Discuss about the Importance of Sustainability and Transparency.
The importance of sustainability and transparency has significantly increased over the last two decades which has had tremendous influence on the business practices (Couldridge, 2014-2015). Unlike earlier when the only relevant stakeholder was shareholder and the only important parameter was the profitability generated by the business, now there has been a decisive shift towards the stakeholder model and hence the focus is not only on profits generation but also the sustainability of the same in the wake of the business practices (Hoque, 2017). Considering the users interest in non-financial information besides the traditional information has meant a shift in the financial reporting as the traditional reporting focuses exclusively on financial reporting with little scope for non-financial parameters. Besides, it is also felt in the 21st century, a significant amount of value is contained in non-financial capital related with intellectual and human capital which needs to be reported. However, currently there is a need to capture the non-financial information into the reports which can be shared and more importantly understood by the users (Adams, 2013).
Integrated reporting is a potent tool in this regards as it tends to capture both the financial and non-financial measures of performance. Integrated reporting refers to the corporate communication whereby a periodic “integrated report” is created which outlines the creation of value by the firm over time. As a result, this report outlines various facets of the governance, performance, strategy and prospects related to the firm which potentially would lead to value creation in various time frames (Adams, 2013). The utility of integrated reporting is apparent from the overwhelming response in the IIRC survey where the investors expressed the valuable nature of the integrated reporting since the non-financial information would be captured. In the above backdrop, the objective of this report is to critically analyse the benefits arising from integrated reporting based on available literature besides outlining the underlying challenges involved.
The first key benefit from integrated reporting is that it can bring about a change in the corporate behaviour to make it more inclined towards sustainability. According to King (2011), the starting point of integrating reporting is the realisation by the board and the management about the sustainability risks along with the negative effects that the company operations tend to have on both society and environment. This realisation leads to alteration of the strategy of the company which tends to become more integrated with sustainability of operations. Besides, integrated reporting acts as an enabling tool which allows the board to enhance stakeholder communication in relation to the overall progress and the challenges involved in relation to the operations becoming more sustainable (Armbester et al., 2011).
Another manner in which corporate behaviour change can come about is when the companies start with the preparation of integrated report. Through this report, it is possible that the weaknesses in the current corporate strategy along with the underlying processes can come to light which eventually would lead to bringing about change in the corporate behaviour so as to rectify the underlying situation (King, 2011). This change in corporate behaviour can enable integration of sustainability in the processes and business decision making. As a result, starting from the very top there is an organisation change at every level which stems to the very bottom as there potentially tends to be a shift in the organisational thinking which acts as a harbinger of change towards more sustainable practices which is regularly monitored and reported through the use of integrated reporting (Hoque, 2017).
Corporate reporting is a key aspect of corporate governance which plays a key role in lowering the agency costs related to monitoring and regulation. In wake of the increasing incidence of corporate frauds globally, there has been growing concerns over financial reporting and increasing transparency. Integrating reporting allows for higher levels of reporting and thereby allow higher levels of corporate governance (Simnett et al., 2009). Two key elements of integrated reporting are governance and remuneration. As a result, the integrated report covers these two aspects in detail highlights the broad strategy underlying framework and the link with sustainability. Besides, the report also highlights the decision making mechanism at the top echelons of the organisation. Additionally, the various actions and change brought in the culture and governance policy to make systems and key aspects more compatible with core IR (Integrated Reporting) philosophy are also highlighted through the integrated report. This enables higher information flow from the company towards the shareholders especially in relation to the underlying philosophy of the organisation and key members (Hoque, 2017). Further, unlike traditional reporting where the board has to choose the shareholders over the other stakeholders, IR provides a mechanism where this is not required considering the integrated report caters to the informational needs of a variety of stakeholders. Also, the information shared by the board tends to provide more confidence to the stakeholders in general owing to disclosures about the internal working and overall corporate philosophy driving the business ahead (Adams, 2013).
