Governance
The intersection of conduct culture and company value
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Note: this article was first written in 2018

Overview

The ethical conduct, trustworthiness and 'social licence to operate' of a company matter to the community and consumers, especially in a post-GFC world. But what about shareholders? They want their investments to perform financially, but such community expectations have meant the days of performance at any cost are long gone.

Instinctively we know that reputation and brand is valuable. Today, we know a poor conduct culture or an absence of ethics at a company will result in its social licence to operate being revoked. This diminishes the company's reputation and brand, and ultimately its value.

Yet, these concepts are difficult to measure. Indeed, brand, reputation and social licence to operate are off balance sheet assets.  To underscore the importance of what  lies off the balance sheet, one need look no further than the off balance sheet liabilities that caused corporate collapse at the likes of Enron.

In other words, off balance sheet assets constitute a company's intangible value.  While these assets add value, they are difficult to measure and so tend to remain largely ignored by accounting standards, resulting in intangible value mostly going unrecognised in statutory balance sheets. This is slowly changing, however, with the uptake  of  integrated  reporting  <IR>  in  recent years, a framework which includes guidance on accounting for intangible value in main-stream filings.

Importance of intangible value

Today, intangible assets - including social licence to operate - represent a significant proportion of the value in Australian listed companies. Based on our estimates, book value represents only around half of  current  market  value  for  the  S&P/ASX200.  Research  in  the US has estimated book value represents less than 20% for the S&P500.

This unrecognised proportion of market value has grown with the decline of manufacturing and resource sectors, and the increasing representation of businesses that create significant value from brands, intellectual property, reputation and human capital.Because the  way in which intangible assets translate to financial value in companies is less easily quantified, it receives relatively scant attention in corporate communications to investors. With limited information available to inform assessments of a company's true value and outlook, the market's recognition of and reward for investment in superior practices remain imprecise and unevenly distributed.

However, this is problematic because superior conduct - and conversely poor conduct - can significantly impact the long term value of a company, especially as conduct affects brand, reputation and social licence to operate.

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