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Is Integrated Reporting Really the Superior Mechanism for the Integration of Ethics into the Core Business Model? An Empirical Analysis

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Abstract

This paper examines the impact of integrated reporting (IR) on the integration of environmental, social, and governance (ESG) issues into the business model and the related economic and ESG performance changes. To investigate these internal and external transformational effects of IR, important differences between IR and alternative ESG reporting strategies are worked out. Using three matched samples of companies from around the world for the sample period 2002–2011, IR companies are matched with companies applying (a) no ESG reporting, (b) stand-alone ESG reporting, or (c) ESG reporting in the annual report. The results suggest that IR is a superior mechanism only for the integration of ESG issues into the core business model when comparing IR with the ESG reporting strategies of (a) no ESG reporting and (c) ESG reporting in annual reports. In comparison with (b), stand-alone ESG reporting, the results indicate that IR is negatively associated with the ESG integration level and with the economic and ESG performance. Moreover, this negative impact is lower for companies that have already implemented ESG management tools prior to the initiation of IR and is stronger for companies residing in countries with legal requirements for the disclosure of ESG information. A separate change analysis reveals that companies do not benefit from a switch from stand-alone ESG reporting to IR. Thus, this paper provides empirical evidence that contradicts the general notion of IR as a superior reporting mechanism, as the benefits of IR are driven by several factors.

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Notes

  1. The International Integrated Reporting Council (IIRC) (previously the International Integrated Reporting Committee) was formed in August 2010 by the Prince’s Accounting for Sustainability Project (A4S) and the Global Reporting Initiative (GRI). The chairman and CEO of the IIRC are Professor Mervyn King and Paul Druckman, respectively. The IIRC brings together a cross section of representatives from civil society and the corporate, accounting, securities, regulatory, NGO, IGO, and standard-setting sectors (IIRC 2010).

  2. In line with previous literature (e.g., Eccles and Krzus 2010), the term stand-alone ‘ESG report’ is used as a synonym for stand-alone sustainability report, corporate social responsibility (CSR) report, triple bottom line report, corporate citizenship (CC) report or other similar terms.

  3. The terms ‘non-financial information’ and ‘ESG information’ are often used interchangeably throughout this paper. Although (per definition) non-financial information additionally comprises information about intangible assets and key performance indicators (KPIs), it seems justified to equate ‘ESG information’ with ‘non-financial information’ because responsible and sustainable business management without the consideration of these two subcategories is not possible.

  4. The recently published empirical study by Churet and Eccles (2014) analyzes the relationship between IR and both the quality of management and financial performance. Hence, their proxy for IR relies on a systematic search of RobecoSAM (asset manager) within annual reports (FY 2011 and 2012) for “management decisions to include, in the main section of the annual report, specific examples of sustainability initiatives and how they impact financial performance” (Churet and Eccles 2014, p. 57). Their findings suggest a significant and positive relationship between IR and the quality of management with regard to ESG issues, but no significant relationship between IR and financial performance. Therefore, their study is fundamentally different from this paper in several ways. First, in this paper, the most direct link is used to measure IR: the integrated report itself. Second, Churet and Eccles (2014) use an ESG score to measure the management quality. This does not constitute a direct internal management measure. This paper strongly differentiates between these two characteristics. Therefore, multiple internal and external proxies measure each of the two dimensions separately, namely the internal management and the ESG performance. Third, Churet and Eccles (2014) measure the financial performance via return on invested capital (ROIC), while the economic performance of the company that is used in this paper represents a company's capacity to generate sustainable growth and a high return on investment through the efficient use of all its resources (ASSET4 database).

  5. For example, Arnold (2012) analyzes in an experimental setting whether the disconnect between financial statements and ESG reports leads to an anchoring effect in the company valuation process. Therefore, participants either received financial and non-financial information separately and successively or simultaneously in an integrated report. They find that financial statement users asymmetrically anchor themselves on their financial value judgments provided that ESG information is given by a stand-alone report (Arnold 2012). Thus, an integrated report may correct distorted valuations.

  6. The Integrated Reporting Committee (IRC) of South Africa was established in May 2010 to develop guidelines on good practice in IR. The founding organizations are the Association for Savings & Investment South Africa (ASISA), Business Unity South Africa (BUSA), the Institute of Directors in Southern Africa (IoDSA), JSE Ltd, and SAICA (The South African Institute of Chartered Accountants). The IRC is chaired by Professor Mervyn King.

  7. In February 2010, the principles of the King Code of Governance of 2009 (King III) were incorporated into the Johannesburg Stock Exchange‘s listings requirements. King III recommends that companies adopt IR and prepare an integrated report. Consequently, the obligation of JSE listed companies to apply the King III principles includes the call for companies to prepare an integrated report or explain their reasons for deviating from them for financial years starting on and after 1 March 2010 (Integrated Reporting Committee (IRC) of South Africa 2011).

  8. The following guiding principles shall be applied individually and collectively for an integrated report’s preparation and presentation: strategic focus and future orientation, connectivity of information, stakeholder relationships, materiality, conciseness, reliability and completeness, consistency, and comparability (IIRC 2013b). The following content elements shall provide a rough draft of how an integrated report could be structured: organizational overview and external environment, governance, business model, risks and opportunities, strategy and resource allocation, performance, outlook, basis of preparation and presentation (IIRC 2013b). Additionally, these content elements imply consideration of the underlying general reporting guidance. When the information is presented, the connection between the content elements should become apparent (IIRC 2013b). Consequently, the content of an integrated report depends on the individual information needs of the company, and they can therefore differ from each other (IIRC 2013b).

