Edition: Dec 2013 - Feb 2014
Editorials

COMPANY REPORTS

Improved worth, gradually

‘Integrated reporting’ promises to measure the intrinsic value of companies and thereby become a vital tool for the long-term investor. Rob Worthington-Smith, a director of the Trialogue consultancy, asks whether these reports measure up to trustees’ expectations.

If you’ve been reading annual reports for the last decade or two, you’ll have noticed a significant change in the messaging, the approach and the content.

They used to comprise multiple pages of management accounts and densely worded ‘notes to the financials’. The glossy pages at the front were often not much more than a PR brochure.

The sustainability movement presented corporate reporters with the opportunity to write warmly in those same glossy pages about the company’s contributions to ‘uplift’ society through its corporate social-investment programmes, and preserve the planet for future generations through various environmental initiatives.

Annual reports have long been in an identity crisis, for the glossy pages have been largely irrelevant to the actual issues facing the business, while the financial reporting was – indeed still is – a look into the rear-view mirror at what’s happened to the company’s financial capital. Where can one find unbiased reporting on non-financial capital, such as customer satisfaction, the management of scarce employee talent and the responsible custodianship of scarce natural resources?

During the first decade of the new millennium, a few companies began to take a more holistic view. Companies in the mining and resources sectors have long reported on issues such as safety and local economic development. And Woolworths, for example, has gained the high ground with reporting on its ‘Good food journey’. However, recent events show there is still a long way to go before reporting matches reality and truly serves the interest of today’s trustees; those looking to reduce risk and earn sustainable returns over the long term.

Soft issues affect your investment

Many of the major market collapses, as well as individual corporate failures, have actually been a result of non-financial miscalculations. Greedy banks behaved irresponsibly in the ways they lent money to vulnerable customers, almost collapsing the financial system in 2007/8.

But that’s a well-worn example. More topical is the current malaise that began with the Arab Spring and seems to be spreading through emerging-market regions – exposing issues founded on the fundamental inequality of these societies.

Companies operating in emerging-market regions face major risks. There are risks to the company’s reputation (sourcing from manufacturers violating human rights), to the company’s operations (strikes and violent protests by labour and communities dissatisfied with their treatment), and to the company’s licence to operate (non-compliance with social and environmental legislation).

Determine intrinsic value

The integrated report should therefore identify the longer-term societal and environmental concerns facing the industry and the company. How the company responds to these challenges, both through risk management and through innovative solutions that capitalise on the opportunities presented, will determine its long-term success and by extension, its true value as an investment. True (or intrinsic) value incorporates ‘intangible value’, or the value inherent in the company’s relationships and resources.

The Holy Grail for the integrated report therefore, is to be able to communicate the company’s response to its stakeholder concerns and other challenges, described in reporting jargon as ‘material issues’. Once these are understood, indicators of company performance can be defined, such as ‘number of customer complaints to the ombudsman per million transactions’, or ‘time lost to injury per x thousand hours worked’.

Accurate reporting against such indicators allows the reader to evaluate how effectively the company is responding to its challenges and whether the new company strategy will put the company in a stronger competitive position relative to its peers.

Improvements needed

Indicators are an important driver of behaviour. Take the current crisis in the mining sector. The Mining Charter’s score (indicator) for community consultation consists only of a ‘yes/no’ tick-box. How can such a blunt reporting instrument contribute to the quality of management’s response to this vital issue?

Another indicator on the Mining Charter scorecard is the company’s spend on local economic development (LED). Again, there is no indicator of how effectively the LED budget is being spent on programmes with sustainable impact.

These are issues that, being increasingly understood by all stakeholders, will demand far better measurement and reporting in years to come. Along with better measurement will of course also come better management, ultimately leading, one hopes, to a more harmonious partnership between government, labour and industry. 

Maturity of leadership

Next time you read an annual report, take note of that glossy front section. Look for companies showing their stakeholders that they have a leadership body that is prepared to face up to its challenges.

By measuring company performance and sharing its strategic response, the leadership is showing you how capable it is of building the company’s business relationships and resources, and trouncing its less responsive competitors. In the final analysis, it is the company’s leadership that will determine the destiny of your long-term investment.