Salterbaxter - Directions Supplement - Dissecting Best Practice In Ftse 100 Annual Reports And Accounts

DIRECTIONS MONTHLY SUPPLEMENT

A SPECIAL EDITION IN ASSOCIATION WITH INDEPENDENT AUDIT

SPECIAL EDITION AUTUMN 07

TRENDS AND ISSUES IN THE WORLD OF CORPORATE REPORTING

DISSECTING BEST PRACTICE IN FTSE 100 ANNUAL REPORT AND ACCOUNTS Directions Monthly Special Edition, Autumn 2007

INTRODUCTION FTSE 100 Annual Report and Accounts Analysis 2007

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Welcome to this special bumper edition of Directions for Autumn – a review of best practice in corporate financial reporting in the FTSE 100. This edition has been brought to you as a collaboration between salterbaxter and Independent Audit, the experts in governance and board performance. The insights and analysis are from people with interesting views on what good reporting should now look and feel like. We hope you find this useful and enjoy the read – especially if your company is one of those spoken of in glowing terms.

Lucie Harrild

Pavan Athwal

The big challenge we’ve tried to address is what, if anything, can be identified as best practice in reporting when so much is up for interpretation? Nigel Salter Director, salterbaxter [email protected]

Richard Sheath Director, Independent Audit [email protected]

There have been numerous recent developments in the world of corporate financial reporting and the majority of these have been technical in nature and left open to the individual companies to interpret in their own way. This has added to the complexity of the disclosure requirements and led companies to think about the details and structures of their reports more than ever before. So how have the FTSE 100 responded to this constantly shifting landscape and what, if anything, can be identified as best practice in reporting when so much is up for interpretation and debate?

What we have set out to do is to look at what we see as the key areas of an annual report in the new world of the business review and in a climate where the very model of public share ownership has been so fundamentally challenged by the private equity model.

First of all we want to explain that our approach to this analysis of best practice is very much about highlighting the positives rather than pointing the finger and finding fault. This is because we know, from our work with our clients, that it can take a lot of time, energy and persuasion to get the board to focus on what can be seen as quite small details. It’s not always easy to see the strategic benefit. And when they’re busy running the business, and with the reporting burden becoming ever more technical, we know why some things are hard to achieve – and that in many cases it’s not for want of trying.

This is, we believe, what is good about the UK model of reporting where we’ve largely managed to avoid regulatory prescription. So there is no absolute guide for ‘good’ reporting in the box ticking sense – but we think it is possible to identify the leaders from the followers. And what’s interesting from our panel’s views is that it’s often only small details and a bit of extra thought that make all the difference.

Having said that, there are a few examples of companies who really don’t appear to be embracing the new spirit and guidance in reporting, but these really are few and far between. Directions Monthly Special Edition, Autumn 2007

We have brought together a panel to look at the reports of the FTSE 100 and identify those companies that appear to be ‘getting’ this new world and responding positively. The idea has been to highlight the beacons so that others may look, adapt ideas to their companies and keep the whole process evolving.

We hope you find this review of interest. As ever, please give us feedback and if you’d like to be involved in future editions of Directions in any way at all please just let us know.

THE PANEL FTSE 100 Annual Report and Accounts Analysis 2007

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Meet the panel We’d like to thank our contributors panel for their time and for their valuable insights. Each panel member has been given the freedom to approach this task in their own way and by bringing their own expertise and views to bear, so there is no attempt made to be absolutely uniform in approach and method. The one thing we have tried to encourage is a focus on whether the reports in question serve to enlighten the reader on the way a company is managed and is performing. We’ve also encouraged people to try to identify where companies go further than box ticking, and ideally even break new ground. We must also point out that each panel member’s views are their own and not necessarily those of this publication or of the organisations they represent. The four key areas that we have defined as central to the best practice debate are:

• The description of a company’s strategy – reviewed by Nigel Salter of salterbaxter • The approach to forward-looking statements and risk – reviewed by Robert Bruce, journalist and FT columnist • The approach to corporate governance reporting – reviewed by Richard Sheath of Independent Audit • The remuneration report – reviewed by Dan Perrett of New Bridge Street Consultants

Robert Bruce

Dan Perrett

Nigel Salter

Richard Sheath

Columnist Financial Times

Partner New Bridge Street Consultants LLP

Director salterbaxter

Director Independent Audit

Robert Bruce is the UK’s leading commentator on accounting, financial reporting, corporate governance and management issues. He writes regular articles and columns on accountancy and financial reporting for the Financial Times. He also writes a monthly column on management issues for Accountancy magazine as well as writing articles for a wide range of other publications. In 2007 he was named IIA Journalist of the Year.

