Robert Kugel's Analyst Perspectives

The International Integrated Reporting Council (IIRC) recently published a draft framework outlining how it believes businesses ought to communicate with their stakeholders. In this context the purpose of an “integrated report” is to promote corporate transparency by clearly and concisely presenting how an organization’s strategy, governance, and financial and operational performance will create value for shareholders and other stakeholders in both the short and the long term. Such a report aims to address broader needs than only those of investors’ and therefore must be more than a simple extension of a company’s external financial reports, which are aimed at a specialist audience including analysts, regulators and lawyers. Those with long memories may recall that in the 1990s the United States Securities and Exchange Commission (SEC) implemented a “plain English” requirement that replaced then-prevailing legalese with something easier for laymen to understand. But despite this mandate, unless you’re familiar with them, these financial filings can be daunting documents to navigate and understand. Financial filings must conform to a structure defined by regulatory authorities to be all-encompassing and to obey an exhaustive list of requirements that may not be relevant to general readers. Every company required to file financial statements with the SEC, for example, must have a section on mine safety disclosures – even Apple and McDonald’s. Thus the filings contain a mass of information that in its totality may not be useful or even comprehensible to those without formal training in financial analysis. An integrated report can address this unwieldiness, being more concise in presenting details, more discerning in presenting risks and more comprehensive in presenting strategy, opportunities and salient trends in its external environment. The IIRC’s work is still at the draft stage, so it’s hard to know how the design of the integrated report will evolve and how responsive it will be to the needs of companies creating them and people reading them. Its backers recognize that many elements of the concept are foreign to people who are used to creating financial reports to shareholders. Beyond that, however, there are important cultural differences that will make it difficult to gain consistent adoption worldwide. For example, compared to European ones, corporate “stakeholders” have fewer rights (either statutory or by consent) in most countries with an Anglo-Saxon corporate tradition. In some countries and/or industries, employees own their jobs, not just their labor. Companies that are consumer-oriented, depend on government largesse or are heavily regulated must be more sensitive to public perception than those that aren’t. The latter may be far less willing to disclose details of, say, long-range capital spending plans if they consider them proprietary, particularly if their competitors aren’t doing the same. Especially in countries with a litigious tradition (such as the United States), it may be hard for internal legal counsel to sign off on a list of risks and opportunities without copious disclaimers and case law that extends “safe harbor” provisions to these reports. If there is a contemporary SEC filing with a concise risks section, I haven’t found it. And then there’s likely to be an overarching concern about achieving accuracy and comparability between companies’ reports in areas where standards are not well developed, such as in measures of sustainability. Organizations such as the Sustainability Accounting Standards Board (SASB) are in the process of developing these standards, but they are not yet fully available. As we know, corporate reports of all kinds these days depend on information technology. It is for those involved in preparing them to wonder whether their company will need new reporting tools to conform to this reporting framework. In our view, the answer is, Probably not. Corporations will still be using the same sort of data stores, reporting tools, spreadsheets and balanced scorecards that they use now to manage the data that will go into an integrated report. In fact our research into organizations find that spreadsheets are used quite frequently (74%) that I have already indicated the importance of finding alternatives. Yet they likely will need to capture different categories of internal operating data and of external industry and general economic data. Creating such a report would be another use case for “close-to-disclose” software that many organizations are currently using to prepare their financial regulatory filings. As well, companies that create integrated reports should plan on making these available on interactive Web pages, as I have discussed before, not just on paper or static Internet reports. Skeptics may view integrated reporting as just a fad, but there is a real need for it. Management accounting, which looks forward and is designed to serve the needs of executives and managers rather than shareholders, is now an outdated reporting method introduced more than a century ago. Still, it’s not clear that integrated reporting has a bright future. Calls for more socially aware reporting methods in the past have gone nowhere, and this may be the latest futile iteration. The idea is bound to encounter resistance. For the average U.S.-based corporate counsel, for example, integrated reporting may be fraught with terror, since, despite its good intentions, it opens up a potential avenue for lawsuits and attempts by outside groups to hijack corporate governance. In many emerging markets, financial reports to shareholders are far more opaque than in developed ones. It’s not clear how forthcoming their integrated reports will be and how accurate the more difficult-to-audit components will be. Consequently, corporations that are not susceptible to public or consumer pressure may be balk at adopting integrated reporting without a legal requirement and legal protections. That noted, senior corporate and finance executives should continue to monitor the progress of the integrated report to be prepared for changes it could bring. Regards, Robert Kugel – SVP Research

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