CHAPTER 5

GENERAL PRINCIPLES OF DISCLOSURE

The meaning of transparency and disclosure

Transparency in stock markets and other financial markets means that information about conditions in
the markets is clear and well understood. For example, transparency exists when investors understand
about the financial situation of companies, and the future plans and prospects for those companies, so
that they can make well-informed investment decisions.

Disclosure means making information available, so that there is transparency. Companies have the main
responsibility for disclosure in the stock markets. They provide regular reports to shareholders and other
investors, and it is from these reports that investors obtain most of their information.

Transparency and disclosure are key issues in corporate governance.

Corporate governance: the need for transparency and disclosure

The need for transparency and disclosures in the financial markets is recognised in codes and statement
of principles on corporate governance.

-The UK Corporate Governance Code includes a principle about the disclosure of financial information by
companies, stating that the board has a responsibility to present 'a balanced and understandable
assessment' of the company's position and prospects in its financial reporting.

-The code of Corporate Governance in Nigeria states that companies should engage in increased
disclosure beyond the statutory requirements of the Companies and Allied Matters Act, 1990. The board
should be guided by the principle of timely, accurate and continuous disclosure of information and
activities of the company so as to give a balanced and fair view of the company including non-financial
matters. The board should use its best judgment to disclose any matter not specifically required in the
code but which it considers to be capable of affecting in a significant form the financial condition of the
company or its status as a going concern.

-The OECD Principles state the requirement with greater force. They state that companies should
provide 'timely and accurate disclosure' about their financial performance and position, and also about
the ownership of shares in the company and also about other corporate governance issues.

-The ICGN Principles emphasise the need for information so that investors can make investment
decisions, and state that companies should, on a timely basis, disclose the relevant information about
the company to enable informed decisions about the acquisition obligations and rights, ownership and
sale of shares to be made by investors.

What information should be disclosed?

There are three main categories of information that investors need from a company:
-Financial information about the past performance of the company, its financial position and its future
prospects.

-Information about the ownership of shares in the company, and voting rights associated with the
shares. This is important for global investors, who may have problems with investing in companies
where there is a majority shareholder, or where there is a complex structure of share ownership, or
where some shareholders have more voting rights than other shareholders (for the same class of
shares).

-Corporate governance information.

Principles of disclosure and communication

There are several basic principles for disclosure and communication of information.

-The information should be reliable. Reliable information is information that is sufficiently accurate for
investors to trust it when making their investment decisions. The OECD Principles, for example, state
that information should be prepared and disclosed with high quality standards of accounting and high
standards for both financial and non-financial disclosures.

-Information should be understandable. One of the criticisms of international financial standards (IFRSS)
is that financial reporting in accordance with IFRSS can be very complex, and some investors might not
properly understand the information that they provide. Many investors support the idea that companies
should provide information about themselves in a narrative form, in addition to providing financial
statements.

-Information should be timely. In the financial markets, 'timely' often means 'communicated as soon as
possible'. Information should be made available to all investors as soon as possible after it becomes
'public'. Efficient stock markets should ensure that information announced by companies is made
available to everyone quickly after the announcement. In the European Union, for example, one of the
aims of the Transparency Directive (introduced in 2007) is to communicate information available quickly
to investors as soon as companies make announcements to the stock market.

-When information is disclosed by companies, it should be equally available to all investors. The OECD
Principles state that the way information is distributed should enable users to access relevant
information in an equal, timely and cost-efficient manner.

BEST PRACTICE DISCLOSURES ABOUT CORPORATE GOVERNANCE

Reporting requirements (Content of best practice disclosures)

The corporate governance reports suggest that the directors should explain their responsibility for
preparing accounts. They should report that the business is a going concern, with supporting
assumptions and qualifications as necessary.

