Modernising corporate reporting: the rise of judgement
The Government’s consultation on Modernising Corporate Reporting is presented as a programme to reduce burdens, simplify company reporting and support growth. But linking the individual proposals is a more significant shift in philosophy.
In making changes to audit, distributions rules and narrative reporting, Government appears increasingly willing to move away from statutory requirements. The proposals rely instead on directors’ judgement, market demand and users’ ability to obtain the information or assurance they need.
That aims to produce a more efficient corporate reporting system, but it could also transfer risks and costs between companies and those who rely on their reporting.
The potential cost savings are easier to measure than the potential downsides. To assess those involves gauging where markets and professional judgement can replace mandatory rules without materially reducing trust.
Audit: will the market buy the assurance it needs?
Government is considering allowing medium-sized companies to opt out of statutory audit.
The argument is straightforward: audit imposes cost and this could be saved by raising the audit threshold. Not every private company has external shareholders or complex financing. If lenders or investors want an audit, the company can choose to commission one voluntarily.
For these companies, that puts considerably greater reliance on market demand. But audit also benefits parties who may have little power to demand it themselves, including trade creditors, employees and smaller investors. The unresolved question is therefore whether companies will voluntarily obtain the level of assurance that maximises economic benefits to all users of their accounts. That raises a question about the public-interest value of audit; measuring this at the level of the individual company is not straightforward.
Distributions: how will board judgement affect dividends?
A similar shift appears in the proposal to replace the existing distributable-profits and capital maintenance regime with a solvency-based test.
The existing rules are complex. Determining realised profits can require significant professional judgement. A solvency test appears to side step this complexity, again potentially saving cost. But it asks for a different judgement: whether the company can safely make the distribution.
This replaces one form of judgement with another. Directors would need to assess future cash flows, financing requirements and resilience. Much will depend on how solvency is defined, the assessment period, and the evidence directors must obtain.
Reporting: how will judgement affect disclosure?
The same direction is visible in proposals to simplify strategic and non-financial reporting. Government is questioning whether companies should continue to report against long lists of prescribed topics, instead placing greater emphasis on information that is financially material to investors and creditors.
There is considerable merit in this. Prescriptive reporting can produce boilerplate and ever longer annual reports without necessarily improving decisions. But removing prescribed disclosures does not remove the underlying information need. It transfers greater responsibility to boards to determine what users actually need to know.
The harder question is therefore whether directors can reliably identify what investors need without detailed statutory prescription, and whether investors will receive comparable information between companies.
A different kind of corporate reporting system
Taken together, these proposals point towards a reporting regime that relies less on rules determining what companies must do and more on directors exercising judgement; markets demanding information and assurance; and professional advisers helping determine what is appropriate.
That may ultimately be a better system. But its success depends on whether markets have the information and bargaining power required to work effectively, and whether professional judgement is sufficiently transparent and accountable.
There is no doubt that in the new AI enabled world the demand for data is growing. What is less clear is the interplay between the amount of data and verification that is optimal, and the decision usefulness of the resulting metrics in a world where analysis is increasingly automated. This consultation questions all these dimensions, the answers will shape the economics around corporate reporting for years to come.
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