The viability statement that UK listed companies are required to produce under the UK Corporate Governance Code has been taking a bit of a bashing recently.
First Sir John Kingman denounced it as ineffective in his review of the future of the Financial Reporting Council, and then last month Sir Donald Brydon’s review into the quality and effectiveness of audit concluded that it was “not so much a serious analysis of a company’s future viability, but instead a piece of boilerplate”. He has recommended that it be replaced by what he calls a ‘Resilience Statement’.
I need to declare an interest at this point, as I was at the FRC and working on the Code when the viability statement was introduced in 2014. The context was a desire to have a more meaningful assessment of a company’s future position than is provided by the ‘going concern’ statement that companies and their auditors are required to make.
Under the definition in international accounting standards, any company can say it is a going concern unless it is on the verge of going out of business. A positive going concern assessment does not tell you very much at all.
The two related aims of the viability statement were to get companies to look further ahead and carry out a more robust assessment of the risks to their future viability, and for them to provide investors and other users of reports with more insight into how that assessment was carried out and what conclusions they have drawn.
There is some evidence that it has had a positive impact to the way companies assess their future viability. Research carried out by McKinsey three years ago found that “the primary impact of the viability statement was to raise the quality and sophistication of the internal dialogue on risks… and their risk modelling”, especially in non-financial companies.
As far as the viability statements themselves go, however, Kingman and Brydon are right. While there are some notable exceptions, most are boilerplate. The question is why, and what can be done about it?
My own view is that root problem is not primarily the statement itself but mutual mistrust on the part of companies and investors.
Investors say that what they want is to understand the assumptions the company has made, how they have been tested against various scenarios and so on, in order to inform their own assessment of the company’s prospects and the agenda for engagement. No doubt there are some investors who do exactly that.
But if you talk to companies the vast majority will tell you that they have never received any feedback from investors on their viability statements. Of the 21 companies that participated in a Financial Reporting Lab project on viability reporting in 2017, only three reported any contact with investors.
Some companies interpret that silence as meaning the statement is not read, and so treat it as a compliance exercise requiring minimal effort. Others worry that, without the opportunity for a more nuanced discussion, stating that they have a reasonable expectation that they will continue to be viable will be wrongly interpreted as a guarantee of future performance, good or bad.
That is when they get nervous. They read ‘viability’ and think ‘liability’. Too pessimistic in their predictions, and they worry they will deter investors now. Too optimistic, and they worry that at some point in the future they will find themselves accused of having mislead investors.
Which is why many companies choose to add endless caveats to their statements, or to restrict them to the shortest time period possible to reduce the likelihood of their predictions being proved wrong, or do the other things that result in boilerplate.
That is understandable to a degree, but it only exacerbates the problem. Because when investors look at a collection of caveats and generalities they may conclude that the company is hiding something – either the fact that they have not done a very robust assessment, or that longer term their prospects aren’t all that rosy. Again, this is understandable, because in some cases that may be exactly what the company is doing.
Of course, companies should be encouraged or required to provide better quality information about how they have assessed their medium- to long-term viability or resilience. The suggestion made in the Brydon report for an enhanced statement seems eminently sensible, and the Financial Reporting Lab’s report contains some good examples of how companies can make the existing statement more meaningful.
However, investor expectations of these statements are unlikely to be met unless there is a change of mindset in companies, and that in turn is unlikely to happen without more investors being willing to engage with companies about their assumptions and assessments. Unless both sides are willing to put the work in, there is a danger that a new, improved resilience statement will simply result in new, improved boilerplate.