The Take

The Argument for Integrated Reporting15/10/18

Integrated Reporting – What is it?

Newly appointed 2019 Competitions Director, Eugenio Mastromattei presents the argument for Integrated Reporting, in this week’s edition of The Take:

In recent times there has been an increasing adoption of Integrated Reporting (IR) by organisations. But what exactly is integrated reporting?

In broad terms, IR communicates how an organisation’s strategy, governance and performance interact and affect the external environment to create value over time. In this article, I will discuss IR more in depth and highlight some of the benefits and shortcomings of IR.

IR provides a holistic view of how companies create value by reporting on six forms of capital: financial, manufactured, intellectual, human, social and relationship, and natural capital. To assist with the preparation of integrated reports, the International Integrated Reporting Council (IIRC) released the IR Framework in December 2013 which contains Guiding Principles and Content Elements. South Africa is currently the only country that mandates IR, and the experience of entities and investors suggests that IR has had huge benefits. An increasing number of organisations are adopting IR and many countries, in particular, Japan, Singapore, Malaysia, India, and the UK are encouraging its adoption.

Why should organisations adopt it?

IR’s increasing adoption trend makes you question why any organisation would voluntarily adopt yet another reporting framework and incur additional costs. However, strong evidence from South Africa proves that IR can have a very beneficial effect from a financial and strategic perspective.

A three-year-study of South African companies found that firms’ valuation is positively correlated to IR disclosures. This positive correlation is stronger in organisations with complex structures and more intangible assets, meaning that the overall information environment is improved and information processing costs are reduced. Additionally, organisations with higher degrees of disclosure performed better in the stock market and in overall accounting performance. Furthermore, better alignment of integrated reports with the Framework reduced costs of equity capital, meaning that investors accept lower investment returns for reduced information risk.

IR not only presents benefits from organisations’ financial perspective, but also from investors’ perspective. IR facilitates responsible decision making for investors by integrating sustainability factors in the investment process. In fact, investors need to understand business models, strategies, opportunities and risks to estimate companies’ ability to create value in the short, medium and long term. This ultimately provides for improved trust relationship with stakeholders and improved corporate reputation.

Another study of South African companies also found a negative correlation between higher levels of alignment of integrated reports with the Framework and errors in analysts’ earnings forecasts, suggesting that IR provides useful and better-quality, future-orientated information.

Lastly, another category of winners under the IR framework are not-for-profit (NFP) organisations. In Australia, NFP organisations struggle to meet reporting requirements which focus on enterprise-like approaches. NFP organisations can benefit from IR as it better captures the activities and forms of capitals (human, intellectual, social and relationship, and natural) that are fundamental to them, but which do not appear in traditional annual reports.

Too good to be true?

So far IR sounds like an extraordinary reporting framework where organisations can only benefit, and it is surprising to see that its diffusion is still relatively limited. So, are there any shortcomings?

IR is criticised for a lack of compulsion. The Framework leaves broad discretion to management on whether to disclose information based on materiality and on whether there are legal prohibition, unavailability of data or competitive harm. In the event of non-disclosure, the entity only needs to provide its reasons, which arguably imposes no obligation on entities. Consequently, this affects the completeness and comparability of reports since firms can omit information.

Several studies also highlight the need of assurance standards in IR. Challenges of assuring integrated reports include the unsuitable criteria of the Framework and lack of consensus over the characteristics, structure and content of a true and fair integrated report since disclosure is highly discretionary. This, in turn, raises liability concerns for auditors and CEOs who fear for personal liability in signing off integrated reports containing forward-looking information. Additionally, another limitation highlighted by South African users is that integrated reports were excessively long, complex, and lacked cohesion between organisational strategy, financial, and non-financial indicators.

Should Australian organisations follow the adoption trend?

It is undeniable that IR has had incredible effects on its adopters: from cheaper cost of capital, to better firm valuation and performance on the stock market, to reduction in costs of information processing. IR has also been welcomed by investors who can use a wider range of information to make decisions, in turn improving trust relationships and reputation of organisations.

Despite these advantages, the reality is that IR still needs development especially in terms of regulations and assurance. For this reason, it may be too early for Australian organisations to mandatorily adopt IR. However, should any Australian organisation voluntarily adopt IR, they can be certain to experience significant ‘first-adopter advantages’ compared to other firms.

If you are interested in writing an article for The Take, contact publications@qutefs.org