Business and Society Review 114:3 365–391
Beyond Transparency: Information Overload and a Model for Intelligibility ROBERT L. LAUD AND DONALD H. SCHEPERS
ABSTRACT The role and evaluation of the modern corporation is being challenged by multiple stakeholders, changing markets and public expectations. Unfortunately, corporate governance, regulation and accounting have played a prominent role in business failure for the past decade resulting in a growing lack of public confidence in our markets. We present a new model that contributes to improving the quality of corporate information by providing not more, but better information through increased intelligibility of overall information, benefiting both the firm and its broad array of stakeholders. It has become apparent that boards, management and regulators have been unable to cope with the rise of business failures by adding increasing layers of regulation that have often served only to exacerbate the complexity and further cloud the transparency of needed information. We have identified a growing number of forward-thinking firms that have found alternative means to provide better
Robert Laud is Academic Director of the Entrepreneurship Program and is an Associate Professor of Marketing and Management Sciences in Cotsakos College of Business, William Paterson University, Wayne, New Jersey. E-mail:
[email protected]. Donald H. Schepers is an Associate Professor of Management in the Zicklin School of Business, Baruch College, City University of New York. E-mail:
[email protected].
© 2009 Center for Business Ethics at Bentley College. Published by Blackwell Publishing, 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK.
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information and strengthen their companies. We offer a stakeholder-centric model for improving information intelligibility based upon the extensive scope and variety of external input derived from the growing social movement organizations. With the added focus on intelligibility, these groups can help foster greater corporate responsibility, meaningful transparency, increased stakeholder benefits, and improved overall performance of the firm.
INTRODUCTION
P
erhaps it is human nature that the more we develop constraints and legal parameters to curtail questionable business behavior, the more some individuals can find means to circumvent regulations or, at least, stretch the boundaries of ethical behavior. Sometimes these intricate yet tangled webs are legitimate, but call into question the tradeoffs between greed and ethics. Questionable practices, investor lawsuits and forced arbitration at blue-chip organizations such as Enron, Citicorp, WorldCom, Tyco, Quest Communications, AOL Time Warner, Fidelity Investments, KPMG, Computer Associates, Global Crossing, and AIG are legion (Daft 2008). In response to this, the U.S. government and quasigovernmental agencies have developed a near unfathomable maze of corporate performance reporting measures that have clearly helped, but are largely inadequate to safeguard corporations and improve the public trust. The end result is that investors, the public, and even management can’t evaluate the extent of their exposure regardless of the position outlined in much company information. Trusting in current and complicated reporting systems has simply proved inadequate, frustrating, oftentimes misleading, and too frequently, detrimental to those very individuals it was designed to protect. The issue goes beyond the combination of standardized monitoring, disclosure, and additional regulation. Enron, for example, was widely monitored, and disclosed a great deal of information, though perhaps in less-than-transparent ways. Further, what information they did disclose, in conjunction with extensive
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monitoring from federal agencies, law firms, investment houses, accounting firms, analysts and even top academics, failed to reveal massive financial fraud. This pattern of what we term “creative fraud” has followed a progression of ever stronger and more encompassing regulations that have evolved since the late nineteenth century, including the Sherman Anti-Trust Act, the rise of the CPA profession, the establishment of the SEC, and the Sarbanes-Oxley Act. The logic was that by encouraging the reporting of accurate information, the financial markets would selfcorrect, financial crises would be avoided and investors would be protected. Yet, even with these regulations, entire world markets have been shocked with large-scale unanticipated corporate debacles. For example, the September 2008 bankruptcy of Lehman Brothers Holding Co., Inc., the fire sale of Merrill Lynch and Co. to Bank of America, and the implosion of AIG have led the SEC to conclude that “further regulation with a deeper functional understanding still make sense” (Scannell 2008). Yet, based upon historical data and the size, frequency and impact of financial market turmoil, additional governmental regulation appears to be a substantial, albeit insufficient part of the solution. Many would argue it has even been part of the problem (Morrison 2004). A case in point is the recent advice from the Office of the Controller of the Currency that Citicorp should have decreased their position in deceptive high-risk investments they themselves created by quietly passing the risk to other institutions (Dash and Creswell 2008). Passing hidden risk to other institutions shirks the social responsibility and accountability that becomes even more important with shifts toward globalization and liberalization in a world economy (Tichy et al. 1997). Our study adds insight in presenting additional means by which organizations can be held accountable and improve their level of good citizenship. There needs to be a focus, not just on more regulatory disclosure (Poncelet 2003), but importantly, on information intelligibility that is decipherable, useful, and timely. Thus, we argue that part of the issue and the solution goes beyond transparency in that transparency should not be equated with understanding and utility. For example, many of those who reviewed Enron’s Special Purpose Entities (SPEs) had little idea of the depth of the problem regardless of the amount of the information they received, or perhaps because of the volume of
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information they received. Our investigation points to the issue of the intelligibility of the information. Simply, stakeholders need an understanding of the whole and its implications. We do not need more information, but better and more intelligible information. PricewaterhouseCoopers (2007) noted that the deficiency in corporate reporting is not so much in the lack of accuracy, but in the lack of adequacy. Accurate numbers that hide the internal reality from investors and other stakeholders, serve neither the company, nor the market, nor society in the long run. The drive for profit maximization, combined with an unintelligible information reporting structure may lead to a distortion of corporate responsibility and accountability. The excuse of having unintelligible information has even become a defense of corporate chieftains such as Enron’s chief executive, Ken Lay, and president, Jeffrey Skilling, who posited that they were not responsible for fraud because they could not understand the accounting data. This tact leaves little hope for proper investment decision making by the many other stakeholders much more distant to the process. In 2008, Citicorp’s chief executive, Charles O. Prince III, said he was unaware of the extensive risk in which his traders were engaged while the internal risk management executives were uncomfortably joined with the traders to maximize revenue. Much of Citicorp’s worth was based upon obscure and exotic investments such as collateralized debt obligations (CDO), which made risk identification difficult, if not impossible to gauge and led to a deterioration of Citigroup’s worth from $244 billion in November 2007 to $20 billion in November 2008 (Dash and Creswell 2008). These issues reflect chronic internal hierarchical management weakness, aggressive cultures, and lax or misleading oversight. Risk management must be independent and intelligible to be viable.
