For the past couple of decades, annual reports have been afflicted by a growing problem.
Indeed, audited annual reports of listed companies in the UK are, on average, more than twice as big as they were in 1996, according to Deloitte UK.
The growing length, often accompanied by increasing complexity, has undermined the reports’ effectiveness. And that’s no longer acceptable, according to corporate reporting and sustainability experts who gathered in Amsterdam recently for a conference on the International Integrated Reporting Council’s Integrated Reporting Pilot Programme, which recently celebrated its first year. The programme is using input from about 75 companies to help the IIRC shape its integrated reporting framework due out in 2013.
Corporate reports should be driven by proactive integrated thinking and decision-making rather than compliance requirements – a change from today’s corporate reporting regimes that produce reams of reactive information with limited value, experts said at the conference.
And that’s the essence of the integrated report, whose aim is to provide meaningful, forward-looking information on how a company creates and preserves its value in the short, medium and long term.
Businesses have found that stretched finance teams, corporate silos and the intricacies of linking non-financial data to strategy are among the main challenges in introducing integrated reporting regimes. But overcoming those hurdles could help companies better plan further into the future – and change the mindset of investors.
“In recent years investors are becoming more short term,” says Susana Peñarrubia Fraguas, a senior investment manager on European equities at DWS Investments. “As soon as you have connectivity the long term focus will return.”
Many executives say investors’ short-term focus is affecting the ability of companies to take a long-term perspective to achieve sustainable value creation – a dilemma caused in part by how companies currently report, according to findings in the CGMA report Rebooting Business, which surveyed 280 CEOs from at least 21 countries.
Seventy-six per cent of respondents think the current reporting system promotes excessive focus on the financials, and 75% see the need for more emphasis on measuring non-financial value.
Finding the right balance
Which metrics should be included in an integrated report is still up for debate. “Our intention is to make the framework extremely flexible, while pointing to the metrics that companies may want to use,” says Paul Druckman, chief executive of the IIRC (at right).
Finding the right balance is important, he said, because if the framework is too flexible, reporting will not be comparable, whereas if the framework is too prescriptive, reporting becomes a compliance-based exercise that does not provide meaningful, forward-looking information.
This balance could also determine the take-up of integrated reporting worldwide. At a time when many in the corporate reporting food chain are calling for simplification, keeping reporting concise and to the point will go a long way into determining its success.
So, too, could regulation. Only South Africa has enshrined integrated reporting into regulation, albeit on a “comply or explain” basis with mixed results. The take-up has been strong in the mining and finance sector but weak elsewhere.
Experts from within business believe integrated reporting should be voluntary for now and market pressures will eventually force regulators into legislating it in the future, but this may not happen as rapidly as some proponents hope.
Regardless, the small steps being taken by pilot programme participants today may become giant strides for business, corporate reporting and investors in the future.
Lessons from the “journey”
Pilot organisations are at various stages on what they fondly describe as their integrated reporting “journey”. During the conference, representatives from many of them offered tips based on lessons learned along the way. Among them:
Expect some hurdles: Christoph Dolderer, director of accounting and taxes at one of Germany’s largest utilities, EnBW, says getting buy-in from the board and other business departments proved to be the company’s biggest challenge when embarking on its integrated reporting project almost a year ago.
“If you want to change something, you have to show [other departments] that what we did in the past was not very good,” he says. “It’s obvious after the financial crisis that you have to change something in corporate reporting.”
EnBW plans to publish an integrated report in 2015. This year, the firm will combine its annual report and its sustainability report into a single report. The company’s motivation to take part in the pilot programme stems from a need to change corporate reporting in Germany, which is voluminous, hard to understand and “doesn’t meet all of the expectations of the stakeholders,” Dolderer says.
Another reason is that the German energy industry is about to go through a shake-up that will change the business models of the major energy providers.
“There is a political decision in Germany to shut down nuclear power plants and 50% of the electricity production from EnBW Group came from nuclear power plants,” Dolderer says. “It’s a big change for us – a redefinition of our business model to focus on renewables. If you change your business model, you have to change your corporate reporting.”
Watch out for risk: Laura Palmeiro, vice president of finance and nature at French food producer Danone, says that a challenge for most companies to grapple with is disclosing forward-looking information that doesn’t expose them to risk.
“When you are doing investor relations, you have certain rules about what you can or cannot say, and you must be careful not to make too many promises because there are legal aspects and liabilities that could arise from that,” she says. “Also, there are certain things that a lot of investors would like to know, but that your competitors would also like to know.”
Palmeiro believes that uniformity in the way that some comparable data is reported could help encourage transparency.
“Because there is no such thing as one unique methodology for measuring emissions for a product, then none of the competitors want to show the amount of CO2 that one bottle of mineral water has, and it’s understandable,” she says. “… We want to be sure we are being measured with the same ruler.
Palmeiro says Danone, which has been publishing sustainability reports since 2003, has a rating of 97 out of 100 in the carbon disclosure project that measures carbon transparency. The next step in its integrated reporting journey is to link the reporting of some parts of sustainability, particularly social aspects, with financial performance.
It is the linking of strategy to reporting for companies that want to become integrated thinkers that is a precursor to producing integrated reports.
