In addition to a country’s stable economy, momentum sustaining policies, quality of on-going policies and the law and order situation, good corporate practices are also necessary to woo foreign investment in the corporate sector.

The upgrading of the corporate practices is indeed, a macro-level national priority. It is no less important at micro level, either. Global investors will not look twice at us unless the existing corporate practices are improved. Change is a progress and the only institution that doesn’t progress, as Harold Wilson pointed out, is cemetery. The result of the survey of the IFC’s Global Private Equity Conference held between May 9-11, 2001 has revealed that 89 per cent of the respondents would pay more for the shares of a well-governed company than for those for poorly- governed company.

It s a hopeful sign that the Securities and Exchange Commission of Pakistan is taking proper measures in this direction. It has already initiated the action to enforce a code of corporate governance and directed stock exchanges to ensure compliance by listed companies within 30 days.

This ‘code’ encompasses detailed guidelines on many issues, e.g., qualification and eligibility of directors, responsibilities and powers of the board, its meetings, decision areas for the board, and contents of directors’ report to shareholders, etc. This article is a limited critique of the recommendations relating to directors’ report for which no scholastic claim is made.

The ‘code’ mandates directors to disclose 17 different aspects in their report; five of them deal with aspects, though not expressly declared, which are already the responsibility of directors, namely, (i) their responsibility with respect to the preparation and presentation of financial statements, (ii) maintaining proper books of accounts required by the law, (iii) adopting appropriate accounting policies, consistently applying them, and making reasonable and prudent accounting estimates, (iv) applying accounting standards as applicable in Pakistan,and (v) affirming company’s going concern status and it remaining so.

The external auditors presently bring out this position in their report to tell users about it. Further, the ‘going concern’ status is also implicit in accounts having been prepared on that basis. The position is no different so far as declaration concerning ‘sound internal control being in place, and monitored by them is concerned. This is a well-understood directors’ responsibility for ages. These 5 provisions of the ‘code’, therefore, add no new dimension in spirit to directors’ disclosures.

The remaining 10 disclosures concern themselves with an assorted array of aspects such as (i) managerial clarification about past stewardship functions such as explaining material deviation as disclosed in the quarterly, half yearly and the annual financial statements (though ‘deviation’ from which is not clear); (ii)(a) performance of management functions such as explaining reasons for not declaring dividends, (b) payment of taxes, duties and explanation with respect to unpaid balance and (c) the number of board meetings held and attendance of each director; (iii) (a) general nature statements such as restating the earlier declaration about going concern in a different form “there is no reason that the business will not be a going concern”, (b) certifying that there has been no material deviation in observing the code of corporate governance; (c) expanded classification of pattern of shareholding, and (d) outlining “significant plans and decisions, such as corporate restructuring, business expansion and discontinuance of business operations along with future prospects, risks and uncertainties surrounding the company”.

As is clear, these 10 disclosures except the position concerning ‘future prospects’ etc. do not enhance users’ ‘visibility’, that is, comprehension of company’s direction. Thus, the disclosures in the directors’ report mandated by the ‘code’ do not achieve full objective. And this because barring the mandate requiring directors’ to outline “future prospects, risks and uncertainties surrounding the company” that certainly ‘breaks new ground’, none other provides to the users idea about the company’s direction.

With respect to the disclosure about ‘future prospects and uncertainties’, the bottom line, unfortunately, is that hardly any good is likely to flow from it. The ‘code’ does not spell out how ‘future prospects and uncertainties’ should be reckoned. It is left indeterminate, to directors’ subjective assessment. It has thus all the making of being reduced to a ‘ritual’ due to honest or deliberate misperceptions.

It is trite to mention that our psychic state at a particular moment tends to greatly shape our perception. Perception of or about an event at one particular point of moment could be different in some way than the perception about the same event at some other moment of time depending on our psychic state.

To see therefore the result emanating from subjective assessment in 3-D, put alongside it the human propensity to conceal negative fall-out and ‘glamorise’ positive aspects of his decisions. Most likely - likelihood that is close to near-certainty is that despite the mandated disclosure the directors’ reports shall, like extant reports, continue to be “ ... and the situation is excellent” type report. (To let you fully appreciate it, I quote Chairman Mao who said “There is great disorder under the heavens and the situation is excellent.”)

As is evident from the situation in other jurisdictions, directors’ report is a prime and significant document to enhance the corporate transparency, visibility, and credibility to the users. For instance, the US MD&A requires directors to provide in their report material historical and textual disclosures as well as identify potential effects of known trends, commitments, events and uncertainties so that the user is able to assess and understand the company’s current and prospective financial position and operating results.”

The framework / guidelines issued by the International Accounting Standards Board (IASB) and the International Federation of Accountants (IFAC) fully support this position.

