Corporate Transparency: The Triple Bottom Line Audit
By Carole Basri and Sherrie McAvoy
In the information Age, the old paradigm of developed and under-developed countries, the First World and Third World, no longer exists. In the era of rapid globalization of corporations and financial markets, brought on by the development of sophisticated communications technologies, transparency has become the new dividing line.
Transparent companies and financial markets will succeed in this new world order; non-transparent companies and financial markets will be shunned by investors and ultimately drained of capital. United States companies have been winners because they promote transparency by means of financial, legal and internal controls, thereby encouraging investor confidence. This is why most U.S. companies have flourished despite the crisis faced my many Asian companies.
Moreover, U.S. corporations have been the primary drivers of the technological change that has spawned a global economy as well as an entirely new area of industry based on the Internet. Not coincidentally, the United States is the leader in venture capital, resulting in such success stories as Microsoft, Yahoo, and Amazon.com. The venture capitalists have used their wealth to generate new wealth under the specially controlled conditions of private equity placement to promote new companies. This process was enabled and encouraged by the creditability of financial audits.
However, where companies, particularly in Asia, have failed to meet the test of financial transparency, the results have been extremely negative. In Asia, banks were using questionable practices prop up the status quo. Japan although it is clearly a developed country with a high standard of living, had failed to establish transparency and now faces a continuing spiraling economic slowdown. Corporate Japan is riddled by interlocking directorates and lack of financial, internal and legal controls. Japan, the world's second largest economy, has in common with developed countries a murky system of corporate governance and "crony capitalism", the latter as seen in Indonesia. In a world of limited capital, companies that wish to remain competitive must achieve global standards of transparency or else risk losing their footing internationally against transparent corporate competitors.
Need for Transparency
Why is transparency the fundamental characteristic of a successful company? It allows for the formation of effective investor research on the company thus promoting realistic investments decisions. Consider again the United States - Japan dichotomy. The purpose of a United States company is to make a profit for its shareholders. In Japan, however, a company exists to promote the interests and the social welfare of its employees, resulting in a society with admirable social cohesion, educational standards, and low crime rates.
In the United States, a company may promote social values, but its fundamental mission, to make a profit, is clear. The need to report financial information accurately, even when the news is negative, is given high priority as means of maintaining the fungibility (marketability) of shareholder stock. In Japan, by contrast, protecting employees' jobs and the status quo comes first. This encourages a lack of clear financial reporting and the appointment of loyal employees and retired employees to the board of directories.
Japan has been mired in indecision for years; it still has not convinced the world that it is undertaking meaningful reform. Because Japanese companies lack fundamental and reliable financial information, they have difficulty in attracting substantial capital from foreign investors for their companies. Recent information from Japanese revealing bad loans in the banking sector totaling billions of dollars, as well as further company failures. Potential investors, fearing the announcement of additional bad loans and bad news, lack the confidence to act, the key ingredient.
The situation of Japanese companies contrasts starkly to that of the United States companies, where financial reports appear on the Internet, compliments of "Edgar", the Securities and Exchange Commission's financial reporting system. Nor surprisingly, money from the financially troubled Asian economy is flowing into the United States companies via the United States stock market as investors seek a safe haven.
Meanwhile, international stock markets are consolidating rapidly. Stock markets in the first world are in the consolidation mode (to reduce transaction costs on the Internet), and the result is that capital markets are becoming more concentrated. The trend toward consolidation underscores the need for transparency in capital markets, making multinational corporations eligible to be listed on these exchanges.
How do you create a mandate for such transparency? You encourage corporate governance within the company. The only way to promote this is to give directors on the corporate board reliable information on the company. Directors must exercise oversight responsibility for the company's operations.
In re Caremark International Inc. Derivative Litigation, 698 A2d 959 (Del. Ch. 1996) requires directors of a company to exercise oversight responsibility over the company's compliance programs. Failure to provide such oversight could result in members of the board being held personally liable.
To promote corporate oversight at director level, compliance must exist within the company. This in turn promotes global standards for employment (e.g., prohibitions on slave labor, prison labor, and child labor) and supports the goals of the Organization for Economic Co-operation and development treaty and the Foreign Corrupt Practices Act (FCPA). In short, corporate oversight provides a means of determining corporate compliance with laws and regulations, as well as with financial and internal controls, and without interfering with the profit-making mechanism of the company.
Paradoxically, this process promotes less government - it pushes the process of government into the company. Government plays a role in setting severe penalties and conducting spot checks to determine observance of the law. But there is less need for bureaucratic apparatus to oversee the law and correct problems, since this function is taken over, through corporate compliance, by the company. Auditing and monitoring are the crucial components in creating a transparent company.
However, U.S. companies even with financial transparency have not been immune from other transparency issues involving environmental and social responsibility concerns. After the Exxon Valdez ran aground causing a catastrophic oil spill, the Union Carbide disaster in Bhopal killing as maiming numerous Indians, the Coca Cola contamination in Europe, allegations of child labor and sweatshop conditions, Unocal use of slave labor in Myramar and Chinese subcontractor incidents of prison labor, in-house counsel often cringes at the possibility that a major disaster can happen at any moment. The companies involved are some of the most respected in the United States, yet they were caught unaware when disaster struck. What may have helped?
Triple Bottom Line Audit
The short answer is international corporate transparency, which requires a triple bottom line audit of not only financial concerns but of environmental and social responsibility issues. No United States or Western European public company would consider anything less than an annual financial audit certified to by a certified public auditor, probably one of the Big Five accounting firms, if possible, to promote financial transparency. As already noted, it creates the undeniable fact that the company finances are clearly ascertainable for corporate shareholders, such as officers, directors, shareholders, and potential investors, ggovernment regulators, the press and the public. Indeed, such an audit creates financial transparency and encourages investor confidence.
Similarly, environmental audits promote transparency in Europe; annual environmental audits are now prepared for most public companies. Furthermore, a number of global energy sector companies such as Shell, BP, Amoco, and Exxon are providing such annual environmental audits for all their global operations. The reasons for these environmental audits are in many instances similar to the reasons for financial audits:
· It benchmarks the company's status in terms of environmental goals and needs;
· It detects wrongdoing, thus reducing the likelihood of environmental spills and mishaps; and,
· It provides reliable environmental information to directors for oversight responsibilities and to investors as to potential environmental issues.
In addition , with the rise of the Green movement and recycling, environmental audits promote and highlight efforts to meet and exceed environmental benchmarks.
Likewise, a social responsibility audit has a similar goal. It assures company stockholders that issues such as bribery, corruption, and exploitation of workers such as child, slave and prison labor will not financially undermine the company and corrupt the integrity of the company, thus, scaring away investors and potential investors.
In-house counsel to an international company would do well to consider the need for a triple bottom line audit covering not only financial, but environmental and social responsibility concerns. This will not only increase the scope of in-house counsel concerns but also the vision. Indeed, it means a systematic approach to issue spotting by in-house counsel. In short, the legal audit recycled for the year 2000 as the triple bottom line is an excellent way to sell the legal audit to your corporate financial counterparts.