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Compliance : Sarbanes Oxley : Governance : Sarbanes Oxley
Putting Sarbanes-Oxley To Work For You
Arming boards with the knowledge and training to do a good job is the number one thing companies can do to improve board performance.
By
Jeffrey Rodek
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Jeffrey Rodek
Executive Chairman of the Board
Hyperion Solutions
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Recently, I spoke at a conference for CEOs. The topic was the effect of recent legislation on corporate boards. Translation: ?how Sarbanes-Oxley is going to suck the life out of your company.? At least that was the feeling I got from some of the participants.
Some of the speakers and attendees thought that the costs of compliance will force companies to go private (which it may in some cases). Others complained that few legislators understand the realities of running companies (which they often don?t). Still others worried that Sarbanes-Oxley will drag boards into too much operational detail and take the focus away from the board?s role as a strategic guide and the shareholder?s advocate (which is possible).
Virtually everyone present spoke of compliance as something that happens separately from and takes away from running a sound and profitable business. This is a misconception that needs addressing.
When conceived and implemented properly, better compliance leads to better corporate governance and accountability, which can lead to breakthrough company performance. In fact, improvements in compliance, disclosure and governance and improvements in performance are inextricably linked. We executives need to get over the idea that that there?s compliance on one hand and then there?s running the business on the other.
To illustrate this point, think of a company that has difficulty putting together its income statement and balance sheet each quarter or knowing within 48 hours when a material event has happened. Is this really a company that can do more than get lucky for a few quarters and consistently produce a profit quarter after quarter, year after year? How would the executives know for sure that the company did in fact operate profitably over the long haul if it has a hard time arriving at its numbers?
On the other hand, think of a well-run company that understands and tracks its key performance indicators, whatever they may be?a company that knows which products, customers, regions, production plants, etc., are most profitable and that does a good job of monitoring cash flow. Do you think that company is going to have a hard time with compliance? I doubt it.
The idea that compliance and performance are linked is very much in the spirit of Sarbanes-Oxley and other regulatory reforms. Whatever their merits or shortcomings, these reforms are intended to restore public trust in corporations? ability to produce shareholder value. That spirit is as much about accountability and performance as it is about compliance.
In addition, there?s a good business case to be made for beefing up compliance and governance. D&O insurance premiums have increased 50-300 percent in the past few years as a result of transgressions committed by a few but affecting many. Corporate restatements have reached epidemic proportions.
Number of restatements by U.S. public corporations
Source: U.S. General Accounting Office
McKinsey & Co. found in 2002 that institutional investors place equal weight on governance and financial measures when making investment decisions. The research also found that evidence of strong governance practices resulted in stock price premiums of 12-14 percent in North America. Research by Parson Consulting found that companies that release their financial results sooner than their industry peers achieve an average 15.5 percent premium in their P/E ratios.
Moreover, Standard & Poors conducted research in 2002 that found, ?companies with higher transparency and disclosure rankings have lower market risk? and ?preliminary empirical findings indicate that companies can lower the cost of equity capital by providing higher transparency and disclosure.? Finally, a recent survey by my company found that 68 percent of senior financial executives at large companies have put measures in place to improve compliance. Of those, 62 percent believe those efforts will help improve company performance.
Sources: 1 Stanford Securities Class Action Clearinghouse; 2 Cornerstone Research;
3 Huron Consulting Group; 4 American Bankruptcy Institute
The current economic climate demands new regulations; public mistrust of companies is at record levels. This is not because boards weren?t independent enough or because tax and audit were performed by the same firms. It?s because of the few extreme cases that dominated the news and the attention of a population already smarting from a severe economic downturn.
So how do companies move beyond compliance to renewed shareholder confidence and breakthrough performance? Not through legislation. While Sarbanes-Oxley is a step in the right direction, companies must go the extra mile in restoring both the appearance and, if necessary, the reality of corporate integrity through solid governance, strong accountability and clarity in disclosure. In fact, a survey by Hyperion last summer indicated that 57 percent of executives thought public companies should report more than GAAP to provide adequate visibility into their operations and restore public confidence.
I serve as both CEO and chairman for my company. Some companies are choosing to split these roles for governance considerations. It?s something that should be determined on a case-by-case basis. Because I wear both hats, the following guidelines are aimed at both executives and board members. These are some best practices for moving beyond compliance to breakthrough performance.