INFORMATION OVERLOAD The impact of information overload on decision making has been well researched over the past ten years as the advent of the internet caused a proliferation of information (Davenport and Beck 2000). Executives needed to deal with new and vast volumes of data, determine relevancy, and identify what sources of
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information were reliable. Our “Age of Information” is still upon us and the profusion of new sources of information continues to grow, along with its inherent complexity. Waddock (2008) focused on the corporate social responsibility (CSR) movement and identified nine categories and over 200 sources of CSR information, including groups that focus on standards, reporting, certification, consulting, CSR memberships, social investment, CSR research, ratings and rankings, activist and NGO groups, and legislation (see Table 1). This is not an exhaustive search, but points again to volume and complexity overshadowing intelligibility and usefulness. Further, there is no formal integration among or between these groups, each acting and reporting independently. As such, the information they produce will limit the overall intelligibility that is dependent upon integrated information. The need is not for more information, but rather, better and meaningful information in which all stakeholders can benefit. There is a universal need for intelligible information regarding firm performance. Investors, market and credit analysts, and brokers all demand increased financial disclosure and reliable information, and firms, auditors and regulatory bodies all supply information. Certainly, information flow has increased in recent years with a growing number of and greater accessibility to analyst meetings, online data bases, published reports, webcasts, quarterly conference calls, and so on. There have also been efforts to improve sustainable business indices through the Socially Responsible Investment (SRI) community (Fowler and Hope 2007). Additional protocols precipitated by Sarbanes-Oxley requiring auditors to report organization risks in a forward-looking context are also a step in the right direction. But as the recent and ongoing crisis in the mortgage-backed securities industry evidences, what we think we know and what we need to know are two very different things when it comes to accurately understanding firm performance and stability. In addition to the growing complexity of information, there is a further compounding effect as a result of the established practice in U.S. corporations of treating certain financial matters as if they were tax issues and, therefore, should be minimized. This is a significant and a distinct line of thought in that corporations are strongly encouraged to avoid tax liability by permissible legal means. Failure to limit tax liability and, thereby, not maximize
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TABLE 1 Corporate Responsibility Movement Categories and Examples*. Category
Note/Definition
Web Site
30 OECD countries originally formed in 1960 to promote ethical business conduct
UN Global Compact Principles
www.oecd.org/department/0,2 688,en_2649_34889_1_1_1_ 1_1,00.html www.unglobalcompact.org
Social Accountability International
www.sa_intl.org
Principles, Standards and Codes OECD Guidelines for Multinational Enterprises
10 principles focused on human rights, labor and the environment Business Standards Setting, Accreditation, Reporting and Certification Supports human rights around the world, interacts with companies, unions, NGOs, governments, SA8000 labor standards Global Reporting Initiative Industry-based international standard for corporate reporting including environment and social Corporate Consulting Responsibility Organizations PwC Sustainable Business Solutions SustainAbility
www.globalreporting.org.
CSR strategy, emissions, health, reputation, supply chain Sustainability strategy, stakeholder engagement, innovation, risk, reporting
www.pwc.com/sustainability
200 CEOs focus on sustainable development, knowledge sharing Top leaders and minds shaping business and societal agendas
www.wbcsd.org
www.sustainability.com
CSR Membership Organizations World Business Council for Sustainable Development World Economic Forum
www.weforum.org
Social Investment Organizations Social Investment Forum
National association focusing on environmental and social investing Institutional Shareholder Services Private group for proxy voting, risk, governance and CSR tools Centers, NGO Watchdog, Activists
www.socialinvest.org
World Conservation Union
Conservation Network of 180 countries, 10,000 scientists and 800 NGOs Greenpeace International Global group to actively protect environment, change attitudes and educate Corporate Social Responsibility Ratings
www.iucn.org
100 Best Corporate Citizens
www.thecro.com/node/615
World’s Most Admired Companies
Evaluates eight inputs on CSR and rank orders top 100 US companies Ranks Top 50 companies with reputation as a key criterion
www.issproxy.com
www.greenpeacr.org/internati onal
www.money.cnn/magazines/ fortune/mostadmired/2008/ind ex.html
Legislation Focused on Corporate Responsibility Kyoto Protocol (1997)
37 countries (excluding US) and European community agreement to reduce greenhouse gases Sarbanes-Oxley Act (2002) Comprehensive regulations that outline responsibilities of auditors, boards, lawyers etc. and discourages misconduct of whitecollar crimes Popular and Academic Journals with a CSR Focus
http://unfccc.int/kyoto_protoco l/items/2830.php
EthicsWorld
www.ethicsworld.org
Journal of Corporate Citizenship
Online website focusing on ethics, anticorruption and governance Newer addition geared toward practitioners, but based in research
*Summary table adapted from Waddock’s extensive review (2008).
