End Quarterly Reporting And The Dominance Of Accountancy

No one would buy a house based on just a couple of facts about it: that it has four bedrooms and a back garden, say. We want to know about the structure and design of the property; how much privacy, how much natural light, the size of the rooms, the facilities of the kitchen and bathroom, and that indefinable entity called 'feel' or 'atmosphere'. Our research extends beyond the property's perimeter: we want to know the nature of the neighbourhood, including crime rate, calibre of the local schools, access to green space and ease of commuting.

So why, when it comes to a company – something far more complex than a building – do we make decisions based on just a handful of indicators, mostly financial? The limitations of this analysis are becoming exposed. The further concentration on a short-term measure, the quarterly report, creates incentives to sacrifice the longer-term wellbeing of the company to create a financial story of growth.

Deepwater Horizon

The past decade has witnessed a litany of crises where huge risks lay undetectable from the reams of financial information: the dotcom valuation bubble; the Enron scandal; securitisation of mortgages; reliance on wholesale banking funding; repeated failures in mergers and acquisitions.

Now we have an event arguably of even greater long-term significance than all the crises listed above put together, which exposes the futility of this agenda. On 20 April this year, the Deepwater Horizon oil rig, run by Transocean on behalf of BP, exploded with the loss of 11 lives and sank. As a consequence, oil began gushing in to the Gulf of Mexico, creating the worst environmental tragedy in US history. At the time of writing, attempts to capture or stem the flow have been only semi-successful. The direct cost to the oil giant of dealing with the spill is more than £600m and climbing, while around £40bn has been lost from market value. Civil and criminal court cases are likely to follow. It will affect retired people in the UK: BP has reported that it pays around £1 in every £7 of dividend income that pension funds receive from FTSE 100 companies. It is impossible to place on a spreadsheet the risks involved in deep-sea oil drilling, but it is logical to conceive of the possibility that pressure to minimise costs within the supply chain can heighten operational risk.

The disaster exposes the fragility of an apparently sophisticated, but still oil-based, world economy. There are incalculable consequences for regional tourism, US energy sources, the future of the Obama presidency and prospects for economic growth.

Brits bashed

This has not been a good year for iconic British companies. British Airways has been hit by declining sales and poisonous employee relations, and Prudential was forced to abandon an ambitious Asian takeover after failing to win shareholder support.

The causes of the three sets of difficulties appear to be disparate, but I would argue that there is a common thread. The 'old normal', defined in an article in the New York Times in 1970 by Milton Friedman, asserted that the sole purpose of a company was to maximise profits, and that concern for any social responsibility was a deviation from sound capitalist governance. The cult of total shareholder value, monitored by quarterly reporting, took hold for the next four decades. Its features included treating workers as just a cost, regarding mergers as short-cuts to growth and cost-saving, treating natural resources as effectively infinite, and environmental risk assessments as an optional extra.

The old normal has failed. It has failed in theory and it has failed in practice. A company can no more ignore the welfare of its workers or its impact on the environment than a footballer can ignore the pitch that he is running upon.

I do not believe, by the way, that the three companies mentioned are totally guided by the values of the old normal, but this orthodoxy forms the corporate atmosphere they work in.

'New Normal'

A more comprehensive approach, often referred to as the 'New Normal', recognises that everything is inter-connected. People comprise the company and create all the assets, they are not just a 'resource' within it. The environment is not a limitless pool of commodities positioned for the convenience of a corporation's profits, but an unpredictable and complex asset that must be respected.

The new normal regards people as the ultimate source of value (and of risk!), and understands that corporations need to interact with the environment, and with other stakeholders, in a sustainable way. Its time has come.

The purpose here is not to diminish the importance of financial information, but to encourage it to be placed it in its proper context. It should not be pressed into service for a function it cannot do – measure risk or the organisation. If instead it is regarded as being a vital source of information alongside others of equal merit – qualitative reports on succession planning, operational risk, product development and so on – it would become more useful. It would take its rightful place in a diverse array of organisational metrics to build up a three-dimensional picture of the organisation's strengths and weaknesses and underlying dynamics.

Qualitative analysis is not the enemy of quantitative analysis. This is something widely accepted in the legal profession, for example. In a court case, you have forensic evidence, perhaps financial data where relevant and other factual information. But you also permit analysis of motive, psychological background and exploration of the nature of the relationships between key parties.

The scandals and errors of the past decade have damaged the reputation of financial reporting. I believe this is because of the excessive weight of the expectations placed upon it. Confined to the forensic task for which it is suited, and placed alongside qualitative information that is complementary, it can become more insightful and better respected.

The Deepwater Horizon disaster serves as a metaphor for our approaches to governance. We are often out of our depth; handling vast, complex entities that can explode without warning; where risk is incalculable, and with tool-kits that are inadequate. Developing a broader approach to governance that seeks to understand complexity and inter-connectedness is not a guarantee against error, but it is a wiser approach in a dangerous world.