Jean-Marc Huët, CFO of Unilever, recently asked: “What would be the impact on our business strategy and our investment decisions if we factor in the full cost of the resources we’re using?”
His words reflect a broader view in business that, in order to have effective strategies, firms need a more comprehensive understanding of how they make their profits, according to Paul Druckman, CEO of the International Integrated Reporting Council (IIRC).
“To do so, they need to broaden the scope of their reporting structure to include more than financial information,” he says.
To this end, the IIRC has launched a pilot programme involving more than 90 organisations, including Coca-Cola, Tata Steel, Hyundai and CIMA, and over 30 institutional investors.
Druckman argues that efficient markets depend on a regular flow of accurate information. There is a growing recognition that firms aren’t well equipped to explain the factors affecting their creation and preservation of value in the short and longer term.
“Reporting has in some cases been reduced to a compliance exercise leading to ever more complex, lengthy documents that fail to show how the company’s strategy and business plan create value,” he says.
“We need a framework that enables a business to express its value-creation process clearly and concisely. Integrated reporting (IR) is just such a framework. It is designed primarily for investors and is being driven by their demand for more value-relevant information. It also fulfils a wider need in business to think across silos.”
IR is part of the broad trend towards openness in business after the financial crisis. “This movement is coming from political leaders and is mirrored by those at the forefront of business,” Druckman says.
“The G8 is focused on transparency. IR supports this, as it puts awareness of an organisation’s strategy, business model and capitals at the heart of reporting.”
Political leadership undoubtedly has an impact on what businesses want from corporate reporting, he argues.
“President Obama’s call for extractive industries to be clearer about where they create profits is important and it’s caused a rethink for many in the sector. The extractive industries are one of the IIRC pilot programme’s most active sectors, as many of these companies are conscious that, in order to improve stakeholder relations, they need to communicate better, especially in light of recent high-profile incidents,” Druckman says.
“Oil and gas is a sector that has in the past been labelled as dirty – it has negative impacts on the resources and capitals it uses. When these organisations tell their stakeholders how they use the capitals available to them to create value now and in the future, we will all benefit.”
Institutional investors are becoming strong advocates of IR. For instance, Aled Smith, fund manager at M&G, recently said: “My strategy is based on the observation that a lot of companies are making good long-term investments that may hurt their short-term cash flow. Investors often overlook these companies because they shun volatility.”
Druckman thinks that many investors are realising that short-termism actually creates volatility and contributes to financial instability, which in turn erodes long-term value.
“To move away from this, investors are seeking to increase their knowledge of the businesses they invest in,” he says. “To make decisions for the short, medium and long term, a finance provider needs an understanding of, and confidence in, their business models as well as a better view of how value is created over time.”
This is evident from the 50 or so institutional investors that have got involved directly with the IIRC, working on an international IR framework that should enable businesses to give them better information.
Steve Waygood, head of sustainability, research and engagement at Aviva Investors, recently said: “A significant number of investors are looking at non-financial issues that are longer term in nature and will materialise in the cash flows of the company, so are relevant to the valuation.”
Technology will play a key role in the adoption of IR, according to Druckman, referring to the report issued last year by software giant SAP.
“It has used its own software to weave together financial and non-financial information, making clear connections between various sections of the report and showing the interdependencies. With a ‘key facts’ page giving lucid and concise explanations of how these factors affect each other, it has used innovative ways to present information that wasn’t previously reported in order to tell its unique story of value creation.”
He continues: “Tangible and intangible information, or the capitals as we refer to them, are at the core of this. Advancements in technology that secure material information helps IR and helps to promote its worth to businesses. It is important to highlight, however, that IR is not about more reporting; it is about better reporting. Although improvements in technology have meant that companies can collect more information, IR is concerned with how they use this information and present it in a comprehensible way to stakeholders.”
Companies that are interested in being more innovative with their reporting, using it as a force for improvement both internally and externally, should consider the resources and evidence arising from the IIRC’s pilot programme, according to Druckman.
“These elements include the Pilot Programme Yearbook 2012 and ‘Building the business case for integrated reporting’,” he says. “They outline the benefits that businesses have had so far on their journey towards IR.”
Quick on the uptake
Druckman says that the IR concept was adopted in a wide range of sectors during the period of consultation on the IIRC’s draft reporting framework, which ran for three months from mid-April.
