A Very Brief History of Financial Reporting

If history serves as an example, supporters of integrated reporting should prepare for a long march. The current institutional infrastructure supporting financial reporting and auditing took decades to build. In the United States, for example, increasing regulations regarding financial reporting and auditing evolved over the past 125 years, beginning with the formation of the American Association of Public Accountants in 1887.² By 1926, in an indication of market forces' potency—and potential good news for integrated reporting—over 90% of companies listed on the New York Stock Exchange issued audited financial statements despite the absence of a law requiring them to do so. Due to a prevailing belief that certain types of information would be useful to competitors, only 62% disclosed sales and 54% cost of goods sold.³

Following the Stock Market Crash of 1929 and the ensuing Great Depression, voluntary disclosure was replaced by mandated disclosure. The 1933 Securities Act⁴ and the 1934 Securities and Exchange Act⁵ (’34 Act) put a strong regulatory stamp on corporate disclosure which continues to this day, with the most recent major regulatory intervention being the Sarbanes-Oxley Act of 2002.⁶ The ’34 Act mandated that all public companies file annual reports certified by independent public accountants and gave the Securities and Exchange Commission (SEC) the authority to prescribe the form in which the required information should be disclosed, the items to be shown in the balance sheet and the income statement, and the methods to be followed in the preparation of reports.⁷ The fact that such a step was necessary in order to ensure the comprehensive and consistent reporting of financial information raises the question of whether integrated reporting must also ultimately receive a formal “stamp of approval” from the State in order to guarantee the format and content of an integrated report.

Neither sustainability nor integrated reporting is supported by anything resembling the well-established infrastructure of standards, frameworks, and reporting requirements that exist in the United States for financial reporting. Small nongovernmental organizations (NGOs), some of which are only a few years old, are responsible for nearly all of the development in this arena thus far. With the exception of South Africa, State support for their efforts is modest, particularly in the largest capital markets. Especially for ideas largely untested in the marketplace, regulators wisely move with caution toward new disclosure requirements. As a result, integrated reporting will remain a social movement for the foreseeable future.

Balancing Experimentation and Codification

Because the balance between experimentation and codification must be well managed before market and regulatory forces can be properly addressed, this strategic issue is of primary importance. In Chapter 2, we described how integrated reporting emerged through company practice, after which it was studied and codified, most recently in the “International <IR> Framework” (<IR> Framework). We also described how attempts at codification continue to be informed by practice, such as in the IIRC's “Pilot Programme Business Network,” which in May of 2014 had expanded to over 100 companies.⁸ Early efforts at codification should be tested in practice so that these frameworks can be improved, but eventually standards must be set in order to move from codification to institutionalization, the fourth and final stage of meaning-making.

This sensible symbiotic relationship masks an underlying tension between standardization and customization. For the audience of corporate reports, “standards beneficiaries,” frameworks (like the <IR> Framework or SEC guidance on the structure of Form 10-K), and standards (for both accounting and sustainability information) have clear benefits. Standardization makes it possible to compare one company's performance to another's—an attribute of interest to shareholders, stakeholders, and even the company itself, enabling it to benchmark itself against its competitors. Standards are useful for regulators because they make it easier for them to determine if regulations are being followed; they inform decision-making. As sociologist Lawrence Busch puts it in his book standards: recipes for reality, “While standards and choices clearly involve different forms of action, the one virtually unconscious and automated, the other conscious and goal-oriented, both are implicated in all situations.”⁹

