Corporate Governance and Heisenberg: a closer look at experience and expectation

I find myself intrigued by Heisenberg, the nom-de-plume adopted by Walt White, the main character in ‘Breaking Bad’.  Faced with a terrifying future (inoperable cancer and impossible healthcare costs), an otherwise unassuming high school chemistry teacher turns to making crystal meth to raise the money he needs.

When pressures are immense, we find it hard to predict how people will react.

The nom-de-plume adopted refers to Werner Heisenberg, known primarily for the so-called Heisenberg Uncertainty Principle:

One can never know with perfect accuracy both of those two important factors which determine the movement of one of the smallest particles—its position and its velocity. It is impossible to determine accurately both the position and the direction and speed of a particle at the same instant.

With that simple statement, Heisenberg instantly dismissed the goals of causal determinism – the notion that (I’m paraphrasing) once you know the rules, and you know where you’re starting from, you can always know exactly where you’ll end up.

It ain’t true for physics.  And it ain’t true for Corporate Governance.

Experience

Experience has shown how often the expectations of regulators and legislators are not met.  In a recent book “A Real Look at Real World Corporate Governance”, some disturbing statistics are provided to illustrate the point:

  • 8% of publicly traded companies each year have to restate their financial results due to previous manipulation or error
  • 10% of Chapter 11 bankruptcy cases involve allegations of fraud
  • 5% of publicly traded companies have been accused of retroactively changing the grant date of stock options
  • 26% of financial service professionals (US and UK) claim to have observed unethical or illegal behaviour first-hand.  16% say they would commit illegal insider trading if they believed they could get away with it.

We have an abundance of other examples closer to home that confirm the point.

Expectation

Corporate Governance, already detailed and complex, is getting ever more detailed and complex.  What used to be an occasional sport has now transformed into a tsunami of regulation and legislation, of investigation and enforcement.   It poses a challenge to Directors, as never before, to keep on top of the expectations of them, their boards and their companies.

Take two topical examples: the imminent Compliance Statement and the latest FRC consultation on Narrative Reporting.

Our new Consolidated Companies Bill is the largest and most complex piece of legislation since the foundation of the state.  One of its provisions bound to generate debate is the resurrected (from the CA 2003) Compliance Statement.  Directors of companies affected will be required to make an annual statement in their Directors’ Report, acknowledging that they are responsible for securing the company’s compliance with its “relevant obligations” and confirming that

(a) there is a compliance policy statement,

(b) there are appropriate arrangements or structures in place to secure material compliance with relevant obligations, and,

(c) a review of such arrangements and structures has taken place during the year.

Everyone knows that the obligations under the Companies Acts apply already.  So, a statement along the lines above should not be a big deal?  The reaction to the previous attempt to introduce such an obligation (under the CA 2003) showed otherwise. Expectation versus experience.

The recent FRC paper on narrative reporting may prove no less challenging.   The FRC states:

The overriding objective of narrative reporting is to provide information on the entity, insight into its main objectives and strategies, the principal risks it faces; and to complement, supplement and provide context for the related financial statements.

Hard to argue with that?  But the previous OFR was withdrawn after heated debate and lobbying. Expectation versus experience.

Don’t get me wrong – I am not opposed to the spirit of these initiatives.  I endorse the views of the FRC CEO, Stephen Haddrill, when he stated:

We strongly believe that good governance enhances corporate performance.  A well governed Board will be clear about its vision for the business and its strategy for achieving it.  At the same time, it will manage risk effectively and be a good steward of the assets entrusted to it, all of which should enhance sustained profitability.

It would seem prudent, however, to make a conscious choice about expectation, tempering ambition on the one hand with delivered compliance on the other.  If given a choice, I would prefer more modest goals, more strictly applied and enforced, than more idealistic goals that excite a hugely varied response.  All the focus on rules and regulations gets us only so far.  Hampel summarised it well:

Process can only ever be a means, not an end in itself: it will always be far less important for corporate success and for the avoidance of disaster than having properly informed directors of the right calibre, bringing openness, thoroughness, and objectivity to bear on the carrying out of their roles

There’s no doubt that the demands on Directors have never been greater, the obligations more onerous, the expectations higher.  All the more reason why Directors must take the time to master these developments to ensure they can reasonably and defensibly discharge their duties – and be seen to do so.

(Originally published in Accountancy Ireland, September 2013)

 

 

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