The Charmed Existence of the Non-Executive Director
Investors in the U.K. are getting used to companies saying the numbers aren’t as previously reported
(Bloomberg Gadfly) -- Investors in the U.K. are getting used to companies saying the numbers aren't as previously reported. It might help if non-executive directors were more accountable.
Last week, Rio Tinto Plc was accused of fraud by the U.S. Securities and Exchange Commission in relation to the disclosure and timing of a $2.9 billion impairment charge on its Mozambique coal operations in its 2012 accounts. Rio says it believes the case is unwarranted, and that it will vigorously defend itself. It settled with the U.K. Financial Conduct Authority -- which did not find fraud but said the impairment should have been recorded six months earlier -- paying $36.4 million.
In July, construction services group Carillion Plc announced an 845 million pounds ($1.1 billion) provision after the board reviewed its contract portfolio because of an alarming deterioration in cash flow. The stock price is down 78 percent.
Capita Plc, an outsourcing group, showed recently how last year's accounts would have looked under the new IFRS 15 accounting approach it has to adopt from next year. Earnings per share were 35 percent lower, net assets swung by 1 billion pounds and turned negative. Same company, same economic circumstances, different numbers.
Rolls-Royce Plc conducted a similar exercise last year, revising its 2015 numbers to similar effect.
These instances highlight the element of subjectivity that goes into financial statements. The directors signed off the numbers as a "true and fair" view of the financial position not long before the picture darkened. What may be true and fair under one set of accounting standards or assumptions may not be under another.
The financial statements in the business services sector occupied by Carillion and Capita are particularly vulnerable to accounting discretion, given the long-term nature of contracts and the phased recognition of revenues. But the reality is that most managers have a bias to optimism. Bonus plans, as well as investor expectations, reinforce that.
Conversely, when a new boss arrives, the business gets "kitchen-sinked." Suddenly the value of past acquisitions is written off, the stock falls, investor expectations are reset, and so is the CEO's incentive plan.
Non-executive directors should be all over the numbers and the internal reporting culture. They already have to sign off on the financial statements as members of the board. The risk is that they abdicate their responsibility to the audit committee, as a recent paper from the Institute of Business Ethics highlights.
Unfortunately, the supervision of U.K. board directors is inconsistent. The Financial Reporting Council, which is supposed to police company accounts, can't even sanction a director unless he or she is also a member of the accountancy profession, and not all are. Non-executives are a critical line of defense against inaccurate financial statements. They need to feel it.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.
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