Dan Perrett is a partner of New Bridge Street Consultants LLP, the UK’s leading executive remuneration consultancy. New Bridge Street Consultants act for over a third of FTSE 350 companies, as well as other quoted and private companies. Dan works on the design and implementation of annual bonus and longer term share plans ensuring that they support the corporate strategy and meet HR goals. This often requires consultation and communication with institutional investors and the preparation of the remuneration report is critical in this process.

Nigel Salter is founding director of corporate communications and design company salterbaxter. He advises major UK and European companies on a broad range of communications and branding issues and frequently writes on corporate reporting, corporate responsibility and corporate governance. His clients currently include 11 of the FTSE 100.

Richard Sheath is a Director of Independent Audit Limited, a governance consultancy specialising in helping boards make sure that strategic leadership and control are working well in supporting corporate performance. He advises boards in the UK and overseas on board and audit committee effectiveness, risk oversight, control culture and internal audit. Richard also advises companies on narrative reporting and has authored guides on the business review and governance reporting. He is the audit committee chairman of Eurochem, a major Russian fertiliser company.

Directions Monthly Special Edition, Autumn 2007

STRATEGY FTSE 100 Annual Report and Accounts Analysis 2007

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Description of Strategy Rather surprisingly, it’s only really in the last few years with the prompting of first the OFR and now the Business Review that companies have really paid attention to describing their strategy effectively in the annual report. There were of course some leading companies who were very clear about this but they were actually few and far between.

Nigel Salter Director salterbaxter

Noteworthy reports: ➜ AstraZeneca Annual Report 2006

Today, a description of the strategy is pretty much standard and so the debate is one of quality – although I have to say that in a few cases I still actually struggled to find anything at all about business strategy, let alone a clearly defined section. And in some cases what was labelled strategy was in fact some bland boilerplate that shed no light at all.

➜ Aviva Annual Report 2006 ➜ BAE Systems Annual Report 2006 ➜ BHP Billiton Annual Report 2006 ➜ Capita Annual Report 2006 ➜ Friends Provident Annual Report 2006 ➜ GlaxoSmithKline Annual Report and Accounts 2006 ➜ HBOS Annual Report and Accounts 2006 ➜ Kelda Annual Report and Accounts 2007 ➜ Kingfisher Annual Report 2006 ➜ Marks & Spencer Annual Report 2007 ➜ Reuters Annual Review 2006 ➜ SABMiller Annual Report 2007 ➜ Severn Trent Annual Report and Accounts 2006/07 ➜ Shell Annual Report 2006 ➜ Smiths Group Annual Report and Accounts 2006 ➜ Vodafone Annual Report and Accounts 2006

The good news is that the good ones are now genuinely worthwhile.

means that it probably doesn’t quite pass the ‘keep it simple’ test. But it’s a great example of some clear management thinking. The other three are all similar in that they dedicate a clear section to the strategy, (the design demarcates it clearly too), they lay out the key points in a simple tabular form and then report progress against the objectives. For me this is what best practice is all about – simple, straight to the point and informative. I also like GSK’s as it neatly refers the reader out to other pages for more detail on the particular strategic point in question. No clear winner though – these four are ideal examples for any other company looking to get this right. They explain their priorities then say how they’re doing against them – not rocket science, but very convincing. A few pitfalls to watch out for: • some companies only put the strategy

The key factors that make a few ❝ stand out are actually quite simple: Is the section clearly demarcated as strategy? Is the reader left knowing more about the business? Is it written in simple English? Is there some sense of performance against the strategy?

