Director responsibility to maximise value especially with the advent of AIFRS
One of these issues is the changing accounting regulatory environment as a result of the adoption of the Australian-International Financial Reporting Standards (AIFRS). This may have a material impact on reported accounting numbers used to measure corporate performance. It will likely also affect executive incentives and remuneration where accounting numbers determine performance-based pay. Directors should ensure that they have thought through the consequences of AIFRS as this may have a big impact upon corporate behaviour and consequently company performance.
In my opinion, one of the most important roles of corporate directors under AIFRS should be to signal to management as unambiguously as possible that their job is to actively manage to create sustainable business value and that this should rank as high as any other business priority. Whilst boards have other issues to deal with, value creation should be at the forefront of their minds. In every annual report, shareholder value is of paramount importance. Modern corporate finance theory also agrees that the primary objective of profit seeking businesses is the maximisation of value.
If boards are satisfied that value creation is a high priority then this should help guide them in managing the change to AIFRS. This is because accounting standards such as AIFRS govern reported accounting results but have little or no impact on the underlying economics and hence value of a business. The intrinsic value of a business is instead driven by cash earnings, invested capital and the cost of capital.
Boards must therefore distinguish between the concepts of value creation and reported accounting performance. They must explicitly recognise that there is a distinct difference between legal the principles of accounting and the underlying economics of a business which determines intrinsic value. Changes in reported accounting numbers under AIFRS such as depreciation, treatment of intangibles and the discontinuing of goodwill amortization should have little or no impact on business value.
Accordingly, boards should ensure that managers are not persuaded to react to changes in reported performance and instead focus on growing the value of the business. If boards are rewarding management for improving accounting measures such as reported profits or earnings per share, rather than rewarding their achievements in increasing business value then they should take measures to address this immediately. Otherwise there will almost certainly be a misalignment between the interests of management and shareholders.
Directors should seek to align the interests of management with shareholders, by avoiding the use of pure accounting numbers as measures and rewards of corporate performance and perhaps provide performance-based incentives linked to sustainable increases in business value. Private enterprise in particular should consider undertaking periodic valuations to assist with this. This can act as a framework in determining where business will be next year and in five years time and how it will get there. They can also greatly assist in succession planning and help with strategies to engineer sustained increases in value. If value creation is what is most important to shareholders, then consequently it should be equally as important to corporate boards.
Jamie Strauch is Head of Valuations for boutique investment bank Hindal Corporate, which specialises in corporate advisory and business valuations. He has a background in corporate finance, funds management and management consulting with valuation experience in Australasia, New York, Africa and India.