In addition, further statements may be required depending on the jurisdiction, such as:
(a) Information about the board of directors: the composition of the board in the year, information
about the independence of the non-executives, frequency of, and attendance at, board meetings, how
the board's performance has been evaluated; the South African King report suggests a charter of
responsibilities should be disclosed

(b) Brief reports on the remuneration, audit, risk and nomination committees covering terms of
reference, composition and frequency of meetings

(c) An explanation of directors' and auditors' responsibilities in relation to the accounts and any
significant issues connected with the preparation of accounts, for example changes in accounting
standards having a major impact on the accounts

(d) Information about relations with auditors, including reasons for change and steps taken to ensure
auditor objectivity and independence when non-audit services have been provided

(e) An explanation of the basis on which the company generates or preserves value and the strategy for
delivering the objectives of the company

(f) A statement that the directors have reviewed the effectiveness of internal controls, including risk
management

(g) A statement on relations and dialogue with shareholders

(h) A statement that the company is a going concern

(i) Sustainability reporting, defined by the King report as including the nature and extent of social,
transformation, ethical, safety, health and environmental management policies and practices

(j) A business review or operating and financial review (OFR)

Furthermore, the information organisations provide cannot just be backward-looking. The King report
points out that investors want a forward-looking approach and to be able to assess companies against a
balanced scorecard. Companies will need to weigh the need to keep commercially sensitive information
private with the expectations that investors will receive full and frank disclosures. They should also
consider the need of other stakeholders.

Mandatory and voluntary disclosures

The nature and amount of mandatory disclosures depends on the laws and regulations of the country.

- Some disclosures are required by law. For example, companies are required to prepare an annual
report and accounts, and present these to the shareholders. Company law specifies what the directors’
report and the accounts must contain, and in addition other regulations about content apply such as the
requirements of financial reporting standards.

- Some disclosures are required by stock market rules. For example the UK Listing Rules require listed
companies to provide information relating to corporate governance in their annual report and accounts.
There are also stock market rules about other announcements by the company, such as profit warnings
and announcements of proposed takeovers.
In addition to the mandatory disclosures required by law or regulation, many companies provide
additional information, as part of their normal reporting cycle.

Typically, these include:

- a chairman’s report describing the activities of the company and its different operating divisions;
alternatively, an operating and financial review by the CEO

- a social and environmental report or a corporate social responsibility report: these reports are
described later.

The reasons for voluntary disclosures

Companies are not required to provide voluntary disclosures, but there are several reasons why they
choose to do so.

- Some voluntary information might be provided as a public relations or marketing exercise, to present
‘good news’ about the company to investors and other users of the company’s published reports.

- Providing information on a voluntary basis might persuade the government or financial service
regulator that compulsory disclosures and regulation are not necessary.

- Companies might publish social and environmental reports out of a genuine ethical and cultural belief
in the responsibilities of the company to society and the environment. If a company believes that it has
social and environmental responsibilities, publishing a report on these issues is a way of making itself
accountable.

- A company might use voluntary disclosures as a way of improving communications with its
shareholders. By giving more disclosures to shareholders, companies might encourage shareholders to
respond, and enter into a dialogue with the company about its strategies and plans for the future.

RELATIONSHIP WITH SHAREHOLDERS AND STAKEHOLDERS

Rights of shareholders

The OECD guidelines stress the importance of the basic rights of shareholders. These include the right to
secure methods of ownership registration, convey or transfer shares, obtain relevant and material
information, participate and vote in general meetings and share in the profits of the company. Under
the OECD guidelines shareholders should also have the right to participate in, and be sufficiently
informed on, decisions concerning fundamental changes such as amendments to the company's
constitution. The guidelines also stress the importance of treating all shareholders of the same class
equally, particularly protecting minority shareholders against poor treatment by controlling
shareholders.

Relationships with shareholders

A key aspect of the relationship is the accountability of directors to shareholders. This can ultimately be
ensured by requiring all directors to submit themselves for regular re-election (the corporate
governance reports suggest once every three years is reasonable).
The need for regular communication with shareholders is emphasised in most reports. Particularly
important is communication with institutional shareholders, such as pension funds who may hold a
significant proportion of shares. The UK Corporate Governance Code states that non-executive directors,
in particular the senior independent director, should maintain regular contact with shareholders. The
board as a whole should use a variety of means for ascertaining major shareholders' opinions, for
example face to face contact, analysts or brokers' briefings and surveys of shareholders' opinions.

General meetings

Annual general meetings

The annual general meeting is a statutorily protected opportunity for members to have a regular
discussion about their company and its management. It allows the board to discuss the results of the
company and explain the future outlook. Shareholders vote on the appointment of directors and
auditors and the level of dividends to be paid.

The annual general meeting is the most important formal means of communication with shareholders.
Governance guidance suggests that boards should actively encourage shareholders to attend annual
general meetings. UK guidance has included some useful recommendations on how the annual general
meeting could be used to enhance communication with shareholders, by giving shareholders an
opportunity to ask questions and use their votes.