http://fl1.findlaw.com/news.fin dlaw.com/hdocs/docs/gwbush /sarbanesoxley072302.pdf
www.greenleafpublishing.com
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shareholder returns might be considered negligent tax management. However, when this same philosophy is applied to financial reporting for the purpose of benefiting corporate officers and executives, it is often done at the expense of its shareholders and the market. Enron took this route (Benston and Hartgraves 2002) in creating wealth for its top executives, while shareholders and the market were not protected. Some firms such as 3M, DuPont, Xerox, Wegmans, and JandJ have successfully implemented new mechanisms for information flow that focus on the needs of multiple stakeholders rather than on internally oriented profitability and compliance goals (Savitz and Weber 2006; Brandsuch et al. 2008). In turn, these firms have found that a stakeholder-oriented model is not just good for the investor, but is also beneficial for the company. This paper offers a new model for corporate citizenship that focuses on the intelligibility and usefulness of information for all stakeholder groups, examines the issue of corporate performance reporting as a key area of concern, and finally suggests a means of implementation of that model.
THE MAZE OF CORPORATE REPORTING Quickly changing business valuations, price-earnings multiples, mergers and acquisitions activity, restructuring, “unforeseen” restatements, and even bankruptcy have allowed some privileged stakeholders and corporate leaders to accrue windfall gains, while many other investors have suffered dramatic losses. The business reporting that surrounds these events is conducted by skilled professionals including corporate and tax lawyers, accountants, auditors, board members, trust advisors, investment bankers, finance specialists, and analysts. These professionals often have years of formal academic and business training and many have passed professional examinations in order to qualify to practice in their profession. By and large, the lay or even the experienced investor, as well as institutional investors will rely upon the financial information and business reporting produced by these professionals. Yet two significant problems arise for which most stakeholders are unprepared. First, there is a considerable lack of understanding of the motives of those preparing various types of disclosures.
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Second, the language within the reports conveys particular meanings and nuances that are not always lucid nor transparent (Tregidga and Milne 2006). Some researchers have found even more disturbing insights into the biases, latent or manifest, that surround certain financial reporting professions. For example, Fogarty and Rogers (2005) found in their research that “the work of financial analysts cannot be understood except as part of the social fabric that embeds professional claims. The institutions that surround the delivery of the opinions regarding the merits of equity investments are powerful influences on the work product of analysts” (p. 331). Moreover, given the abstruseness of each professional’s area of expertise, and the geometric complexity of linking each area, it is little wonder that professional and lay investors alike have been losing confidence in their ability to judge a business’s prospects for success or failure. At a foundational level, determining what information is needed is often as much of a problem as to who should provide it: the senior executive team, the board, strategy consultants, investment bankers, government officials, accountants, auditors? Further, even once identified, the reliability, usefulness, and timeliness of the information is difficult to verify and relate to other activities or financial actions in the market. The multiple internal and external regulatory mechanisms that failed at Enron, but were improved through SOX, can now be argued to have failed again in the recent subprime mortgage debacle, bank failures, and credit crisis. We should also question whether the SEC is an adequate stakeholder protection entity when it was the SEC that supported the high-risk SPEs at Enron (Morrison 2002) and other organizations. Conflicts of interest, inadequate board member skills, and the inability to diagnose and report risk and assess sustainability require a new and truly external solution set (Gillan and Martin 2007; Savitz and Weber 2006). The Limits and Failures of Performance Reporting and Responsibility Gaining insight into the issues of assurance responsibility requires an appreciation of how the strategies of management and the resulting operations and activities of the business come to be represented in a set of required financial statements. Given the sheer volume of knowledge required, it is not surprising that more
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help, clarity and safeguards are warranted in understanding performance reports and their implications. Most companies and stakeholders, however, have relied solely upon traditional, albeit often flawed, business reporting measurements and on the individuals responsible for these reports. Investors, whether neophytes or experienced professionals, do not understand who is responsible for what, let alone the details of securities law, CPA responsibilities, government regulation, analyst roles or banking regulations. Further, current financial reporting does not help investors assess market economics, the impact of changing regulations, investor behavior, the long-term strength or sustainability of a company (Lumsden and Boyle 2004). Understanding the financial flow, responsibilities and performance reporting, will help individuals and corporations to see more clearly what responsibilities are delineated to various groups. Table 2 provides a summary of the key responsibilities of each of the stakeholders in the business performance system. With regard to the limits and failures of reporting, there are two areas of major concern. The first is the systematic failure of the current checks and balances of the financial reporting systems to uncover fraud, misdeeds, high-risk decision making, or simply weak links in the organization. Although some researchers believe that reliable financial statements can be achieved