Over the past few years we have seen a trend towards many different ways of measuring corporate success. At the heart has been the view that, with pure financial reporting figures becoming ever more complex, the story of corporate performance should be told just as much through narrative reporting and through the use of intangible issues.
This is an excellent trend. Telling the corporate story from an ever-growing number of sources within the organisation has to help to give a more useful picture to stakeholders and investors alike. The trend is also growing. The recent report from the Prince of Wales Accounting for Sustainability project makes the point that only if sustainability issues are connected to the more traditional financial reporting issues will their true effects be properly measured. By doing so the real effect of sustainability issues on the business will become apparent for the first time and so start to influence performance and strategy. Anything that gives both management and outsiders better information on which to base their decisions must be good.
But there is a downside. Widening the range of measures which are perceived as significant can produce other effects along the way. Take the latest report from Deloitte on narrative reporting in annual reports. Its title, Written to Order, tells you the story. What the firm found in its annual survey of this area was that companies were not using the opportunity to explain, but were instead sticking closely to whatever formula they were comfortable with. In part, it blames it on companies following the pro-forma model reports that firms like Deloitte have produced for clients in the past. And, bravely, Deloitte has dropped such models from this year’s report.
It is an old story. Guidance on financial reporting is changed in the hope that companies will strike out on their own and in an original fashion. Some do. But the majority seek comfort and retreat into formula. Not much changes.
And there is another pitfall. And it is made plain in the recent report on remuneration issues released by PricewaterhouseCoopers. In the firm’s review of 2007 in the remuneration field similar problems are highlighted. The review is an exhaustive survey of an area where much is changing. The variants in the elements in a remuneration package would have the traditional senior director or employee from even a decade ago baffled at the sheer variety.
Remuneration has moved from a solid lump of pay allied to a scattering of fringe benefits to an astonishing array of remuneration calculations based on a drive for incentives. Some might say that the growth in this field owes more to the rapacious greed of remuneration consultants than to the perceived refusal of executives to perform without a range of incentives dangled before them. And that is undoubtedly true.
Another part of the business world has become impossibly, and probably unnecessarily, complex. But there is little that can be done about that now, though a good solid downturn through 2008 might have executives racing back to the comfort zone of a simple salary. Performance incentives are great when without too much of a touch on the tiller the business is going to roar ahead regardless.
Where PwC sees a real problem is in the distortion that all this creates. Once upon a time, company chairmen insisted that only shareholder value mattered. These days it is different. “Factors such as employee engagement and customer satisfaction are proven leading indicators of future financial success,” says PwC. “No organisation acting rationally in the interests of its shareholders can afford to ignore these. So from a variety of motivations, companies are increasingly looking beyond the purely financial measures of their performance.” Linking remuneration to all of this is fine, says one part of the argument. It is the old cliché of what gets measured, gets done. But, as PwC points out, there is another side to the argument. “The opposing school takes the view that such a linkage will lead to dysfunctional behaviour,” it says. It can be that the very act of using a metric reduces its effectiveness.
It cites the National Health Service as living proof of this. As it points out: “It is often possible to achieve a specific numerical target in a way that was not envisaged – with unintended consequences.” And there is another simple consequence of all this. The sheer complexity of the measurement, the measures themselves, the timing concerned and the calculations mean that any transparency which might be desirable has gone out of the window. This is probably no bad thing for the employees, directors and staff involved. The more opaque the process the more they can defend their remuneration.
The recent Little Blue Book of Governance Pitfalls published by Independent Audit, has a simple risk at the top of its list for the remuneration committee. “Weak alignment with strategy,” it says, “triggering the wrong behaviour.” And wrong behaviour in 2008 is going to be punished much more severely by economic circumstances than it was in 2007.