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My long list of noteworthy companies is: AstraZeneca; Aviva; BHP Billiton; BAE Systems; Capita; Friends Provident; HBOS; Kelda; Kingfisher; Marks & Spencer; Reuters; SABMiller; Severn Trent; Shell; Smiths Group and Vodafone. But the best ones are Aviva, Capita, GlaxoSmithKline and Kingfisher. Capita is slightly different in that the heart of the report is structured around its four key strategic points. This is thorough and provides a real insight into the way the business is run and why, but if anything the huge amount of detail about the strategy ends up making it rather hard to understand – or at least it takes a long time read which

content in the full report and not in the annual review – I can’t see any good reason for this. • I noticed that a number of companies

have an identical approach and structure using the words ‘Delivering on strategic goals’ then discovered that all of these were being done by the same design company. I think this is disappointing – sausage factory strategy strikes me as a bit lame. • very few companies separate their

strategy out as a section on their websites. This would be a useful step forward.

➜ My favourite(s): Aviva, Capita, GlaxoSmithKline and Kingfisher

❝ They explain their priorities then say how they’re doing against them – not rocket science, but very convincing.

❝ Kingfisher’s strategy overview

Directions Monthly Special Edition, Autumn 2007

FORWARD-LOOKING STATEMENTS & RISK FTSE 100 Annual Report and Accounts Analysis 2007

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It is a little thing. But it suggests that they are thinking for themselves in how they present the information rather than relying on the lawyer’s template.

❝

Reuters Annual Review 2006

Forward-looking statements & Risk

Robert Bruce Columnist Financial Times

➜ My favourite(s): Reuters Annual Review 2006

Directions Monthly Special Edition, Autumn 2007

There is a fundamental problem with the section of any business review which deals with forward-looking statements and with risk. And that problem is lawyers. Here is the standard wording from the 2006 report of Rio Tinto, the international mining group. It can be found in many other companies, as the legal boilerplate takes control. ‘The words “intend”, “aim”, “project”, “anticipate”, “estimate”, “plan”, “believes”, “expects”, “may”, “should”, “will”, or similar expressions, commonly identify such forward-looking statements’, it says. This is then followed by a statement that the group‘ cannot guarantee that its forward-looking statements will not differ materially from actual results’. For the user of a business review this may be what Monty Python used to refer to as a statement of the ‘bleeding obvious’. It is a shame because forward-looking information is increasing in scope, usage and value. But to have it damned by legalese boilerplate takes the gloss and some of the value off it. At least Rio Tinto puts its caveat upfront, on page 7, rather than losing it in the depths of more verbage. And it comes immediately after a page of serious risk factors. So readers, assuming they work from front to back, will have all these warnings ringing in their ears as they move forward to meatier things. They are probably better suited than readers of the 2006 effort from Bradford & Bingley, the building society. This features an extensive diagram of the risk reporting structure but you do wonder whether

something like this, which probably makes sense internally, is going to help externally. With hindsight in these troubled times it is the sentence on page 19 which is the most significant for a mortgage lender. ‘Credit risk is defined as the potential financial loss if a customer or counterparty fails to meet their obligations to us as they become due’. Too right. Too often companies do not use the straightforward language which their users would prefer. So it is good to see another mining group, Xstrata, taking a positive view of the forward-looking strategy section. Too often such stuff is described passively. Xstrata understands, quite rightly, that only verbs will do. They are active and strategy should be active. So across a spread of proposed strategies by sector on page 20 of its 2006 report every sentence starts with a verb. But, if one was looking for a winner in the current clutch of accounts you would have to choose Reuters annual review for 2006. The key section here is what it calls its ‘risk radar’ on page 9. Issues are grouped under ‘risk’, ‘impact’ and ‘action’. They are clearly expressed, and in one thoughtful aspect, which others could do with following, each one is linked to the section and page where the answers will be found. It is a little thing. But it suggests that they are thinking for themselves in how they present the information rather than relying on the lawyer’s template.

GOVERNANCE FTSE 100 Annual Report and Accounts Analysis 2007

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❝ …very few have taken a good step back, well away from the boilerplate, and asked how the real essence of their governance can be shared.

❝

Reuters Governance spread

Governance Boards can make a fundamental difference to corporate performance. Get the mix of people wrong, fail to get them working together well, lose focus or miss crucial developments, and you can soon find that the business is at sea. So you’d think that boards would make a real effort to give shareholders confidence that their interests are in the good hands of a well-functioning board.

