as many as 600 pages before leaving you with the same misleading impression...”.
More information, less relevance
Crotty points out that people who run listed entities appear to have decided that the best way to deal with the need for improved disclosure is to provide vast amounts of information – “rather like drowning someone who is dying of thirst”. And the obligation to comply with increasing layers of legislation fuels this torrent. “So we have increased disclosure but not improved disclosure,”Crotty points out.
Not surprising then that companies complain that the annual report is not being read. Further, engagement with the investor community reveals that the report is not being used for its intended purpose, namely to find out how the company creates sustainable value and how it is performing in achieving its goals. This is a wasted opportunity. Those companies that can use their report to communicate these messages will be in a far better position to direct the often-misinformed public conversation about their business conduct.
“The Law of Inverse Relevance: The less you intend doing about something, the more you have to keep talking about it.”
– Sir Arnold, in the BBC series Yes Minister
Calling companies to account
The King commission process began in South Africa at the beginning of the nineties to tackle corporates’ lack of willingness to confront the issues facing them. It continues to this day. In summary, the movement is aimed at steadily improving the quality of governance, particularly on non-financial issues. As part of this, it aims to enhance disclosure of environmental, social and governance (ESG) issues as the drivers of ‘value creation’, or ‘intangible value’, or even ‘sustainable value creation’.
Internationally, the Global Reporting Initiative (GRI) and International Integrated Reporting Committee (IIRC) have created standards and guidance for reporting.
Driving compliance, not good reporting
Two consequences of the King process are of relevance to reporting. The first is that it stimulated the promulgation of further legislation demanding compliance from companies listed on the JSE. This resulted in an understandable change in attitude from companies. At the outset of the reporting cycle, the answer to the question: “what should we report on?” was not: “whatever will help the reader understand how the company creates value,” but rather: “whatever is necessary to comply with the Company’s Act, King III, the GRI table of indicators, and more recently, the International Integrated Reporting Council’s IR framework (not to mention the NCA, the CPA, RICA, POPI, etc.)”.
It is entirely feasible that if the GRI and IIRC decided to leave customer satisfaction off the list of required disclosures, most companies would drop such an obviously fundamental measure of value creation from their reporting.
The second consequence of the King process was that South Africa shot to the top of the global rankings for annual reporting. A survey of 2 000 companies in 23 countries, conducted by Harvard Business School professors Robert Eccles and George Serafeim in 2012, indicated that South African companies were among the best in terms of incorporating non-financial issues into the annual report and interpreting how these issues influence value creation.
South Africa leads off a low base
Rising to the top of the rankings was a false dawn for reporting in South Africa. The reporting fraternity understood the concept of integrated reporting and its value before most of its peers in other countries. Indeed, South Africans were among the architects of the new reporting frameworks and guidelines.
Reports were filled with phrases like: “we acknowledge that lending to customers who can’t afford to repay their loans can create a liability for us and adversely affect the long-term sustainability of our customers and their communities”. Simply crystallising the issues was enough to put South Africa’s reporting at the forefront of this emerging arena. But it does not mean that South African companies are more responsible in their management of ESG issues. And such declarations cry out for the company to respond. In the example above, this should have included a policy statement setting out the company’s approach to responsible lending, the performance of their loan book and a description of any initiatives – such as frontline training and customer education – that the company might have been engaged in to reduce the long-term risks of a credit bubble.
For most companies, taking the step to disclose their performance and discuss the challenges they face requires a level of openness they have simply not been prepared to go to. The enthusiastic reporting community, as well as the requirements of King III, have pushed them up the hill with the promise of a new and sustainable future. But when a short-term bridge needs to be crossed, for example how to report on the company’s response to increasing childhood obesity when it makes its profits from the sweets aisle, all too many corporate leaders have retreated.