While standards necessarily have their detractors, most commonly among those to whom the standards apply (the “standards-users”), the process by which they are created is ultimately a political negotiation. This is a common trope in the history of corporate reporting, starting with the first attempt in the United States to establish a set of accounting standards, which all companies and auditors would have to use.¹⁰ On one side of the trade-off between comparability and a more accurate, entity-specific measure, companies tend to argue that a set of standards is a “one-size-fits-all” model that fails to consider their unique circumstances. Determining entity-specific accuracy is complicated, however, when those measurements cannot be compared across companies. In the absence of standards, companies find it easier to choose a methodology that makes their performance look as strong as possible—a problem when the interests of the standards-users must ultimately be balanced with those of the standards-beneficiaries. Standards-users will attempt to influence the standards in ways that benefit them—typically by seeking less transparency and more degrees of freedom for customization. Standards-beneficiaries favor greater transparency and comparability. That said, standards vary in terms of prescriptiveness. Corporate reporting observers commonly distinguish between “rules-based” (as many claim U.S. Generally Accepted Account Principles (GAAP) to be) and “principles-based” (as many claim International Financial Reporting Standards (IFRS) to be) standards. The more rules-based the standard, the fewer degrees of freedom a company (and its auditor) have in using their judgment on how best to report on an issue.

When standard setting occurs in a non-State context, as with the NGOs discussed in this book, the perceived validity and utility of the standard will be a function of how effectively the standard-setter manages the politics of the standard-setting process. Since companies adopt these standards on a voluntary basis, it is natural for these NGOs to use the number of companies that have adopted their standard or framework as a metric of their effectiveness. While sensible, these organizations run the risk of seeing the standard (framework) become an end in itself rather than a means to an end—the crux of the dilemma.

Being too doctrinaire too early, as by insisting that a company can only call its report an integrated report if it is substantially based on the <IR> Framework, for example, can raise the bar too high and discourage adoption. Is it better for companies to call a combined report an integrated report in order to start them on the journey, to gain their intellectual and emotional commitment to the movement? Doing so risks clouding the term's meaning, whose codification and institutionalization is important to the movement's success. Conversely, attempting to draw a hard line raises questions of whether the NGO has the necessary resources to monitor what companies are doing, let alone the enforcement mechanisms to ensure compliance. NGOs have neither the State's resources to do the former nor its authority to do the latter. This does not mean they are completely impotent, however. Mechanisms can be created for companies to submit their report to be reviewed and, if approved, put on an official list of approved adopters. Trademark protection can also be used to limit careless claims about adoption.

Recommendation Number One: The International Integrated Reporting Council should establish a process for companies to get voluntary certification of whether their integrated report and website qualify as “integrated reporting” under the brand of the IIRC.

Balancing Market and Regulatory Forces

Adding and changing reporting regulations is a constant source of struggle between companies and those demanding information from them. Both parties put pressures on the State based on their own concerns. Although listed companies accept reporting requirements as a prerequisite for access to the capital markets, they still decry additional reporting burdens. Virtually any additional reporting requirement being considered by a country's legislature or a regulator¹¹ becomes the subject of a fierce debate. Companies argue that it will be costly to implement, may be irrelevant, will put them at a competitive disadvantage, or increase litigation risk—raising the question of just where the “sweet spot” falls between the extremes of irrelevance and risk. Companies insist that a proper cost/benefit analysis be done before they are required to report and point out, with some justification, that reporting requirements are never eliminated, even for issues that are no longer salient. Those in favor of a new reporting requirement will have equally strong arguments about the benefits to a particular group of having this information. Because the struggle between these forces represents the ongoing negotiation between the Corporation and the State over what responsibilities the former has for the license to operate given to it by the latter, it is inevitable.

Any group whose mission is directly related to reporting must decide how to frame its work in the context of the existing mandatory reporting environment. At one extreme, the group can adopt a purely regulatory strategy. In this case, it lobbies the appropriate government bodies to get its reporting framework or standards adopted as an additional reporting requirement or more likely, to get them included in an existing reporting requirement. If successful, this strategy for the movement means the State will enforce company compliance with integrated reporting as it does with financial reporting. If the regulation is carefully crafted and well-enforced, it can also contribute to the reliability and comparability of information in an integrated report.

The success of such a strategy requires overcoming a number of barriers. Because of the resistance it will likely see from the corporate community, the State is typically slow to act in this domain, making regulation a long-term goal. Consequently, such a strategy can require substantial resources that few NGOs have. Finally, while regulation can ensure broad compliance, it can also result in just that—a tick-the-box compliance approach that meets the letter but not the spirit of the law.

