Brydon Review into UK Audit

"Language matters." so begins the Sir Donald Brydon Review into UK Audit.

In parts touching on the philosophical, Brydon suggests:

"Audit is not broken but it has lost its way and all the actors in the audit process bear some measure of responsibility."

Recommendations:

• A redefinition of audit and its purpose

• The creation of a corporate auditing profession governed by principles

• The introduction of suspicion into the qualities of auditing

•The extension of the concept of auditing to areas beyond financial statements

• Mechanisms to encourage greater engagement of shareholders with audit and auditors

• A change to the language of the opinion given by auditors

• The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement

• Suggestions to BEIS' work on internal controls and clarity on capital maintenance • Greater clarity around the role of the audit committee;

• A package of measures around fraud detection and prevention • Improved auditor communication and transparency

• Obligations to acknowledge external signals of concern • Extension of audit to new areas including Alternative Performance Measures

• The increased use of technology

Brydon quoting Karthik Ramanna  “I know of no better system than market capitalism to sustain liberty and create prosperity – and market capitalism cannot function without a robust audit function. If we do not save auditing, we cannot save capitalism.” 

And on fund managers.... " I was also rather underwhelmed during the Review by the interest in audit shown by some of the portfolio managers with whom I spoke. Few appeared to read the audit report thoroughly and several took the view that it was enough to know whether or not the auditor had given an unmodified opinion."

I do note, I did not speak to Brydon but have tangential advisory interests through being on an advisory group for IASB and for FRC.

Review can be found here.

The Private and External Costs of Germany's Nuclear Phase-Out

NBER Dec 2019. The Private and External Costs of Germany's Nuclear Phase-Out by Stephen Jarvis, Olivier Deschenes, Akshaya Jha.

“Many countries have phased out nuclear electricity production in response to concerns about nuclear waste and the risk of nuclear accidents. This paper examines the impact of the shutdown of roughly half of the nuclear production capacity in Germany after the Fukushima accident in 2011. We use hourly data on power plant operations and a novel machine learning framework to estimate how plants would have operated differently if the phase-out had not occurred. We find that the lost nuclear electricity production due to the phase-out was replaced primarily by coal-fired production and net electricity imports. The social cost of this shift from nuclear to coal is approximately 12 billion dollars per year. Over 70% of this cost comes from the increased mortality risk associated with exposure to the local air pollution emitted when burning fossil fuels. Even the largest estimates of the reduction in the costs associated with nuclear accident risk and waste disposal due to the phase-out are far smaller than 12 billion dollars.”

Paper Here.

Leadership / WeWork


Leadership at WeWork


-A reflection on WeWork

-On what it means to lead

-The problems of charismatic leaders

-The value of the S-1

[Update, ofc, the CEO has resigned now]


Much is being written on WeWork and the debate around its valuation as it has tried to list on Public markets. Scrutiny of the business, governance and the like. A friend mentioned in passing the other day how the regulation behind the S-1 filing document was one of the most-value adding pieces of financial regulation law of history. This episode seems to back this up, as the transparency that the S-1 filing has brought has cast a scrutiny  that may have been lacking before.


The law is the 1933 Securities Act - “An act to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof, and for other purposes.”


There’s plenty of analysis of the business model and valuation. I’m interested in an assessment of the CEO as a person from what we can tell.


There has been analysis about its CEO and his “self-dealing” taking his trademark on “We” and selling it back to the company. Plus the side ventures WeWork has invested in, which closely align with the CEO’s personal interests, but seem further away from WeWork’s core business.


Namely a private school, a surfing/wave pool business, a natural food and an energy drink business. Plus WeWork has bought a private jet at $60m.


As a fundamental investor looking at company fundamentals and management - what it means to be a leader is an important question for me - although I know not for everyone.


When I’ve asked people, especially employees, what they look for - they tell me  they look to their leaders to reach out beyond themselves and beyond their own self-interest to a “wider purpose” to some purpose higher than themselves.


I sense this “purpose” led work - attractive to the younger generations - is becoming ever more important.


It’s one of the problems in the sense of “fairness” for executive pay.


When we see a CEO whose actions seem to have such self-interest to go along with the typical self-belief - typically needed - I don’t think people especially employees are inspired by that.


To me, that goes to the heart of the challenge with WeWork (and previously with the former Uber CEO) - it’s a challenge of leadership.


I know a multi-millionaire biotech CEOs who still travel economy as this means there is more money left to pursue the mission - save people’s lives.


So When Wework says this of its mission:


“When we started WeWork in 2010, we wanted to build more than beautiful, shared office spaces. We wanted to build a community. A place you join as an individual, 'me', but where you become part of a greater 'we'. A place where we’re redefining success measured by personal fulfillment, not just the bottom line. Community is our catalyst.”


And


“Create a world where people work to make a life, not just a living.”


I’m unsurprised that some have found jarring the CEO’s interconnection with what many view as his personal interests.


I am surprised neither the board nor a good friend/adviser has taken him aside and offered him other advice (or in the case of the investments sanctioned them).  



This twitter story by an early WeWork employee (number 17)  is also telling about how she wasn’t given options/stock. https://twitter.com/tristajaye/status/1162471350851817472?lang=en


Update: WeWork CEO has now gone. He’s still a billionaire though. 


Incentive Pay, CII update

Strong emphasis on time vesting awards:

CII overhauled its policy on executive compensation, urging public companies to dial back the complexity of pay plans for top executives and set longer periods for measuring performance for incentive pay. The new policy cautions against the pitfalls of performance-vesting awards and encourages companies to explore adopting simpler plans comprised of salary and restricted shares that vest over five years or more. The policy also recommends that companies consider barring the CEO and CFO from selling stock awarded to them until after they depart, to ensure management prioritizes the company’s long-term success. Although performance vesting share plans can work well for some companies, recent studies suggest they may not provide a strong enough connection to long-term company performance on a broad level, and use goals and metrics that can be numerous, overlapping, flexible and hard to understand.

CII notes:

For some companies, emphasis on restricted stock with extended, time-based vesting requirements—for example, those that might begin to vest after five years and fully vest over 10 (including beyond employment termination)—may provide an appropriate balance of risk and reward, while providing particularly strong alignment between shareholders and executives.Extended vesting periods reduce attention to short-term distractions and outcomes. As full-value awards, restricted stock ensures that executives feel positive and negative long-term performance equally, just as shareholders do. Restricted stock is more comprehensible and easier to value than performance-based equity, providing clarity not only to award recipients, but also to compensation committee members and shareholders trying to evaluate appropriateness and rigor of pay plans.

This is in line with work I’ve mentioned previously that Alex Edmans and Tom Gosling have done via the Purposeful Company.