(a) Notice of the AGM and related papers should be sent to shareholders at least 20 working days before
the meeting.

(b) Companies should consider providing a business presentation at the AGM, with a question and
answer session.

(c) The chairs of the key sub-committees (audit, remuneration) should be available to answer questions.

(d) Shareholders should be able to vote separately on each substantially separate issue. The practice of
'bundling' unrelated proposals in a single resolution should cease.

(e) Companies should propose a resolution at the AGM relating to the report and accounts.

(f) The UK Stewardship Code 2012 emphasises the importance of institutional shareholders attending
annual general meetings and using their votes, to translate their intentions into practice. Institutional
shareholders should provide their clients with details of how they've voted.

(g) Codes with international jurisdiction, such as the OECD principles, emphasise the importance of
eliminating impediments to cross-border voting.

The Myners report

The Myners report in the UK Review of the Impediments to Voting UK Shares (2004) aimed to address
concerns about problems in administering proxy votes and the beneficial owners not taking sufficient
interest in the votes. The report makes a number of recommendations.
(a) Beneficial owners

Beneficial share owners should ensure that their agreements with investment managers and custodians
who are accountable to them should include voting standards, establish a chain of responsibility and an
information flow on voting and require reports by investment managers on how they have discharged
their responsibilities. Investment managers should decide a voting policy and stick to it.

(b) Electronic voting

The report recommends the adoption of electronic voting to enhance the efficiency of the voting
process and to reduce the loss of proxy votes.

(c) Stock lending

Stock lending is a temporary transfer of shares or other securities, from a borrower to a lender, with
agreement by the borrower to return the securities to the lender at a prearranged time. The report
comes down against stock lending on the grounds that voting rights are effectively transferred, and
lending sometimes takes place specifically to transfer voting rights. Myners recommends that stock
should be recalled if there are votes on contentious issues.

(d) Investment managers

Investment managers should report to their clients how they have exercised their voting responsibilities.

(e) Procedures at meetings

Myners addresses the situation where votes at company meetings are decided on a show of hands, with
one vote per member present, unless a poll is called. Myners suggests that a poll should be called on all
resolutions. The report also recommends that proxy forms should include a vote withheld box, to
identify the extent to which shareholders are consciously abstaining. The report also recommends giving
the right to speak and the right to vote on a show of hands to anyone who has been appointed to act as
a proxy by a member (an alternative to filling in a proxy form).

UK Stewardship Code

Seven principles

The UK Corporate Governance Code refers to guidance in the UK Stewardship Code, published in July
2010 and revised in September 2012. The Stewardship Code states that institutional investors should:

(a) Disclose how they will discharge their responsibilities

(b) Operate a clearly disclosed policy for managing conflicts of interest

(c) Monitor performance of investee companies to gain assurance on the operation of the board and its
committees by attending meetings of the board and the AGM and should be particularly concerned with
departures from the UK Corporate Governance Code, and also seek to identify threats to shareholder
value at an early stage
(d) Establish clear guidelines on when they will actively intervene, when they are concerned about
strategy and performance, governance or approach to risk

(e) Be willing to act collectively with other investors, particularly at times of significant stress or when
the company's existence appears to be threatened

(f) Operate a clear policy on voting and disclosure of voting activity; they should not necessarily support
the board

(g) Report to their clients on their stewardship and voting activities; they should consider obtaining an
independent audit opinion on their engagement and voting processes.

CORPORATE SOCIAL RESPONSIBILITY

Corporate Social Responsibility is related to the idea that as well as their responsibilities to shareholders,
boards of companies are also responsible to the general public and other stakeholder groups. There are
two key areas of responsibility:

-General responsibilities that are a key part of the board’s duties which need to be completed in order
to succeed in their industry and/or are regulatory/legal requirements that are imposed on them.

-Duties that are viewed by some as going beyond these general responsibilities.

Principles of CSR

Corporate social responsibility has five main aspects. For any company, some of these aspects might be
more significant than others:

- A company should operate in an ethical way, and with integrity. A company should have a recognised
code of ethical behaviour and should expect everyone in the company to act in accordance with the
ethical guidelines in that code.

- A company should treat its employees fairly and with respect. The fair treatment of employees can be
assessed by the company’s employment policies, such as providing good working conditions and
providing education and training to employees.

