Market disclosure is an underappreciated challenge in innovation governance as smaller listed companies grapple with complexities of informing investors about key initiatives.
That is the view of Theo Hnarakis FAICD, former CEO of Melbourne IT and an experienced company director in high-growth private and public emerging companies. He chairs ASX-listed software-as-a-service provider Dropsuite and promising meat-processing start-up Provenir FarmGate MSU; is non-executive director of Tapp Money, a privately owned fintech; and a former chair of listed digital media company Crowd Mobile.
“Meeting continuous disclosure requirements for innovative small listed companies can be challenging,” says Hnarakis. “The board is mindful of the organisation’s disclosure obligations, but determining if a product innovation, customer win or strategic alliance is price sensitive could be difficult, in some cases. The board and management may not know at the time whether an innovation will be material to the share price and thus needs to be disclosed.”
Hnarakis says: “You can end up in a no-man’s land. I’ve seen situations where your company does a deal with a much larger firm that does not want the information released until they are ready, or not released at all. You risk damaging the relationship, which is very significant for the small company, if you disclose the information too early. But you also risk breaching ASX Listing Rules – and getting boards into hot water – if you do not announce the news.”
There are exceptions to ASX Listing Rules about immediate notice of material information; for example, that which is a trade secret or part of an incomplete proposal or negotiation (Section 3.1, ASX Listing Rules). But those and other disclosure exemptions are not always clear-cut for innovative small listed companies and their boards.
Ensuring the organisation issues balanced commentary on innovations is another challenge, says Hnarakis. “In a small listed company, management and the board work hard to raise awareness of the organisation’s progress. You don’t want to understate important news about the company’s growth and potential,” he says. “But if the company overstates the significance of an innovation, and nothing comes of it, there could be backlash from investors who claim continuous disclosure rules were breached and seek to hold the board to account.”
Hnarakis’ view on market disclosure of innovation is consistent with an important recent study on director practices on innovation, “Driving Innovation: The Boardroom Gap,” by the University of Sydney in partnership with the Australian Institute of Company Directors.
Recommendation three of the study said organisations should have a narrative on innovation. “Directors and management should clearly distinguish incremental innovation from disruptive innovation … Agreed language and a clear narrative will set expectations for the executive team, broader workforce, members/shareholders and other stakeholders.”
The study added: “Directors also need to ensure that the communication strategy of their vision is robust and clearly communicated, both by themselves and management. A suggestion that came from several directors was that boards should create a narrative to highlight the importance of investments for transformational innovation, even if that means reinvesting capital that is currently returned to shareholders as dividends. This shift in approach may need to be done as part of a broader conversation on building sustainable, long-term value for shareholders and the need to take greater risks to achieve it.”
The study did not focus specifically on market-disclosure challenges with innovation. But its recommendation that organisations have a narrative of innovation, distinguish between different innovation forms and bring stakeholders on the organisation’s “innovation journey” makes sense for small listed companies.
But such disclosure is not always easy. Announcing organising strategy and potential innovation milestones to the market can be tricky. Disclose too much and the company could give rivals sensitive information about its innovation pipeline; disclose too little and investors could be kept in the dark and continuous disclosure rules breached in some circumstances.
Hnarakis say innovation disclosure is more problematic in small listed companies. “In large companies, you have greater scope to hide innovations when it is not clear if they are material. For example, a potential product innovation in a large corporate may not be price sensitive, so there is less urgency to disclose it to the market. In a small company, a product innovation could be price sensitive so must be disclosed immediately.”
“…there can be problems if the entrepreneurial CEO is too optimistic about the potential of their company’s innovations. They need to understand their organisation’s disclosure obligations on ASX and learn to stand back and tell the innovation story in a fair, balanced and timely manner to the market.”
Disclosure of strategic alliances can be complex, says Hnarakis. “I’ve been on boards where the organisation forms an alliance with a much larger organisation. Board and management cannot know for sure at the time if that alliance will translate into significant sales and whether it will be material to the share price. The alliance is usually a big deal for the small company, but far less so for the large organisation, which might kill the deal quickly if it does not deliver early results.”
Working with CEOs who have low or no investor relations experience can be another governance challenge with innovation disclosure, says Hnarakis. “The board might work with a founder CEO who has taken a private tech company public and has no experience dealing with shareholders in a listed-company environment. The board has a significant ‘coaching’ role with the CEO to help him or her create an investor relations narrative around the firm’s innovation.”
Boards sometimes must rein in entrepreneurial founders. “The start-up CEO’s great strengths are usually their passion, self-belief and willingness to make sacrifices to build a company,” says Hnarakis. “But there can be problems if the entrepreneurial CEO is too optimistic about the potential of their company’s innovations. They need to understand their organisation’s disclosure obligations on ASX and learn to stand back and tell the innovation story in a fair, balanced and timely manner to the market.”
Company resources are another issue in innovation disclosure, says Hnarakis. “Small listed companies, particularly those still in the pre-revenue phase, want to preserve capital. They do not have funds for in-house investor relations experts and lots of legal advice on innovation disclosure. Issuing market announcements on potential innovations can be costly and time-consuming, so management and the board must be clear on whether the news is material.”
Hnarakis says an advantage of small companies is boards can get closer to the innovations. “There is an old governance saying that boards need short fingers and long noses. That is, they need to be looking closely at the organisation without getting involved in day-to-day management. In smaller firms, boards need to be prepared to be a little more hands-on.”
He adds: “Boards I am on spend time understanding their organisation’s innovation pipeline. Directors get a feel for innovations that are more significant than others and will need timely market disclosure, and those that stay under the radar for a little longer. It can be a fine line knowing what the organisation should disclose on innovation, but the challenge is even greater if directors are not close enough to the business.”