Richard Sheath Director Independent Audit

Noteworthy reports: ➜ BAE Systems Annual Report 2006 ➜ Barclays Annual Report and Financial Statements 2006 ➜ Imperial Tobacco Annual Report 2006/07 ➜ J Sainsbury Annual Report 2006 ➜ Marks & Spencer Annual Report 2006/07 ➜ National Grid Annual Report and Accounts 2006 ➜ Reuters Annual Review 2006

The governance section of the annual report is a good opportunity to get the message over. But most companies are still missing it. You have to sympathise (a bit at least). The compliance statements have to be there, and trying to get the chairman interested in adopting a different style can be an uphill struggle, especially if time’s running short. But most companies are still missing it. It’s not all bad news. For the past four years since the introduction of the revised Combined Code we’ve looked at FTSE 100 governance reports and in many cases they’ve improved: there’s more reporting in the past tense (telling us what was done, not just what is supposed to be done), clearer explanations of what’s been done to assess effectiveness, more insight on independence issues and, here and there, examples of particular issues that have cropped up and how the board has responded. Audit committee reporting in particular has got markedly better.

❝ ➜ My favourite(s): BAE Systems and Reuters They stand out by using interview and letter style to give the reader better insight into the role of governance and how the board works. That little bit of extra thought goes a long way in bringing board governance to life.

Directions Monthly Special Edition, Autumn 2007

A good report doesn’t just repeat the Reserved Matters. It uses a few examples of how the board has focussed its work during the year to drive strategic performance or respond to developing risks or problems. It will explain how the mix of skills on the board is right for today’s business and in supporting the future strategy.

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The way the board is driving the right behaviour through leadership and through reward will be discussed. The board will explain how it has got new insights through better information, briefings or management interaction. And the improved reporting on what was done to assess the board’s

effectiveness will be brought to life by at least a few examples to show that this is a board looking for continuous improvement and not resting on its laurels. The audit committee will explain what it did to evaluate the effectiveness of the external and internal auditors – not just tell us that they did it. The nomination committee will give us reassurance that they’ve not just responded to immediate needs but have also actively reviewed success and contingency planning from a strategic perspective. And the remuneration committee will explain how, in making sure rewards support strategic goals, they’ve managed to tackle the technical complexities and form an independent view. With a picture like this, the reader can start getting more comfort that governance is working well and seeing how the board is supporting strong performance. It’s difficult to get this from a report that reads like a textbook description of what a board does, interspersed with compliance statements. Some are getting there. Reports sticking out from the crowd for particular features include Barclays and Marks & Spencer (for their insight into board activity), Imperial Tobacco and National Grid (for their useful detail on board evaluation), and J Sainsbury (useful examples of board and remuneration committee focus). But it remains a curate’s egg: even those reports that are strong in some areas provide little insight in others. And very few have taken a good step back, well away from the boilerplate, and asked how the real essence of their governance can be shared. Two of the FTSE 100 who have made a good start in doing this are BAE Systems and Reuters so they become my ‘favourites’ for the past year. They stand out by using interview and letter style to give the reader better insight into the role of governance and how the board works. That little bit of extra thought goes a long way in bringing board governance to life.

REMUNERATION FTSE 100 Annual Report and Accounts Analysis 2007

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Remuneration The remuneration report is one of the most important parts of a company’s annual report because: (a) for quoted companies, shareholders must be given the opportunity to vote on it; and

Dan Perrett Consultant New Bridge Street Consultants LLP

Noteworthy reports: ➜ National Express Annual Report 2006 ➜ Schroders Annual Report and Accounts 2006/07 ➜ Severn Trent Annual Report and Accounts 2006/07 ➜ SMG Annual Report 2006 ➜ Standard Life Annual Reports and Accounts 2006

(b) it seems to be the first section sought out by journalists. Whereas they like to remind us of an actor’s age after giving his/her name, with company directors they seem to prefer to quote their pay! This attention has resulted in the quality of FTSE 100 remuneration reports improving considerably over the past few years. Contents of a Remuneration Report For a fully quoted company there are statutory and best practice disclosure requirements which have led to a fairly standard structure for a remuneration report, namely: – details of the Remuneration Committee’s role and composition; – the general policy statement on pay; – descriptions of the individual components that make up total remuneration;

➜ Vodafone Annual Report and Accounts 2006

– details of the non-executive directors’ pay;

➜ Wolseley Annual Report and Accounts 2006

– explanation of the directors’ service contracts; and

➜ WPP Annual Report and Accounts 2006/07

– the audited tables of emoluments and rights to shares.

