Despite their reputation in the 1980s as corporate raiders, most private equity firms attempt to improve the performance of their portfolio companies through better corporate governance. But while the G in ESG (environmental, social, and governance) has always been important in the industry, the E and the S have been virtually nonexistent. Private equity has been comfortable seeking returns with little concern for the long-term sustainability of portfolio companies or their wider impact on society. That needs to change, the authors write, because PE has grown so large that society's most urgent challenges can't be addressed without the industry's active participation in the sustainability movement. Having interviewed a large sample of executives who run PE firms and the asset owners that fund them, the authors offer recommendations for how private equity can emerge as a leader in the ESG field--to benefit the wider world as well as its own long-term performance.
We have entered a new era for business in which sustaining competitive advantage requires companies to transform their business models for sustainability. As a result, leaders need a systemic understanding of sustainability challenges-and how their companies can play a part in addressing them. The authors-current and former senior consultants at Boston Consulting Group-introduce the concept of Sustainable Business Model Innovation (SBMI) and the four steps required to achieve it: Expand the business canvas; innovate for resilience; link to drivers of value; and scale the initiative. Many examples of companies large (3M, BASF, PepsiCo) and small (Ajinomoto, Indigo AG, Veolia) that have achieved SBMI are provided throughout. In the end, the authors show that it is not only possible-but increasingly critical-to create social and business value with one business model.
This is an MIT Sloan Management Review article. For decades, companies have used custom metrics that don't conform to generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) as supplements to their official financial statements. Some common non-GAAP measures include adjusted earnings before interest, taxes, depreciation, and amortization (known as adjusted EBITDA), free cash flow, funds from operations, adjusted revenues, adjusted earnings, adjusted earnings per share, and net debt. However, as the authors point out, it's not unusual for these alternative measures to lead to problems. Since companies devise their own methods of calculation, it's difficult to compare the metrics from company to company -or, in many cases, from year to year within the same company. According to the authors, alternative measures, once used fairly sparingly and shared mostly with a small group of professional investors, have become more ubiquitous and further and further disconnected from reality. In 2013, McKinsey & Co. found that all of the 25 largest U.S.-based nonfinancial companies reported some form of non-GAAP earnings. Press releases and earnings-call summaries often present non-GAAP measures that are increasingly detached from their GAAP-based equivalents. In addition to creating potential problems for investors, the authors argue, alternative metrics can harm companies themselves by obscuring their financial health, overstating their growth prospects beyond what standard GAAP measures would support, and rewarding executives beyond what is justified. Board members, top executives, compliance officers, and corporate strategists need to make sure that whatever alternative measures companies use improve transparency and reduce bias in financial reports. Although no standard is perfect, the authors note that GAAP and IFRS standards provide a foundation for consistent measurement of corporate performance over time and across businesses.
In a perfect world, investors, board members, and executives would have full confidence in companies' financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Unfortunately, that's not what happens in the real world, for several reasons. First, financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith. Second, standard financial metrics intended to enable comparisons from one company to another often fall short, giving rise to unofficial measures that have their own problems. Finally, executives routinely face strong incentives to manipulate financial statements. In recent years, we've seen the implosion of Enron, the passage of the Sarbanes-Oxley Act, the 2008 financial crisis, the adoption of the Dodd-Frank regulations, and the launch of a global initiative to reconcile U.S. and international accounting regimes. Meanwhile, the growing importance of online platforms has dramatically changed the competitive environment for all businesses. In this article, the authors examine the impact of those developments and consider new techniques to combat the gaming of performance numbers.
The boom years have made business careless with working capital. So much cash was sloshing around the system that there seemed little point in worrying about how to wring more of it out, especially if that might dent reported profits and sales growth. Today, capital and credit have all but disappeared, customers are tightening belts, and suppliers aren't putting up with late payments. It's time, therefore, to take a cold, hard look at the way you're managing your working capital. If you do, say Insead professors Kaiser and Young, you'll very likely find that you have an awful lot of capital tied up in receivables and inventory. In this article, the authors explore six common mistakes that companies make in this area: managing to the income statement, which can encourage executives to tie up capital in stock and receivables because income statements often fail to include important cost items; rewarding the sales force for growth alone, which makes concessions in the terms of trade more likely, as salespeople look for ways to get customers to buy; overemphasizing production quality, which often results in gold-plated and slow production processes; tying receivables to payables, because even an unfortunate and costly change in supplier terms should in no way be a reason for revisiting the customer relationship; applying bankers' current and quick ratios, which tends to increase the likelihood that a company will face a liquidity crisis; and benchmarking competitors, which can make managers complacent when their working capital metrics are in line with industry norms. Simply correcting these mistakes will release a lot of hidden cash.
Because executive pay policies show very little sensitivity to company value, underperformers often are overpaid, whereas top performers are underpaid.
In the current economic climate, there is tremendous pressure--and personal incentive for managers--to report sales growth and meet investors' revenue expectations. As a result, more companies have issued misleading financial reports, according to the SEC, especially involving game playing around earnings. But it's shareholders who suffer from aggressive accounting strategies; they don't get a true sense of the financial health of the company, and when problems come to light, the shares they're holding can plummet in value. How can investors and their representatives on corporate boards spot trouble before it blows up in their faces? According to the authors, they should keep their eyes peeled for common abuses in six areas: revenue measurement and recognition, provisions and reserves for uncertain future costs, asset valuation, derivatives, related party transactions, and information used for benchmarking performance. This article examines the hazards of each accounting minefield, using examples like Metallgesellschaft, Xerox, MicroStrategy, and Lernout & Hauspie. It also provides a set of questions to ask to determine where a company's accounting practices might be overly aggressive. These questions are the first line of defense against creative accounting. The authors argue that members of corporate boards need to be financially literate.