Former SEC chairman, Arthur Levitt, and others like him, point to the accounting profession (e.g., Arthur Andersen) as the root of the evil done by Enron and the dozens of other suspected firms now under SEC investigation. In doing so, these first-stone casters do the public a great disservice. In fact, the rock throwers are aiming at the wrong target. The actual source of the betrayal is not a conflict between auditors and same-firm consultants. The underground taproot that actually feeds the accountability dilemma are the decisions – whoever makes them – about disclosure and nondisclosure.

Why does the word “disclosure” have the ring of secrets being divulged? What does “disclosure” mean when the adjective “full” precedes it? The accounting definition of “full disclosure” relates to just about anything in a financial statement or report that assists in its interpretation. Admittedly, accounting is a specialized language and set of procedures; therefore, the uninitiated do need help in making sense out of most financial information. This lack of transparency is a significant part of the trouble.

A second major difficulty stems from the fact that financial reporting is – well – financial. That means the unit of expression is monetary, hardly a comprehensive declaration of what is happening inside an organization. Performance management systems such as the Balanced Scorecard attempt to elucidate and remedy this simple shortcoming. Additional trouble stems from the accepted practice that financial reporting “often results from approximate rather than exact, measures.” (FASB, CON 1,¶20) A final fly in the ointment is the historical nature of financial statements; that is, “The information provided by financial reporting largely reflects the financial effects of transactions and events that have already happened.” (FASB, CON 1,¶21) All these financial statement aspects add up to a context where “full disclosure” really isn’t.

Who wants or needs full disclosure? The answer is anyone who has a claim on, or an interest in, the resources of the organization. The list of these claimants and interested parties goes well beyond shareholders. So, what if corporate executives really worked to disclose all that needs disclosing? The first task relevant to full disclosure – and the subject of the remainder of this discussion – is exposing the primary underlying assumptions that guide disclosure. For the sake of relative simplicity, the context here is only the public corporation.

Primary Assumption #1: Profit is the Prime Measure

Recognized or not, almost every organization works to support and achieve success in a prime measure. For example, a steel producer’s prime measure is tons of steel.  Some would argue that “share price” is the prime measure of the public corporation; however, share price is the result of a result, namely, profit or profit distributed as dividends. No matter how many other constituents – employees, suppliers, the community, the environment – actually hold a stake in what a corporation does and how it performs, the first duty of the public corporation is to increase the wealth of its shareholders wealth. Make no mistake. All corporate roads lead to this profit imperative, whether the path is labeled employee productivity, value creation, or the more direct, earnings per share. The profit imperative has its origins in the corporate charter and its language that dictates the duties and responsibilities of corporate directors. Specifically, the charter and its duties call for action that is in the best interest of the corporation and its shareholders. True enough. However, the second part of the charter language – but not at the expense of the community – has been omitted from some State charters. If not omitted, it is generally ignored.

The startling result of giving equal attention to, and full disclosure of, the second half of the responsibility in corporate charters would be to report in several additional performance areas including:

·     Human capital measures: employee satisfaction, workforce turnover, wage and benefit fairness, and the health of working conditions (e.g. space, air, hours worked), and work impacts on employees’ lives outside of work.

·     Externalized environmental costs: Adam Smith is widely quoted by economists, but most of them seem to forget that Smith insisted that a business recognize and “internalize” all of its costs. Current corporate accounting systems not only do not account for environmental damage (e.g. toxic waste, destruction of habitat), but actually give corporations an expense deduction for “natural resource depletion.” In essence, this twisted logic acts on the false assumption that the planet’s common heritage is owned by corporations!

·     Externalized social costs: Health and education could be significant measurement categories here. How much does the corporation support the health of society? (Think the tobacco industry and the Target Market’s success in opposing it.) Corporations would report on their impacts on any community in which they do business. For example, wages paid to Indonesian and Philippine laborers would be separately reported, as well as human capital measures for them.

Performance and full-cost reporting based on concepts like these would disclose far more significant information than the insignificant disclosures sought for off-balance-sheet items (e.g. leases, special purpose entities). At first, as an awareness-raising exercise, such full disclosure could be reported in parallel with conventional financial statements. Soon after, investment in socially responsible firms might become the norm. Corporations unwilling to prepare and publicize balanced performance reports like these just might have something worth hiding.

Primary Assumption #2: Shareholder Productivity

A more fundamental question lies behind the question, “What is full disclosure?” That question is, “Why is disclosure needed?” The answer relates to what Marjorie Kelly, author of The Divine Right of Capital, calls “shareholder productivity.” Never heard of it? Don’t be surprised. It is a corporate performance measure that does not exist. Employee productivity measures are well known. Robert Simons (Harvard Business School) developed ROM, return on management. Financial productivity and efficiency measures are too numerous to mention. Even some measures of environmental responsibility are emerging. Yet, shareholders remain largely immune to measurement.

The reason that “shareholder productivity” is not in our business vocabulary is that shareholders are not expected to produce anything. Why? Simply stated, in public corporations, shareholders are generally absentee owners. (Think large institutional investors such as pension fund managers). Obviously, an owner who never sets foot in the business won’t have a clue about how it is performing. Naturally, it follows that such owners/investors need performance reports and a bevy of analysts quailing to interpret them.

Similar to the remedies suggested for the problems inherent in managing the organization toward profit as the prime measure, this situation calls for performance reporting on ownership including:

·     Who owns what per cent of the corporation? Any ownership position greater the .25% for the reporting period would be exhibited, along with how long shares have been (or were) held. The length of position measures would expose owners with long-term support of the firm, as opposed to short-term, margin owners, mainly concerned with wealth extraction. Unless a shareholder is a working employee of the firm, any investment earnings extract resources from real assets – tangible and human. This is a matter of disclosure that distinguishes ownership profiles, but makes no judgment on them.

·     What are the owners’ objectives for their ownership shares? Knowledge of these objectives would clearly show the expectations the corporate executives should be working toward fulfilling.

·     Disclosure of conflicts of interest, especially as pertains to corporate executives, owners, and Board members.

·      Disclosure of misconduct: Boards and Audit Committees would discourage misconduct (i.e., conduct not in the interest of shareholders and/or society) by publicizing both the actions and the results of the actions.

It would be easy to continue this line of full-disclosure thinking. But this isn’t really what corporations or investors have in mind when they ask for full disclosure, is it? Corporations want to look good to investors. Investors want their money to be not only safe, but – well – productive, even though they themselves are not.

These assumptions are two of many that must be challenged, debated, and resolved. It makes good business sense simply because the current trajectory is no longer viable in terms of planetary resources. Any improvement in existing accounting systems to reflect such changes must ground itself in ever more clear and complete disclosure. Such full-disclosure statements would promote transparency, lead to discovery and remedy of pathologies, and prevent the current illness from spreading to epidemic proportions.

BIO

Catherine and Joe Stenzel are the Editors-in-Chief of the Journal of Cost Management, and authors of Essentials of Cost Management to be published in the last half of 2002 by John Wiley & Sons. The Stenzels can be reached at genesis@visi.com and 612-871-0042.

© Genesis Organizational Diagnostics, Ltd., Minneapolis, MN, 2002