Abstract
This paper examines the association between Integrated Reporting and firm valuation. Using a sample of listed firms in South Africa, we examine the association between cross-sectional variation in Integrated Reporting disclosures and firm valuation in the period after the implementation of Integrated Reporting. We find that firm valuation is positively associated with Integrated Reporting disclosures. This result suggests that on average, the benefits of Integrated Reporting exceed its costs. We predict that Integrated Reporting reduces the information processing costs in firms with complex operating and informational environment. Consistent with our prediction, we find that the positive association between firm valuation and Integrated Reporting is stronger in the firms with higher organizational complexity, suggesting that Integrated Reporting improves the information environment in complex firms such as firms with high intangible assets, firms with multiple business segments and large firms. Furthermore, we find that in firms with higher external financing needs, the sub-sample of firms with higher Integrated Reporting have higher firm valuations, suggesting that Integrated Reporting mitigates the information asymmetry between corporate insiders and external suppliers of capital. Additional analysis indicates that firms with high Integrated Reporting outperform those with low Integrated Reporting both in terms in stock market and accounting performance.
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Notes
IIRC International Integrated Reporting Framework. Available at http://www.theiirc.org/wp-content/uploads/2013/12/13-12-08-THE-INTERNATIONAL-IR-FRAMEWORK-2-1.pdf.
Over 100 companies participating in the IIRC Pilot Programme have contributed to the development of the International 〈IR〉Framework and demonstrate global leadership in this emerging field of corporate reporting. Available at http://www.theiirc.org/companies-and-investors/pilot-programme-business-network/.
B20 Panel of international accounting network (2014) “Unlocking investment in infrastructure: Is current accounting and reporting a barrier?” Available at http://www.theiirc.org/wp-content/uploads/2014/06/unlocking-investment-in-infrastructure.pdf.
We note that the〈IR〉 framework posits that 〈IR〉 can potentially benefit multiple stakeholders such as investors, bondholders, regulators, competitors, employees, managers, suppliers and customers and society at large. However, it is outside the scope of this study to examine the effect of 〈IR〉on multiple stakeholders such as investors, bondholders, regulators, competitors, employees, managers, suppliers and customers and society at large. We leave to future research to examine the effect of 〈IR〉 on other stakeholders such as investors, bondholders, regulators, competitors, or society at large.
We thank the referee for highlighting this point.
Durnev and Kim (2005) measures the quality of corporate disclosures using disclosures related to corporate governance practice compiled by Credit Lyonnais Securities Asia (CLSA 2001). CLSA groups the scores of corporate governance practices into six categories of governance: discipline (managerial incentives and discipline towards value-maximizing actions), transparency (timely and accurate disclosure), independence (board independence), accountability (board accountability), responsibility (enforcement and management accountability) and protection (minority shareholder protection). In contrast, our measure of integrated reporting score (IRSCORE) employed in this paper is more holistic because corporate governance practice constitutes one of the eight components of the IRSCORE (see Sect. 3 for details).
Firms in weaker legal regimes have difficulty in raising external capital because investors have lower trust in legal protection of their rights. Since this distrust leads to higher costs of capital, firms with external financing needs have incentives to mitigate investors’ concerns by providing better quality disclosures.
To provide a perspective of the strength of country-level shareholder rights and disclosure quality, we compare South Africa and United States. Using a sample of 49 countries, La Porta et al. (2006)) develop a “shareholder-right” index to measure the strength of country-level shareholder rights that ranges from zero (weak shareholder rights) to five (strong shareholder rights). The mean country-level shareholder right is 3. Both United States and South Africa have a shareholder right of 5. Furthermore, La Porta et al. (2006) also developed a country-level “disclosure index” to measure the depth and quality of disclosure listing requirements that ranges from 0 % (weak disclosure rules) to 100 % (strong disclosure rules). The mean disclosure index for 49 countries is 59 %. The disclosure index for United States and South Africa are 100 and 83 % respectively.
During the sampling period, 13 firms entered the sample and 5 firms exited the sample. In robustness test, we obtained qualitatively similar results by excluding firms that entered or exited the sample during the sampling period.
Due to the principle-based nature of the IR framework, we acknowledge that our scoring process is subjective. To reduce the subjectivity of the coding process, both research assistants completed the coding process independently (see Appendix A for details). Furthermore, the validity of the coding is strengthened by the consistency between the self-constructed IR scores using the IR framework and the external ratings from Ernst and Young (2012) on the quality of the integrated reports produced by the top 50 listed firms on Johannesburg Stock Exchange in 2011. The mean total IR scores for firms ranked by Ernst and Young as Top/Excellent/Good are 120/96/71 respectively.
In this study, we did not examine the firms involved in the IR pilot program as these firms are not randomly assigned. For example, firms in the pilot IR program tend be large listed firms with long operating history. We thank the referee for highlighting this point.