Help the board in its primary role as the shareholders? advocate
This is a critical starting point. Being the shareholders? advocate consists partly in being a watchdog on compliance and governance, but those are simply table stakes, the price of entry. It?s more about making sure the company is achieving its potential and delivering maximum shareholder value in a responsible and sustainable way. That entails strategic counsel and in-depth knowledge of what makes your particular company successful.
Boards need greater clarity
Directors should demand more clarity, though not necessarily more information. Too often, directors are handed a fat binder full of facts, figures and reports, but these don?t always give them more insight into how to help run the company better. Directors need reports on the business and operations, not just finances. In general, cash flow and product, customer and regional profitability reports are the kinds of reports that can tell you where you are and aren?t making money.
More specifically, companies need to determine which few key performance indicators (KPIs) they want to commit to at a corporate level and then track those consistently for as long as they continue to be the measures that matter. Consistently disclosing these KPIs as part of quarterly earnings is a good idea because, as discussed earlier, research shows that companies with greater transparency and disclosure are rewarded with premium stock prices. We did this at Hyperion and it not only achieved our objective of providing external stakeholders with more transparency into operations, it also helped us hold managers accountable for the results they promised to deliver. We found we were able to galvanize employees around the issues that define success or failure at our company.
Arming boards with the knowledge and training to do a good job is the number one thing companies can do to improve board performance. Prospective board members are already performing more due diligence before they commit to a position, and the management team should continually ask sitting board members if they have what they need to feel comfortable performing their role.
Shareholders need greater clarity
Disclosure within 48 hours of a material event is becoming a basic requirement under Sarbanes-Oxley. However, there is so much more companies can do to improve clarity for investors without deluging them with reams of data.
For example, putting out a cash flow statement concurrent with the earnings announcement is a prime case of how companies need to go beyond legal requirements in reporting to the public. Having a handle on where cash flows in and where it flows out is critical to knowing what is going on in the financial life a company. If you think of cash as the lifeblood of a corporation, understanding cash flow is as important as a cardiologist being able to see which blood vessels are blocked and where the tissue is dying as a result.
Currently, between one-third and one-half of Fortune 100 companies report cash flow concurrent with their earnings reports, as opposed to waiting for the 10-Q. This is a way companies can distinguish themselves in terms of transparency, and I believe more and more companies will opt to do so in the future.
Management needs greater clarity
Investments in compliance are just the beginning. Proper disclosure and controls are crucial, of course, but so are having quarterly?or even more frequent?plans and budgets that are signed off by management, not just finance. You?ve got to have management buy-in or you can never reach what we call, ?no excuses execution.? You also need to forecast better and more frequently if you expect to quickly know when you?re off course, either because of market conditions, fraud or anything else.
Accountability also means being open to input and constructive criticism. It means not shooting the messenger. My CFO has a great expression: ?bad news doesn?t get better with age.? You?ve got to be willing to look at a problem in order to solve it, and the sooner you do that, the better for everyone.
Focus on company culture
Going beyond compliance to breakthrough performance means going beyond numbers and reports to people and the standards of behavior that are expected of them. When I was president of the Americas at FedEx, our credo was ?people, service and profits.? The idea was that if you hire good people, take care of them and keep them focused on customer service, the profits will follow. If you emphasize profits at the expense of employees and customers, you don?t have a sustainable model. It?s a three-legged stool that doesn?t stand if one of the legs is missing or out of balance with the others.
For example, I?m proud to report that Hyperion is one of Fortune magazine?s ?100 Best Companies To Work For? for 2004. We received this honor, based largely on the weight of employee questionnaires, because we communicate our vision and mission thoroughly and consistently across the company, we have a very low turnover rate, we encourage people to move around within the company and we offer competitive compensation with an emphasis on pay for performance. That?s the ?people? leg of the stool. Part of our formula is that?to a greater or lesser degree?the bonus of every single person in the company is tied to customer satisfaction measurements. That?s the ?service? leg of the stool. As a result, our stock has doubled in less than two years and we?ve seen nine straight quarters of improving profitability, which is noteworthy in the software industry these days. That?s the ?profit? leg of the stool.