- A company should demonstrate respect for basic human rights. For example, it should not tolerate
child labour.

- A company should be a responsible citizen in its community. Responsibility to the community might be
shown in the form of investing in local communities, such as local schools or hospitals. This can be an
important aspect of CSR for companies that operate in under-developed countries or regions of the
world.

- A company should do what it can to sustain the environment for future generations. This could take
the form of:

- reducing pollution of the air, land or rivers and seas

- developing a sustainable business, whereby all the resources used by the company are replaced
- cutting down the use of non-renewable (and polluting) energy resources such as oil and coal and
increasing the use of renewable energy sources (water, wind)

- re-cycling of waste materials.

CSR and stakeholders in the company

The concept of corporate citizenship and corporate social responsibility is consistent with a stakeholder
view of how a company should be governed. A company has responsibilities not only to its shareholders,
but also to its employees, all its customers and suppliers, and to society as a whole. In developing
strategies for the future, a company should recognise these responsibilities. The objective of profit
maximisation without regard for social and environmental responsibilities should not be acceptable.

Formulating a CSR policy

The following steps might be taken by a company to implement a CSR policy:

- It should decide its code of ethical values, and possibly publish these as a Code of Ethics.

- It should establish the company’s current position with regard to its CSR values, and decide the
position it would like to reach in the future. The gap between the current position and the target
position provides a basis for developing CSR strategies.

- The company should develop realistic targets and strategies for its CSR policies.

- These strategies should be implemented.

- Key stakeholders in the company should be identified, whose views the company wishes to influence
(employees, pressure groups, customers).

- The company’s CSR achievements should be communicated to the key stakeholders. This is the main
purpose of CSR reporting.

- The company’s CSR achievements should be monitored, and actual achievements compared with (1)
the targets and (2) the CSR achievements of similar companies (including business competitors).

CSR and competitive advantage

The significance of CSR varies between different countries. In some countries, particularly Europe and
North America, companies are waking up to the strategic possibilities and strategic advantages of being
an environmental-friendly company. Customers might be willing to pay more for environment-friendly
and for ‘healthy food’. There is growing interest in smaller motor cars and cars driven by bio-fuel or
electricity. CSR activities can therefore create value. Michael Porter (Harvard Business Review, 2006)
suggested that companies should not merely be taking corporate social responsibility seriously as an
idea. They should also be ‘embedding’ CSR into their corporate and business strategy, in order to build a
competitive advantage.
CSR and institutional investors

Pressure on companies to show greater CSR awareness has come from institutional investors, as well as
the general public and consumers. There are some ‘ethical investors’, including some investment
institutions, that choose to invest only in companies that meet certain minimum standards of social and
environmental behaviour.

In the UK, the National Association of Pension Funds (NAPF) (now the Pensions and Lifetime Savings
Association – PLSA) published a policy document on CSR in 2005. This stated that it did not consider CSR
to be a corporate governance issue, since corporate governance is concerned mainly with how to handle
the potential conflicts of interest between shareholders and management. The NAPF suggested that CSR
issues are an issue for the management of a company rather than its governance. However, the NAPF
policy document stated that the board and managers should remember the company’s wider role in
society; the longer-tern prospects of a company can be damaged by maximising short-term gain in a
manner that society finds unacceptable and this can lead to shareholders suffering real financial losses.
These losses could be due to consumer preferences changing or new legislation adding more costs to
the company.

Triple bottom line reporting

Triple bottom line

The term ‘triple bottom line’ was ‘invented’ in 1994 by J Elkington. Its aim is to encourage companies to
recognise social and environmental issues in their business models and reporting systems. This method
of reporting is encouraged by the Global Reporting Initiative (GRI), an internationally-recognised non-
profit body that promotes sustainability reporting. Note that some companies explicitly refer to having
complied with GRI in their annual reports. The ‘triple bottom line’ gets its name because companies
report their performance not simple in terms of profit: they provide key measurements for three
aspects of performance:

- economic indicators

- environmental indicators, and

- social indicators.

Triple bottom line reporting is therefore providing a quantitative summary of a company’s economic
environmental and social performance over the previous year.

