PricewaterhouseCoopers Page 1 Three Talks in One* Building Public Trust ValueReporting Enterprise...

PricewaterhouseCoopers

Three Talks in One*

Building Public TrustValueReportingEnterprise Risk Management

Energy Insurance Mutual Risk Managers Meeting

Dr. Robert G. EcclesPresident, Advisory Capital PartnersSenior Fellow, PricewaterhouseCoopers

*connectedthinking


Building Public Trust


Issues for Your Consideration

The crisis in accounting (Building Public Trust)

Pressure for greater transparency (The ValueReporting Revolution)

A new approach to risk management (Enterprise Risk Management)

Will provide a quick overview of each

Will provide supporting material for each topic


The Crisis in Accounting

Wave of accounting scandals (and failed governance) in the U.S. several years ago

Now seeing something similar in Europe (e.g., Adecco, Ahold, Parmalat)

U.S. response was Sarbanes-Oxley- Litigation was rushed in a very political environment- Has added significant compliance costs- Assumes the existing financial reporting model

Focus on earnings and the Earnings Game Regulatory filings rather than information used by management Higher penalties on executives for malfeasance Much tighter regulation of the accounting profession

Need to step back and take a broader view


True Capital Market Reform Can Happen

Six key actions for restoring public trust and investor confidence:

1. Create principles-based global accounting standards

2. Develop additional industry-based performance information

3. Improve external reporting beyond regulatory requirements

4. Use the Internet to enhance performance reporting and analysis

5. Perform audits which present a “true and fair” view of the business

6. Strengthen all links in the Corporate Reporting Supply Chain


Action #1 – Create Principles-based Global Accounting Standards

A global economy needs a global set of generally accepted accounting principles

Investors want to choose companies regardless of country

Companies want access to capital from all over the world

Global GAAP should be based on principles, not detailed rules

Get the “best of both worlds” between U.S. GAAP and International Financial Reporting Standards (IFRS)


Company performance and future potential cannot be reduced to a single number (e.g., earnings or cash flow)

Global GAAP information must be supplemented with other financial (e.g., pro forma earnings) and nonfinancial information (e.g., customer retention)

A supplemental framework is needed

Each industry will develop standards within a Tier II framework

Action #2 – Develop Additional Industry-based Performance Information


Action #2 – Develop Additional Industry-based Performance Information

An Example From Telecommunications And Pharmaceuticals


Action #3 – Improve External Reporting Beyond Regulatory Requirements

Articulate the company’s “Holistic Story”

- Strategy and plans- Targets and benchmarks- Actual and desired risk profile and risk

management procedures- Internal control systems and

compliance programs- Compliance policies and programs- Principles of corporate governance- Compensation policies and amounts- Other performance metrics, including

company-specific ones- Commitments to other stakeholders


The Corporate Reporting Transparency Framework


Action #4 – Use the Internet to Enhance Performance Reporting and Analysis

Content and format are integrally linked

- Information is still largely provided in a clumsy paper-based format

- All this changes with Extensible Business Reporting Language (XBRL)

XBRL is a taxonomy for “tagging” information Provides the context for explaining what the information means XBRL enables obtaining information directly off the internet

- Microsoft, Nasdaq and PricewaterhouseCoopers have developed an XBRL demonstration site

www.nasdaq.com/xbrl 20 semi-conductor companies 5 years of data including income statement, balance sheet and footnotes.


How XBRL Changes the Consumption of Corporate Reports

Action #4 – Use the Internet to Enhance Performance Reporting and Analysis


Action #5 – Perform Audits Which Present a “True and Fair” View of the Business

Today’s audit opinion is about the financial position of the company

- Accounting and auditing standards vary by country- Historical financial statements are an incomplete picture - An “Expectations Gap” exists about what an audit opinion really

means- The audit needs to stand for more- Issues around risk and liability will need to be addressed


Action #6 – Strengthen all Links in the Corporate Reporting Supply Chain

Every Group Must Take Responsibility for Improving our Markets


Action #6 – Strengthen all Links in the Corporate Reporting Supply Chain

The Need for Better Corporate Governance

Directors need to remember that they represent shareholders

Much of the current focus is on structural reforms

Equally important are issues of qualifications, process, resources and compensation

Legislation and regulation should be balanced with market forces


ValueReporting


Pressures for Greater Transparency

Roughly two-thirds of CEOs think their company’s shares are undervalued

Market sets price based on information- Companies are not reporting information they regard as useful in running the company- Analysts and investors agree that they are not getting this information- Audit Committees say they are not getting this information

ValueReporting is about greater transparency by companies- Financial and nonfinancial information- Tangible and intangible assets- Integrated perspective on risk and strategy- Market rather than regulatory driven

Benefits of greater transparency- More accurate stock price- Better managed company- A way to move beyond the Earnings Game


Companies create sustainable economic value by developing, operationalizing and executing superior strategies which guide the company towards delivering valuable products and services.

These strategies yield future cash flows greater than investment or economic profit.

Companies ensure that investors realize the value created by the business units and the corporate center by managing and delivering upon market expectations.

Companies preserve the value of the underlying business unit cash flows through effective management controls, risk and tax management.

Value

Creation

Value

Preservation

Value

RealizationInvestmentCommunityCompanies

A Better Managed Company

Why Is ValueReporting Important?