if there is a system of well-balanced corporate governance, other researchers have found that the inherent conflict of interest, complexity, and unintelligibility of financial data has outgrown current monitoring mechanisms (Rezaee 2005). U.S. Treasury Secretary, Henry Paulson stated that the issue is not too little regulation, but that current controls are “outdated, outmoded, ineffective. The architecture that was put in place . . . hasn’t kept pace with evolving financial markets” (Tumulty and Calabresi 2008). The spread of stock option misuse, back-dating, off-balance sheet accounting, lack of analyst oversight, suspension of ethical codes, board failure, and so on, are merely symptoms of the larger issue of systematic accountability and financial-system failure. The second major endemic concern is the quantity and extent of personal failures attributable to the professions involved in business reporting. Apart from the limits of governmental control mechanisms, for example, SEC, Sarbanes-Oxley Act (2002),
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TABLE 2 Summary of Responsibilities by Stakeholder Groups. Stakeholder FIRM Board of Directors
Chief Executive Officer
Management
Employees
Company Finance & Accounting Staff
Audit Committee (board subcommittee) Internal Audit (either employees or outside professionals) External Auditors (outside professionals)
Key Activities & Responsibilities • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
Approve the business strategy Maintain financial and fiduciary responsibility Oversee major investments Ensure legal and ethical conduct Hire and fire the CEO Evaluate, select and compensate senior executives and other board members Review and approve major investments, objectives, policies, budgets Identify major issues Hire and evaluate key managers Serve as management’s voice in board deliberations Set ethical and performance standards for the entire organization Communicate with shareholders through the annual report, etc. Retain top advisers Develop and monitor business strategy Obtain and manage the organizational capability to execute the business strategy Develop plans and budgets Make day-to-day commercial and operational decisions and manage to achieve plan and budget Implement and manage an internal control environment Report to the Board on the progress and performance of the business Seek the counsel and approval of the Board on key issues and decisions Perform the tasks assigned to them Make the decisions delegated to them Seek the counsel and approval of management on key issues and decisions Record the financial transactions of the business in compliance with the company’s accounting policies Propose to management and the board accounting treatments for new transactions Prepare financial information for management and the Board Prepare the company’s financial statements Review quarterly and annual financial statements Monitor quality and adequacy of the Company’s internal controls Review and approve scope of internal and external audits Assess the adequacy and reliability of the company’s system of internal controls Review significant business processes and assess risks Perform commercial and/or financial reviews of significant business activities or transactions Express an opinion that provides reasonable assurance that financial statements are fairly presented Perform verification procedures, on a sample basis of the company’s financial transactions Ensure the company’s proposed accounting is in compliance with GAAP Report to the audit committee on issues related to the company’s financial accounting and reporting
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TABLE 2 Continued PROVIDERS & INTERPRETERS Strategy, Business • Provide advice and assistance to the Board, Management and employees with Consultants & respect to improving, or designing and implementing new strategies, Advisors organizational structures or capabilities • Advise the Board & Management on the legality of proposed commercial activities • Assist management in determining legal approaches to proposed activities Investment Banks • Recommend and/or advise management with respect to investment activities – M&A, Debt & Equity Raising and Structuring Securities Analysts • Perform independent research into the company and its market and assess its potential future performance INVESTORS Individuals, • Understand and monitor the risks associated with specific investments Employees and • Monitor a range of information sources with respect to the investment Institutional • Understand their respective risk appetite and the appropriateness of their individual investments and overall investment portfolio INVESTORCENTRIC GROUPS Lawyers (in-house or outside)
External Advisory Bodies (Environmental, Social, Financial, etc.)
• • • • • • •
Uncover the causes of past mistakes in corporate decision-making Develop alternative strategies to both management and investors Develop analytics to reduce risk and improve overall performance Communicate openly with the board, management and other stakeholders Integrate with governance structures, risk and compliance decision making Develop a team approach that is value-add, integrated, and can link key functions to improve performance Provide open dialogue to investors, analystsand others to ensure transparency, fiscal responsibility and risk minimization
Foreign Corrupt Practices Act (1977), there are foundational issues of personal integrity and ethics. The human condition and fortitude for ethical conduct is variable, and financial complexity has led to the opportunity for individuals to take advantage of circumstances, however dire, at the direct expense of shareholders, employees and the public. Enron’s managers, traders, and executives, as well as external analysts, advisors, lawyers, and bankers, were involved in some form of opportunism. Consider the blatant opportunism of Lou Lung Pai, Enron’s head of wholesale gas trading, who sold his personal stock for $250 million and became the second largest landowner in Colorado while the division for which he was responsible lost over $1 billion (McLean and Elkind 2003). Although Pai met regulatory requirements we have to question whether merely following regulatory requirements will drive ethical executive behavior (see, e.g., Trevino et al. 2000).
