06 May 2019

Integrated Reporting in a Nutshell

John Wilcox

Integrated Reporting (represented by the symbol ‹IR›) is a long-term issue for companies rather than an immediate concern for the 2019 proxy season. This is particularly true in the U.S., where integrated reporting has been undertaken by only a few companies.

Background

The issues that are driving the integrated reporting movement are already deeply embedded in today’s global financial markets. They reflect the fundamental shift from industrial to service-based economies  in developed countries, where intangibles now represent 80% of companies’ value (up from 20% of their value 30 years ago).* This shift to value creation based on intangibles, technology and intellectual capital is further reinforced by the stewardship principles adopted in recent years by institutional investors (including the giant index funds). The agenda that these long-term investors bring to their oversight of portfolio companies and their proxy voting decisions is increasingly focused on the following issues:

  • Long-term business strategy
  • Sustainability goals
  • Environmental and social policies as well as corporate governance (ESG)
  • Non-financial risk factors and growth opportunities
  • Corporate purpose and corporate culture
  • Human capital management
  • Board composition, accountability and transparency
  • Corporate reporting that presents a fully integrated, holistic picture of the business enterprise
  • Direct engagement with shareholders outside of traditional disclosure and reporting practices
  • Long-term financial performance rather than short-term stock price movements
  • Strategic shareholder activism
  • Stakeholders as well as shareholders

Demand for companies to deal with this agenda will continue to fuel interest in integrated reporting and its underlying principles of integrated thinking and integrated management.

What is Integrated Reporting?

The International Integrated Reporting Council (IIRC), which leads the global movement, defines integrated reporting as:

"[A] process founded on integrated thinking that results in a periodic integrated report by an organization about value creation over time and related communications regarding aspects of value creation."

Integrated reporting brings together material information about an organization’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It provides a clear and concise representation of how the organization demonstrates stewardship and how it creates value, now and in the future.

But integrated reporting isn’t just a reporting process. It’s founded on integrated thinking, or systems thinking. Integrated thinking drives an improved understanding of how value is created and enhances decision-making by boards and management. The more integrated thinking is embedded in daily operations, the more naturally this information will be expressed in internal and external communications. On this basis, integrated thinking and integrated reporting are mutually reinforcing.

The IIRC web site (www.integratedreporting.org) is the starting point for companies considering a move to integrated reporting. Its most important feature is the integrated reporting framework, which explains the fundamental concept of sources of capital and their contribution to financial performance and long-term value creation.

Obstacles to ‹IR›

There are obstacles to integrated reporting that must be considered before the practice can achieve widespread acceptance. The most frequently mentioned concerns are as follows:

  • There is no standard model for an integrated report.
  • Without standardized models, integrated reports lack the comparability that financial market professionals rely on to conduct peer comparisons and calculate relative value.
  • Materiality of environmental and social risks will vary substantially in different industries and require evaluation on a company-by-company basis. Materiality is best determined by the companies themselves, further complicating peer comparisons.
  • Although sustainability metrics have been developed by groups such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI) and others, they are applied differently by different companies and different industries in different countries.
  • Companies’ internal organization and reporting lines often work against integrated reporting.Departmental structures, budgets and specialization can discourage the internal collaboration that is required for effective ‹IR›.
  • Regulation can be an obstacle, particularly in rules-based jurisdictions such as the United States, where communication outside regulatory guidelines can increase liability. South Africa leads on the regulatory front with its requirement for all listed companies to adopt integrated reporting on a comply-or-explain basis.
  • Audit firms are grappling with the question of whether their standards should be expanded to include ESG, sustainability and non-financial risk factors. Pending decisions by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), auditors provide an assessment of these factors in addition to their review of a company’s financial picture.

It is important to recognize that departure from standardized reporting – which may be viewed by investment analysts as an obstacle because it impedes peer comparisons and calculation of relative value – is in fact one of the primary goals that companies hope to achieve through integrated reporting. Proponents of ‹IR› argue that the value of an integrated report outweighs the inconvenience and extra effort it imposes on securities analysts.

Potential Benefits of ‹IR›

Recognizing that the ‹IR› movement is rooted in fundamental changes in thinking, management and culture, proponents of ‹IR› recognize two categories of potential benefits—internal and external. Because ‹IR› is still in an early stage of development, these benefits are largely theoretical, supported by logic more than data.

The potential internal benefits include the following:

  • Improved teamwork, collaboration and elimination of internal silos;
  • Strengthened corporate culture fostering pursuit of a clearly articulated corporate purpose and long-term goals;
  • Deeper involvement of the board in setting long-term strategy;
  • Clear explanation of business strategy that creates unity and efficiencies among disparate divisions and subsidiary operations throughout a company;
  • Greater visibility for the board of directors and senior management leading to closer ties with all levels of employees;
  • Inclusion of stakeholder interests in strategic planning.

The potential external benefits:

  • ‹IR› meets the growing demand from institutional investors for an integrated picture of the business;
  • ‹IR› explains how the company creates value for stakeholders as well as shareholders;
  • ‹IR› rationalizes in business and financial terms a broad range of “hot topics” such as climate change, social issues, boardroom decisions, sustainability;
  • ‹IR› provides substantive content for engagement and governance road shows;
  • ‹IR› increases board transparency and strengthens shareholder support for board policies;
  • ‹IR› encourages proxy voting on the merits and reduces the incidence of box-ticking;
  • ‹IR› reduces the likelihood of a company being targeted by opportunistic shareholder activists.

Conclusion: The future of integrated reporting is closely linked to developments in corporate governance, climate change, social issues, sustainability, corporate reporting, investor stewardship, regulation and the various other issues discussed in this Morrow Sodali series of Issues for Companies in 2019. Our advice to client companies is to keep a close eye on these developments, monitor the activities of leading companies in their home markets and evaluate examples of integrated reporting. If current trends continue, it is likely that obstacles to integrated reporting will be reduced and demand will increase. Over the long term, companies should be able to realize the benefits – both internal and external – from adopting integrated thinking and reporting principles that will enable them to tell their own unique stories to all the audiences they need to reach.

 

*See: https://www.oceantomo.com/intangible-asset-market-value-study/, cited in The Conference Board Working Group Report on Integrated Reporting.

Topics

Issues for companies in 2019 Global