Social and Environmental Reporting /Sustainability reporting (CSR Reporting)

Except in some highly regulated situations (such as water), the production of a social and environmental
report is voluntary. The problem, and the subject of most debate is what should be the typical contents
of such a report and how do we measure it. Frameworks do exist, such as the data-gathering tools for
the Global Reporting Initiative (GRI), AccountAbility (AA1000) and the ISO14000 collection of standards,
but essentially there is no underpinning compulsion to any of it.
Environmental reporting

Godfrey, Hodgson and Holmes (2003) have defined environmental reporting as the 'disclosure of
information on environment related issues and performance by an entity'. It typically contains details of
environmental performance in areas such as: The information is published in either the annual report
and/or as a self standing report.

Social reporting

Owen and Scherer (1993) explain that there is a significant concept underlying corporate social
responsibility; this is that corporations should be concerned about society at large.

Social reporting is generally context specific, and typical contents will vary with industry, however the
following issues should be included in a company's considerations:

• measures of emissions (e.g. pollution, waste and greenhouse gases)

• consumption (e.g. of energy, water and non renewable mineral deposits).

• human rights issues

• work place, occupational health and safety

• training and employee issues

• fair pay for employees and suppliers

• fair business practices

• minority and equity issues

• marketplace and consumer issues

• community involvement

• indigenous peoples

• social development

• charitable, political donations and sports sponsorship.

The Global Reporting Initiative (GRI)

Companies can adopt whatever approach they choose when reporting voluntarily on environmental
impacts. However, two developments designed to provide guidance on supplying more social and
environmental information are the Global Reporting Initiative (GRI) and the development of full cost
accounting.

The Global Reporting Initiative, as its name suggests, is a reporting framework and arose from the need
to address the failure of the current governance structures to respond to changes in the global
economy. The GRI aims to develop transparency, accountability, reporting and sustainable
development. Its vision is that reporting on economic, environmental and social importance should
become as routine and comparable as financial reporting.

GRI Guidelines

The GRI published revised guidelines in 2006. The main section of the Guidelines (Report contents) sets
out the framework of a sustainability report. It consists of five sections:

(a) Strategy and analysis. Description of the reporting organisation's strategy with regard to
sustainability, including a statement from the CEO. In addition, there should be a description of key
impacts, risks and opportunities. This section should focus firstly on key impacts on sustainability and
associated challenges and opportunities, and how the organisation has addressed the challenges and
opportunities. It should secondly focus on the impact of sustainability risks, trends and opportunities on
the long-term prospects and financial performance of the organisation.

(b) Organisational profile. This should provide an overview of the reporting organisation's structure,
operations, markets served and scale.

(c) Report parameters. Details of the time and content of the report, including the process for defining
the report content and identifying the stakeholders that the organisation expects to use the report.
Details should also be given of the policy and current practice for seeking external assurance for the
report.

(d) Governance, commitments and engagement structure and management systems. Description of
governance structure and practice, and statements of mission and codes of conduct relevant to
economic, environmental and social performance. The report should give a description of charters,
principles or initiatives to which the organisation subscribes or which the organisation endorses. The
report should also list the stakeholder groups with which it engages and detail its approaches to
stakeholder engagement.

(e) Performance indicators. These divide measures of the impact or effect of the reporting organisation
into integrated indicators.

REVIEW QUESTIONS

1. Z plc is a publicly quoted company. Its products are based on raw materials grown in tropical
countries and processed either in these countries or in the eventual sales markets. Processing is
undertaken partly by Z plc and partly by sub-contractors. The products are branded and sold
worldwide, but mainly in the United Kingdom and North America. They are sold to consumers
through a very large number of outlets. Z's chief executive has always regarded annual reporting
as ideally never exceeding legal requirements. However the non-executive directors have for
some time expressed concern that the company has not developed any systems of
environmental or social reporting to shareholders, although many comparable companies
already publish such information as part of their Annual Report. A government minister has now
stated that legislation will be considered if all companies do not make progress on reporting on
social and environmental policies. One non-executive director has raised the possibility of going
further and preparing a report based on the principles of integrated reporting.
Required;

(a) Identify the main issues that could be covered in the environmental and social report. (8 marks)

(b) Analyse the impact of business partners and other stakeholders on the content of the
environmental and social report.

(c) Identify the information that the board requires to review the company's progress on
environmental and social issues.

2. Suggest examples of the following types of disclosure:

(a) Mandatory disclosure
(b) Voluntary disclosure