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Auditors are also subject to the powerful influences of personal success, which is often tied to client fees and client satisfaction scores. If a client is dissatisfied, they may lessen scope or change auditors, which is a powerful threat closely linked to the career success of the auditors and their management. The need to follow a code of ethical guidelines in the accounting profession is founded upon human behavior with variation in outcome based upon a person’s life experience, internal fortitude, career pressure, and client situation (Windsor and Warming-Rasmussen 2007). When individuals operate in a system with questionable checks and balances, and where risk is rewarded above all else, it should not be surprising that ethics become marginalized. Objectivity and the avoidance of inherent conflicts of interest would more likely be found in an external entity that is not tied financially to the reporting results. The issues of ethics and responsibility account, in part, for the expansive evolution of external corporate responsibility reporting organizations and the overall social investment movement (Waddock 2008). Yet, despite the good intentions and many contributions of these external monitoring systems, they fall short in providing intelligible and integrated information that would help the decision making of multiple stakeholders and provide early warnings of potential issues. Isolated data points require a level of integration from which more meaningful scenarios and collective conclusions can be drawn. For example, an investigation of the 2008 subprime mortgage debacle shows that the stakeholders and public were provided large amounts of corporate financial information, and that government policies and housing regulations were in place. However, these same stakeholders were lacking intelligible, integrated and timely information that, if known, would likely have altered the high-risk behavior of many financial institutions and unknowing individual investors. In effect, the markets would correct for known and substantial risk. The Reporting Dilemma The investment landscape has changed drastically over the last 30 years. In 1980, the Dow Jones Industrial Average (DJIA) started the year at 838.74; in 2000, it began the year at 11,497.12, a nearly 14-percent compounded annual increase. On April 7, 2008,
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the DJIA hit its peak at 14,164, and as it rose, so did the number of investors. Institutional funds accounted for much of the new capital, especially with the proliferation of mutual fund investments. In addition, this upward trend led to the development of more complex investment instruments such as derivatives, contrarian hedge funds, real estate investment trusts, and repackaged mortgage loans. Investor exuberance, as Shiller (2002) points out, set the stage for high levels of financial risk that many companies were glad to exploit as long as they could. By November 13, 2008, however, the DJIA had retreated to 7,965, losing some 6,199 points, and costing stockholders over $15 trillion (WSJ, 2008). Remarkably, available information that would have protected stakeholders and companies from this evolving crisis was unobservable (see Shiller 2008). As Robert Shiller notes, the dangerous extension of credit that led to foreclosures, bankruptcies, writeoffs, and the global credit tightening, is cause for a massive financial revamping. He also argues for better information, not more, and simplification, not complexity. The irony is that Shiller had forecasted the current situation with information he accessed that simply was not disseminated by the large financial institutions or government agencies. Thus, the information that the markets had was extensive, voluminous and filtered, but lacked clarity, focus, intelligibility, and accountability. Companies face at least three categories of investors, all of which need intelligible information: small investors, with little or no business experience and little ability to read financial reports; large investors, who may have a personal investment professional or possess the ability to read and understand basic business reports; and institutional investment professionals, who are hired to invest monies on behalf of participants in the institutional fund. As Fogarty and Rogers (2005) argue, intelligibility of these reports is embedded in isomorphic fashion, so that the more remote an investor is from the investing profession, the more difficult it is to comprehend reports or their underlying meaning. Further, the more one requires interpretation and advice, the more likely they will defer to and accept the opinion of others, regardless of how well-versed, ethical and accountable these third parties might be. And, as recent events have shown, even those in the profession have difficulty understanding the full meaning of certain business reports (Benston and Hartgraves 2002).
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The performance reporting infrastructure in companies has been slow to change with defendants claiming it is too fragile and regulated to be modified compared to other business functions. We argue this is exactly where much improvement could be made to enhance the value of reports to all stakeholders, lay or professional. A classic principal–agent conflict is evident, whereby management seeks to maximize public domain numbers, while keeping much of the firm’s performance within the “black box” of the internal reporting infrastructure. This inherent conflict of interest has become so extreme that some have proposed corporate financial reporting insurance, whereby premiums are paid for by the company with the investors as beneficiaries (Ronen 2006). However, insurance premiums would be expensive and add to corporate overhead while potentially contributing even more to the unintelligibility of information and risk. There are two critical actions that individuals and corporate entities should consider in order to balance the current corporate performance myopia with external input. First, all interested stakeholders, including corporate leaders, management, institutional and private investors, customers, suppliers and employees, should have some understanding of the maze of information flow and relationships in corporate performance reporting in order to acknowledge inherent risk. In Figure 1, we provide a high-level overview of how strategy translates into operation and ultimately financial statements, illustrating the involvement of stakeholders in the process. The second critical action centers on the need to create firm cultures that are stakeholder centric, where all stakeholders are treated as critical input contributors while also sharing needs for intelligible output information. We next explore this model and then examine its impact on information flow.
