Hywel Ball 16 Nov 2018 11:04am

Can changing value creation reporting build trust in business?

In order for society and economies to thrive, business needs to focus on long term value creation for their customers, employees and the wider community, rather than just short term results for shareholders, writes Hywel Ball, EY’s UK&I managing partner of assurance and UK head of audit

Office meeting
Caption: How do you encourage long-term decision-making that benefits all?
It’s a simple statement to make, but the long-term versus short-term phenomenon is an issue that academics, politicians and some of the best business minds have grappled with for many years.

How do you encourage long-term decision-making that benefits all, rather than short-term profits that benefit a few? What do you need to measure to demonstrate long-term value creation to the financial markets? And crucially, could changing the way we measure value help companies focus both on the long term and meet wider stakeholder needs?

These are some of the big questions that lie at the heart of a project that we have been working on for the last 18 months – The Embankment Project for Inclusive Capitalism – and which over 30 global organisations have come together to help try to find a market solution. Project participants have today signed an open letter, stating that the findings of the Project will help provide a clearer understanding of how businesses create both long term value and stable and inclusive economies. If some of these principles are used more by corporates, we believe it will go a long way to improving trust and confidence in the capital markets.

EPIC (as the project has been dubbed) was created by EY and the Coalition for Inclusive Capitalism and has brought together asset owners, asset managers and CEOs of public companies, representing over $30trn (£23.4trn) of assets under management and almost two million employees around the word. Participants include companies such as BlackRock, Unilever and JP Morgan. The aim: to make reporting more informative by developing a framework and measures to better articulate the long term value created by businesses for a broad array of stakeholders.

One of the big challenges, recognised by all the project participants, is that current reporting metrics are falling short. In an era of artificial intelligence, data mining, social media and a 24-hour news cycle, the metrics that markets and investors use to evaluate a company’s success have largely remained the same. Businesses across the world are still reporting to financial markets based on a lot of the accounting principles and concepts from the 1970s.

It is perhaps not surprising then that, despite continuous updates, these standards are struggling to keep pace. With the growth of the knowledge economy, more and more of a company’s value lies in its culture, innovation and intellectual property – so called ‘intangible assets’. And yet these are largely absent from corporate reporting. Research suggests that across all global markets, only 50% of a company’s value is captured on balance sheets and for the S&P 500 this falls to below 20%.

This matters - and not just to auditors like me. If companies are unable to measure and communicate the long-term value they are creating, it’s more likely that management or investors will be focussed on short-term returns. It becomes harder to justify significant investments in things like innovation, training or technology - particularly when there’s a trade-off with short-term dividends - unless you can demonstrate the potential long-term gains to the business.

It also has a detrimental impact on public trust. Recent high profile corporate failures have highlighted the importance of companies being able to communicate with a wider group of stakeholders, beyond just shareholders. While it would be too simplistic to say that corporate reporting is wholly responsible for falling levels of trust in business, a lack of transparency is almost certainly a contributing factor.

So how will the Embankment Project for Inclusive Capitalism help? And what have we achieved over the last 18 months? The project has resulted in an open source framework and an initial set of metrics that represent a tangible and significant step forward. Our findings offer well researched yet practical ways to measure factors that participants agreed contribute to a company’s long term value. These factors are focussed around an organisation’s approach to talent, innovation, governance, society and the environment, and address issues such as the approach to employee well-being, recruitment and leadership skills of the board.

With challenges so complex, we don’t claim to have found the silver bullet: there is no simple solution that will eliminate short-term pressures along the value chain. We recognise that there is more work to do, but I’m proud of the progress that we have made. And with 30 organisations coming together to work on these issues, including the world’s largest asset managers, I’m encouraged that we are taking positive collective action to support greater long term value creation in business.