First, a warning, this really is a stream of consciousness, based on things I have seen/experienced since 1984, when I started out as a trainee analyst, and is just meant to provoke thought and prompted by a couple of big shocks in the UK quoted sector over the past couple of weeks, both on AIM and the full market.
Ultimately, the buck stops with the CEO, but how can shareholders be better protected from shocks, who should practically be doing the protecting, and how. How can shocks be prevented/minimised?
Nothing I am saying is particularly new, but might now actually be an ideal time to be addressing these issues?
If the board is falling short, who should be doing the protecting
Shout, not whisper
Inevitably, one looks to the the auditor, but in many, not all, instances of big profit warnings, the evidence of problems was there to see in the accounts, so it very probably is the case that auditors are doing their jobs effectively in drawing up the accounts, but that the real problem is that what auditors produce/the emphasis, is insufficient for shareholders’ requirements – to my mind, there needs to be considerably more upfront and open revelation of problems and bold, ‘loud’ commentary: right at the top of any announcement with an indication of how big a problem the auditor sees this as being (not hidden away on page 54 in a mass of other detail) and maybe even with a scoring system? Could this level of openness be achieved under the current system?
What about analysts?
Analysts are not auditors. Many sell-side analysts are conflicted, and in fact many (most?) are more marketers than financial experts – I could quote a number of examples, but can remember one very clear instance in a company’s figures, a company that produced multiple products, where a massive stock build-up was actually a punt on ONE unproven product, but no-one seemed to bother, even given the potentially dire implications for cash. On the buy-side, even for larger funds, analysts cannot possibly keep track of all their holdings in the detail that an auditor does, and smaller funds have no chance.
Reliance on analysts is insufficient. So, back to auditors …
A great time to further address conflict of interest?
‘Under Section 235 of the Companies Act 1985 auditors are appointed by and report to the shareholders of the company. ‘
Source: ICAEW; https://www.icaew.com/-/media/corporate/files/technical/audit-and-assurance/audit-quality/audit-quality-forum/agency-theory-and-the-role-of-audit.ashx:
I am sure that, de juris, this happens, but, de facto, what is really happening/how effectively is this implemented? Many might argue that auditors often are more beholden to companies than shareholders.
Given some of the solid work being done recently as regards corporate governance in the UK, might now be the time to figure out a way to make auditor appointment truly independent AND, as importantly, using modern technology, give auditors a role of real-time oversight, so that significant problems can be spotted and reported to the market as soon as possible/addressed in time?
Maybe things could be tightened up under the current system, but probably it needs legal intervention, augmented and addressed in the meantime by a tightened code of practice/self-government. Of course, companies might not comply, but that should have significant consequences for share-raisings, valuation/cost of capital.
No suggestions are new, and mine certainly are not, but maybe having auditors directly appointed by a shareholder group, and a significantly reduced audit rotation period (currently, I believe, ten years, extendable to twenty!). We are supposed to be in a technological age: detailed information and commentary should be easy to store in order to pass information on and a handover/overlap period mandated as part of any contract drawn up. If companies are incapable of implementing that, then there are clear implications. Regardless, it might be argued that any inefficiencies in the overlap period would surely be more than offset by savings due to reduced conflict and complacency, and improved oversight.