9 July 2021

What’s the point of the Government’s big corporate shake-up?

By Jon Moulton

As part of a recent consultation, entitled Restoring Trust in Audit and Corporate Governance, the Government is proposing a huge list of changes to audit, company law, governance and regulatory frameworks. The proposals will have a significant impact on corporate finance.

My eyes rapidly dropped from BEIS’s monster main document of proposals to the related, catchily titled Impact Assessment (IA). This is just 210 pages, and purports to show the costs and benefits of what it describes as “around 150” recommendations. That’s 83 recommendations from the Kingman Review, four from the Competition and Markets Authority and 64 from the Brydon Review. You would hope that the cost/benefit analysis would clearly convey why massive change is deemed appropriate. But, as we all know, life is full of disappointments.

First, and most oddly, the numbers are, it seems, all in ‘2016 prices’. This predates any of the reviews and is rather less useful than simply current values. But let’s put that to one side – at least it’s a price.

The first of the segments evaluated in the IA is the extension of the public interest entity (PIE) definition. The effect is that more organisations will be required to meet more corporate governance and disclosure rules. This extension of the PIE definition will load lots of cost on to businesses, including AIM companies, that have a marketing capitalisation of more than €200m

The analysis shows set-up costs of £124.7m and annual costs of £185m. These figures are then fed into a Discounted Cashflow (DCF) model, with a 3.5% discount rate and costs ceasing abruptly at the end of a decade. No explanation is offered for the 3.5% nor for the 10year duration of the costs. But if you accept these assumptions, you get a total DCF cost of £1.7bn

All the proposals get similar treatment. If you use current gilt rates, roughly 1.25%, as a discount rate and assume the costs last 20 years, the PIE DCF cost doubles to £3.4bn. On that basis, the overall proposals will have a net present value of around £10bn. 

These cost estimates are not strongly defended. The |A says: Estimates of costs are tentative at this stage more policy work and responses to the consultation will help us refine our estimates.”

Given the process timetable, this will mean that, in all likelihood, the proposals will be law before costs are well understood. This is lousy process and there has been more than a year for estimates to move beyond tentative‘. 

Cynical? Me?

OK, enough of the costs. What are the benefits? What do you get for a £10bnplus outlay? Well, that‘s really interesting. In every single one of the 27 costbenefit summaries, a pretty damning admission appears – no benefits monetisedin the value of the benefits box. They do write of possible esoteric benefits, but without putting a number on any. Not even cynical old me believes there are absolutely no measurable benefits somewhere among the 150 proposals.

It‘s worth remembering that these changes are being imposed on the audit industry and companies because of perceived poor quality of auditing and corporate governance. The proposals themselves are the result of audits’ of the status quo. There is definitely an element of irony in the fact that the related measurement of the proposals should be so feebly constructed. If the Financial Reporting Council reviewed the IA with the rigour with which it reviews audits, then a bottom rating would seem inevitable

The whole purpose of an impact assessment is to see if the policies being pushed forward make sense. I expect that those policies will now proceed, regardless of this weak cost/benefit analysis

For the record, I actually think there is a huge problem in implementing the wide-ranging proposals in a reasonable time. Theres simply not enough capacity of audit capability to do so at all quickly. Rushing things will carry very predictable risks

This article first appeared in Corporate Financier, the magazine of the ICAEW Corporate Finance Faculty.

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Jon Moulton is founder and chairman of Better Capital.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.