This is the year of corporate reporting. Its importance was underlined last week when the UK’s company reporting watchdog, the Financial Reporting Council (FRC), wrote to the chairs of audit committees calling for improvements.
The FRC’s letter stressed the need for “greater transparency” in “times of uncertainty”. Brexit, shifting geopolitical trends, the climate crisis and changing public expectations of business, have all had an impact on corporate reporting demands.
Not least among them is the new need for companies to report this year on how they fulfil their section 172 responsibilities.
Section 172 is a clause in the Companies Act 2006, which lays out a director’s responsibilities. As debate around sustainability, corporate purpose and the climate crisis has intensified, the application of section 172 has come under close scrutiny.
While the duties have been around for more than a decade, reporting against them has not. Nor, many commentators would say, has much attention been given to section 172. Indeed, one top consultant says boards have shown “little regard for 172”, mostly because it was never enforced—despite looking like a fairly rigorous set of demands. Observers point out that section 172, despite its explicit terms, has failed to stop corporate failures.
Enforcing the duties
Section 172 asks directors to consider the “long term” consequences of their decisions; how they considered the “interests of employees”; and how their actions “fostered” relationships with suppliers and customers.
In addition, the duties include considering the impact on “the community and the environment” and how a reputation for “high standards of business conduct” is maintained.
These are all topics embedded in the current widespread discussion of whether business should shift to a model that prioritises “stakeholders” over “shareholders”. It turns out it was there in British law all along.
But the emphasis is now not so much on the duties themselves but on enforcing them or, at least, how directors will report on how their duties are fulfilled.
For boards who give these issues little consideration the reporting could be painful. For others it may be relatively easy. Indeed, other reporting demands—the Strategic Report, implemented in 2013, and the Viability Statements in 2014—have significant overlaps with the new section 172 report.
But the section 172 report adds another layer. In short, government wants companies to report on the “main methods” directors have used to “engage with stakeholders” and understand their issues, and how that understanding has affected decision-making. Guidance from the government says it should be “meaningful and informative”.
An integrated advantage
Some companies may find themselves with an added advantage when they come to compiling their 172 reports. According to Richard Martin, head of corporate reporting at ACCA, a professional body for accountants, companies who use integrated reporting (IR), will have worked through many of the issues spotlighted by section 172. In particular, IR, would have forced companies to focus on the stakeholders their reports need to address.
“They’ve already been doing it,” says Martin, though he adds that those it is mainly companies that have been “more advanced on reporting”.
Attention, he says, is likely to fall on issues that hold an interest on wider groups, beyond those that provide capital. And that means climate and community. Section 172 is emphatic that a director “have regard” for their company’ s impact on these areas.
According to Matt Stroh, head of professional standards at the audit firm Grant Thornton, one of the challenges will be to show how directors have fulfilled their duty to employees, a responsibility that also appears as part of the new UK Corporate Governance, published last year.
But the combination of the section 172 reporting, plus new audit guidelines on going concerns will provide a basis for auditors to test management strenuously.
“And what helps us as auditors is the fact that management will have some very clearly codified responsibilities for taking ownership of the likely consequences of any decisions in the long term,” says Stroh.
A good fit?
One long-term issue illustrated by recent examinations of the collapse of travel firm Thomas Cook, is the fit between a company’s finance model and its business model. Directors now having to report on how they fulfilled their duty to ensure those two elements were a good fit might pause for thought.
So will 172 reporting be a new uncomfortable process for directors?
“It shouldn’t be,” says Stroh, “because clearly all these facets are part of one’s role as a director. However, I think trying to explain concisely, and to a whole group of different stakeholders, in an unstructured way is really challenging.”
Stroh’s concern is that the lack of a reporting framework and detailed guidance on what should be reported means reports could be different from one company to another, presenting problems for comparability.
In its letter on annual reporting, the FRC makes a simple point about section 172. “The duty is not new; but the reporting requirement is.”
That should be enough to focus minds. The new rules apply to financial beginning after 1 January 2019. The first set of reports will appear next year.
Section 172 in detail
172 Duty to promote the success of the company
(1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.
(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.
(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.