Food 4 Thought

Corporate Governance in Integrated Reporting: Do we have a power failure?

Corporate governance was again frontpage news in November 2018 as Carlos Ghosn, head of the Renault-Nissan-Mitsubishi Motors auto alliance was arrested by Japanese authorities on suspicion of underreporting his income by half over the last five years. It highlights ongoing corporate governance challenges among corporations in Japan, including lack of independent oversight for executive pay. The Nissan case illustrates failure of corporate safeguards and internal control, at a company that lacked committees for audit, nominations and remuneration.

In another country where Integrated Reporting <IR> is also well established, the South African government is struggling to clean up corporate governance at state-owned enterprises. In November the Finance Minister suggested that the highly indebted South African Airways should be shut down. Governance at the company has progressively failed amidst alleged corruption during years of the Zuma presidency. The same scenario is evident at the power utility Eskom, which Government is seeking to revive with a new Board and reforms to control state-guaranteed debts of over US$ 30bn.

Failure in governance as illustrated by these cases raises questions about the impact of transparency and disclosure to combat fraud and improve the quality of governance. In both Japan and South Africa, new corporate governance codes explicitly promote principles such as ethical leadership, transparency and independence. The first principle of the King IV Code of 2016 is that “the governing body should lead ethically and effectively”. This includes transparency and the view that “sunlight is the best disinfectant”, as famously stated by US Supreme Court Justice Louis Brandeis in 1914. But how and where best to disclose information on corporate governance, in a manner that avoids the “mindless compliance” often attacked by IIRC Chair Mervyn King?

In its latest assessment of what material topics the 60 Industry Leaders of the Dow Jones Sustainability Index (DJSI) most report on, Materialitytracker noted a significant trend in how and where corporate governance is reported on. An automated analysis was done by Datamaran of latest annual reports published up to October 2018 by 48 of the Industry Leaders. Using natural language processing (NLP) in scanning the sustainability reports (SRs), integrated reports (IRs) and financial reports (FRs) of the companies involved, the Artificial Intelligence technology found (as in the past) that Governance is a thematic area most covered in FRs.

While business ethics and corruption are among a top 10 issues most emphasised in SRs and IRs, the Datamaran screening found that the 15 IRs published to date this year by DJSI Industry Leaders do not devote significant attention to governance. This is rather addressed in FRs. The top 10 most emphasised topics in FRs include the governance-related topics of employee compensation and benefits (#1), anti-corruption and bribery (#2), business ethics (#3), executive compensation (#8) and board compensation (#9).

Considering that governance is one of the key content elements of the <IR> Framework, it is surprising that sustainability leaders do not devote more attention to governance in their <IR>s. While governance as a compliance theme is traditionally dealt with in FRs as statutory reports, one would expect the more strategic content of <IR>s to clearly address the role of governance as part of integration in reporting, processes and thinking. This is all the more important considering recent findings by the South African IRC (2017) on weaknesses in reporting on governance. A clear weakness was found to be lack of explanation of how governance structure, processes and practices contribute to the value creation process.

Consultations on the IIRC <IR> Framework in 2017 showed limited uptake of the required responsibility statement by “those charged with governance”. This raises the challenge of ethical and effective leadership. Effective disclosure on corporate governance in <IR>s deserves closer examination. As Judge Brandeis added many years ago, “electric light (is) the most efficient policeman”. While some powerful corporations struggle to keep the lights on,  we are best advised to pay closer attention.

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