Governance focus:
what needs to change?

The good news, however, is that there are just two really key areas that regulators want covered more extensively this year: the company’s strategy and its business model

You may have resorted to hollow laughter when faced with Cutting Clutter: Combating clutter in annual reports, this April’s Financial Reporting Council (FRC) discussion paper.

Faced with the first full year of the new UK Corporate Governance Code, not to mention a raft of further post-financial crisis guidance from UK and EU rulemakers, the paper’s idea of slimming down annual reports at the same time as firms are being asked to disclose more seems a tall order.

Navigating the morass

It’s not as if things were straightforward before. In the absence of a single, coherent piece of legislation outlining annual report essentials, those involved in the corporate reporting process are already obliged to consult a patchwork of disparate legislation and guidance to ensure that they meet all necessary requirements.

As the UK’s Investor Relations Society puts it: “The extent and complexity of the regulations and guidance on annual reports is already demanding. Simplifying — not adding to — this morass would be helpful, allowing companies to focus on quality, not quantity.”

Faced with the welter of new rules and recommendations, it would be understandable if companies retreated back into the very ‘fungus of boilerplate’ that the FRC urges them to avoid. The good news, however, is that there are just two really key areas that regulators want covered more extensively this year: the company’s strategy and its business model.

Engaging stakeholder attention

It’s likely that your company has already outlined its strategy and business model to some extent in previous annual reports. The new guidance presents a perfect opportunity to build on this. It offers the chance to spell out what differentiates your business and why it is worthy of stakeholders’ patronage, investment or interest, by clearly setting out what your business is, does and plans to do. Look at it as the equivalent of introducing the characters and context in a novel.

The new governance code recommends that this new content is located in the business review rather than tucked away in the corporate governance section. This makes narrative sense, as it means that the company sets out its stall at the beginning of the report. Indeed, a number of annual reports released before the June 29 deadline for code compliance, outlined the company’s business model and strategy in the opening pages, before the formal start of the business review.

Defining the business model

A company’s business model can be defined in different ways, from how a firm makes money to how it delivers products and services. Essentially, the FRC wants you to outline what your company stands for and does.

The best definitions and descriptions of business models in this year’s reports employ graphics (including maps, pie charts and tables) and concise summaries (supported by longer commentary for those who require it). They also offer clear signposts to further information in other parts of the publication or on the corporate website.

Many companies provide their business model information in the strategy section of their report. Most firms label the section explicitly, although some add their own flourish, such as ‘Our business model for sustainable growth’.

Crucially, this year’s very best annual reports do not present strategy in a silo

Building on previous disclosure guidance, many of this year’s reports have strong strategy sections. The most impressive include clear overview summaries; key strategic objectives; indications of how the strategy reflects the corporate vision; details of how strategy feeds into business planning; and links to breakdowns of KPI performance. Crucially, the best annual reports do not present strategy in a silo. Instead, strategy content runs throughout every section of the report — just as strategy implementation runs throughout every part of a business.

Bringing the board story to life

While raising the profile of governance principles at the very beginning of your annual report narrative, make sure you don’t neglect the corporate governance section itself.

Traditionally the Cinderella of the annual report — written to comply rather than to communicate — corporate governance sections in the best 2010/2011 annual reports are as engaging as the rest of the narrative.

In doing so they go some way to achieving the FRC’s goal of embracing “confident and persuasive communication with shareholders”.

The best performers infuse their corporate governance sections — and their boards — with life. They preface committee reports with personal, photo-bylined introductions from the appropriate chairmen; use personal pronouns and subjective language, rather than legalese, and, for example, talk candidly about what they actually did on board training days, not just that they happened.

They also use the tried and tested communication techniques of clear navigation, informative headings and a strong storyline that communicates strategic messaging. Not rocket science perhaps, but far from routine in conventional corporate governance reporting, driven, as it always has been, by a focus on compliance.

As regulators and investors increasingly demand greater insights into how companies really operate, whatever clutter you cut this year, your compelling board story should remain intact.