BENEFITS AND ADVANTAGES OF SCM The SCM model (Figure 2) provides an effective way to gain supportive insight on corporate actions that help both the firm and other stakeholders. The optional stakeholder-centric inputs are derived from a selected subset of social movement, activist, or NGO categories that help elevate intelligibility concerns which are
Manage Operations
application of accounting policies • Finance team prepare financial statements
• Audit Committee reviews selection and
Prepare Financial Statements
Management
budgets • Management establishes and maintains operations • Board reviews progress
• Management establishes business plans and
Audit Committee
Publish Audited Financial Statements
Investor Decisions
• Board signs off on financial statements • Auditor sign-off on audit opinion
Board
• Management designs • Board approves
Determine Business Strategy
FIGURE 1 The Business Performance System.
control environment
• Internal Audit report on effectiveness of internal
with accounting policies
• Finance team process transactions in accordance
Record Financial Transactions
Internal Auditors
Finance Team
procedures management and employees enter into transactions with customers and suppliers
• According to established policies and
Enter Into Transactions
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FIGURE 2 Stakeholder-centric Model for Improving Intelligibility. Primary Information Generators
Information Processors
Stakeholder-Centric Management
Providers
Firm Integrated/Optional CRS Input Categories*:
•Board of Directors •CEO &
•Investment Banks •Rating Agencies •Securities Analysts •Brokers •Strategy & Business
•Principles, Standards & Codes (e.g., UN Global Compact)
Management •Internal & External Auditors
•Business Standards & Reporting (e.g., Global Reporting Initiative)
Consultants
•Centers, NGO Watchdog, Activists (e.g., World Conservation Union) •Social Investment Organizations (e.g., Institutional Shareholder Services
Regulators
Investors
•Corporate Responsibility
•SEC •IRS •AICPA •GAAP •FASB
Legislation (e.g., Kyoto Protocol)
Benefits •Enhanced Reputation •Reduced Liability
•Individual •Institutional •Employees
Benefits •Financial Return •Reliability •In-depth Review
*See Table 2 for detailed list
of importance to all those interested in the long-term sustainability of corporate enterprises. Although it may seem counterintuitive to invite watchdog groups to comment on internal documents, these groups can provide valuable insights and assist in the distribution of more reliable and useful information, not just more information. As Waddock (2008) has noted, this institutional infrastructure for corporate responsibility is already evolving. Mattel, for example, regularly invites the International Center for Corporate Accountability (ICCA) to audit its overseas subcontractors to provide third-party assurance that subcontractors have safe plants and are treating their employees according to Mattel’s guidelines, and in turn, ICCA makes its report public (for the latest report, go to http://www.icca-corporateaccountability.org/). Outside groups such as these are ideally suited to provide the support of an external viewpoint and validation that should be valued by the company.
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SCM Reporting Benefits Rather than viewing compliance and reporting as simply highcost, overhead functions, companies should focus more on collaborative strategic partnering between these functions and the customer. When companies in any industry lose sight of their multiple stakeholders and focus on wealth accumulation at the expense of a multi-bottom-line orientation, they put at risk social, ecological, and corporate sustainability benefits (Waddock 2008). Leveraging stakeholder input and the need for intelligibility should be a strategic activity for all functions in an organization, especially reporting (Laud 2005). Improving intelligibility should not be a stand-alone activity, but would foster multiple benefits if integrated with risk management, internal and external audit, SOX initiatives, control processes, quality, and executive decision making. The question now arises as to how an organization can move intelligible corporate reporting from a high-cost, time-consuming maintenance function to a strategic value-add. We believe that many organizations should optimize coordination among the internal reporting functions and external stakeholder-oriented groups much like consumer goods companies link internal marketing functions with external research. Our goal is not more activism, but rather more intelligible, integrated and timely information. This simple solution not only benefits external stakeholders, but also directly improves the legitimacy of the company. We further suggest that the social investment movement, and the Global Reporting Initiative in particular, place new emphasis on intelligible and integrated information, and not just transparency and accountability, which have already proven to be inadequate safeguards. Corporate entities are responsible for producing a large number of detailed reports including balance sheets, income and cash flow statements, disclosure notes, auditor statements, IRS filings, and stock reports and offerings. These reports are heavily regulated by various governmental or quasi-governmental agencies, including the SEC, IRS, AICPA, GAAP, PCAOB, and FASB, with the intent of investor protection. Although numerous measures have been put in place to guide the process of data reporting, the vast majority of companies generate the reports through
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a myopic view of self-preservation. As with Global Crossing, Merrill-Lynch, Enron, Citibank, Fidelity Investments, and scores of other firms whose involvement in questionable activities have been brought to court or arbitration, legal actions are often too late for the protection of many stakeholders. We have found that even experts who contribute to this complexity and biased positioning will complain of their limited knowledge outside their area of expertise and their discomfort in having to rely upon the output of others. Inaccurate and unintelligible data may then flow systematically through the reporting process with little opposition. The Securities and Exchange Commission has recently voted to improve financial reporting by mandating the use of XBRL, an interactive data format (http://www.sec.gov/spotlight/ xbrl.shtml). At a meeting on May 14, 2008, it voted a three-year phase-in of the format, beginning with the largest 500 firms in the first year, and extending to smaller firms in subsequent years (Burns 2008). XBRL is a metadata format that assists users with definitions and ties throughout a firm’s business reports. XBRL goes a long way to increasing investor protection by providing standard definitions, interactivity throughout firm documents, and firm-to-firm comparability almost immediately. While this will do much to help analysts and investors integrate data, we believe more needs to be done to make the data intelligible. Input from groups such as Investor Shareholder Services, the Corporate Board, and various NGOs could provide additional insight if there was a commitment to create and share more intelligible information. Importantly, these social movement groups act as independent entities and are less likely than those in the “information processor” category to be co-opted by the firm. The proliferation of nonmandatory “watchdog” organizations is indicative that many companies can capitalize on the rising tide of cost-effective external input. For example, the emerging “ethical investment” movement has gained the attention of and has been adopted by many stockholders and shareholding fund managers who scrutinize the practices of businesses in their portfolios (Bunn 2004). The purpose of our SCM model shows that these external groups can be utilized in a positive nonadversarial manner.