At the other extreme is a purely market-based strategy in which the group appeals to the self-interest of companies to voluntarily adopt its framework or standards through an “it's just good business” pitch. Common arguments include the idea that doing so will help investors better understand the company's value proposition (presumably resulting in a higher stock price), that the company will enhance its reputation and credibility with stakeholders (presumably reducing the risk of being a target of some NGO's campaign), that the discipline in gathering the data for external reporting purposes and using it for internal reporting purposes will lead to a better-managed company (integrated thinking), and that the company will also be better managed as a result of the dialogue and engagement with shareholders and other stakeholders that comes with the reporting of this information (the transformation function of corporate reporting). Compared to a regulatory-driven approach, this strategy is much less threatening. Consequently, it is less likely that the corporate community will mobilize itself to slow down or stop the initiative.

When companies voluntarily decide to implement a practice, they will also attempt to adhere to the spirit of its intent rather than to treat it as a mere compliance exercise. Not surprisingly, most NGOs focused on reporting place great emphasis on the benefits of voluntary adoption, while also pointing out the risks of failing to report and falling behind peers already adopting the practice. The disadvantage of this strategy is that adoption can be slow when relying entirely upon the voluntary actions of companies. Furthermore, system-level benefits, such as the ability to compare the performance of any given set of companies and influencing resource allocation decisions at a societal level, are lost. Nevertheless, Global Reporting Initiative's (GRI's) success with sustainability reporting is evidence that a market-based strategy can be effective.

In practice, a combination of both strategies should be used, the balance shifting over time. A largely market-based strategy is most effective in the early days of a movement while it is still heavily focused on the codification stage of meaning. During this stage, the movement is creating awareness and some degree of institutional legitimacy, finding early adopter companies and an audience who cares about what these companies are reporting, and gaining testimonials from them and their stakeholders about the benefits. At this time, the movement can engage with regulators to educate them and ascertain their willingness to provide some degree of support, laying the groundwork for the institutionalization phase of meaning. The greater the degree of market uptake, the more likely regulators will provide this support. In doing so, they would be moving with the wind, rather than against it. The movement can also be opportunistic and seek to embed its work in pending legislation or regulation. The pace at which the movement increases its emphasis on a regulatory strategy must match that with which experimentation is shifting to codification. Even in the unlikely chance that a mandate is achieved early on, a strong regulatory focus while experimentation is still active can backfire if the regulation ends up being suboptimal or runs counter to the desired goal.

The balance and timing of the mix of these two pure-type strategies will also vary by country. For example, a more heavily regulatory-oriented strategy is likely to be more successful in the European Union or China than in the United States, where, at least in the short term, a more market-based strategy would be effective. Within the larger countries, and on a global basis, sector- or industry-specific strategies may also be appropriate, although it would be more relevant for mobilizing market rather than regulatory forces.

Recommendation Number Two: Members of the integrated reporting movement should engage in a dialogue to establish a global strategy for the balance and timing of market- and regulatory-based strategies to speed the adoption of integrated reporting, adapting this strategy to take account of country and sector context as necessary.

Greater Advocacy from the Accounting Community

With deep expertise in financial accounting and reporting and, increasingly, sustainability reporting, accounting firms and associations have a critical role to play in the integrated reporting movement. Possessed of the capabilities and global scale to conduct audits of the world's major corporations (whose combined market cap is close to 100% of equity held by investors), the Big Four accounting firms—Deloitte, Ernst & Young (E&Y), KPMG, and PricewaterhouseCoopers (PwC)—are especially important. The integrity of the world's capital markets depends upon audits that ensure the quality of the information investors are using to make decisions. To the extent that investors—and ultimately regulators—believe that this information can be more effectively delivered through integrated reporting than separate financial and sustainability reporting, companies will depend on their auditor to help them issue reports with the appropriate level of assurance. But these firms must be less timid. They must become stronger advocates for all aspects of integrated reporting, including the necessity for integrated assurance.