The industries that took the most interest tend to be less well understood by investors and wider stakeholders, he reports.
These include financial services, utilities and the extractive industries, which particularly need to be able to tell their story of value creation over time in a clearer, more concise way.
IR’s unique selling point is that it is market-led – that is, it’s created by the business and investor communities for the business and investor communities, stresses Druckman, who lists some of its main identified benefits:
- Establishing the basis for a more meaningful engagement with investors. IR helps a firm to fulfil its stewardship role by placing the strategy and business model at the centre of communications, better articulating the investment case.
- Breaking down silos. As Bob Laux, senior director of financial accounting and reporting at Microsoft, says: “IR provides a holistic method for explaining how the organisation is doing and how the management thinks it will do in future. It takes into account the connectivity and interdependencies between the range of factors that have a material effect on an organisation’s ability to create value over time.”
- Disclosing more than financial information alone. There is a growing understanding among all stakeholders that, in order to convey a full story of value creation, all resources and relationships need to be considered and communicated.
- Conveying information clearly and concisely. As Russell Picot, group CFO at HSBC, notes: “Investors are frustrated by the challenge of unravelling hundreds of pages of material. At the moment reporting has a very heavy compliance burden. Sometimes that gets in the way of good communication.”
- Focusing on the future. Currently, most of the information available to investors is historic. They are required to navigate a course around the next corner with only a rear-view mirror, as if there were no road ahead. IR serves as the road map that supports investment decision-making. Citing a study by the Black Sun consultancy of the behavioural effects of IR among the companies involved in the pilot programme, Druckman says 98 per cent of them believe that the shift towards IR should lead to a better understanding of how their businesses will create value over time.
DRUCKMAN ON THE GLOBAL ADOPTION OF IR
“The countries that are leading on the journey towards IR are doing so for a variety of reasons, but generally it’s because the culture and future of business in these countries – for example, the G8 nations that are calling for a focus on transparency – match the principles of IR.
“Moving to IR promises to offer any country that adopts it a competitive advantage. As Magnus Böcker, chief executive of the Singapore Stock Exchange, says: ‘We support having a continued discussion on IR, as we want to participate to help share the future.’
“I recently visited Australia, a key territory for creating awareness and promoting IR, because the country will in 2014 take on the presidency of the G20, where there is a keen interest in IR as one of the supporting themes for work on transparency. Japan’s Ministry of Economy, Trade and Industry has established a corporate reporting laboratory to examine how reporting can support long-term investment. And the Asia Pacific Economic Co-operation Business Advisory Council is seeking to establish whether IR could significantly accelerate long-term investment in strategically important sectors, including infrastructure and energy financing.
“Policy-makers in the EU have also taken steps towards IR, with Michel Barnier, European commissioner for the internal market and services, stating: ‘We are following with great interest the evolution of the IR concept.’
“South Africa is the best example of early adoption. The Johannesburg Stock Exchange has committed to having IR as a listing requirement as soon as we at the IIRC publish our international reporting framework. South African businesses are already required to produce integrated reports under the country’s King III corporate governance code.
“With our pilot programme operating in 25 countries, the move to take up IR is widespread, yet there are certain regions where there are problems. In America, for example, there are perceived inconsistencies between IR and restrictions on reporting on future activity. There are also certain regions that we have yet to reach, such as the Middle East, where corporate reporting in the main isn’t at a stage where it can develop into IR. But organisations such as the Pearl Initiative, a private-sector-led not-for-profit organisation established to improve transparency, accountability and business practice in the Arab world, are laying the groundwork for the introduction of IR.”
Illustration: Tomi Um
The whole story (so far)
- Business ethics 
- Career talk 
- Corporate finance 
- Law and regulation 
- Management accounting 
- Networking and social 
- Professional development 
- Reporting and Governance 
- Risk management 
- Strategic management-economics 
- Studying CIMA 
- Sustainability 
- Technology 
- Studying Exam E1 
- Studying Exam E2 
- Studying Exam E3 
- Studying Exam F1 
- Studying Exam F2 
- Studying Exam F3 
- Studying Exam P1 
- Studying Exam P2 
- Studying Exam P3 
- Studying Exam T4 
- Studying Exam C02 
- Studying Exam C03