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09 April 1999ANNUAL REPORT AWARDS View the rulesTRANSPARENCY AND INTEGRITY DO COUNT Shareholders and fund managers want and need to be informed
Does corporate reporting matter? If there was any doubt about it - and the directors of many JSE companies evidently are still not convinced - it should have been erased by the turmoil in international markets over the past two years. The ferocious swings in equity markets, whether in Asia, Latin America, eastern Europe, southern Africa, or even North America and the European Union, have emphasised more clearly than ever that share valuations depend on investor confidence. That, in turn, demands credibility and transparency on the part of listed companies. Despite recent recoveries, many of the emerging markets remain far below earlier peaks of two or more years back. As many commentators have noted, this is not simply because of economic stasis or decline. Once the tremors started, investors discovered that the levels of corporate disclosure and the application and consistency of accounting standards in these regions are often erratic at best. Suddenly it became unacceptable to invest in ignorance, or when published accounts failed to convey a reliable picture of risk. Accounting standards in SA are better than in many of the other emerging markets that compete for the attention of international fund managers. Some of these investors have commented on the relatively high standards of transparency and the regulation of local financial markets. But, as is again shown by the FM's annual accounts award, there are still huge disparities in the reporting standards of companies listed on the JSE. Those at the top of the rankings - the best appear in the Top 20 and in the Roll of Honour - would probably attract plaudits almost anywhere. The directors of those in the Bottom 20, on the other hand, palpably demonstrate their disdainful attitudes to shareholders through their published accounts and their general attitude to communication. Leading the overall ranking again this year is cement and lime producer Alpha, with an impressive 190 points, or 100%. This company has long been at the forefront of corporate reporting in SA. Sadly, its shares were delisted last year, after its controlling shareholders, Anglovaal and Holderbank, bought out the minorities ahead of a restructure of the company. As Alpha has previously led the Top 20 on three or more occasions, it no longer appears in this ranking but instead is listed in the Roll of Honour (and in the overall ranking). SA Breweries (SAB), Morkels and York Timber are others that no longer appear in the Top 20 for the same reason. But their scores are shown in the overall ranking, where they remain firmly in the upper levels. Winner of the Top 20 ranking is Amalgamated Beverage Industries (ABI), the soft-drink bottler controlled by SA Breweries. ABI, fourth in this table last year, captured 189 points, or 99,5%. It is followed by the former SAB subsidiary, retailer Edgars Stores, with 186 points, or 97,9%. Third is Cape-based clothing group Seardel Investment, with 184 points, or 96,8%. Most Improved reporter this year is Aukland Health, whose score jumped from 38 points (20%) to 128 (67,4%). It's followed by Teljoy Holdings, up from 92 (48,4%) to 142 (74,7%), and LA Retail Stores, up from 51 (26,8%) to 105 (55,3%). The Bottom 20, regrettably, includes some familiar names, such as Spur Holdings and Pals, along with at least one new listing in Billcad - hardly an auspicious start as a listed company. The primary purpose of this award and the accompanying rankings is to expose the reporting standards of listed companies, and to help lift the standard of corporate reporting in SA. Both the disclosure standards and the criteria applied for this award have tightened and broadened enormously since it was first published by the FM in 1964. This is not a competition. Nobody enters for it. All companies whose shares are listed in the industrial sector of the JSE are automatically included in the evaluation and the results. That includes those that are domiciled in other countries, where legal requirements may be less exacting or, simply, require different forms of disclosure. All the accompanying rankings are based on annual accounts and interim reports for the 1997 financial year. The method applied in arriving at the results is unchanged. The evaluation is done through a points scoring system, and the criteria on which points are awarded have been published in the FM, so all those involved can see where credit is gained or lost. These criteria will soon appear on the FM's website, as will any revisions as they are made. Notably, the rules applied for the current award were not revised last year to take account of any rulings or practices in the accounting profession. Revisions are usually done about every two years. But that simply underlines the poor performance of this year's laggards. This system offers an objective, concrete and transparent method of judging, with all the eligible companies on the JSE treated according to a common yardstick. The judging is administered by Jean Myburgh, senior lecturer at the University of Pretoria's Department of Accounting, and is supervised by Prof Leon Brummer, director of the University's Bureau of Financial Analysis. Points are awarded simply for the disclosure of specified information, primarily