  9. Although external reporting tends to serve the information provision to external stakeholders in the first place, it can also have a great impact on the internal decision making. Revenue recognition and earnings management are common examples in financial reporting (Eccles and Serafeim 2014). For instance, new information from better corporate reporting strategies puts internal stakeholders (e.g., board members, executives, managers, employees) in the position to actively influence the daily business of the company and make internal transformational processes possible. In this paper, the focus is on this ‘internally-driven transformation.’

  10. The presentation of information in financial and annual reports is often very complex and therefore difficult to understand for stakeholders, especially for those who are not familiar with financial accounting measures and figures. For this reason, the impact of a company’s economic strategies and activities on stakeholders could be misunderstood without a connectivity of information, as most of the financial information is presented on a historical basis. This backward-looking orientation of financial reporting can be understood as a ‘rear-view mirror’ of the company’s performance (Serafeim 2014). In contrast, non-financial information “can provide insights into the company’s expected future financial performance” (Serafeim 2014, p. 3).

  11. The international IR framework defines a matter as material “if it could substantively affect the organization’s ability to create value in the short, medium or long term” (IIRC 2013b, p. 33). Therefore, an integrated report should be a communication tool that reflects relevant and material information in a superior conciseness.

  12. The problem of voluntary initiated and occupied assurance services is obvious: ESG reports receive almost exclusively negative assurance (e.g., ‘nothing came to our attention…’) rather than positive assurance (e.g., ‘in our opinion…’) that is more investor-useful (Eccles and Serafeim 2014; Serafeim 2014; Eccles and Krzus 2010). Third-party assurance of ESG reports largely varies in scope, depth, and frequency, so that “report readers would often have great uncertainty in understanding how the assurance provider undertook the engagement, what they reviewed, [and] what […] the meaning of conclusion [was]” (Deegan et al. 2006b, p. 368). The results from Perego and Kolk (2012) support this view by finding great variability in the adoption of assurance practices. Thus, the diversity of assurance standards and the type of assurance provider seem to shape the quality of ESG assurance statements, limiting the effect of trust and credibility that an assurance statement should actually have (Perego and Kolk 2012).

  13. This is in line with findings by Serafeim (2014). Serafeim (2014, p. 12) finds that “integrated reports are filed on average 22 days earlier after the end of the financial year than sustainability reports.”

  14. In this sense, it is essential to highlight the difference between ESG reporting and ESG performance. As assurance on ESG reports can be chosen independently; the information contained in the reports does not necessarily need to be truthful (Simnett et al. 2009). Stand-alone ESG reports can be misused as ‘advertising brochures’ hiding the true ESG performance of the company. By creating a new picture via ‘window-dressing’ or ‘cheap talk,’ it is possible to influence, or rather manipulate, stakeholders’ external perceptions and evaluations (Marquis and Toffel 2011, 2014). Building corporate reputation and gaining external legitimacy can be the primary reason for a company to engage in ESG issues and their reporting (Simnett et al. 2009; Bebbington et al. 2008; Cho and Patten 2007; O’Dwyer 2002, 2003). Empirical findings even indicate that ESG reporting can be coupled with an intent to negotiate and control the ESG agenda (Larrinaga-Gonzales et al. 2001).

  15. Most of the following arguments can be transferred to the reporting strategy of including non-financial information in the annual report. For instance, because the non-financial information within annual reports is illustrated under certain sub-sections, the missing link between financial and non-financial information also promotes an isolated view and evaluation. Furthermore, the piece of non-financial information in the annual report is not subject to audit.

  16. The economic definition of externality, namely, external effects, is very narrowly defined as “the activity of one individual [that] externally affects the utility of another individual” (Buchanan and Stubblebine 1962, p. 381). When the term externality is used in this paper, it refers to the product or consequences resulting from IR that can affect both related and unrelated parties. This extended understanding takes into account the general character of ESG issues.

  17. The business model of financial institutions such as banks, insurance companies, and finance companies is fundamentally different. Therefore, ESG reporting and management practices are not likely to be applicable or material to them (Eccles et al. 2013).

  18. In the matched samples, the countries with mandatory ESG reporting are Brazil, France, Ireland, Malaysia, Netherlands, South Africa, and the United Kingdom. Countries without mandatory ESG disclosure requirements in the sample are Australia, Austria, Belgium, Hong Kong, Japan, Mexico, Portugal, Singapore, South Korea, Spain, and Switzerland.

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Acknowledgments

The author thanks the editors and the anonymous referees for helpful comments and suggestions. The paper has mainly benefited from the 18th International Symposium on Ethics, Business and Society at the IESE Business School in Barcelona, Spain, 2014. Thanks also go to the 2015 International Accounting Section Mid-year Meeting of the American Accounting Association.

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Maniora, J. Is Integrated Reporting Really the Superior Mechanism for the Integration of Ethics into the Core Business Model? An Empirical Analysis. J Bus Ethics 140, 755–786 (2017). https://doi.org/10.1007/s10551-015-2874-z

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