As a robustness check, any deviation of more than 20 points in the firm-specific IRSCORE between the two research assistants was manually reviewed by the authors to resolve the deviations. Since the maximum IRSCORE is 200, based on a parsimonious materiality threshold of 10 %, we select 20 points as a cut-off for checking deviations of IR scores compiled by the two research assistants. The difference in IRSCORE coded by the two research assistants exceeded 20 points affect approximately 4 % of our sample. For these cases, the authors manually resolve the differences in the IRSCOREs. Our test results are qualitatively similar if we exclude these firms.
Gold Fields Ltd was also evaluated the best company in Ernst & Young Excellence in Integrated Reporting Awards 2012.
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Acknowledgments
We appreciate the insightful comments and constructive suggestions from the editor (Cheng-Few Lee) and the referees. Kin-Wai Lee acknowledges the financial support from Nanyang Technological University’s Tier 1 research Grant RG175/14.
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Appendices
Appendix 1: Construction of Integrated Reporting Score (IRSCORE)
In this section, we describe the construction of our Integrated Reporting Score (IRSCORE) and provide evidence supporting its reliability and validity. We construct a composite integrated reporting score (IRSCORE) based on the information firms provide in their integrated reports. According to the International Integrated Reporting (IIR) Framework by the International Integrated Reporting Council (IIRC) (December 2013), there are eight major content elements of the integrated report. The IIR Framework does not specify the weights to be allocated to the content elements. In the absence of specific theory on the relative weights to be allocated to different content elements, we construct our integrated reporting score (IRSCORE) as an equal-weighted score of the eight major content elements.
Our construction of the IRSCORE is essentially a content analysis of integrated reporting disclosure based on the IIR Framework. In each major content element, we outline 5 questions to measure the comprehensiveness and quality of the IR disclosure based on the principles embedded in the IIR framework. We evaluate the information provided in response to each of the question on a scale of 0–5 where 0 represents non-compliance with 〈IR〉 principles and 5 represents strong compliance with 〈IR〉 principles. Hence, the minimum score per each major content element is 0 (comprising 5 questions × 0 point per question) and the maximum score per each major content element is 25 (comprising 5 questions × 5 points per question). We repeated this scoring algorithm for all 8 major content elements. Hence, the final aggregated IRSCORE ranges from a minimum of 0 points (comprising 0 points per each major content element × 8 major content elements) to a maximum of 200 points (comprising 25 points per major content element × 8 major content elements).
We employ two research assistants who are knowledgeable in IR to manually evaluate the integrated reports based on the IIR Framework and to construct the IRSCORE for each company in the sample. We tested for inter-rater consistency and reliability of the evaluation using the Cronbach’s alpha test. A Cronbach’s alpha score of 91 % was obtained.Footnote 12
We evaluated the extent to which the information disclosed in the integrated report address the questions as shown below in each content element. The questions are based on information provided in the 2013 IR Framework.
Item | Major content element | Questions |
|---|---|---|
1 | Organizational overview and external environment | What is the organisation’s mission, vision, culture and values and the circumstances under which it operates? What is the organization’s competitive landscape and market positioning? How is the organization’s ability to create value in the short, medium and long-term affected by significant factors in the external environment? Does the integrated report provide information about the effects of significant external environmental factors on the organization such as legitimate needs and interests of stakeholders, macro and micro economic conditions including economic stability, globalization and industry trends, market forces, technological changes, societal issues, environmental challenges, political and regulatory environment? Does the integrated report link the significant factors affecting the external environment to the availability, quality and affordability of capitals that the organization uses or affects? |
2 | Strategy and resource allocation | What is the organisation’s short, medium and long term strategic objectives and how does it intend to get there? What are the organisation’s resource allocation plans? Does the organization link its strategy and resource allocation plans to its business model and changes needed to implement its strategy? Does the organization link its strategy and resource allocation plans to external environmental influences, stakeholder engagement and risks and opportunities identified? What differentiates the organization in terms of competitive advantage and its ability to create value? |
3 | Business model | What is the organization’s business model? To what extent does the business model create value for the organization in the short, medium and long term? What information does the integrated report provide about the inputs (stock of capitals), business activities, outputs and outcomes of the business model? How is the business model linked to other content elements such as strategy, risks and opportunities and performance? For organizations that operate in multiple businesses with multiple business models, what is the extent of connectivity and synergistic benefits that exist amongst the different business models? |
4 | Governance | How does the organization’s governance structure support its ability to create value in the short, medium and long term? What information does the integrated report provide about the organization’s leadership structure including its skills and diversity? What information does the integrated report provide about the organization’s specific processes for strategic decision making, risk management and addressing of ethical and integrity issues? How is the organization’s culture, ethics and values reflected in its use of and effects on the capitals including its relationships with key stakeholders? Are the remuneration and incentives of directors and senior executives linked to value creation and to the organization’s use of capitals in the short, medium and long-term? |
