Edition: Dec 2014 - Feb 2015
Rethinking value or business as usual?
Jonathan Hanks* sets out to answer.
Since March 2011, all JSE-listed companies have ostensibly been required to publish an integrated annual report or to explain why they haven't. Although this has proved to be nothing more than a soft ‘expectation' that the JSE by its own admission (rather surprisingly) has not sought to push, SA companies have nevertheless been leading the way globally in publishing annual integrated reports.
BIG CHALLENGE WILL APPLY
"Looking to the future, I am concerned that as a country, and indeed globally, we are collectively undermining our long-term capacity to create value. A significant challenge that we face is that many of the big decisions taken today by business and government are informed by a failure to assign sufficient value to the resources we rely on."
– Sanlam chief executive Johan van Zyl
Guided initially by recommendations of the King Code, and by a January 2011 SA discussion paper on integrated reporting, more detailed guidance on integrated reporting is now provided at a global level by the International Integrated Reporting Council (IIRC). A worldwide coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs, the IIRC's principles-based framework provides a clear set of guiding principles and content elements aimed at informing the development of integrated reports.
The ambition behind integrated reporting is bold. It seeks fundamentally to change corporatereporting practice, embed integrated thinking within mainstream business activities, and prompt a more efficient and productive allocation of capital. This is in the belief that integrated thinking and reporting will "act as a force for financial stability and sustainability".
Underpinning it is the growing realisation that current reporting and accounting practice have failed us, epitomised particularly by impacts of the global financial crisis. Explaining the rationale for its work, the IIRC argues that the crisis "was in part driven by individuals and organisations focusing on short-term profits, irrespective of their long-term sustainability".
The IIRC believes that this short-term focus "has demonstrated the need for capital market decisionmaking to reflect long-term considerations, and has called into question the extent to which current corporate reporting disclosures sufficiently highlight the systematic risks to business".
Given this context, the stated primary purpose of an integrated report is to explain to providers of financial capital how an organisation creates value over the short, medium and long term. The integrated report is intended to achieve this by providing investors with insight into the critical resources and relationships (the so-called "six capitals") that are used and affected by an organisation.
By prompting companies to reflect and disclose how they interact with the external environment, it is hoped that this will foster a more nuanced appreciation (amongst both companies and investors) of the true value of the social and environmental resources and stakeholder relationships that companies ultimately depend on, but that are currently largely undervalued.
In being urged to ‘rethink value' and improve the quality of their information, companies’ reports will enable investors to ensure more efficient and productive allocation of capital, and companies themselves will be prompted to revisit their business models. Or that is the theory.
As Mervyn King puts it: "If done properly, organisations that produce an integrated report for the first time will take a new look at themselves and their business models . . . and will be encouraged to explore new and potentially innovative opportunities in their products, services, processes and markets". He further maintains that integrated reporting "has the ability to improve strategic decision-making, improve performance and enhance reputation among stakeholders".
Unclear, however, is whether this ambition is being realised; or whether integrated reporting may in fact be giving legitimacy to the existing out-dated model of value creation.
Recent SA experience
The picture is mixed. While there are pockets of excellence in the corporate approach to integrated reporting (and thinking), and in the nature of investor engagement on this issue, these are far from widespread.
For integrated reporting to fulfil its potential in prompting companies to revisit their business models, it's critical that the reporting process does not simply become a compliance-driven exercise administered in comparative isolation by the company secretary or investor relations department. Instead, it will require the active engagement of the organisation's governing structure in the reporting process. This includes identifying, communicating on, and responding to, those material issues that impact on the organisation's capacity to create value.
With few exceptions, it is difficult to assess from many of the recent ‘integrated reports’ whether this level of engagement and introspection is taking place. There remains a lingering suspicion that for many companies integrated reporting is little more than yet another compliance requirement.
As accountancy firm PwC recently put it: "Too many reports display the dead hands of compliance and the editorial committee; too few companies have cut through the historic clutter and the short-term financials to create a strategic picture of the business that is informative and convincing."
Given that investors are the principal intended audience of integrated reports, it is useful to consider their perceptions on the value of integrated reports. There are divergent views. For instance:
While it is difficult to reach a robust conclusion on company and investor perceptions without further research, a strong case can be made that many in the local corporate and investment communities remain largely unconvinced of the benefits. In some instances, this reflects a worrying lack of appreciation of the need to rethink value, with short-termism continuing to dominate.
In other instances, this may be a result of too many poor-quality ‘integrated reports’ that fail to provide a compelling and transparent interrogation of how value is created. Both reasons are cause for concern.
If integrated reporting is to deliver its full potential, we shall need a more informed appreciation within the corporate sector, and amongst investors and trustees, of the underlying purpose of integrated reporting. This purpose is to rethink value.
* Hanks is a managing partner at Incite (www.incite. co.za), an SA-based international advisory network that works with leading corporates throughout emerging markets. A member of the working group of the Integrated Reporting Committee in SA, he contributes to the work of the International Integrated Reporting Council and the Global Reporting Initiative.