The Bruce Column – Going for long-term value

  • Robert Bruce Image

19 Sep, 2011

In a season when every headline seems to be talking about financial disaster there is an inevitable relief inherent in anything which focuses on and enthuses about how to achieve the long-term sustainability of business.

This is where the advantages of the discussion paper on integrated reporting, produced by the International Integrated Reporting Committee, (IIRC), strike a chord. But the optimism has to be tempered by some of the paradoxes currently at its heart.

Just take this one section on the benefits it is hoped to create for investors in terms of connected information: 'Integrated reporting makes clear the linkages between the organisation's strategy, governance and financial performance and the social, environmental and economic context within which it operates. It also better aligns externally reported information that management uses for decision-making. This enables investors to assess more effectively the combined impact of the diverse factors that materially affect an organisation's long-term value'.

That is fine. But that is only one user-group. Others in the discussion paper include the reporting organization, policy makers, regulators and standard setters and then a long list of 'others' including civil society, employees, assurance providers and academics. Take any of those and think through what they would want. And then think how, in many cases, those wants would be in conflict with many of the others. The aim may be to move the system a long way from a simple financials-only matrix. But saying it will work for everyone ignores the history of the development of financial reporting, for example. A primary audience needs to be established.

Even the recent history of financial reporting shows that what regulators want and what users want and what standard-setters feel they should be providing are all very different things and are often diametrically opposed. As the Chairman of the IASB, Hans Hoogervorst, observed recently this annoys many 'who believed the accounting should be neutered in order to protect investors from themselves and to avoid the markets from being spooked'.

Sooner or later someone has to decide which of the users is the most important. Without wishing to put a damper on the whole thing a conceptual framework would focus future work, and would provide consistency and comparability from the eventual results.

The discussion paper also attempts to create an antidote to the inexorable growth in the length and complexity of annual reports as they exist currently. The information, by and large, already exists, though not necessarily all in the CFO's inbox. The idea is that integrated reporting could be a way of bringing it all together and putting it into a cohesive structure which people can both understand and draw lessons from. Its intention is not to simply communicate the financial outcomes of the application of IFRS, for example. It tries to put everything into its context and, hopefully, produce a much richer picture. The intention is to communicate value rather than just figures. But again simple human nature suggests that this is not going to finish up a much simpler document. With more inputs people, across the whole range of different users, will all want different outputs. Show an analyst a richer mix, for example, and they will want greater detail and a wider range of ways to look at it.

One of the hoped-for outcomes is that integrated reporting should reveal the odds on the organisation surviving the years ahead. Sustainability is not only about not chopping down trees. It is about being able to limit life-threatening risk and foolish behaviours. The paper talks of several different types of capitals: not just financial, but also manufactured, human, intellectual, natural and social capital. It may sound peripheral to the accountant's mindset. But that is only because the perceptions of that mindset are slow to change. Back in 1973, as one of the discussion papers' charts shows, 83% of market value was represented by physical and financial assets. By 2009 that percentage was down to 19%. That is a huge change which has not entirely been reflected in the thinking around its reporting. Everyone knows that intangible elements have grown. But few have taken on board by quite how much. Perhaps the IASB, in its efforts to re-think its agenda priorities, should carry out a research project on intangibles. That would help clarify the thinking.

Financial reporting has moved a long way towards meeting this change. There is much innovation in terms of risk-reporting, in the effect of reputational risk, and in the costs of non-financial risks. But formally it needs to do more. The quality of existing financial reporting is high. Where the real work needs to be carried out is on the rest of the reporting which would go into the integrated reporting pot. All that needs to be improved and connected to the financial reporting.

The credibility needs to be there, and the pilot programmes planned for the next two years should add to that. Where integrated reporting is still short on the credibility side is in its implementation. There are enough of the global great and the good on the IIRC to enable its thinking to filter effectively into the thought processes of all those around the world who could bring their influence to bear. But, as history shows, that is not necessarily enough. In the end it is legislation that does the trick. The word mandatory concentrates the mind.

You can already see this happening. The latest research report from consultants Black Sun shows the current prevalence of forms of integrated reporting around the world. Analysing some 101 companies across several G20 markets it found that South African corporates scored most highly, 73% of them meeting the key criteria. And the reason is not hard to see. The Johannesburg stock exchange has made it a condition for all companies listing there. But that is still not going to be enough. There needs to be a conceptually thorough process with a standard-setting body involved and if integrated reporting is to include financial reporting the question is whether the IASB should be the body that facilitates this new challenge. But irrespective of what the right answer is for the question of who sets the standards, what is clear is that there needs to be a high quality, internationally accepted framework for this to work.

For the IIRC the most important issue in the short-term is that of creating enough support so that turning integrated reporting into a requirement around the world is something that users genuinely desire and are happy with. In an ideal world, in the words of Paul Druckman, Co-Chairman of the IIRC working group: 'We would like integrated reporting to be picked up and used as the mainstream report voluntarily'. But as he makes clear it can only come when people are convinced. 'If people see it as just being more reporting then it will hit all sorts of barriers', he says. That is only a start. It will have to become mandatory soon after. And that is where the high level encouragement which the discussion paper provides and the pilot programme for companies to take part comes in. 'It is our aim that it will become mandatory', says Druckman, 'but we need everyone, preparers, companies and standard-setters to feel that they are at the right stage of the journey'.

What has been published is a discussion paper. The direction is fine, the momentum is building, but these are still the early easy days of ideas. The detail and the structure need much more practical work before it has a reasonable prospect of success.

The author needs to declare an interest. He was writer to the original connected reporting proposals, which started the integrated reporting ball rolling, a member of the Executive Board of the Accounting for Sustainability programme, and remains a member of its Communications Group.

Robert Bruce
September 2011

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