Investors miss the point of viability statements - FutureValue
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Investors miss the point of viability statements
24/11/2016
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Concise guidelines from the Investment Association, representing what it says its members want to see in viability statements, should be among the most useful information for companies when preparing their Strategic Reports.  But these recently published short guidelines are much less helpful than one might have expected. In fact, they are more likely to sow confusion than to shed light. The more worrying aspect is that they display muddled thinking. If, indeed, the guidelines really reflect what investors want, the worrying conclusion would have to be that there is little understanding of strategic thinking or strategic management among the investment community.

On the one hand the guidelines are asking for companies when assessing viability to consider longer timeframes than the typical three to five year horizons that appear most prevalent, to reflect “the long-term nature of equity capital and directors’ fiduciary duties”. On the other hand the guidelines seek to distinguish between what the documents calls risks “that impact performance” and risks “that threaten day-to-day operations and the company’s existence”. The IA is suggesting that the viability statement should only address these risks to operations, deferring consideration of these longer-term “performance” risks to some separate consideration of plans for the future to be presented distinct from the viability statement. How does one reconcile longer viability assessment timeframes greater that three to five years with purely operational risks? Moreover, is IA asking for more expansive and even longer Strategic Reports to accommodate this distinction?

What is the viability statement if it is not about demonstrating the effectiveness of the strategic management processes of a company? A period of three or five years is about the medium-term prospects and the upside potential. In the correct strategic context, risks to performance, as the IA calls them, and risks to operations should be equally considered. Correctly prioritised they are, taken together, the risks that will influence directly a company’s capacity to achieve its strategic objectives. The IA seems to be confusing the viability statement with the shorter term going concern statement where the risks that threaten day-to-day operations and existence are quintessential.

If there is a broader issue here, that may in part excuse the IA’s apparent muddled thinking, it may have more to do with the word ‘viability’. This word confers a sense of downside risk and not the upside risks of creating value and upside potential. And perhaps this is symptomatic of a bigger issue here – that, in reporting risks, companies are prone to look solely at protecting existing value to the exclusion of the risks of creating value – these are the risks that impact performance, in IA’s distinct parlance.

The IA’s guidelines are at least helpful in one respect. They show up the inadequacies of the first efforts of reporting companies at presenting their viability statements. At least 80% of companies put their viability statements at the end of their evaluation of risks in the Strategic Report, at the suggestion of their auditors. This has the effect of creating a narrow perspective focused purely on risk, and largely devoid of strategic thinking; this is a narrow perspective, says the IA, that investors have been keen to avoid. Assessment of viability should be the explained consequence of a Board’s strategy review process and set out in, or as a sidebar, to the Chairman’s Statement and cross-referred to the Governance Report. It currently does not serve any purpose beyond compliance as a postscript to principal risks and uncertainties.

Maybe we missed the point in the IA’s Guidelines? The real agenda may be more to do with IA’s members’ pre-occupation with confirming ongoing returns than with establishing robust potential. After all, if investors were really concerned about the long-term they would want viability statements to do more than reassure on the sustainability of dividends, which is what the guidelines claim. They would want those statements to reassure on the sustainability of profitability and of growth in that profitability, to enable dividends to grow into the future. Perhaps it is no coincidence that FutureValue’s research of the last ten years has suggested a bewildering lack of strategic literacy in the investment community.