Integrated reporting also tends to provide an additional benefit in the form of higher engagement with stakeholders which tends to enhance the corporate reputation (Bebbington et al., 2008). In the recent times, the companies have realised the importance of engagement with the stakeholders and have also realised that it should not be through verbal commitments but in the form of reports that can be held as valid evidence. This has led to the proliferation of various voluntary measures being adopted in a bid to engage the stakeholders with not only financial value creation but also highlight the non-financial value creation (IRCSA, 2011). This information enables investors to make prudent information especially the institutional investors that tend to be quite sensitive in relation to any lapses on the corporate governance practices. Further, it is expected that IR would enable the company to deal with sensitive issues considering better transparency and reputation amongst a wider group of stakeholders. Hence, integrated reporting is of high significance in situations where crisis or uncertainty is involved (Serafeim, 2015). As per IIRC and IIA (Institute of Internal Auditors), integrated reporting is essentially a communication tool which tends to lead to higher engagement with stakeholders without the need to prioritise them (TIIA, 2015).
Carrying forward, the improvement in corporate reputation leads to a host of advantages. This can allow the company to attract talented human capital at lower cost, charge a premium for the prices, lower the finance cost and enhance negotiation with host governments for favourable terms (Dhaliwal et al., 2011). The lower cost of capital based on higher organisational transparency has been highlighted by IRSCA (Integrated Reporting Committee of South Africa) (IRSCA, 2011). This declining cost of capital is especially prominent for firms which tend to have low coverage by analysts (Zhou, 2014). This lowering of the cost of the capital leads to higher earnings being reported on account of lower finance costs and leads to stock appreciation which is conducive for investors. Integrated reporting besides improvement in reputation also leads to better management of performance of the company. This is because, IR enables identification of other capitals besides the financial capital (Hoque, 2017). This stems from the fact that integrated report enables identification of these various capitals which are not recognised in traditional financial reporting. Since these are recognised and reported, therefore there are strategic decisions taken in order to manage and enhance the same which in the long run could potentially improve the performance of the company. This is in sharp contract with the traditional reporting which focus only on progress in financial terms and hence do no capture the sustainability of the business (Adams, 2013).
If IR does lead to better performance management of the company by allowing the company to focus on different capitals, then the same should lead to better performance and elevation in valuations. As per Lee and Yeo (2016), it has been found that firm valuation and integrated reporting disclosures tend to have positive association. Further, their research also indicated that firm with high IR tend to outperform the firms with low IR in terms of performance related to stock market and also accounting. As per Zhou et. al. (2017), a negative association has been found between integrated reports alignment level and earnings forecast error which tends to reiterate the importance of IR as a communication tool which is not only helpful to the investors but also the analyst community since it does represent useful incremental information.
Even though there are multiple benefits of IR as have been outlined below, but the adoption of this concept has been slow owing to the various challenges and limitations related to implementation. The first and foremost challenge in relation to IR is the lack of assurance services available. In order to performance audit of financial performance, there is a host of assurance services that are available. But, this is not the case with IR owing to which the reliability and accuracy of these reports could be dubious. This directly stems from the lack of clarity of appropriate reporting framework and accounting standards to capture the parameters of non-financial performance. The IIRC is currently working towards development of a globally accepted framework for IR but there has not been any major breakthrough in this regards (Adams, 2013). Owing to lack of acceptable standards, it is difficult to reliably capture the non-financial aspects. This is also a major reason why the assurance services for IR does not occur as there can be potential liability for the auditors as the user may rely on the integrated reports to make their decisions. Also, the cost factor for providing assurance services in terms of upgrading audit skills also currently remains an unviable proposal owing to limited demand in this regards (Simnett and Huggins, 2015).
Also, due to lack of universally acceptable standards, it is not possible to allow for comparison of performances between two firms which may belong to the same industry and same geography also. Besides, the measurement and quantification of the non-financial metrics and integration with the measures of financial performance is quite a complex task. On the other hand, traditional financial reporting is comparatively more mature and hence can be easily captured (IRCSA, 2011). Further, the data source used for IR may be diverse, inconsistent and unreliable. Also, there are concerns with regards to using the additional information by the users for prudent decision making. In the wake of the above, the potential benefits of IR may be significantly eroded. Additionally, the cost involved in shifting to IR and having the requisite infrastructure in place to obtain the requisite data seems to be a big concern for the relatively smaller firms that do not see much merit in shifting to IR especially when the same is not mandatory as per the current regulations (Adams, 2013).
