By Jason Piper, technical manager, tax and business law, ACCA
What is it that stakeholders or investors in a company want to know? (I’m choosing to consider the terms as interchangeable for now – if I’ve invested something in a company, be it time, money or emotional capital, then I have a stake in it.)
Broadly, they want to know that the company is “well run”. They might have different reasons for wanting to know that, or even subtly different definitions of it, but whether they want to see a financial return, know that the company isn’t harming the environment in production of their goods, or simply that they’ll still be around and paying wages in 2 years’ time, good management will be key.
A range of recent research has revealed an interesting new proxy for detailed reports on specific ranges of measures in assessing management quality – management diversity, and specifically gender diversity at board level. Research in the US has shown a link between the presence of women on Boards, and a significantly reduced likelihood of financial restatement, and that such diversity has a greater impact on corporate financial behaviour than prescriptive rules and regulations on audit review and independence of board members.
Now that sounds like good news for those seeking to justify mandatory targets for gender diversity at board level, and compulsory reporting of the relevant statistics, and to some extent it is. But board diversity has to be pursued for the right reasons – and if the imposition of quotas results in tokenism and a ‘box ticking’ approach to reaching targets then the worry is that no good will be done. And of course businesses may exist which are perfectly well run by an all male, or all female, board; simply reporting on the board’s makeup does not necessarily indicate its efficacy.
While details of, for example, the demographic breakdown of management may be of some interest, it is more fundamental to the continued existence of the entity – and so of more direct concern to its stakeholders – that management have correctly identified and addressed the essential financial issues facing the company. And that surely is what is key for any stakeholder in a company – for once the company has been chosen as the business form, financial performance is key to the continued existence of the entity. If it fails to stack the numbers up then it won’t matter how environmentally friendly or socially worthy its aims are, creditors will pull the plug. In the UK at least, even if the creditors don’t do the job, the directors will be committing an offence if they don’t close the company down. Solvency is the key fundamental to continued life of the company, and while knowing that half the board are women will give you a statistical probability (for now, while it is still a matter of choice) that the business is better run than most, it is only an indirect indicator and less reliable than commentary on the methodology behind the company’s assertion of its overall general financial health. We should surely be concerned that without an understanding of how the underlying going concern/liquidity/solvency position of the company has been established, the financial statements may be of limited overall value to stakeholders. A company’s compliance with quotas regarding management diversity is less important to its survival, and the protection of creditors, than their financial effectiveness. The importance of understanding the basis of any report is key. For example, the preparation of accounts on a ‘statement of affairs basis’ as opposed to a ‘going concern’ basis will often be significantly less positive, since the inclusion of all contingent and future liabilities (in particular redundancy costs) will often result in a net negative balance sheet. On a related note of course the lack of regulation around preparers of company financial statements could also be a cause for concern. If the financial statements are a principal element of the safeguards for creditors, is it necessarily appropriate that they can be prepared by someone with no financial knowledge or qualifications, or is there a risk that this devalues the reliance which can (or ought) to be placed on them?
The inclusion of information, or data, for no good reason does not in fact improve stakeholders understanding of a business, and may distract from the key information. By all means we should promote diversity, as the evidence shows it improves performance. But if we must prioritise the disclosures a company must make, and the indicators by which it will be measured, should we not focus on the source of success (financial soundness) and disclose it directly, rather than relying on proxies such as board diversity?