Integrated Reporting: Will It Make a Difference?
Nick A. Shepherd | January 19, 2016 |
The concept of integrated reporting as proposed by the International Integrated Reporting Council (IIRC) offers a sea change opportunity for corporate accountability—but will it make a difference? Will it significantly impact and change the way organizational risk is managed and assessed and decisions are made or will it add costs with few benefits?
The concept of integrated reporting is certainly timely; depending upon traditional financial reporting no longer provides investors with a clear representation of the value of their investment. While an earnings and cash flow statement give some indication of an organization’s net worth, the balance sheet often represents less than 20% of the assets employed to earn income and create an organizations value (See “The Intangible Corporation” and surveys by Interbrand and Brand Finance).
Investors and other interested stakeholders have traditionally depended on a growing patchwork of supplementary reporting to understand areas of risk and sustainability and to provide the additional information they require. This ranges from mandatory environmental reporting in some jurisdictions to triple bottom line reports, corporate social responsibility reports, carbon disclosure reporting, and other approaches. Recent additions, such as the UK Strategic Report required by the Financial Reporting Council, also aim to increase insight. In addition, efforts by the accounting profession have resulted in broadened management commentary in the management discussion and analysis. Each of these brings added administrative work to the organization and also raises the question of the integrity of the information provided.
This is not a new problem; since the Savings and Loan scandal in the late 1980s, the media has asked whether those responsible were asleep at the wheel and if they should have known better. To some degree, management also had a problem in the past trying to make decisions based on purely financial information. The publication of the Balanced Scorecard in 1996 highlighted this. It argued that a broader range of strategic and operational metrics are required to make effective management decisions and understand the relationship between financial performance and process performance, customer performance and relationships, and the development of human skills (learning and growth).
However, many implementations of the scorecard approach failed to make a difference, and there may be some lessons here for adoption of integrated reporting (as an example, see “A Critique of the Balanced Scorecard as a Performance Measurement Tool”). For the scorecard approach, little value was gained if the measures adopted were not linked to strategy and, thus, decision making and alternative choices. If governance and culture weren’t impacted then management failed to gain support for strategic shifts. If financial measures remained dominant, trade-off decisions would be biased toward continued short term benefits. In my 2005 book, Governance, Accountability, and Sustainable Development, I highlight the governance issue and suggested the need to expand the management lessons learned through broader reporting to the level of broad-based governance.
For integrated reporting to make real change it must result in a different set of decisions. If, like many scorecards, the integrated report is either only populated with “available” metrics and/or becomes an end in itself, then it will probably fail in its goal of changing outcomes. Worse still, if the focus becomes one of compliance and audit then it can easily become another costly burden for business that adds little value and fails to impact decision making and corporate behavior. So what is the actual desired outcome of integrated reporting? Certainly not the report itself. The need for an integrated approach comes from a pedigree that includes recognition that:
- financial accountability no longer fully represents corporate accountability;
- an effective organization manages a portfolio of resources in order to operate—one of which is financial capital but also includes human, intellectual, relationship, natural, and manufactured capitals;
- for an investor, there may be unknown risks associated with the maximization of financial returns while other capitals required for sustainability are depleted;
- continuing to treat “externalities” as costs for society to bear is no longer socially acceptable nor feasible for global survival; and
- ignoring intangibles can in fact result in destruction of organizational value, shareholder wealth and sustainable capacity (in this case, intangibles is used in the broader sense than those recognized under GAAP, IFRS, and the US Financial Accounting Standards Board).
So for integrated reporting to be effectively implemented, the metrics developed must be strategic in nature and directly linked to the drivers of organizational value and sustainability. This requires adoption and complete understanding from investors so that as an interested party, they start asking the right questions. In many situations, being asleep at the wheel can be caused by not knowing what you don’t know. If investors don’t understand the interaction of the organizational resources used to create and sustain value, it is going to be hard to support the required strategies for sustainability.
A key challenge for leadership—both managers and investors—will be making the right decisions. Business attempts to operate on a level playing field and, within this, to make decisions that gain a competitive advantage. This in itself is a challenge in a global business environment with a wide range of differing legislative frameworks. Survival is about making the right decisions and balancing financial returns, which drive access to capital with sustainable decisions both for the business and for society. Successful organizations will be those whose decision makers are closest to the societies and communities within which they operate, know the drivers of organizational value and sustainability, and can make fast and informed decisions.
It could be argued that organizations that already have this integrated thinking have no need for a structured approach to integrated reporting as it already forms the foundation of their business model? However recent studies appear to indicate that few companies have yet integrated this approach to explain sustainable thinking.