While the Big Four are involved in the movement, we believe they have not been sufficiently active in their integrated reporting advocacy out of concern that their clients would perceive this to be naked self-interest. The cynic would say that the accounting firms support integrated reporting because it represents a potentially large new source of revenues from audit and advisory services. Leaving aside the obvious irony that companies unabashedly pursue their own economic self-interest, we recognize that, as a profession, accountants must be held to a higher standard of placing their clients' interests before their own. But professions are also expected to provide the best advice to their clients. This includes points of view on issues they think their client should know about—even if the client is not interested in hearing the idea or does not even like it.

When it comes to the audit function, the client situation is complex. The “real” clients for an audit are investors, yet the practical reality remains that the company they are auditing selects and pays the auditor, making the company a client as well. Consequently, if the accounting firms, in their professional judgment, firmly believe that integrated reporting is beneficial to both investors and the integrity of the capital markets—and their actions so far suggest that they do—they should not be bashful in proactively bringing this point of view to their company clients and investors. Since adopting integrated reporting is still a voluntary company decision that can be executed with varying degrees of depth, the company can decide whether to retain its accounting firm (and other advisors) to help them start the journey or not. No company is being forced to pay for a service it does not want. It is the responsibility of the company's auditor to make sure its client is sufficiently informed about integrated reporting, including its still-uncertain costs and benefits, in order for the company to make an informed decision about this new management practice.

Recommendation Number Three: The Big Four firms should work with other accounting firms and professional accounting associations to establish a proactive campaign to create awareness and understanding of integrated reporting among their clients and to develop assurance standards for integrated reporting.

Achieving Clarity Regarding the Roles of Key Organizations

Throughout this book, we have discussed the central role of the IIRC and the supporting roles played by GRI, the Sustainability Accounting Standards Board (SASB), and CDP. Together, these four organizations are creating the institutional infrastructure necessary for integrated reporting. They are also, however, creating confusion in the marketplace as companies, investors, and stakeholders struggle to understand their missions and how they relate to each other. Are they complementary or competitive entities? Understandably, companies, investors, and stakeholders are also often confused about what exactly they are supposed to do in order to effectively respond to the entreaties each organization is making of them.

Our view can be simply expressed. The IIRC has established a high-level, principles-based framework for integrated reporting. From its inception, it was clear that it had no intention of becoming a standard setter for how specific pieces of information should be measured and reported. As that is the work of the other three organizations, their missions are clearly complementary to the IIRC. Each can provide input to a company about the nonfinancial information it decides to include in its integrated report.

Like the IIRC, SASB is focused on investors. Its standards are a baseline for consideration that, since they are currently being developed in a U.S. context only, may need to be adapted for global application. Some will come from metrics established by CDP, which we see as a “subject matter expert” in greenhouse gas (GHG) emissions and increasingly, on water and forests. SASB has signed an MOU with CDP, and SASB's “open source” approach will leverage the work done by CDP. When climate issues are material, the recommended key performance indicators from SASB will likely come from the work of CDP. Similarly, GRI can leverage the work of CDP in its guidelines on climate issues.

Finally, GRI and SASB have a complementary relationship. As the former's G4 Guidelines cover sustainability reporting from a global perspective, they include information material to many stakeholders that, although not material to all investors today, could be tomorrow as the management of social and environmental issues becomes increasingly necessary for a company to create value over the long term from both a risk and opportunity perspective. We do not believe that sustainability reporting will or should go away as a result of integrated reporting. Rather, its relevance for companies to maintain their license to operate will only increase. SASB's sector-specific standards for issues material to investors, which could include GRI indicators just as they could CDP metrics, will be supplemented by sustainability reporting to meet the needs of stakeholders.

Recommendation Number Four: CDP, GRI, IIRC, and SASB should work together to clarify for companies, investors, and other stakeholders how their missions are related to each other; they should also form collaborations which are mutually beneficial in support of the movement.

A Possible Scenario

We will conclude this book by sketching one possible way the adoption of integrated reporting could unfold in the coming years. This is most definitely not intended to be a prediction. It is a thought experiment to imagine the drivers of adoption of integrated reporting in different countries.