I can?t stress enough how important corporate culture is to improving accountability and performance.
Focus on board culture
At my company, we?ve established a board member profile which works for us. We want directors to be engaged and ask the hard questions that help make us a better company. That means they need the time and commitment to be involved. Most of our board members are local, so it?s not as difficult to set up face-to-face meetings and impromptu interaction.
We like to have them attend company functions, like our analyst day events, company social events and our user conferences where they can interact with customers, partners and industry luminaries, as well as employees. We look for ways for them to interact with top management outside of board meetings. This gives them more personal insight into what kind of company we are and also provides employees a forum in which to communicate with board members.
Since we don?t want our directors spread too thin, we recently expanded our board and we don?t have anyone sit on more than two committees at a time. They?re all independent (except for me) but we require them to be knowledgeable about our business and our industry. And they don?t have to be CEOs to do a great job.
Set up a governance committee
I have done this with good success in the past year or so, and I highly recommend it. We reviewed a list of nearly 20 items and prioritized them for immediate, mid-term and back-burner consideration based on a combination of what was legally mandated and what would serve the business. The list included such issues as mandatory retirement ages, maximum number of boards directors can sit on, stock ownership guidelines, staggered voting, shareholder rights, poison pills and whether to expense stock options.
It is entirely possible that in a few years, governance committees will have outlived their usefulness. In fact, I hope it is the case that governance is less of an issue several years from now. However, for the time being governance committees are important for restoring trust externally and to make sure that companies aren?t missing anything during this era of increased scrutiny.
Avoid the checklist mentality
Right now, executives are being inundated with checklists from legal, audit, accounting and other consultants. However, there is a potential pitfall in adhering too closely to checklists. Everyone needs to show they?ve conducted their due diligence in reviewing and revising compliance and governance policies, and everyone has their lists of ?must do? items.
However, we must avoid a ?checklist mentality.? Slavish adherence to those lists can lull us into a reactive ?CYA? mode and get in the way of tackling the real issues. Checklists are useful but we have to keep an eye on the big picture.
Conclusion
Sarbanes-Oxley is a step in the right direction. However, no legislation is perfect in either its design or its implementation. Companies need to go the extra mile in improving corporate integrity in both appearance and fact.
While boards of directors remain the best representatives of shareholder interest, boards need to accept even greater responsibility to ensure integrity, accountability and improved performance. They must have increased visibility into both the financial and operational drivers in the companies they govern, but this requires not just time, commitment and the right culture; it requires tools, training and the knowledge needed in order to be more proactive and effective.
I believe Sarbanes-Oxley and similar legislation can be an opportunity to use clarity in reporting to drive greater shareholder confidence. And ultimately, the greatest return on investment in compliance is the breakthrough performance a company can realize when recognizing compliance measures as an opportunity instead of an impediment.
Jeffrey Rodek
Executive Chairman of the Board
Hyperion Solutions
Jeff Rodek was named chairman and CEO in October 1999 to provide strategic leadership and direction and drive Hyperion?s profitable growth. Prior to joining Hyperion, he served for five years as president and chief operating officer of Ingram Micro, the world?s largest wholesale provider of technology solutions, products and services. In January 1998, while at Ingram Micro, Rodek joined the board of directors of Arbor Software, which merged with Hyperion in 1998.
Before joining Ingram Micro, Rodek spent 16 years at Federal Express Corp., a $20-billion global provider of transportation, freight, and e-commerce and supply-chain management services. Rodek?s career began in Operations Research, continued in Financial Planning and Analysis, then Operations. His last position at FedEx was senior vice president, the Americas.
Throughout his career as a provider and user of decision support and performance management software, Rodek gained an appreciation for the value of software in measuring performance and driving improved profitability.
Rodek holds a bachelor's degree in mechanical engineering and a master's degree in business administration, with an emphasis in finance, from The Ohio State University.
He currently serves on the board of directors of NewRoads, Inc., a leading provider of outsourced business operations solutions to companies engaged in multichannel, one-to-one direct commerce.
In addition, Rodek is a member of the advisory board to the Fisher College of Business, The Ohio State University and was recently selected to join the board of directors for the The Ohio State University Alumni Association.
Rodek has been married for more than 25 years to his wife, Chris, and they have three children.
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