Conclusion
Based on the above discussion, it would be fair to conclude that there are several benefits related to adoption of IR. One of these is with regards to change in corporate behaviour and decision making which tend to align with the broader objectives Additionally, it is a useful tool for enhancing the engagement with the stakeholders which enables greater transparency, better corporate governance and leads to improved reputation. It is also highlighted that IR adoption could lead to improvement in performance of the company as different capitals are managed well. Besides, the better corporate reputation can lead to lower finance cost, better negotiation and higher stock price.
However, on the downside there are limitations to IR especially with regards to non-availability of assurance services, lack of globally acceptable standard, unreliable data sources which tend to undermine the reliability of IR. Also, comparison of integrated reports across organisation is not possible and further decision making based on the same may be complicated. In the wake of these points, it is apparent that while IR makes sense from the futuristic reporting point of view but there are implementation and supporting ecosystem issues which are present that needs to be sought out through the use of global platforms such as IIRC. Once these limitations and challenges are sought out, it is expected that IR would be transform the financial reporting forever.
References
Adams, C. (2013), Understanding Integrated Reporting: The Concise Guide to Integrated Thinking and the Future of Corporate Reporting. London: DoShorts.
Armbester, K., Clay, T., Roberts, L. (2011), Integrated Reporting: An Irreversible Tipping Point. Accountancy SA, April. p29-31.
Bebbington, J., Larrinaga, C., Moneva, J.M. (2008), Corporate social reporting and reputation risk management. Accounting, Auditing and Accountability Journal, 21(3), 337-361.
Cheng, M., Green, W., Conradie, P., Konishi, N., Romi, A. (2014), The international integrated reporting framework: Key issues and future research opportunities. Journal of International Financial Management and Accounting, 25(1), 90-119.
Couldridge, D. (2014-2015), Investors and Integrated Reporting. Accountancy SA, Volume Special Reports. 32-34.
Dhaliwal, D.S., Li, O.Z., Tsang, A., Yang, Y.G. (2011), Voluntary nonfinancial disclosure and the cost of equity capital: The initiation of corporate social responsibility reporting. The Accounting Review, 86(1), 59-100.
Hoque, M.E. (2017) Why Company Should Adopt Integrated Reporting?, International Journal of Economics and Financial Issues, 7(1), 241-248.
IRCSA. (2011), Discussion Paper: Framework for Integrated Reporting and the Integrated Report. South Africa: The Integrated Reporting Committee of South Africa.
King, M. (2011), Foreword. In Integrated Reporting Committee, (IRC) Framework for Integrated Reporting and the Integrated Report, Discussion Paper. South Africa: Integrated Reporting Committee of South Africa.
Lee, K., Yeo, G. (2016), The association between integrated reporting and firm valuation. Review of Quantitative Finance and Accounting, 47(4), 1221-50
Serafeim, G. (2015), Integrated reporting and investor clientele. Journal of Applied Corporate Finance, 27(2), 34-51.
Simnett, R., Huggins, A.L. (2015), Integrated reporting and assurance: Where can research add value? Sustainability Accounting, Management and Policy Journal, 6(1), 29-53.
Smith, S.D.S. (2015), Effect of Integrated Reporting on Financial Performance, S.l.: An Unpublished Dissertation of DBA: Capella University
The Institute of Internal Auditors (TIIA) (2015), Enhancing Integrated Reporting: An Internal Audit Value Proposition. France: European Institutes of Internal Auditors
Zhou, S. (2014), The capital market benefits of IR. PhD Thesis, University of New South Wales.
Zhou, S., Simnett, R., Green, W. (2017), Does Integrated Reporting Matter to the Capital Market? ABACUS, 53(1), 94-132
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