Towards dynamic accountability

Accountability is a fundamental component of governance, whether the governed entity is a country, a company, or indeed any other corporate entity, including charities, cooperatives, the NHS, or universities.

What is meant by governance? Most definitions of governance, particularly corporate governance, focus on what governance does (direct and control). An alternative definition considers what governance really is:

“Corporate governance describes the way that trust is achieved, power exercised, and accountability shown, in corporate entities, for the benefit of members, other stakeholders, and society.”

Consequently, accountability is a fundamental part of governance. Yet, accountability remains the least discussed aspect of the subject.

The corporate governance matrix

The well-known corporate governance matrix suggests that the process involves strategy formulation, policy-making, monitoring/supervising management, and providing accountability.

The right-hand side of the matrix (strategy formulation and policy-making) is essentially forward-looking, covering the overall responsibility for corporate performance, whereas the left-hand demands (monitoring/supervision and accountability) are concerned with the present or past and reflect responsibility for corporate conformance and compliance with law and regulations.

On passive accountability

Many directors think of accountability as the last step in the governance process, reporting the result of recent corporate performance. The literature on accountability has focused predominantly on financial reporting, independently audited in line with the relevant accounting principles or standards. Recent calls for reporting non-financial information have added a further dimension, including, for example, reports on strategy, sustainability, and ESG (Environment, Society, and Governance).

Such reporting suggests a passive approach to accountability, which provides information in line with regulations. Passive accountability typically takes credit for good results but blames poor results on external circumstances, such as market conditions, economic developments, or geo-political issues.

Consider some examples of directors’ reports in such companies:

• “Revenues this year increased by a satisfactory 8.3%”—ignoring the fact that a large part of that increase was due to price increases reflecting inflation and that, in fact, the company had lost market share to competitors.
• “This year the company has faced shortages of imported components and supply chain difficulties, which have adversely affected results”—taking no responsibility for the board policies which relied on imported components or strategies that approved the supply chains.
• “Shareholder value, reflected in our share price, has increased substantially this year, justifying higher dividends and directors’ remuneration”—ignoring the comparable rise in the stock market overall, and failing to recognise that dividends and directors’ bonuses depend more on cash flow than share price.

Board reports showing good results under passive accountability too readily become congratulatory public relations exercises, rather than serious explanations or, worse, opportunities for self-promotion by the chief executive or board chair. However, if the results are less satisfactory, passive accountability blames unavoidable external factors, outside the board’s control.

Prior to each of their collapse, the boards of Northern Rock Bank, Enron, and Carillion produced congratulatory annual reports:

• Northern Rock took credit for its significant growth, outpacing competitors, without recognising the increased risk associated with junk-bond rated financing.
• Enron took pride in its growth, which was based not only on supplying energy, but by creating a market for energy futures, without realising that, in the process, their strategic risk profile had changed from a low-risk energy producer to a high-risk financial institution.
• Carillion gave shareholders a stream of high dividends, based on profit growth, but did not draw attention to the funding of those dividends, which was based on increasing financial leverage (debt/equity ratio), relying on interest-bearing loans, which led to corporate collapse when interest rates rose.

In other words, passive accountability tends to provide the minimum data required by reporting regulations, does not accept responsibility for poor results, and sees accountability as the final step in the corporate governance process.  

On dynamic accountability

By contrast, dynamic accountability recognises that passive accountability, routine reporting, and compliance with regulatory demands is not enough. Dynamic accountability believes that reporting performance in terms of financial profit or loss, income and expenditure, or even Key Performance Indicators (KPIs), is insufficient: a complete picture needs to show not only what the results were, but how and why they occurred.      

Overall transparency needs to provide information on the context in which the results were achieved. Only then can readers see the full picture. That might include, for example, comparing the entity’s performance with industrial sector norms, describing market conditions, even comparing competitors’ performance.

Accepting responsibility for performance follows in dynamic accountability. The governing bodies of all corporate entities should not only report their organisation’s performance, but accept responsibility for it—whether good or bad, above or below expectations—explaining why those results have occurred. Then, in dynamic accountability, boards describe how they intend to build on the reported results as the basis for future strategic developments, policies, projects, and plans.

It is apparent that the governance matrix (Figure 1) has an underlying dynamic—strategy formulation leads to policy-making, which underpins management plans, budgets, and decisions, which produce the outcomes monitored and supervised by the board, leading to accountability, which, in dynamic accountability feeds into future strategy formulation and policy-making.

In other words, dynamic accountability is concerned with transparency, making visible the entire picture. Moreover, dynamic accountability accepts responsibility for all results—good or bad. It also recognises the need to build reported outcomes into future strategies, policies, and projects.

The significance of culture in accountability

Much of the literature on accountability assumes Western accounting rules. Most countries following these Western practices are democracies, with judicial system and law courts independent of the state. Increasingly, however, economic activity, wealth creation, and associated governance practices are found in countries with autocratic or oligarchic systems of governance. In many of these countries, the law courts are not independent of the state, but respond to state demands, “in the interests of the people.”

Consequently, corporate entities operating in these states need to recognise political influences in their governance processes. Two examples from China illustrate such situations:

• The Initial Public Offering (IPO) flotation of Ant Financial Services on the Shanghai and Hong Kong Stock Exchanges would have been the world’s largest IPO. But it was withdrawn by the Shanghai Exchange, at the last moment, following state intervention.
• Ant was originally the financial services arm of the vast Alibaba Group, which provides retailing/communication platforms, similar to, but larger, than Amazon. The board of Alibaba was forced to change its organisation structure and unusual governance processes following government intervention.

China is a one-party state and companies operating there need to be sensitive to the political component of corporate governance. Similarly, companies in some countries in Africa, Latin America, and the Middle East need to be aware of political and other cultural influences in their governance processes, including accountability.

AI support for dynamic accountability

We have seen that dynamic accountability can provide higher transparency, requires boards to take responsibility for results, and feeds these results into future strategies. Each of these processes can be enhanced with artificial intelligence (AI) tools. For example, Workiva combines, on one platform, financial with non-financial records to support regulatory requirements, ESG reporting, internal audit, and risk management routines. NICE Actimize can flag compliance with both financial and non-financial reporting needs. Diligent Boards is a suite of AI tools that can support board strategic thinking through data-driven insights that identify relevant competitive, economic, environmental, or socio-political issues.

AI can monitor news sources, social media, and internal systems for early warning of stress, which could result in financial or reputational loss. AI can also assess mass data to suggest money-laundering, bribery, insider dealing, and conflicts of interest. Nevertheless, when using AI, boards should ensure that their AI systems are compatible with their corporate strategies, ethics, and accountability goals.

The way ahead for dynamic accountability

In dynamic accountability, performance reports are not seen as the final step in the governance process, but as an ongoing phase in the corporate governance cycle. Responsibility is accepted by the board for all results, good or bad, explaining how and why these results have occurred. Boards with dynamic accountability also explain how they intend to build current results into future strategies, policies, and projects. Introducing dynamic accounting will need a change of attitude in some boardrooms.

^{Featured image by PublicDomainPictures from Pixabay.}