Ethical Accounting - The corporate world through ethical eyes.

It’s not enough now to run a profitable business and satisfy shareholders.

No company could have delighted shareholders more than Railtrack, increasing profits and dividends to record levels. Except that it’s alienated practically everybody in the country who’s not a Railtrack shareholder while doing so.

Now the company’s management is under perform-or-die pressure from the government to improve rail safety and boost investment to promised levels.

Worse, they’ve created a climate in which the public is not inclined to give Railtrack the benefit of the doubt if anything goes wrong in future.

Railtrack’s woes are a salutary lesson for blue chips in many other industries. Building a healthy bottom line is not enough. You have to do it in a way that doesn’t upset other stakeholders, from customers and business partners to communities and pressure groups.

And the penalties for getting it wrong are tougher than ever. The Public Interest Disclosure Act provides more protection for those who expose corporate wrongdoing and uncaps the compensation whistleblowers can claim at industrial tribunals if they’re sacked.

The new Competition Act introduces a maximum fine of 30% of turnover over three years for companies guilty of anti-competitive practices. The Involuntary Homicide Bill, which creates a new offence of ‘corporate killing’, could make individual directors and senior managers responsible for workplace death.

All of which means that a new standard for social and ethical accounting – AA1000 – launched by the Institute of Social and Ethical AccountAbility is more than timely. AA1000 is a 96-page document which sets out a process and framework for taking decisions about a whole range of social and ethical issues. The standards could stimulate management action across a range of issues (see panel, right).

Simon Zadek, AccountAbility’s council chairman, says: ‘Before now, companies that wanted to take control of their destiny by proving themselves ethical were feeling their way in the dark. There was no established process as there is for financial and environmental accounting – and no way of assessing what constituted good or bad practice.’

AA1000 provides best practice guidelines for companies based on a consensus from experts around the world. Zadek adds: ‘More importantly, it gives internal and external stakeholders reassurance that there is real substance behind an organisation’s actions – that it’s more than PR.’

Many companies are edging towards the social and ethical reporting agenda but few are doing enough. A joint Arthur Andersen/London Business School survey of FTSE-350 companies and unquoted companies of similar size – Ethical concerns and reputation risk management, showed that 78% have a code of conduct and 40% have ethics training – double the number three years ago.

But, while welcome, on their own neither provide the kind of comprehensive action that steers a company away from potential trouble. Indeed, a code of conduct too often proves an Achilles heel when a company is found not to have followed it. Harish Bhanyani, a manager in Arthur Andersen’s ethics and responsible business practice, says that more companies need to adopt a holistic approach.

One company that’s done so successfully is the Cooperative Bank. Its fourth partnership report will appear in April. Paul Monaghan, partnership development manager, says the bank first introduced an ethical policy in 1992. Since then, social responsibility and ecological sustainability have been key components of the bank’s market positioning. Profits have grown every year on the back of that strategy.

The Partnership Report focuses on how the bank performs with each of its seven key stakeholders – staff, customers, suppliers, community, national societies, past and future generations of the cooperative movement and shareholders. Monaghan explains: ‘We ask ourselves three questions with each partner as a means of defining key targets.’

The first question is: what matters to you most in your relationship with the bank? For customers, it might be service. For business partners, the speed at which they’re paid. Cooperative Bank uses this information to define the issues and set the targets on which it wants to be judged.

When all the stakeholders have defined what matters to them, the bank asks itself two further questions. First, do we deliver on these issues in a responsible manner? ‘That’s where an ethical policy comes in,’ says Monaghan. Secondly, are we delivering in an ecologically sustainable manner?

For example, the bank is already sourcing more than half of its electricity from renewable sources.

The key point about the Partnership Report is that the data it contains is independently verified and audited – for example, MORI is used to poll customers on satisfaction issues – so that people know it’s more than an empty PR exercise.

And Monaghan points out that the Partnership Report leads to action.

For example, last year’s report drew attention to shortcomings in the bank’s diversity (equal opportunities) policy and its community involvement.

Says Monaghan: ‘This year we’ve been putting in a lot of effort on diversity issues to make sure we’re up to speed. On community, people were pleased we were making so many charitable donations but we needed better management systems to ensure that the money we gave actually made a change.’

Cooperative Bank uses a three-person mixed team to put together its annual partnership report. The team includes somebody with an accountancy background and the task takes about three months to complete. The cost of external verification and commentary comes to between £50,000 and £60,000.