IFAC divides information into two sets, namely, material information and non-material information, the former being that “omission or misstatement (of which) could influence the economic decisions of users taken on the basis of the financial statements.”

IFAC’s International Standard on Auditing Standard 320, Audit Materiality). The litmus test to judge the utility of existing directors’ report generally is to evaluate whether the information contained in the extant report adds information omission of which could influence the users’ decisions?

The answer to this seems to be so obvious that it literally walks out. I leave it to readers, however and move on to next aspect of the issue.

The IASB has stated that financial statements provide information about the financial position, performance and changes in financial position of an enterprise that facilitates wide range of users in making economic decisions (Paragraph 12, Framework).

Another objective of financial statements, the IASB points out, is to show the results of the stewardship of management, or the accountability of management for the resources entrusted to it to enable users to make decisions, for example, whether to hold or sell their investment in the enterprise or whether to reappoint or replace the management, (Paragraph 14, Framework).

The IASB has, however, added a ‘caveat’ concerning the above - the caveat that “financial statements do not provide all the information that users may need to make economic decisions since they largely portray the financial effects of past events and do not necessarily provide non-financial information” (paragraph 13 of the Preface).

Naqvi has rightly said, “The people who read financial statements are interested in the future. Bankers and creditors want to know if obligations will be met. Investors want to know if their expectations will be met.” (Syed Masound Ali Naqvi, Accountants’ Role in Revival of the Economy, The Pakistan Accountant, May - June 2001, pages 33-41).

For this, the users obviously need to have information that enables them to view the past results and future prospects through the eyes of management. The big five accountancy firms have said in a joint statement in January 2002: “Backward looking financial statements are no longer sufficient to communicate real value and risk.

Financial Statement disclosures are plentiful, but they may lack meaning. Many different streams of information - not just earnings - are needed for informed decision-making.” (Financial Management, February 2002, Page 5, Journal of the Chartered Institute of Management Accountant, UK).

The Performance Reporting Initiative Board (CPRI Board) of the Canadian Institute of Chartered Accountant’s (CICA) also has observed “ ... financial statements are ... not sufficient means of measuring and reporting on overall performance...” and are required to be “complemented and supplemented by information” needed by the users.

The Management Discussion and Analysis Reports (MD&A) serve the purpose of directors’ in some countries, e.g. the USA, Canada. The US SEC clarifying the information the registrant (directors) should disclose in the MD&A has pointed out that numerical presentations and brief accompanying footnotes alone are insufficient for an investor to judge the quality of earnings and assess the likelihood that past performance is indicative of future performance.

The MD&A therefore should give the investor an opportunity to look at the company through the eyes of management by providing to him both a short and long-term analysis of the business of the company; it should provide material historical and textual disclosures including the potential effects of known trends, commitments, events and uncertainties that enable investors and others to assess and understand the company’s current and prospective financial position and operating results.”

In Hong Kong, in addition to lot other disclosures that tend to push literally almost all sensitive, key critical pointers to past performance into the ‘open’, the directors are obliged to (i) discuss the main positive and negative factors and influences, which may have major effects on future operations and results, whether or not they were significant in the period under review; (ii) identify and comment on the management of principal risks and uncertainties in the main lines of business, and describe, in quantitative terms, the potential impact of those risks on the results of various business aspects, and (iii) comment on impact and resources of off-balance sheet assets and liabilities. If we reckon the inherent insufficiency of financial statements, Section 236 of the Companies Ordinance, 1984 should logically mean disclosure of textual and other information that supplements financial statements’ and enables investors and others, “to assess and understand the company’s current and prospective financial position and operating results”.

It is suggested that in order to achieve the desired objective of introducing good corporate practices, the ‘Commission’ may cull MD&A Reports of US and Canada and directors’ reports of other jurisdictions, distil disclosure requirements etc. and issue a ‘re-stitched’ revised enforcement order.

In the meantime, the ‘Commission’ may consider remedying the following situation:

(i) Risk management policies have far reaching consequences. Information about these is a very essential piece of ‘information’ for informed decisions. Directors should therefore not only disclose it but external auditors may be required to review it, as the position is learnt to be in some jurisdictions.

(ii) The directors’ affirmation that “there are no significant doubts upon company’s ability to continue as a going concern” may be raised from ‘statement level’ to the ‘level of meaningful and purposeful user information’. In order to assist users in ‘assessing and understanding the company’s current and prospective financial position and operating results”, the directors should in support of their affirmation disclose the main positive and negative factors and influences, in quantitative terms, where possible, on which their opinion / affirmation is based, that would have major effects on future operations and results, whether or not they were significant in the period under review.

(iii) Directors should declare off-balance sheet assets and liabilities; it was these that had shredded Enron.