BusinessCompany NewsTransparency: coming out of the shadows

Transparency: coming out of the shadows

When the Centre for Financial Research and Analysis raised doubts about the way that outsourcing specialist Capita Group was accounting for certain expenses last summer, Capita's share price dived.

The CFRA’s comments came at a time when the market was already jittery about support services firms.

For example, Amey’s share price had gone into freefall after it admitted that new accounting standard UITF 34 would hit earnings.

But Capita’s executive chairman Rod Aldridge wasn’t prepared to see his company suffer the same fate. The central question was how the company treated bid costs in its accounts.

The new standard required firms to take them as a cost through the profit and loss account. The market’s worries were that Capita hadn’t been doing that and, like Amey, it would take a nasty hit in its bottom line.

Capita’s financial results were due within days of the CFRA’s comments.

It immediately issued a statement: ‘As part of the interim results presentation, Capita will demonstrate that it has consistently adopted more conservative accounting policies than those required by the relevant standards.’

The statement was enough to make the company’s share price bounce back 3% to 254p. It had originally fallen from around 300p. Analysts and financial journalists were called to meetings to reinforce the message that Capita was committed to maintaining a ‘cautious and prudent approach’.

So does openness pay? It certainly had a positive impact in Capita’s case. But if transparency is good for business, most big players have yet to get the message. When the Economist Intelligence Unit surveyed the UK’s ten largest companies on transparency for its white paper, Corporate governance: the new strategic imperative, it found that most failed the test. Generally, companies provided information about governance issues but it was difficult to find in annual reports or websites.

There were, however, wide variations both among the companies and in their disclosure of different types of information.

Most companies have always paid at least lip service to ‘openness’ and ‘transparency’. Philippa Foster Back, director of the Institute of Business Ethics, says the two words are among the eight most used in codes of company conduct and business principles.

But becoming more transparent has become a critical issue since the Enron and WorldCom scandals. These and other events, where honest investors were fleeced of their money, prompted demands for more regulations or laws to protect investors.

But there’s a danger that the rush for more stringent standards could be self-defeating.

What’s becoming clear is that the question of transparency is not quite as, well, transparent as it’s made out to be. As Derek Higgs, who has just conducted an official enquiry into the role of non-executive directors, has put it: ‘The first thing in this game is that there are no absolutes. There’s no such thing as getting it right – there are only behaviours that tend to improve the outcome.’

Ted Awty, chairman of KPMG’s client services board, worries that calls for more transparency will merely increase the volume of disclosure – thus obscuring what’s really important. ‘Clarity and openness are often in the minds of regulators but they can be translated by companies as sheer volume of disclosure, which isn’t effective,’ he says.

One example of this is the new disclosure rules for director remuneration.

Companies have to provide a statement of the philosophy behind the remuneration scheme. They must also graph their own performance in shareholder return over five years against competitors. This sounds like the kind of information investors need to ensure that directors are being rewarded for success rather than failure.

But as Ruth Bender, a finance lecturer at Cranfield School of Management and a specialist in directors’ pay, points out: ‘At first sight this looks brilliant, but if you’re paying people over a three-year period and graphing results over five, it’s going to get investors confused.’ She believes some companies may choose to include non-financial elements, such as customer satisfaction, in their calculations of directors’ bonuses. The highly prescriptive approach in the rules won’t pick this up.

So just what should a company be doing to become more transparent in the right kind of ways?

Bender argues that directors need to think again about first principles.

‘If you go back to what corporate governance is for, it’s really about running a company responsibly. You might want to start by mapping your relationship with all the entities that are important – customers, employees, investors, the environment and so on – and then disclose enough to the world to enable them to see how you are managing those relationships effectively.’

Awty says: ‘The test that I apply is simple. When you read an interim or annual report are you left with a good understanding of the business and its drivers? And can you tell how the business is performing against those drivers as well as the major risks it faces and what it’s doing to mitigate those risks?’

He adds: ‘I think all the major corporates I work with have a good understanding of the key drivers of the business and track them vigorously. However, very few actually disclose them, and in some cases, but not all, it would certainly help the understanding of the business for there to be more driver disclosure.’

So why don’t more companies get back to simple transparency principles such as these? One reason, as Awty acknowledges, is that information can be confidential. Another reason is that company directors don’t always agree on what should be disclosed. Indeed, being completely open about the direction that every key performance indicator is moving may make a company more vulnerable to criticism if some are heading the wrong way.

Another difficulty is that some companies find themselves in a position where one statistic drives short-term share price. One example, is major clothing retailers and the spring and Christmas selling seasons.

Certainly, there are analysts and investors who latch on to simple statistics such as these, but boards could often do more to reveal the wider range of drivers which are key to longer-term success.

In the end, there seem to be two key strands to the transparency debate.

The first is how to improve the quality of corporate governance by being more open about a whole range of governance issues.

It seems that most companies fall far short of best practice on this.

But British firms (who score only 1.1 out of a best practice 3.0) are by no means the worst. Average scores for leading cap companies in the US (0.5) and Japan (0.4) are much poorer. They are only marginally better in France (1.2) and Germany (1.3).

The second strand is to enable investors to make a better judgement about the risk issues which might influence their decisions.

One argument suggests that the market will reward companies which are more open about risks with a premium on share price, but this is not always certain.

What does seem clear is that both institutional and private investors will want more and better information about their potential investments in the future. More transparency could be the price of restoring market confidence.

  • This article first appeared in our sister publication Financial DirectorCAPITA GROWTH

Before her very public resignation Estelle Morris, the former education secretary, said she was a ‘very dissatisfied customer’ of Capita, writes Gavin Hinks.

The reason being that Capita was the company that had won the £400m contract to run the Criminal Records Bureau – the organisation that got so far behind in providing checks on teachers before they could start work.

Capita’s tentacles stretch much further though and its services are thought to touch the lives of an estimated 33 million people.

After qualifying as a public sector accountant with CIPFA, executive chairman Rod Aldridge went on to work for his professional body for nine years.

Then in 1987 he led a management buyout worth £350,000 of the institute’s consultancy arm. It is now a publicly quoted company with a market capitalisation of £1.6bn.

Aldridge himself was recently ranked 337 on the Sunday Times Rich List.

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