As social and ethical reporting gains wider acceptance in more companies – perhaps stimulated by AA1000 – there could be a greater role for accountancy professionals to play. AccountAbility is talking to more than 50 universities around the world about building a social and ethical accounting module into accountancy degrees.

‘We believe there will be social and ethical accountants and auditors available and being qualified from UK universities within the next couple of years,’ says Robert Beckett, director of development at AccountAbility.

But given the breadth of the agenda, the accountancy profession has to climb a learning curve as steep as Everest in a short space of time if it’s to contribute to the emerging debate about social and ethical reporting.

Many business people may find it uncomfortable at first living in the new corporate goldfish bowl. But the positive side is that a more open approach does provide opportunities to create new and lasting business value. And, anyway, when did you last hear a goldfish complain?

THE COPENHAGEN CHARTER

Reporting to different stakeholders – like employees, customers and business partners – is all very well. But what are the implications for management? Teddy Wivel, a partner in the Copenhagen office of Ernst & Young, spent part of last year with colleagues from KPMG, PricewaterhouseCoopers and Danish accountancy practice Mangan Morgen seeking to answer that question.

The result: the Copenhagen Charter, billed as a management guide to stakeholder dialogue and reporting. Wivel says the charter shows how a company can turn stakeholder reporting aspirations into activity.

He believes it neatly complements AA1000 by showing not just what, but how social and ethical reporting can be done.

Wivel says the key to making social and ethical reporting work in practice is persuading directors and shareholders that it is an essential part of the value creation mechanism of the company.

‘Financial accounts don’t tell the whole truth. In fact, the amount of truth is less and less in that financial accounts increasingly don’t explain the wide difference between the book value and the market value of many companies,’ says Wivel.

That can only be explained by looking at issues such as the quality of its brands, the expectations of its customers, its ability to attract the best employees and other similar issues. And those are very reliant on its reputation in the marketplace – a reputation that can be laid waste if it doesn’t attend to the social and ethical issues which provide a large corporation with its ‘licence to operate’.

The Copenhagen Charter contains three main parts. Part one shows how social and ethical reporting can be used to create both internal and external value. It stresses that the processes of social reporting must be integrated into the strategic management of a company.

Part two deals with principles of stakeholder reporting. It shows how to lay the groundwork by establishing stakeholder processes and procedures.

It demonstrates how stakeholder reporting can be embedded in the day-to-day management of a company. And it provides guidelines on communicating with different groups of stakeholders.

Part three is about making stakeholder reporting credible – moving away from fine words to reports that carry weight. It provides guidance on developing relevant information, choosing accounting principles and verifying the reported information.

The charter says: ‘Companies that commit to stakeholder reporting do so with the aim of securing balanced and sustainable value creation for all key stakeholders.’

Wivel believes the accountancy profession will have a key role in helping to bring social and ethical reporting to centre stage. ‘My wish is that in five years, auditing and verifying social and ethical reports should be part of the core business of all major accounting firms.’

HOW TO USE AA1000

AA1000 provides a standard that most corporates can use to underpin a wide range of management activities. These include:

– Measurement: Identify key performance indicators by engaging with stakeholders.

Bring the company and stakeholders closer together towards a common understanding of what matters about performance.

– Quality management: Encourage feedback from stakeholders on social and ethical performance. Use the feedback to improve understanding of what stakeholders want and to manage those desires alongside other objectives.

– Employee recruitment and retention. Define corporate values in ways that attracts high-quality new employees and retains the loyalty of the best of existing staff.

– External stakeholder engagement. Create a climate of increased trust between the company and external stakeholders by defining and reporting on social and ethical policies.

– Partnership. Deepen value-based relationships along a supply chain by defining good practice behaviour in those relationships.

– Risk management. Create a framework for managing the risks inherent in any relationship with groups of stakeholders – such as attacks on brands or disputes with employees.

– Investors. Satisfy demands from investors for authenticated information about social and ethical importance. Especially important when dealing with the growing number of ethical funds.

– Governance. Use the standard as part of a company’s governance process to ensure that behaviour is aligned with values and strategy.

– Government and regulatory regimes. Encourage governments to trust self-regulatory processes – and avoid legislation – by showing that self-regulation is audited and accountable.

– Training. Train social and ethical accountants using AA1000 as a foundation of good practice.