5 | Risks and opportunities | What are the specific opportunities and risks that affect the organization’s ability to create value over the short, medium and long term? What information does the integrated report provide about the organisation’s key risks which include strategic, supply chain, political, financial, human resource, environmental, information technology and reputation risks? Does the organization identify the specific sources of risks and opportunities, assess the likelihood that the risk or opportunity will come to fruition and determine the magnitude of the effect if it does? What specific action steps does the organization take to mitigate or manage key risks or create value from key opportunities including identifying associated strategic objectives, strategies, policies and KPIs? Does the organization use the guiding principle of materiality in reporting any real risks that are fundamental to the ongoing ability of the organization to create value even if their probability of occurrence may be small? |
6 | Performance | To what extent has the organization achieved its strategic objectives? What are the organization’s outcomes in terms of effects on the capitals used in the value chain (both positive and negative)? Does the integrated report provide information on outcomes such as customer satisfaction, shareholder return, contribution to taxes, job creation, employee development and engagement, improved living standards, impact on environment and the organization’s license to operate? Does the integrated report discuss the state of key stakeholder relationships and how the organization has responded to meet key stakeholders’ legitimate needs and interests? To what extent does the integrated report combine financial performance with performance regarding other capitals such as human, natural, intellectual, manufactured and social? |
7 | Outlook | What challenges and uncertainties is the organization likely to encounter in pursuing its strategy? How is the organisation equipped to respond to critical challenges and uncertainties that are likely to arise? What are the potential implications for the organization’s business model and future performance? Does the discussion on potential implications include the effects of the external environment, risks and opportunities on the achievement of strategic objectives? Does the discussion on potential implications include the availability, quality and affordability of capitals and their effect on the organization’s ability to create value over time? |
8 | Basis of preparation and presentation | How does the organization determine what matters to include in the integrated report and how are such matters quantified or evaluated? Does the integrated report provide a summary of the organization’s materiality determination process and key judgements adopted? How does the integrated report identify its reporting boundary and explain how it is determined? Are material risks, opportunities and outcomes attributable to or associated with other entities or stakeholders included in the integrated report to the extent that they materially affect the ability of the financial reporting entity to create value? Does the integrated report provide a summary of the significant frameworks and methods used to quantify or evaluate material matters included in the report? |
Appendix 2: Examples of integrated reporting (〈IR〉) disclosures of listed firms in South Africa
This appendix provides examples of two of the top 〈IR〉 companies that have obtained among the highest IR scores in our evaluation and one company that has obtained among the lowest IR scores in our evaluation.
The first example is Gold Fields Ltd.Footnote 13 Overall, Gold Fields Ltd scored excellently in almost every aspect of our evaluation. Its 2012 integrated report provides a concise account of how the various aspects of the business relate to each other. An overview entitled “Our business,” outlines how the company adds value, its global footprint, details of its restructuring, its vision, values and stakeholder promises, its strategy and, finally, a financial overview. Its table of contents clearly illustrates a high degree of compliance with the eight content elements of 〈IR〉 framework. The section on how the business adds value through its business process is also provided below. Gold Fields attempts to link its specific business process (which encompasses (1) exploration (discovering gold bearing ores around the world), (2) analysis (identifying and modeling extraction opportunities), (3) development (design and construction of mines and infrastructure), (4) mining (physical extraction of gold), (5) processing (physical and chemical processing of ore) and (6) marketing (sale of refined gold)) and value creation. Gold Fields also articulates the state of key stakeholder relationships and how the organization has responded to key stakeholders’ legitimate needs and interests. For example in its stakeholder engagement section, Gold Fields explains the linkages between non-financial performance measures (such as culture and climate rating, lost-time-injury-frequency rate, energy per ounce of gold produced, and years of gold reserves based on current production) and its stakeholders (such as investors, employees, regulators, trade unions, local community and host government). The section on Strategic analysis with the “Strategic performance dashboard” in the stakeholder engagement section provides a comprehensive integration of strategy, shareholder risks, KPI’s, performance and forward-looking information by strategic requirement.
Netcare Ltd is another example of a company that has scored excellently overall and in particular in its risk management section. In its 2012 integrated report, the company articulates that understanding risks is an inextricable part of doing business. Netcare does not attempt to eliminate risk completely but rather provides a structure to continually identify, assess, evaluate and manage risk. Engaging in risk is inherent in all its activities as the company achieves its strategic objectives and increases stakeholder value. The report provides considerable details on the company’s risk management process and the key business risks critical for the sustainability of its southern African operations. The company discusses its plans and processes to mitigate these risks, which is linked to the company’s strategy and value creation.
Capevin Holdings Ltd is an example of a company that has scored poorly in our evaluation. Its 2012 integrated report looks like a traditional annual financial report and very little effort is made to discuss the company’s strategy, business model, stakeholder engagement or other content elements of the IIRC framework. In fact the company stated in its Corporate Governance Statement on Page 5 that it does not consider application of all principles contained within King III to be appropriate as it is a passive investment holding company.
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Lee, KW., Yeo, G.HH. The association between integrated reporting and firm valuation. Rev Quant Finan Acc 47, 1221–1250 (2016). https://doi.org/10.1007/s11156-015-0536-y
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DOI: https://doi.org/10.1007/s11156-015-0536-y