The case of irresponsible lending at Abil
African Bank Investments Ltd (Abil) provides a telling example. If it had used the power of non-financial indicators in its reporting to provide advance warning of potential danger in its unsecured lending book, its management would have been prompted to change its policy from pursuing so aggressively the acquisition of low-income clients to applying lending models aimed at reducing the risk of bad debts.
Mehluli Mncube, representing the Eskom Pension Fund and Sentinel Retirement Fund’s investment in Abil, attacked management at the company’s 2013 annual general meeting for being dishonest with its “glossy” explanation of the company’s lending model at the previous year’s meeting. Within a month of that meeting, the National Credit Regulator imposed a R300-million fine on Abil for reckless lending. While this was eventually settled with the regulator for R20 million, the company’s profit dropped by 88% in the 2013 financial year, accompanied by a 60% drop in its market value.
Clearly, companies are strongly motivated to dress up their reports, to enhance their reputation in the eyes of their customers, the government, and of course their investment community. It is no use pretending that these motivations do not exist. Managers have become conditioned to putting spin on their own performance, for an improved façade may boost the short-term prospects for promotion and reward.
Why aren't annual reports balanced?
There are several reasons why annual reports in South Africa are such a poor reflection of the company’s true story of value creation.
Few understand that sustainability is about value creation
Generally, there is a lack of understanding of sustainable business. Many line managers are under the mistaken impression that sustainability means planting trees and saving the environment, rather than understanding it as a process of creating value through building relationships and resources for the long-term benefit of the business and its stakeholders. Naturally this skewed notion of the concept results in line managers regarding reporting as being a distraction from their real work.
Operationally focused managers view reporting as irrelevant
However, even line management’s internal business reporting bears little connection with long-term business value creation. This is not surprising when one scrutinises the way these managers are incentivised and rewarded. Performance measures are mostly directed towards operational productivity, the drivers of short-term performance.
Negative indicators trigger corporate fear
Further, non-financial indicators often measure the negative consequences of corporate behaviour. For instance, by measuring lost time due to injuries, the company gets advance warning of the risks that may be building within its operations and that could lead ultimately to deaths. But it sounds like bad news. Other examples of such measures include: absenteeism, employee turnover, fines and penalties, disputes, and legal cases against the company. Not surprisingly, being asked to report on these indicators can seem threatening. In a culture of fear that can quickly envelop a large organisation, managers will try and deflect the bad news in any way they can.
Governance is a good place to hide
The easiest way to deflect bad news is to seek refuge within a dense corporate governance bureaucracy. This apparatus is largely aimed at complying with the ever-increasing layers of regulation designed to reign in excessive, exploitative and unethical corporate behaviour. It also provides companies with an armoury of committees, mandates and policies to reproduce in the annual report in the form of so-called ‘boiler-plate’ reporting.
The rewards of enlightened leadership
Very rarely, a report does tell it like it is, addressing the important issues and presenting a balanced view. In its 2012 annual report, PUMA deals frankly with its challenges in Cambodia where low wages, poor nutrition, and substandard health and safety practices in factories supplying the brand caused mass fainting, wild-cat strikes and violent protests. It is clear that PUMA has squared up to these challenges and is engaging proactively with all influential stakeholders in the region, including various activist organisations, such as Better Factories Cambodia (BFC) and the Fair Labour Association (FLA). Reports such as this one have a positive impact on stakeholders. Analysts, journalists and the public gain an immediate sense of trust in the leadership and are more likely to show sympathy and loyalty to the brand in times of stress.
As this example shows, enlightened leadership is the answer to effective annual reporting. Corporate leaders need to develop confidence in a basic value system that underpins their thinking. This ought to be as simple as: do the right thing, think and plan for the long term, walk the talk and say it like it is.
In conclusion, CEOs need to realise how valuable the annual reporting process can be for the business. Internally it is an opportunity for the business to take stock, fine-tune strategy, reset targets and get its staff committed to long-term value creation. Externally, the report shows readers that the company’s leadership understands the important issues and has a plan for tackling them.
Published on the Trialogue Website: March 17th, 2015