Nervous investors demand better corporate practice

In the post-Enron world attention is focused on firms where accountingpractises are less than transparent. Investment Editor, Mary Canniffeexamines a timely report by the Irish Association of InvestmentManagers

Investors are demanding more transparency in the accounts and corporate governance practices of publicly quoted companies in the new post-Enron market environment. Investor confidence worldwide has been shattered by the Enron debacle where the published accounts and corporate governance failed its investors utterly. Inflated earnings and obfuscation that hid losses and debts in accounts signed off by one of the Big Five global accounting partnerships misled the investors, who relied on its published reports and accounts.

Markets have now turned their attention to outing and punishing other firms where accounting practices are less than transparent or where there are issues of corporate governance. Shares of well known companies such as Tyco, PNC Financial Services and General Electric have suffered. Shares in Elan have fallen just over 70 per cent in recent weeks on concerns about its accounting policies and the outlook for its drug products.

Underlying market concern is the lack of transparency and clarity in company statements, which limits how much investors can understand about the company, its earnings, its liabilities and how it is run.

For this reason this week's report from the Irish Association of Investment Managers on corporate governance in Irish public companies last year is timely. The IAIM, which represents fund managers, focused on what it considered the fundamental issues in corporate governance - board structures, the importance of non-executive directors and accountability to shareholders. It found a high level of compliance among Irish companies but, without naming any companies, said there was room for improvement.

Separation of the positions of chairman and chief executive: This is seen as important in Britain and Ireland to ensure the accountability of the chief executive to shareholders, through a chairman who can hire and fire. Just over one in five Irish listed companies fall foul of this provision. Among the top 15 public companies, which between them account for 88 per cent of the Irish market, Elan, Jefferson Smurfit Group and Kingspan all combine the roles in one person - Mr Donal Geaney, Dr Michael Smurfit and Mr Gene Murtagh respectively.

In recent weeks, Dr Smurfit announced his intention to step down from his chief executive role in October although he will retain the chairmanship.

The Combined Code (best practice introduced in 1998 - the London and Irish Stock Exchanges require listed companies to state whether they comply with these rules and to list areas where they are not in compliance) states: "There are two key tasks at the top of every public company - the running of the board and the executive responsibility for the running of the company's business. There should be a clear division of responsibilities at the head of the company which will ensure a balance of power and authority, such that no one individual has unfetterd powers of decision." The code calls on companies who combine the roles to justify publicly their positions.

On those Irish companies combining the roles, the IAIM said the justifications given were inadequate because they did not address the fundamental issue of accountability.

Independence of non-executive directors: The independence of non-executive directors is seen as a crucial part of corporate accountability. International corporate governance rules are weak in this area because there are no clear criteria on what constitutes "independent" or on what proportion of a board should comprise independent directors. Companies can therefore say they have, for example, three independent directors while investors may not be satisfied with the independence of some or all of these directors.

IAIM has called for general agreement on a definition suggesting the following could not be considered independent: a recent former company executive; a consultant earning fees from the company; someone with personal ties to key directors or senior management; a company supplier; or someone in receipt of share options.

Non-Executive directors: The Combined Code states that non-executive directors should make up not less than one-third of a board, should be of sufficient calibre and number for their views to carry significant weight and that the majority of non-executive directors should be independent.

The IAIM found that non-executive directors made up the majority of the board at 60 per cent of Irish quoted companies. The association called for companies to have a majority of non-executive directors, stressing their importance as shareholder representatives and their roles on audit, remuneration and nomination committees.

All directors should be presented for re-election on a regular basis and defined terms of office for non-executives should be set to bring fresh perspectives to the company.

Internal control: The Combined Code requires companies to "maintain a sound system of internal control to safeguard shareholders' investments and company's assets". Pointing out that practical guidance on implementation of this requirement was published in the Turnbull Report in 1999 and that companies were given a transitional period for full implementation, the IAIM said it would evaluate compliance in its next survey. It will look for a level of disclosure which would enable shareholders to make a reasonable evaluation of the quality of internal control and related procedures.

Remuneration and audit committees: The IAIM found a wide variety in the quality of remuneration committee reports. The Combined Code proposed remuneration committees comprising independent non-executive directors. While 85 per cent of ISEQ companies had remuneration committees comprising non-executive directors only, IAIM said "in some cases, the independence or otherwise of these directors depends on the interpretation given to the term 'independence' ". It called on committees to give shareholders "sufficiently detailed information" on performance pay and incentivisation schemes so they could make "reasonable and informed judgment".

On audit committees and internal control, the survey found that 79 per cent of Irish quoted companies fulfilled corporate governance requirements. Of the minority of companies, which had no internal audit function, the IAIM said it "has considerable difficulty in understanding how an audit committee of non-executive directors, regardless of the size of the company, can carry out its duties effectively, in the interests of shareholders, in the absence of an internal audit function". It called on such companies either to set up such a function or explain why they it was not necessary.

The bottom line on accounting practices and corporate governance is that investors want to be given all the information - warts and all - they need to make informed judgments when they go into the market to buy and sell shares. They want that information to be clearly presented. They want corporate accounts to show the substance of what is going on rather than on finding accounting rules that can be used to legitimately take deals/arrangements of substance off the balance sheet and bury them in long-winded and unclear notes to the accounts. They want companies to comply with best corporate practice.

Where they are not in compliance, investors want the companies to state their reasons in their annual reports so they can judge for themselves if their actions are appropriate.

As the IAIM puts it: "We want them to tell the story - the full story - so we can make our own judgments on the company."