SA corporates fail despite apparent good governance. This article argues for looking beyond the box-ticking and virtue-signalling, to where leaders may be found with the maturity to identify and respond to the real vulnerabilities that face their industry and their businesses.
By Rob Worthington-Smith
06 March, 2018
How is it that here in South Africa we pride ourselves in the quality of our governance and can point to the pioneering work of the King Commission in developing frameworks for governance and for reporting, yet suffer so many failures in corporate governance?
Pension funds need to be invested in dependable businesses
Some businesses thrive in the cut and thrust environment of few rules. If one thinks of the high-tech environment, where new systems continuously jostle for customer eyeballs, and where today’s heroes are tomorrow’s also-rans, it is understandable to find entrepreneurs willing to take substantial risks in the hope of hitting a home run. Naspers managed this with its investment in Tencent. What an amazing story that has been. Now the company has set itself up as a venture capital business, tossing more piles of cash at promising start-ups, ever hopeful that another wild success will counter the inevitable flock of failures.
However, as sectors become more established in society, so rules and regulations are brought to bear on participants in order to ensure fair play towards all stakeholders involved, from customers to communities, the supply chain and other business partners and competitors. Investors in these sectors aren’t looking for the gun-slinging entrepreneur, for there are seldom opportunities for wildly exciting performance. Rather, the attraction for investing in these sectors is the assurance that the downside risk is being responsibly managed. By tending to corporate governance, companies should offer their investors stable, solid returns through up and down business cycles.
As pension fund trustees, you may decide to invest a small part of your fund into some exciting prospects. But it is more likely that most of your portfolio will be invested in solid and stable sectors where risk is quantifiable and well-managed.
It must be hugely disappointing then, to find so many well-established South African companies committing serious crimes of governance, either by outright fraud and misdemeanour (such as in the case of Steinhoff), or by simply being asleep at the wheel (as in the case of the fine paid by MTN in Nigeria).
Twin reporting mischiefs: Box-ticking and virtue-signalling
Having made a decade-long study of the corporate reporting environment, I have come to some conclusions around leadership maturity that may be helpful as you consider how to craft and manage your investment mandates.
Back in the nineties and noughties, there were two clear streams emerging in corporate reporting. The first was driven by the King Commission and the second by the Sustainability movement. King was the pioneer in developing a number of solid principles that should be the foundation of good corporate governance. However, what we saw, and still see, is the natural reaction by companies to this set of rules – a response I call ‘gaming’. Whereas King was meant to change the mindset of corporate boards towards how they dealt with challenging issues, instead it became an opportunity to simply put in place codes, policies and charters that could be referred to when filling in the list of King requirements. In other words, this stream became simply a box-ticking exercise. Many of these standards elicit a similar response: The JSE SRI index, the UNPRI, the Global Compact and the Carbon Disclosure Project (CDP) being others. Who knows what relevance the CDP has to business sustainability? Hardly anyone, yet you’ll find compliance to the CDP in practically every large company report. That’s like tossing an anchor overboard without tying it to the ship – the job got done, but not very useful to establish a mooring.
The sustainability movement is squarely responsible for the second stream that has led companies astray. Back in the day, mining and resource companies used to produce a Safety and Health Report, then adding a Quality section and an Environmental section. Along came the concept of Sustainability, presenting corporate public relations officers with the perfect opportunity to signal the company’s virtue to the whole world. From a standing start, these reports soon swelled to tens, if not hundreds, of pages of stories, pictures, captions and quotes extolling the extent to which companies go ‘beyond compliance’ in contributing to communities, building Mandela schools, recycling head office stationery and turning off lights at night.
Business is built on trust and trust is earned through building up a reputation over many years for being trustworthy. This is the hard-earned goodwill that forms tangible value for a business, and is embodied in the company’s brand. Creating a story for the business is not a bad thing. Woolworths created its Good Business Journey and put the company on a course towards higher moral ground. However, when the corporate traveller finds the hill too steep to climb, it is all too tempting to keep the façade through a concerted PR effort, while the underlying business strays from its moral principles.
How to identify the masterful and mature
As a pension fund trustee, the company you want to invest in is the one with solid, mature and dependable leadership – a team you can have confidence in to detect challenges appearing over the horizon and to respond to them strategically and in the best interest of your policyholders. How do you identify such companies?
Ironically, the very source of box-ticking and virtue-signalling, the company’s annual integrated report, is exactly where we can separate the gun-slingers and slackers from the masterful and mature business leaders.
The integrated report demands five actions from the corporate leader:
- Identify the most important (material) issues that may affect returns to shareholders in the short-, medium- and long term
- Understand these issues, including how they may be a concern to society and how they may impact on company in terms of reputation, regulation, licence to operate and competitiveness
- Drive the issue at leadership level and hold yourself as leader accountable for how these issues are dealt with successfully or otherwise
- Measure progress in terms of dealing with the issue, using comparable, relevant and reliable performance indicators
- Develop and implement a strategy for your company that addresses the issue, ensuring stronger relationships and resources, and ultimately long-term value creation for your shareholders (policy holders).
Reporting on these five simple actions is what the International Integrated Reporting Council (IIRC) had in mind when the Integrated Reporting Framework <IR> was launched in 2014. Amazingly, such common sense seems to have passed by both the sustainability movement (and its close cousin, the ESG investing industry) and many corporate boards here in South Africa.
But not all. There are a number of new blue chips emerging that may prove to build sustainable value over the long term. Likewise, there are many laggards that have failed to front up to their vulnerabilities. These are coming home to roost now, revealing those that have set themselves adrift to the detriment of their shareholders’ hard-earned savings.
SIDE BAR
The FarSight Model of Leadership Maturity
From our research into decades of corporate reporting, and noting the significant difference between how mature leaders report against these five actions compared to immature leaders, FarSight developed a model for assessing leadership maturity in terms of how well companies respond to their most material issues. Every two months we analyse a sector of around eight companies on the JSE and submit our findings to the asset management industry through our channel partner, Legae Securuties, the first B-BBEE Certified Stock Broking firm in South Africa. Summaries of these findings, and how the model works, can be found at www.FarSightFirms.com
* Rob Worthington-Smith is the founder of FarSightFirms.com. The FarSight model analyses leadership maturity based on the IIRC’s Integrated Reporting Framework, an international standard designed to guide companies towards better reporting of their value creation story. In the SA asset management market, FarSight has an exclusive working partnership with Legae Securities.