of a financial nature, that would be helpful to analysts, investors and other interested parties. As we have often noted, the aesthetic aspects of the report - the design, the readability or the frequency of photographs of the directors - have never played a part in this award. This is not to say presentation is unimportant, but it can be difficult to judge objectively. However, the investment community and the accounting profession are increasingly demanding that corporate accounts should do more than merely comply with the laid-down standards. Indeed, in its corporate governance guide entitled Stakeholder Communication in the Annual Report, the SA Institute of Chartered Accountants (Saica) notes: "Statutory financial statements on their own are not sufficient to provide an appreciation of the nature of the business, the risks it faces and its financial prospects." Nor should the annual report be aimed solely at shareholders. The Saica document adds that the King Report (on corporate governance) describes a stakeholder as any person, entity or interest group that has some association with the enterprise. Three classes of stakeholders are identified: shareholders; parties who contract with the enterprise, such as employees, customers and suppliers; and parties that have a noncontractual relationship with the enterprise such as government, local authorities and representative bodies. In that spirit, this award does give credit for inclusion of information and comment on topics such as an employment report, environmental reporting and a statement on corporate governance. Points can also be gained for information about the directors and management, a matter of clear interest to investors. This, of course, is an area that has shown up the gaps between local accounting practices as applied even by the best of the local companies and the requirements in countries such as the UK and US. When Billiton and SAB listed in London, they were forced to reveal juicy details, including the remuneration and benefits of individual directors. Local readers of their listing documents were fascinated. Yet this has long been a standard disclosure requirement in those countries. And it soon will be in SA, when the amendment to the Companies Act is passed. (This will also allow companies to acquire their own shares.) Some other gaps are being closed or narrowed. Several new accounting standards put forward by Saica have been or are being approved. These deal with interim reporting, segmental reporting and the disclosure and raising of deferred tax liabilities. Others to be proposed soon deal with discontinued operations, the treatment of business mergers or take-overs and intangible assets. If these are enforced, they will clamp down on the "big bath" treatments often seen when new managers push every negative they can find, including a slightly leaky kitchen sink, through the income statement, only to come out with a miraculous recovery the next year. Intangible assets, such as goodwill acquired through acquisitions, will have to be amortised through the income statement and not, as is often done in SA, written off directly against share capital. This could make the financial effects of many take-overs look radically different. Some of these have been hot issues even in the US, ostensibly at the forefront of enforcing full and fair disclosure through powerful regulatory bodies. In a speech at New York University last September, Arthur Levitt, chairman of the Securities & Exchange Commission, launched a campaign against what he called a widespread decline in the quality of accounting by US companies. He highlighted five examples of accounting "illusions" and deceptions that he wanted to stamp out. These included the use of big bath charges (described as large restructuring charges which in effect reduce a company's future expenses) and "cookie jar" reserves (a form of secret reserve set up during the good years to provide a source of profits for the future). Others were the large write-offs that often follow mergers, the recognition of revenues by a company before a sale has actually taken place, and the misuse of tests of "materiality" to hide items that might have a large impact on investor perceptions if disclosed. Much of the problem in SA hinges on enforcement of accounting standards. The accounting profession is continuing to push for legal backing of the Generally Accepted Accounting Principles, and Saica is hopeful that it will be enacted before too long. This could make a huge difference. Some directors of listed companies apparently don't believe in consistently applying Gaaps. However, the real issue is to encourage and demand a culture of excellence in reporting. Levitt blamed the deterioration partly on pressures from the stock market, which had become used to rising earnings in a bull market. When companies failed to live up to these expectations, they were often punished by a sharp fall in their prices, putting them under pressure to massage earnings. Perhaps, too, the problem lies in the greed of directors and managers owning huge shareholdings and options in the company. Many managers, however, have also discovered that once investors lose confidence in the integrity and transparency of a company's accounts, it can be fiendishly difficult to restore - along with the share price.
By: Andrew McNulty
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