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SCM and Reputational Benefits The implementation and incorporation of external stakeholders in company operations and reporting, as demonstrated in the SCM model, provides the added benefit of reputation enhancement. By already utilizing intelligible external input from social responsibility groups, firms such as Dow Chemical, Xerox, and McDonald’s have accrued benefits beyond those of their competitors who have had a more internal singular focus. The benefits of building reputation and brand are a central concern to these firms. Gardberg and Fombrun (2006) have noted that corporations with reputations for good citizenship received various benefits, including a reduced liability of foreignness, enabling them to enter foreign markets at lower cost than firms with lower reputations. Thus, many global firms might benefit from a similar approach in leveraging SCMs to build reputation. Groups such as Investor Shareholder Services, Social Investment Forum, Social Investment Research Analysts Network (SIRAN), Institute for Responsible Investing, as well as others could play a more significant role through an enhanced focus on intelligibility with its potential and important impact upon reputation. Waddock (2008) notes that the United Nations states there are hundreds of thousands of NGOs that cross a wide area of societal interests. Some of these NGOs are devoted to the larger social investment movement, others are focused on specific issues such as child labor or pollution, and other NGOs are specific to individual companies. All these initiatives contribute to reputation at some level and provide an additional source of value to all stakeholders. With a stronger focus on intelligibility and reputation by NGOs, both the companies and the customers may have a more positive experience. For example, there is evidence that firms are benefiting from better “green” reputations and many consumers will buy green products based on that reputation. SCM and Reduced Liability “Tax” Benefits The SCM model also provides benefits by leveraging the reputational assets and potentially reducing liability “tax,” and lowering cost of capital. In Europe, for example, many pension funds invest
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in socially responsible businesses not simply because they are socially responsible, but because such reputations lead to better risk management, and hence better returns. This links to another SCM model benefit, the reduced liability “tax.” Firms with poor reputations potentially carry more liability, and this will result in reduced equity investment, forcing either slower growth or increased use of debt. This is essentially a tax on the firm. Enhanced reputations can result in the greater availability of equity capital, combined with better debt ratings linked to better risk management. Ronen (2006) contains a variant of this “tax” in the form of corporate reporting insurance. Whether the firm pays insurance or incurs lawsuits is of little consequence, however, because the stakeholders are being taxed either way by falling victim to existing and continued lower standards. Increased intelligibility increases other stakeholder benefits as well—among them increased reliability of information, comprehensive firm data and the potential for greater financial returns. When the firm can reduce its liability-related risk, it benefits the stakeholders through better, more reliable returns (Vogel 2005). Through the SCM model, the stakeholders also receive a more comprehensive view of the firm, which, in turn, would prompt organizations to set higher standards. Such better intelligible information also redounds to the firm, in that the likelihood of derivative lawsuits (investor lawsuits against the Board and management for failure to disclose) would be less likely. One effort at providing information that supports this viewpoint is the United Nations Principles for Responsible Investment (see Box 1). SCM and Decision-Making Benefits By gaining the additional insights offered by our SCM model, the information processors, including directors, firm management, and auditors, will have a better and broader sense of the firm’s real financial position and overall risk exposure. A lack of knowledge or understanding would then no longer be a convenient executive or analyst excuse. The external input groups can provide an important check and balance on both how the information is processed and what it is intended to demonstrate in an intelligible format. Also, those who interpret the reporting information as intermediaries to investors, including security analysts
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Box 1 The United Nations Principles for Responsible Investment In 2006, the United Nations promulgated these six principles regarding Environmental, Social and Corporate Governance (ESG) issues in an attempt to promote responsible investments and disclosures. Signatories include asset managers, investment managers, and professional service partners, with over USD 13 trillion invested according to these principles. 1. We will incorporate ESG issues into investment analysis and decision-making processes. 2. We will be active owners and incorporate ESG issues into our ownership policies and practices. 3. We will seek appropriate disclosure on ESG issues by the entities in which we invest. 4. We will promote acceptance and implementation of the Principles within the investment industry. 5. We will work together to enhance our effectiveness in implementing the Principles. 6. We will each report on our activities and progress towards implementing the Principles. Governed by a body of members elected from among the signatories, these principles are intended to be aspirational for the investment community, and provide a measure of information and protection for investors. Each principle is accompanied by a list of suggested activities that signatories might take in order to fulfill the principle. In addition, there is a Secretariat at the UN that assists signatories. The specific activities of that Secretariat include providing guidance, building networks, enhancing collaboration, and evaluating progress. For more information, visit the UNPRI website at: http://www.unpri.org/
and individual and institutional brokers, provide secondary balance checks on the quality and applicability of the information for prudent decision making. Lastly, the SCM model supports the investors as true valued stakeholders adding to the value of the overall firm performance, not just because they invest, but because they cause the firm to continuously improve, beyond what is standard today. As a result, the firm becomes more transparent in key areas, can leverage external input more efficiently, and can count on reputational enhancement through its openness and exposure to external nonadversarial groups.
