Integrated reporting and directors’ responsibilities

written by Carol Adams

The International Integrated Reporting Council (IIRC) is set to change the nature of corporate reporting, facilitating sound management and impacting on the work of boards.  It has high profile backers including regulators, the accounting profession, investors, standard setters and NGOs.

Corporate reporting is the primary means by which organisations are accountable for their performance.  The focus of reporting to investors to date has primarily been on bottom line dollars.

Integrated reporting is about to change that requiring organisations to report on their governance and strategy as well as their financial performance and in the context of their internal and external environment – including their workers and the natural environment.

The standard setters involved in the move include those responsible for determining how companies report their financial performance and others concerned with accountability to a broader range of stakeholders on social and environmental aspects of an organisation’s performance.

By changing the way that accountants and boards in particular think about business success and make strategic decisions, integrated reporting has the potential to change the relationship between business, society and the environment.  Climate change and scarce natural resources, for example, all have an impact on the long term success of a business.  Integrated reporting should bring this into focus.

The consultation draft of the international <IR> framework released this month is already causing concern amongst directors with the Australian Financial Review (Shaun Drummond AFR 17th April) quoting directors worried about the prospect of being sued if disclosures on future strategies and business models don’t come true.  It seems a little irrational and the benefits outweigh the risks.

Anticipating resistance the consultation draft states: “…the banner of commercial sensitivity is not to be used inappropriately to avoid disclosure”.

In fact integrated reporting can help Directors in their governance of risk management processes and their decisions about strategy.

Integrated reporting requires the development of processes to identify issues which materially impact on strategy, business model or ability to create value.  Such processes will improve risk management – thereby reducing director risk.  It makes good business sense.

In any case elements of strategy, at least in a broad sense as required by integrated reporting, are already publicly available.  It is the internal capabilities of the various parts of an organisation to work together that gives the organisation its competitive advantage.

The key issues on which integrated reporting is set to change corporate thinking are:

1. Longer-term strategic planning

Whilst the short and medium term aren’t ignored, <IR> stands out from other reporting frameworks in its emphasis on long-term thinking. The requirement to provide information on an organisation’s strategy will encourage senior executives and boards to think long term.

This is a win-win for the environment, society and business.  Short-term thinking has contributed to significant negative environmental impacts which have damaged business reputations.  There are ample examples of companies plundering the environment and abusing human rights to make a quick buck.

2. Focus on the ‘six capitals’

A key innovation of <IR> is the ‘six capitals’ concept.  These are: financial capital, manufactured capital, intellectual capital, human capital, social and relationship capital, and natural capital. In preparing an integrated report, a business recognises that they are all play a role in creating value.  Natural capital includes water, land, minerals, forests, biodiversity and ecosystem health.  The maintenance of natural capital is seen as fundamental to long term business success and integrated reporting requires organisations to report its importance to the business, how they impact on it, and steps taken to maintain it.

Integrated reporting promotes an understanding of the trade-offs that are made across the six capitals in the process of creating value for providers of finance.  This will improve decision making.

Long gone are the days when financially literacy at board level suffices.

Boards need to be ‘six- capital literate’ in order to assess performance, identify risks and develop strategy.

3. Creating value

The concept of creating value by working with a broad range of stakeholders such as workers, customers, local communities and regulators encourages senior executives and Boards to think about performance more broadly than the financial bottom line so that value creation is long term.  Value creation goes beyond financial returns to providers of capital and considers the impact on the other capitals. Integrated reporting encourages senior managers to think about a broad range of stakeholders, relationships and activities that contribute to value creation.

The process of developing an integrated report has many benefits:

  • ‘integrated thinking’ – collaboration across functions to consider the business model and identify trade-offs in the development of strategy;
  • a future focus on strategy;
  • identification of risks to the continued availability, quality and affordability of all six capitals (not just financial capital) which are required to fulfil the strategy;
  • development of systems and processes which will capture all the information needed to make sound decisions.

Issues are defined as material for integrated reporting if they could “change the assessments of providers of financial capital with regard to the organisation’s ability to create value”.  It relies on providers of capital having an understanding of what creates value, being concerned about the long term and communicating this to business.  Reporting on social, environmental and economic sustainability performance will be important in informing investors and others where value is depleted as well as enhanced.

Stakeholders are mentioned in terms of their potential to impact on the ability of the organisation to create value – and not their concerns about organisations depleting value.

But organisations ignore stakeholders at their peril.  Stakeholder engagement is critical to challenging organisational thinking and making this change.

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