❝

It is easy to read, there is a key development section showing what is new in the year, clear policy statements that avoid clichés and it makes good use of tables and charts.

❝

➜ My favourite(s): Schroders Annual Report and Accounts 2006/07

Directions Monthly Special Edition, Autumn 2007

Qualities of a Good Remuneration Report The standard format described above does support a clear structure because it separates the forward-looking policy sections from the backward-looking ‘what has been paid’ sections.

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Committee may introduce the advisory vote on remuneration at the Annual General Meeting. • Summarising remuneration policy in a

succinct table. A very good example of this is National Express’ remuneration report. This clearly shows how the policy supports the company’s strategic objectives. • Using charts to show the balance of a

remuneration package. I think the leading example of this is WPP’s remuneration report. However, companies can take different approaches to valuing certain elements of pay, particularly the equity incentives, meaning that it is harder than you think to compare pay policies across different companies. • Showing how pay compares to market

rates. An example of this kind of disclosure is the remuneration report of SMG. While the inclusion of this information has been welcomed by many institutional investors, I query whether this conflicts with the investor criticism that pay is being ratcheted up by companies ‘chasing’ the median. • Retrospective disclosure of annual bonus

outcome. This is not governed by the legislation or Combined Code but is increasingly being asked for by institutional investors. Over the coming years I expect disclosure on annual bonus plans to increase. Severn Trent is a good example of a company that already does this. • Giving an update on progress under

outstanding awards. This is a good indicator of whether or not long term incentives are achieving their goals. One of the few companies that disclose this in the remuneration report is Wolseley.

In previous years, a common criticism of remuneration reports was when they • Giving a summary of how employees merged the policy and the previous practice; share in a company’s success. Standard for example, combining the descriptions Life introduces its remuneration report of the share plans that the company by explaining how many of its employees will use in future years with the ‘dead’ participate in share plans. share schemes that are in run-off mode. For FTSE 100 companies, this is much My favourite is the Schroders Annual less prevalent now. Report and Accounts 2006/07. Their 2006 remuneration report continues to build Specific qualities from remuneration reports on the fundamental and market leading published in 2007 that I think are effective re-write done for their 2004 report. It is and can be viewed as market leading are: easy to read, there is a key development section showing what is new in the year, • Introducing the remuneration report with clear policy statements that avoid clichés a covering letter from the Chairman of the and it makes good use of tables and charts. Remuneration Committee. For example, Vodafone used this approach this year to explain the key principles of their remuneration policy and the changes that they had made during the year. This gives the report a personal touch and replicates how the Chairman of the Remuneration

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ABOUT US SALTERBAXTER ADVISE COMPANIES ON STRATEGY, BRANDING, CORPORATE COMMUNICATIONS AND DESIGN. Our clients are extremely varied and include FTSE 100 companies; some of the world’s most exclusive brands; independent, entrepreneurial businesses; world leading educational establishments; law firms; private equity firms and media companies. We name companies, re-invent companies, and re-position companies. We help companies communicate with shareholders and advise them on how to address corporate responsibility. We launch, brand and re-brand. A key area of our expertise is corporate reporting and we advise leading UK and European organisations on strategy and design for their financial and CR communications programmes. We currently work with 11 of the UK FTSE 100.

Contact: Lucie Harrild [email protected] Tel: +44 (0)20 7229 5720

Pavan Athwal [email protected] Tel: +44 (0)20 7229 5720

Directions Monthly supplements our main Directions report. This report is published each year and is now regarded as the UK’s most comprehensive analysis of the trends and issues in CR communications. If you want a copy of the full Directions Annual Survey and Report, call us on the number below or email [email protected]

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