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SCM Governance and Ethics Benefits Our SCM reporting model will also improve corporate governance and ethics. Transparency has proven necessary, but not sufficient, for good governance and ethics. Adding intelligibility to the reported information should increase the drive to better governance and ethical behavior. The pressure will come through investor activists, an already very active group. The Interfaith Center for Corporate Responsibility, a watchdog organization, reports over 300 resolutions for the 2008 proxy season (http://www. iccr.org/shareholder/proxy_book08/08statuschart.php). Pension funds and other institutional investors are likewise active in proposing shareholder resolutions. Such filings have proven effective at changing corporate behaviors (see, e.g., Clark and Hebb 2004; Donoher and Greening 1998; Graves, Rehbein and Waddock 2001; Schepers 2007; Waddock 2000).
THE WAY FORWARD This is merely the beginning of a discussion of the proper roles of the modern corporation’s various constituencies as they contend with changing markets and public expectations. We believe our model contributes to improving the market for corporate information by providing not more, but better information flow through increased intelligibility of overall information, benefiting both the firm and its broad array of stakeholders. Further, it has become apparent that legislators and regulators have been unable to cope with the failures and wrong-doings by adding increasing layers of regulation and reporting. In fact these layers often seem to facilitate those who want to hide misdeeds more than they uncover them. We have identified a growing number of forward-thinking companies who have found alternative means to upgrade their performance reporting, strengthen their companies and provide better information to their stakeholders. The SCM model has a wide range of applications based upon the extensive variety and scope of external input capabilities. We believe the utilization of social movement groups focused on the added charge of intelligibility will result in greater cash infusion at lower cost of capital,
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increased investor awareness and protection, and increased information flow reporting the overall performance of the firm. A final question that arises is how is this model implemented? We first consider the macro level. Rather than implementing more indecipherable regulation, which has already proven ineffective at constraining market participants from gaming the system, we propose that the competitiveness of the marketplace be used to judge the ability of a firm in seeking to secure adequate capital at the lowest price. Firms that become known for displaying the most intelligible information will have greater access to the capital markets, and thereby gain competitive advantage over their rivals. Rather than reporting standards that operate at, or slightly above, the level of regulatory requirements, enhanced standards would encourage competitive forces in innovating the development of more intelligible reporting schemes backed by NGO review, as firms seek to bring in larger investments. Further, our proposed SMC model will also easily adapt to the increased international competition for capital and equity, which is enhanced by the globalization and interdependence of the world market. At the microlevel, each firm will likely find different schemes for implementation because of the nature of their industry, issues at hand, and corporate structure. Technology firms, for example, may link to an NGO that is quite different in focus than the NGO used by extraction firms. Firms with higher levels of decentralization may have more local inputs, as opposed to firms that have a more centralized structure. The actual means of implementing such a model could be handled in two exemplary ways. The first would be to have the standard enterprise risk management (ERM) function house the NGO interface. The ERM function would maintain appropriate relationships and leverage the NGOs to provide additional expertise that the company could use in either responding to or being proactive with particular issues. The second option would be to set up a specialized semi-independent unit that interfaces with NGOs and is exempt from company interference. Much like today’s common diversity units, these intelligibility-focused NGO units would operate autonomously and would receive some support and protection through government regulation. Although there is a need for political support for intelligibility, the government has yet to respond with any significant impact
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on these issues in support of either investors or other stakeholders. Therefore, we have focused primarily on market forces such as combined NGO and company initiatives as a viable method to drive improved intelligibility. We believe that broad implementation of information clarity would be enhanced by regulation, but current political agendas are focused on other exigencies. More research is required to identify the range of implementation options for the SCM model, but we believe that existing prototypes and current ERM functions would facilitate this concept quite readily. There are many areas for further study, and it may be useful to cite a number of these issues including: addressing the intelligibility needs of the broad continuum of stakeholders with their various levels of understanding; identifying the kinds of information to which investors, as risk-holders in the business, are entitled, but that the board, management or regulators believe they are not; understanding how intelligibility of performance information is affected by the need for timeliness by the different stakeholder categories; and determining how various stakeholders can play an active or formal role in selecting activist groups to work with company management.
SUMMARY The market for intelligible firm information is vibrant and extensive, with various participants and an opportunity to increase the range of benefits for all. We have attempted to contribute to the understanding and use of this market by first examining the many sources and pathways of firm information, and second, by assessing this market through the framework of the various stakeholder groups. At any one time, we fully expect there will be failures in this market and there will be calls for increased regulation. However, by utilizing the growing number of optional and external social movement groups, we believe firms can increase both stakeholder protection and long-term corporate performance. Some forwardthinking firms are already taking advantage of elements of this model and we anticipate many more will follow. We are, after all,
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trying to maximize two actions at the same time, stakeholder protection and market efficiency. We fully anticipate that some organizations will be slow to encourage improving the intelligibility of information. This is ultimately short-sighted, however, and moving forward, few organizations will be able to ignore the demands for greater intelligibility which is clearly on the rise.
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