Some will ask, ‘Why have you written this book?’ Our own question is different: ‘How could we not have written this book?’
There is a time to stand up and be counted – to stand up and offer one’s best. Hence this book, addressing a topic that has been forcibly brought to the world’s attention: the future of corporate reporting in a time when major business failures and a stiff critique of the practices of auditors and influential securities analysts have shaken the public trust.
The epicentre of this earthquake has been in the United States, focused particularly on the Enron bankruptcy and the conduct of Enron’s independent auditor, Andersen. However, the global capital markets are so closely integrated that aftershocks have been felt around the world.
Crisis is opportunity. Virtually every participant in what we have called the corporate reporting supply chain is looking for new answers, new ways to assure investors and other stakeholders that the information they are receiving enables them to understand companies in detail and in depth.
We hope that this book stimulates dialogue among all of us who are responsible for building public trust in the markets, on which the progress of society in all parts of the world depends.
Enron; is the largest market cap company in business history to go bankrupt.
Despite headline news coverage all over the world, it will be years before the full story is known. Even then, new interpretations of this watershed event are sure to appear.
Clear beyond doubt is that this business failure has captured the attention of the public. The cast of this contemporary drama includes senior executives, directors, accountants, lawyers, sell-side analysts, accounting standard-setters, rating agencies, market regulators, business trading partners, employees, banks, investment banks, and large and small investors. Billions of dollars in value have been lost, and questions are being asked about how much of that value was real in the first place.
The consequences have been enormous in jobs lost, money lost, retirements in jeopardy, and sullied reputations of many innocent people who did nothing wrong except to work for or do business with Enron.
Not surprisingly, many accusations are being made, many lawsuits have been filed, and proposals for new regulators and laws are under review in many countries.
Yet the awakening brought about by this genuinely tragic event promises much of value. Enron is the proverbial straw that broke the camel’s back.
There were precursor events – well-publicised business failures in a number of countries, the collapse of the internet bubble, and declines, volatility, and nervousness in the equity markets due to a host of factors, all quite independent of the Enron bankruptcy.
But Enron was the last straw. Attention is now focused on the virtues and flaws in the capital markets, which are more than ever recognised by the public as the foundation for value creation all over the world.
Public trust has been shaken in the institutions on which this value creation depends. These institutions share a collective responsibility for producing the information on which people of many kinds – investors, lenders, trading partners, customers, employees – depend to make a wide range of economic decisions. The challenge now is to institute the necessary reforms to ensure that public trust does not disappear, and the foundation for those reforms lies in corporate reporting.
Re-examining the corporate reporting supply chain
The corporate reporting supply chain begins with company executives, who prepare the financial statements that are reported to investors and other stakeholders. These financial statements are approved by an independent board of directors, attested to by an independent auditing firm, analysed by sell-side analysts, and broadcast by information distributors, including data vendors and the news media. Investors and other stakeholders then make their decisions. Standard setters and market regulators establish the roles and responsibilities of many, although certainly not all, of the participants in the corporate reporting supply chain. Enabling technologies of many kinds are used by all participants.
The time has come to re-examine how the corporate reporting supply chain works and how it can be improved. This can only be done by stepping back from the drama of the moment, yet using the event as a catalyst for reflection.
Business failure will always exist in free capital markets – even the best corporate reporting will not make this go away. Improved reporting can, however, reduce the number and consequences of business failures when it enables management, the board, and the market to respond more quickly.
Key elements of public trust
The Enron bankruptcy is not the most important issue. Instead, it is how the aftermath of this business failure can serve as a lens to sharpen our collective focus on the key elements that create public trust in markets and, therefore, allow those markets to allocate capital efficiently. These elements are easy enough to describe, but not always easy to practice.
Spirit of transparency
The first element is a spirit of transparency. Corporations have an obligation to give willingly to shareholders and other stakeholders the information needed to make decisions. Corporations are simply the people who work in and manage them, while the board of directors of the corporation exists to ensure that the interests of shareholders are well served.
For various reasons, management and boards are not consistently making available information that they know investors would want. Too often, this failure is based on the mistaken belief that playing the earnings game – managing and beating the market’s expectations about next period’s earnings – will increase shareholder value. Sometimes business leaders want to hide such issues as compensation policies and conflicts of interest, which they know would not meet public approval if they became visible.
Today, shareholders and other stakeholders are demanding a much higher level of transparency. Recognising that transparency is necessary to create and protect value, they will no longer accept being left in the dark.
Financial institutions have a special responsibility here because of their role in allocating both equity and debt capital on which companies depend for their growth. Financial institutions must demand transparency from companies in order to improve this capital allocation process. What should be obvious is that they must practice what they demand of others. The cost to financial institutions of poor information is a high one; they have a very real incentive to foster a spirit of transparency in the markets as a whole.
Culture of accountability
The second element is a culture of accountability. Providing information is not enough. It must be accompanied by a firm commitment to accountability among direct participants in the corporate reporting supply chain and those who define how it should work. Commitment means taking responsibility, and this can only occur when an ethos exists that values and understands accountability. This accountability is collective: every member of the corporate reporting supply chain must also commit to collaborating with all others. This chain is only as strong as its weakest link.
Management must hold itself accountable for using shareholders’ money to make decisions that will create value for those shareholders. Independent boards exist to see that this accountability is recognised and maintained by management and the board.
Accounting firms are responsible for providing assurance on certain of the information that management produces and reports. In addition, accounting firms are responsible for never forgetting that their work serves the interests of shareholders, not just the company that writes the check.
Analysts are responsible for using the reported information to produce high-quality research that investors can use to inform their decisions.
Further, analysts are responsible for providing research that is free from any bias due to economic conflicts of interests.
Standard-setters are responsible for establishing principles and rules for making this information useful and reliable. Regulators are responsible for ensuring that all of these groups fulfil their roles, and through careful oversight regulators are responsible for proactively identifying problems.
Information distributors are responsible for making sure that information they cite or analyse from corporate reporting sources is delivered without distortion to the public. Hardware and software vendors need to be constantly monitoring and introducing useful new technologies.
Finally, investors must bear the ultimate responsibility for obtaining, understanding, and analysing the information they use as they make personal judgements about risk and return and invest accordingly. Today, investors and other stakeholders are demanding greater accountability from those on whom they depend for information. Yet they must hold themselves ultimately accountable for their decisions and avoid investments where full information is unavailable or their understanding of available information has gaps.
People of integrity
But even transparency and accountability are not enough to establish public trust. In the end, both depend on people of integrity. Rules, regulations, laws, concepts, structures, processes, best practices, and the most progressive use of technology cannot ensure transparency and accountability. This can only come about when individuals of integrity are trying to ‘do the right thing’, not what is expedient or even necessarily what is permissible.
What matters in the end are the actions of people, not simply their words.
Doing the right thing cannot be compromised, especially through actions that purport to create value for shareholders, but which ultimately betray them. Without personal integrity as the foundation for reported information, there can be no public trust.
- Building Public Trust: the future of corporate reporting by Samuel DiPiazza Jr, CEO of Pricewaterhouse-Coopers and Robert Eccles, president of Advisory Capital Partners.