Globally, the explicit call in 2014 for integrated reporting in the Sustainable Development Goals (SDGs)¹² has become an important accelerator, since it has put the movement on the agenda of all countries that signed on to the SDGs, which were adopted in 2015. Rather than being an isolated movement, integrated reporting is now one element of a broader call by Aviva for “integrated capital markets,” defined as “capital markets that finance development that meets the need of the present, without compromising the ability of future generations to meet their own needs.”¹³ Other elements of integrated capital markets include integrated: incentives, financial regulation, stock exchanges, financial literacy, asset ownership, investment consulting, asset management, corporate brokerage, corporate governance, proxy voting, and investment legal duties.

Western Europe continues to lead the way with a new Directive in 2019 that explicitly calls for integrated reporting. Although it does not specify any particular framework or set of reporting standards, companies are increasingly using the <IR> Framework as guidance for their annual report, even if the degree and manner that they do so varies by country. Companies also begin to use SASB's standards, which have been adapted by most countries for their local circumstances, as the basis for these reports. The G4 Guidelines, which have now evolved to G5 Guidelines, serve as the basis for sustainability reporting. They are accompanied by a clearer explanation of when they are and are not relevant to integrated reporting. Active efforts are underway to harmonize the G5 Guidelines, SASB's standards, and Version 2.0 of the <IR> Framework, published in 2018. As companies, investors, and stakeholders gain clarity about the relationship between integrated reporting and sustainability reporting, the growth of each acts as an accelerator for the other.

Brazil remains a leading country in integrated reporting and Japan becomes one. In Brazil, BM&FBOVESPA takes a further step in its “Report or Explain” Cycle and calls the initiative “Report or Explain for Integrated Reports and Supplementary Sustainability Information.”¹⁴ By 2020, approximately 80% of listed companies are doing so. In Japan, the Tokyo Stock Exchange has made integrated reporting a listing requirement. The seeds for this were laid in 2014 when the Financial Services Agency released its stewardship code which aims, on a comply or explain basis, to promote medium- to long-term sustainable corporate returns based on seven principles that guide investors on their stewardship responsibilities.¹⁵

China surprises the world in 2018 when, following the release of the <IR> Framework 2.0, the China Securities Regulatory Commission (CSRC) mandates integrated reporting for all listed companies. Since the Shenzhen Stock Exchange and the Shanghai Stock Exchange have been requiring sustainability reporting since 2006 and 2008, respectively, this does not come as a surprise to Chinese companies.¹⁶ Furthermore, voluntary adoption by Chinese companies has been rapidly growing since 2016 as they seek access to foreign capital markets and business partners, so this regulatory mandate by the CSRC is simply building on strong market momentum.

The U.S. remains a distinct laggard in terms of the number of companies producing self-declared integrated reports. Reporting requirements in the U.S. continue to discourage companies from paying more than cursory attention to the <IR> Framework, although sustainability reporting based on the G4 and G5 Guidelines continues to accelerate. The biggest movement in the U.S. is the adoption of SASB's standards in an increasing number of 10-Ks. The global reaction is mixed. On the positive side, some supporters of the movement recognize what a significant step it is for companies to include nonfinancial information in the carefully scripted and heavily lawyered 10-K. On the negative side, other supporters point out that this is just one more example of “American exceptionalism”—another version of the U.S. GAAP/IFRS movie. The debate shows no sign of being resolved any time soon. Many applaud this U.S. version of integrated reporting. Others belittle it as a rules-based approach that fails to implement the real principles of integrated reporting as laid out in the <IR> Framework, which itself continues to evolve as the IIRC learns from the experiences of companies, investors, and other stakeholders.

Final Reflection

If success is defined as near-universal adoption by all listed companies, will the integrated reporting movement be successful? We are cautiously optimistic. The challenges may be great, but the necessity is even greater. While integrated reporting is not a panacea that will create a sustainable society, it is an important management practice that can contribute to this goal. We are personally dedicated to this cause and we hope that this book serves as one small contribution to it.