The compliance community is going to hear more discussion in coming months about the costs and benefits of compliance programs – for the companies themselves, investors, and the public at large.
Jay Clayton, new chairman of the Securities and Exchange Commission (SEC), gave a speech on July 12 about what his priorities as leader of the SEC will be. He outlined eight principles. Chief compliance officers should make particular note of Principle 7: “The costs of a rule now often include the cost of demonstrating compliance.”
Clayton isn’t wrong to raise the issue. Compliance costs can be expensive, especially for new companies, or companies new to operating compliance programs. The compliance community is going to hear more discussion in coming months about the costs and benefits of compliance programs – for the companies themselves, investors, and the public at large.
So we’re back to the perennial question: How do we articulate the ROI of compliance, and the ROI of an ethical culture generally?
The question is difficult because the costs are concentrated, while the benefits are diffuse. When CFOs grumble about the size of a budget request, or operating executives tally up employee hours spent on compliance training, those costs have dollar amounts attached. So do fees from the audit firm and outside counsel. So do hours the audit committee spends in meetings talking about compliance.
The benefits, on the other hand… Alas, “Think of all those financial restatements and FCPA penalties we didn’t have!” is hardly an impressive argument to CEOs and audit committees. Compliance officers can do better. We can create a better story of value.
Remember What the Benefits Are
Compliance officers can’t defend the benefits of a strong compliance program unless you quantify those benefits smartly.
that damage from restatement is something compliance officers can estimate.
For example, the Sarbanes-Oxley Act (SOX) was enacted in 2002 to improve the reliability of financial statements. Or, to put it another way, the goal of SOX compliance is to reduce the chance of financial restatement – and that damage from restatement is something compliance officers can estimate.
According to financial research firm Audit Analytics, restatements have plunged since SOX went into effect: from 1,853 in 2006, to 671 in 2016. The percentage of companies experiencing a restatement has fallen too, from 12 percent to 6.8 percent across the same decade. The average adjustment to income jumped from $3.5 million in 2014 to $7.96 million in 2016, but that’s more due to a few large restatements skewing the average for a smaller population of restatements overall.
With fairly straightforward analysis, you can model possible restatement costs should your own company experience one. To do that, study the restatements of your peers. See what the adjustment to income was; plus fees to legal and audit firms, as well as the audit committee; plus money paid in shareholder litigation; and so forth. Those costs (and others) are what your company might suffer if it ignores financial controls, processes and policies.
Now consider your costs of compliance per dollar of revenue. Then ask: What might be the costs of restatement per dollar of revenue? That’s one analysis – more precise, more data-driven – to help estimate the costs and benefits of compliance. (It also illuminates how you might drive down costs by consolidating controls, adjusting policies, and so forth.)
And the ROI of Culture
Strong SOX compliance is only the tip of the iceberg. Companies grapple with the same questions for FCPA compliance, antitrust concerns, workplace harassment claims, and more. The costs – for tools, training, assessment, reporting – are clear. The benefits, less so.
Buried in those figures are items like a company’s brand reputation and managerial skill, and organizational trust.
Some correlations can be (and have been) documented. For example, the share price of companies named to Ethisphere’s “World’s Most Ethical Companies” list in 2017 outperformed the U.S. Large Cap Index by 6.6 percent in 2015 and 2016. Companies with a stronger ethical culture have lower employee turnover. They also have better reputations, which attracts more prospective employees, resulting in access to a better workforce.
And at the macroeconomic level, intangible assets and goodwill are becoming a larger portion of the corporate balance sheet over time: from 8.7 percent of all assets in 2012 to 11 percent in 2016, according to research firm Calcbench. Buried in those figures are items like a company’s brand reputation and managerial skill, and organizational trust.
What enhances those items? Dedication to high standards, ethical and otherwise. And as companies keep outsourcing physical assets, such as manufacturing operations or HR functions, management of those third parties will only become more important to a company’s value.
The broader point – one we’ll need to keep fixed in our minds as Washington begins to revisit compliance obligations – is that the ROI of compliance and culture does exist. It can be measured in some ways, and correlated to better business performance in others. And from that analysis, you can find your next move to make the investment worth it.
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