In many countries the role of business in society appears to be in a state of flux. Specifically, according to the Edelman Trust Barometer, trust in business is falling. The reasons are not definitive, but they include the failure by many organisations to effectively deliver what their customers expect, the increasing wealth gap, and, for some, poor behaviours.
This has led to an increase in demand for accountability in both the public and private sectors. Today’s boards need to be the guardian of the reputation of their organisations. The collapse in just one week of the public relations firm Bell Pottinger demonstrates the fragility of reputation; specifically the need to address their trust P&L, and accountability to key stakeholders.
Although not a new concept, accountability has been refuelled by new technologies that allow for an unprecedented access to information about organisations’ practices and performance. Examples of this renewed interest in making people in charge of organisations more accountable is easily seen by the scrutiny that management compensation is subject to by activist investors in the corporate arena.
In the public sector, the August 2016 impeachment of Brazilian President Dilma Rousseff amid accusations of public accounting manipulation to hide the magnitude of the country’s deficit is unprecedented. In the UK, a requirement has recently been announced for the multiple of the CEO’s remuneration to that of the average employee to be published. This will require remuneration committees to communicate both the rationale and the link to performance.
Revealing as these events may be about the public interest in how organisations behave, they reveal some level of frustration about the current state of corporate and public governance practices and the difficulties of effectively reforming them. Several pieces of new legislation have been passed and codes of conduct established, yet governance and accountability still seem to need further improvement. The recent demand by the Investor Forum, which makes the case for a long-term approach to investment, on the disclosure of non-financial information by banks highlights the current state of affairs.
To understand this frustration it is necessary to dig a little deeper on the mechanisms being used to make managers more accountable and to align incentives with performance. For executives and public officers to be made accountable it is necessary first to agree on a common set of metrics that have to be measurable and established ex ante of the actual performance. The rules of the game must be known and be clear to all parties involved and be contracted before the performance is actually observed. What is seen today in many organisations is that most of the metrics managers are engaged and remunerated for are financial in nature. The general public and many stakeholders, however, expect executives to be accountable to a much broader set of dimensions including customer satisfaction, environmental impact, and regulatory compliance, just to name a few. To fill this expectations gap it is necessary to evaluate institutions and personal performances through a common and integrated set of metrics that can be clearly stated and communicated to a broader audience of stakeholders not limited to investors.
This integrated scorecard should be clear and distinct, providing the financial reporting picture as well as details of the internal mechanisms used to evaluate performance including compensation. In this direction the International Integrated Reporting Council’s (IIRC’s) Integrated Reporting Framework provides a concise and robust structure to evaluate an organisation’s performance around a broader set of dimensions. Formed around a six capitals-based model, this includes but is not limited to financial issues as it considers the social, intellectual, technological, human, and environmental elements of an institution’s behaviour. The IR Framework and metrics it embeds are much closer to the general public’s expectation about the performance of modern organisations than traditional GAAP measures.
Although it is well-recognised that much progress has been made by corporations around the globe to produce integrated reports and to engage in integrated thinking, little has advanced in the use of this framework in internal performance evaluation and compensation mechanisms. This dichotomy needs to be solved in order to align the interests of executives, investors, and the global community that expects nothing but the most ethical and competent behaviour from modern institutions.
Managers should have the new demands for a more sustainable performance explicitly included in their job descriptions. This should be well-aligned and harmonised with their compensation to avoid a separation between preaching and practice. The leading organisations of tomorrow will succeed not only because they have good financial results but also because they can answer the claims of a broader and more demanding stakeholder group. Active and well-connected boards and other groups responsible for establishing corporate governance mechanisms should seize the initiative and not sit waiting for the new wave of regulatory demands that will eventually surface.
The task is not insignificant as many of these dimensions are not easily measured. The key challenge for boards is in ensuring that the agreed purpose and values of the business are clearly integrated into the strategy, and are embraced by all those in the business and its delivery partners, with the critical linkage made to the achievement of the strategy within employee job descriptions and incentives.
Because it is difficult should not work as an excuse to avoid embracing a broader set of more sustainable metrics. We have focused on financial measurements while the majority of value, over 80%, is not recognised on the balance sheet.
So we urgently need to address the value drivers relevant to today, developing non-financial KPIs to enable the board and management to deliver long-term success focused upon meeting the needs of all key stakeholders – customers, staff, the supply chain, the environment, and, of course, investors.
Charles Tilley is executive chairman of the CGMA Research Foundation and the former CEO of CIMA. He is a member of the International Integrated Reporting Council and is chairman of the International Federation of Accountants’ Professional Accountants in Business Committee.
Alexsandro Broedel Lopes is group finance director of Itaú Unibanco, where he developed one of the world’s first integrated reports for a financial institution. He serves on the board of the IIRC.