Performance Measures and the Utility Industry

Utility CFOs’ perceptions of whether the market properly values their company

0

10

20

30

40

50

60

Strongly Over-Values

Company

Tends toOver-ValueCompany

About Right Tends toUnder-Value

Company

StronglyUnder-Values

Company

No Opinion

Source: 1999 PricewaterhouseCoopers Capital Markets Survey


How Actively a Measure is Communicated

Importance of a Measure

Reporting Gap Information Gap

Perception Gap

Understanding Gap

Quality of Information

Quality Gap

Communication gaps prevent market value from reflecting underlying value

Management’s Valuation

Investors/Analysts

Market Value

Value gap

How Adequately a Measure is Communicated

Importance of a Measure

Performance Measures and the Utility Industry


Performance Measures & the Utility Industry

High Importance Medium Importance Low Importance

CFOs’ Perceptions of the Relative Importance of Performance Measures

Utility CFOs recognize that a broad range of financial and non-financial measures are useful for managing their companies

Source: 1999 PricewaterhouseCoopers Capital Markets Survey

1. Regulatory environment and price controls

1. Quality of management

2. Cost reduction

3. Investment/acquisition strategy

4. Operating profit growth

5. Operating cash flow growth

6. Market growth

7. Strategic direction and focus - integrated v specialist player

8. Risk management processes

9. Margin improvements

10. Brand value/reputation

11. Environmental strategy, performance and cost

12. Geographic focus/exploiting changing markets

1. Market share/position

2. Revenue growth from new services/ geographies/customers

3. Extent of competition/ barriers to entry


1. Brand value/reputation

2. Cost reduction


4. Geographic focus/ exploiting changing markets



7. Market growth




1. Cost reduction


3. Geographic focus/ exploiting changing markets



6. Market growth





Measure ranked as top ten by investors and/or analysts but not by companies. These data are for general utility companies. Data are also available for generators, retailers and network companies.

The Top Ten Performance Measures Utility Industry

Perceptions of the Relative Importance of Performance Measures

Companies Investors Analysts



3. Cost reduction




7. Market growth




PricewaterhouseCoopers Quality Gap

Information, Reporting and Quality Gaps in the Utility Industry

Companies Analysts Investors

Information Gap #

Companies

Reporting Gap#

# Gap exists when the difference is equal or greater than 20 percent.

Performance Measures



3. Cost reduction




7. Market growth






3. Cost reduction




7. Market growth





Enterprise Risk Management


A New Approach to Risk Management

Enterprise risk management is a process, effected by an entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives

Committee of Sponsoring Organizations (COSO) initiated a project on enterprise risk management

- Next “Big Thing” after Internal Controls – an Integrated Framework- Draft report has been put out for public exposure and comments received- Final report and application guidance will be published this summer

PricewaterhouseCoopers’ CEO Survey (1391 CEOs)- Basic processes in place- Much less progress on “full implementation”- Benefits are very real- Barriers are significant- Two main strategies exist for making real progress


The Committee of Sponsoring Organizations Enterprise Risk Management Framework

* The Committee of Sponsoring Organizations Enterprise Risk Management Framework

- Forms the framework for Sarbanes-Oxley

- Activities are considered at all levels of the organization

COSO* ERM


Which of the following processes does your organization have in place?

Basic Processes of ERM


To what extent do you agree or disagree with the following statement regarding regulatory compliance?

Basic Processes of ERM — Compliance


Elements of Full ERM Implementation

To what extent do you agree or disagree with each of the following statements regarding risk management and ERM?


To what extent do you agree or disagree with each of the following statements regarding risk management?

Levels of Commitment


Which of the following are key challenges that restrict your organization in identifying and managing enterprise-wide risks, and which is most challenging?

Challenges To Implementation


To which of the following groups do you periodically report your company’s enterprise-wide risk portfolio, and how often does this occur?

Reporting Risk Profile


Percentage reporting strong or considerable positive impact

Benefits of ERM


When would you expect your organization to have effective and efficient ERM in place?

Is ERM in Place?


When ERM is a CEO priority Percentage reporting strong or considerable positive impact

Full ERM Implementation


When ERM is a CEO priority

Challenges


When ERM is a CEO priorityPercentage reporting strong or considerable positive impact

Benefits of ERM


When ERM is integrated in strategic planningPercentage reporting strong or considerable positive impact



When ERM is integrated in strategic planning

Challenges


When ERM is integrated in strategic planning


Benefits of ERM


CEO priority advanced practitioners




CEO priority advanced practitionersPercentage reporting strong or considerable positive impact

Benefits of ERM


Strategic planning advanced practitioners




Strategic planning advanced practitioners


Benefits of ERM


Action Items

Establish one or more industry-based consortia to establish Tier-Two Standards for non-GAAP information

- Include all relevant members the Corporate Reporting Supply Chain- Will be adopted on a voluntary basis: let the market decide

Determine and implement optimal level of transparency- Do a company-specific “ValueReporting” Survey- Establish a process that involves senior management and the Board

Design and implement a process for enterprise risk management

- Do a self-diagnosis based on questions in CEO survey- Read COSO report when it is published this summer

More information can be found at www.pwc.com or from [email protected]

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