“It should be easier for us because we already have an integrated strategy,” Palmeiro says.
Integrated “thinking” drives reporting: “Integrated thinking” is one of the main challenges pilot programme organisations have faced in the first year.
“It tends to be the board or the CEO who has an overview of the business, but as soon as you go down into [lower levels of] management and junior people, they are stuck in their individual silos,” Druckman says.
Tai-Hong Fung, CPA, Microsoft’s senior manager of corporate accounting in the US, says that integrated decision-making and connecting data to strategy is essential in making reports meaningful.
“When management is visiting us, we try to see what are the key priorities within sustainability and why are they important for the company,” she says. “We really see that most of this information is not very well integrated into the strategy of the company. If we try to integrate ESG (environmental, social and governance) factors into our current securities selection analysis and we see management is not integrating these factors into the strategy – not putting any kind of connectivity between these factors and the way they are running the company – then, for me, it does not have any value.”
Focus on what’s material: One way of reducing the reporting burden is by focusing on materiality. Investors have called for annual reports to clearly identify material risks, and the financial and strategic implications of all capital. Organisations in the pilot programme are still trying to determine which issues are material to stakeholders.
“It’s what makes sense for your business,” says Palmeiro of Danone, which makes products such as yogurt, baby foods and mineral water. “As a food company, our sources for the foods that we prepare all come from nature. So we have to take care of these resources, make sure they are not polluted and will be sustainable for many years, otherwise our company will suffer. That is an example of something that is very material for us.”
EnBW, meanwhile, is reaching out to shareholders and investors to determine what is material. Materiality should allow companies to focus on reporting on what matters most to stakeholders in the integrated report, but it is not a one-size-fits-all approach.
“The integrated report will be the primary format to publish information, but besides that you can have other information put up on your website,” Dolderer says.
Additional CGMA resources:
“How to assess the impact of climate change on your organisation”: Adapting to environmental factors including those related to climate change will affect how you compete in a changing economic landscape. This tool provides a mechanism to record where further action needs to be taken and provides a basis upon which a climate change strategy can start to be formulated.
“How to drive value from sustainability performance management and the CFO's role”: Based on a report produced by CIMA in association with Accenture, this tool is intended to assist those implementing a sustainability strategy to define their role in performance managing the sustainability of their organisations.
“Enhancing value through sustainability: Tips for the finance team”: Finance professionals can expect to play a bigger role in sustainability reporting, says Stephen T. Starbuck, CPA, the Americas leader for climate change and sustainability services at Ernst & Young, who offered some tips for the finance team at the AICPA’s International Business Conference in Washington.
“P&L pioneer”: German sports apparel maker Puma is the first major company to quantify and report the monetary cost of its environmental impact in a formal profit and loss statement. The company’s chairman and chief executive explains the rationale and business benefits.
“Three views on integrated reporting”: Could integrated reporting be the way the world’s large corporations communicate with investors in the future? We asked an investor, a preparer and an advocate for their takes on integrated reporting.
CIMA and AICPA active in integrated reporting efforts
By Arvind Hickman and Ken Tysiac
The Chartered Institute of Management Accountants and the American Institute of CPAs, who partnered in the creation of the CGMA designation, have been active in integrated reporting efforts.
CIMA plans to combine its financial and sustainability reporting for this fiscal year. One of the driving forces behind its integrated reporting programme has been CEO Charles Tilley, FCMA, CGMA, who is chairman of the IIRC’s technical task force and is a long-term advocate of better corporate reporting.
CIMA participates in the IIRC’s pilot programme and has been measuring aspects of its environmental, social and governance (ESG) factors, making the journey to integrated reporting more of an evolution rather than revolution.
“There were lots of things going on within CIMA that would contribute towards an integrated report, but were not being brought together and linked in our annual report,” says CIMA’s head of corporate reporting policy, Nick Topazio, ACMA, CGMA. “So the integrated part is what we need to move forward.”
The real benefit to introducing an integrated reporting regime is not so much the reporting, but the integrated decision-making within the organisation itself, Topazio says. “That’s what helps to create the value, while the reporting helps disseminate the message.”
CIMA also has a leadership role in the IIRC’s business model work stream.
The AICPA has been involved in enhanced business reporting and sustainability efforts since the early 1990s. While pushing for greater involvement by CPAs in sustainability, the AICPA is supporting the IIRC’s mission and advocating for a voluntary, global, best-practices framework for integrated reporting.
In addition, the AICPA is leading the materiality work stream of the IIRC, as integrated reporting requires an assessment of what is material just as financial reporting and sustainability reporting do. The AICPA also has served as host to IIRC roundtables and sponsor of a meeting for U.S. companies participating in the IIRC pilot programme.
Annual reports have focused only on entities’ financial results for too long, Susan Coffey, CPA, CGMA, AICPA senior vice president for public practice and global alliances, said in a comment letter to the IIRC late last year. Coffey said the financial reporting model currently in use was not designed to describe business models companies follow now that rely heavily on deploying intangible assets to create value and drive profitability.
“It is important to achieve integrated reporting to provide stakeholders with the information that is indicative of current and future value creation potential,” Coffey said in the letter.