here comes the really big board

  • Date:01 Oct 2005
  • Type:CompanyDirectorMagazine

here comes thereally big board

 

Britain’s new operating and financial review regulation makes UK directors wish they had a crystal ball. Selwyn Parker reports

 

This time last year Multiplex was looking good with the new Wembley stadium, its flagship construction job in Britain. As far as directors knew, progress was moving steadily towards an official opening in time for next year’s FA Cup on May 13. Multiplex expected to book a projected profit on the project of around £20million.
Then things went pear-shaped with strikes by construction workers and legal challenges by sub-contractors. By May of this year, Multiplex’s profit had turned into a £45m loss and founder John Roberts had stepped down as executive chairman. In short, the plans of an otherwise successful company had been completely overtaken by events.
But at least Multiplex can take comfort in the fact that the operating and financial review (OFR), the British Government’s latest weapon against mis-reporting by companies, wasn’t in force last year. If it had been, the directors of the Australian company might have found themselves the target of legal action by shareholders, not to mention regulatory authorities, on the grounds that it had failed to foresee these setbacks. That’s because the Labour Government has refused to write “safe harbour” legislation into the OFR that would have protected Multiplex and similarly afflicted companies from claims over their failure to predict what could be argued as the unpredictable.
The theory behind the introduction of the OFR is that companies must paint as complete as possible picture of the future so investors and other stakeholders can see where they’re heading before they commit their money. Under the new rules, the process must involve every factor that may materially affect the commercial future – liquidity, human capital, environment, social and community, suppliers and other business relationships, possible legislation, ethics – you name it.
The government argues the OFR only requires what every good company should do and, anyway, it’s an “important weapon in the fight for competitive advantage” that will “act as a catalyst for improved strategic thinking.”
It continues: “We believe a successful company is one whose directors look at long-term as well as short-term issues, and who take all the factors affecting the company’s [commercial] relationship into account”.
Few would argue with these sentiments. After all it’s what good companies do all the time. But the OFR’s remit is so broad that it will require yet larger boards and probably, as the working paper on OFR cheerfully admits, a new breed of director. That is, the “non-corporate” director who may not know anything about business but is an expert on everything that may impinge on the future – global warming, political upheavals in Africa, social behaviour, health hazards among many other factors.
And because not even the addition of non-corporate directors can be expected to cover the full range of issues that must be included in the OFR, the authorities suggest that boards consider establishing advisory panels to further bolster the board’s collective, crystal-balling expertise.
   To take an example directly from the working paper, the directors of a mobile telephony company should include in the OFR their views on possible health hazards arising from masts and use of handsets, which would surely require a scientist. Similarly, a food-processing company’s OFR should include something “quantitative” – hard figures rather than just a few bland words – about the potential risk of a supplier’s use of pesticides, which may require an environmentalist.
But the OFR raises another issue. Namely, how accurately can a business predict the distant future, let alone the immediate one.
OFRs must cover the life-cycle of the business in progress, even if it’s 20 years. Thus, technically speaking, Multiplex should have been able to see at least three years ahead and predict problems with subcontractors. Similarly Brambles Industries could have been faulted for failing to identify the problems with its CHEP wooden pallets that hurt its performance in UK and USA in the past two years.
About 1300 UK companies are now producing their first OFRs with considerable trepidation. Although a few of the big listed companies have done so for some years, as they have in Australia, this was a voluntary process. The new rules are much more prescriptive, requiring detailed information that directors fear could be used to hang the board if things go awry. As PricewaterhouseCoopers says, albeit hoping OFRs will be for the good in the long run, “the new OFR raises many risks for the management of any company”.
The main such risk is the absence of a legislative “safe harbour”, as there is in the USA. A leading corporate law firm, Allen & Overy, believes that even directors who prepare OFRs “honestly and diligently” could face legal claims over, for example, an unforeseen catastrophe that damaged their business but had not been identified as a particular risk. Presumably a tsunami would not provide grounds for a claim but a flood might.
The fear in UK businesses, already reeling from the Labour Government’s onslaught of regulation, is that OFRs will turn into yet another bout of time-consuming and expensive box-ticking, despite the working paper’s hope that it does not.
The head of corporate governance at the Institute of Directors, Patricia Peter, says members fear that it will be very costly in terms of time and money to “do these things properly and in a way that doesn’t open [the company] to greater liability”.
But will OFRs really paint a more detailed “narrative” of the company, as is hoped.
Supermarket chain Sainsbury’s is one business that over the past few years has voluntarily published its own review in its annual reports. In 1999, for example, it glowingly reported the introduction of software-driven supply chain that would dramatically cut costs. It turned out the new system cost £3billion and didn’t work, although of course nobody knew that at the time.
When the OFR working party invited responses last year to its proposals, it only received 79 replies out of the 1300 liable businesses. Almost all of the respondents were large companies and household names. Most were said to be generally in favour although directors were “very concerned about liability extending beyond shareholders”, for instance to customers and other stakeholders.
If those businesses with the biggest resources were worried about extended liability, how anxious must be the 1220 or so other companies who were presumably too busy to send somebody to meetings.
In the end the much less regulated AIM exchange could be the winner. Australia’s RFC Corporate Finance, which is a nominated adviser to AIM companies, suspects the introduction of the OFR could turn some companies away from the London Stock Exchange main board. “Perhaps it will be a factor”, says executive director Stephen Allen. “It will impose additional costs.” Not to mention risks.