Nick Shepherd 30 Jan 2019 02:11pm

Why poor integrated reporting is pointless

Is a failure to grasp the potential of integrated reporting resulting in wasted effort?

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Caption: There is no real audit of this information

Many organisations are starting to invest significant time and effort into improved communications with investors and the public, using broader metrics and frameworks such Integrated Reporting (IR). To what degree is this really adding value – particularly for investors who seek to better understand their risk related to protection and growth in capital and continuity of earnings?

Some would argue that the effort is wasted. There is no real audit of this information and much of it fails to explain the integrity of the system or business model that the organisation uses to create its own value.

Here is the problem; integrated reporting still owes much of its heritage to Corporate Social Responsibility (CSR). While this is laudable from a changing societal risk impact, it fails to address the shift in resources used by organisations.

Thirty years ago, 80% of corporate value – what investors were willing to pay for a stock – was represented by financial capital. Thus, audits and reporting that focused on financial capital usually did a good job of informing shareholders and regulators of an organisation’s health and sustainability.

Today on average only 20% of a shareholder’s value is represented by financial capital – 80% by non-financial “value.” Yet when organisations fail, the auditors and the accounting profession seem to be front and centre. Remember – accounting is not accountability. Many organisations that have adopted integrated reporting focus on environmental and community related social aspects. These are helpful but not adequate for determining overall business risk.

A recent article in Fortune magazine, “An Evolve-or-Die Moment for the World’s Greatest Investors” by Adam Seessel illustrates that even Warren Buffett – who has a broad due diligence approach, using more than financial health to evaluate investment opportunities – has identified the need to change approaches to understanding “asset light” organisations.

Others, such as Black Rock CEO Laurence Fink have been leading the charge for much greater understanding and disclosure of organisational health. In his last annual letter to CEO’s he talked about the importance of all stakeholders and suggested that “companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate”.

The IR business model and reporting framework suggested by the International Integrated Reporting Committee (IIRC) and endorsed by A4S (Accounting for Sustainability) provides a great approach that adds five additional capitals to the traditional financial capital – these being natural and social relationship (embracing much of the historic CSR requirements) but also human capital, manufactured capital and intellectual capital.

However even the IIRC, which tracks leading practices using its framework, sees the need for more “integrated thinking” if expanded reporting is to truly add value in a balance sheet based “asset light” world. For example, many leaders pay lip service to “people being their greatest asset”, yet most adopters of IR seem to believe that reporting on compliance issues such as health and safety and diversity, plus discretionary decisions such as levels of training provide the insight needed.

This is woefully short of what is needed to assess underlying risk. Surely, when the cost of human capital is one of the most material expenses involved in operating an “asset light” organisation, and it creates other key “assets” such as internal and external relationships, intellectual capital and even manufactured capital that asset light organization thrive on, this depth of transparency is completely inadequate?

What investors and boards need to understand is how the business model is operating and how healthy and sustainable it is. To do this much greater information is needed about areas such as corporate culture. How good and respected is leadership at all levels?” How much development and promotion are from within? How effective is succession planning? How effective is collaboration and cooperation across areas to stimulate innovation and creativity? Beyond just overall turnover, what is the retention of key talent? How much of the total spent paying people is being invested in future initiatives and capabilities (building intellectual capital or manufactured capital) versus converting inputs to outputs?

Until investors, boards and regulators grasp the importance of non-financial behaviour within an organisation and stop relying solely on financial assessments, the risk of unethical behaviour, poor leadership and failed organisations will remain hidden from view until it’s too late.

Nick Shepherd is president of Eduvision a Council member at the UK based Maturity Institute where he leads their work on Integrated Reporting