Corporate Reporting Needs a Reboot
There is a clamor of voices demanding the rebooting of capitalism, from academics (such as Michael Porter) and politicians (like Al Gore) to investors (such as CalPERS) and Occupy's street activists.
The common thread is that today's model of capitalism overemphasizes short-term financial data and neglects information that gets at the true sources of sustainable value creation — things like innovation, brand equity, customer loyalty, and key stakeholder relationships. Corporate reporting today emphasizes compliance, boilerplate and legalese. As a result, we have a massive glut of filings, press releases, analyst reports and articles focused on financial data. The system has lost sight of the point of reporting: to give companies access to financial capital by communicating their value to investors.
The consequence of the systemic failure of this lopsided model is that companies focus on short-term financial performance — because that is what they believe investors are interested in — to the detriment of long-term value creation. Investors, meanwhile, compensate for the lack of knowledge about issues central to longer term value by pricing in a risk premium. This can result in market valuations that do not reflect the fundamental performance or prospects of the business, leading to a misallocation of capital and reduced visibility for investors, reinforcing short-term decision-making. And it is business that pays the price through more expensive capital, while furthering a flawed model of capitalism.
Fortunately, there is a better way to communicate about the sources of value creation: integrated reporting. Such reporting integrates material information about a firm's financial performance with information on sustainability performance and intangibles such as intellectual and human capital.
From the investor standpoint, integrated reporting provides insights about a firm's business model, strategy, risk, performance and prospects that are simply not available under the current reporting model. It therefore supports investor decision-making by providing a more complete basis for dialogue with the company's board and an assessment of present and future value. This benefits not only the investor, but also investors' beneficiaries and the broader economy by providing a platform that encourages financial stability. Companies such as Danone, SAP, AkzoNobel and Unilever are already pushing the boundaries on their corporate reporting in this direction.
This week, the International Integrated Reporting Council (of which I am the chief executive) launched the consulting draft of integrated reporting framework. Over the next ninety days, the IIRC is seeking feedback on the draft from companies, investor groups, reporting standards organizations, accounting bodies and regulators — anybody who has a stake in seeing the transformation of corporate reporting.
The framework differs from standard financial reporting in a number of ways:
It provides guidance on reporting that goes beyond simply conveying past performance in order to help investors understand how value is created (or destroyed) in the company, given its business model and its strategies, risks and opportunities. It acknowledges that financial capital is not the only asset in a business that drives value creation; instead, a business must report on the interaction of six different types of capital: financial, manufactured, intellectual, human, social and relationship, and natural. It demands that reporting go beyond being simply a mash-up of a firm's existing reports, or a forced combination of the financial and sustainability reports. Instead, it is a concise report that concentrates on material issues — those relevant to investors — that affect the firm's strategy and future orientation.
Despite the evidence of green shoots representing a new pathway for corporate reporting, I don't believe that true integrated reporting exists anywhere just yet. However, the new framework gets us closer to that goal.
While all this makes me hopeful for the future of corporate reporting, one dark cloud hangs over my outlook: US companies are lagging their European, Asian and Latin American counterparts in moving towards an integrated reporting model. Of course, we have great examples of US companies, such as Coca Cola, Prudential Finance and Clorox, joining around ninety global companies in IIRC's pilot program right now, alongside dozens of investors. But my concern is that there are deep-rooted reasons why the US environment may stifle innovation in corporate reporting.
One is that companies hesitate to make statements about anticipated future performance because they fear litigation. But there are other reasons too. Many see reporting as a compliance issue — if it's not legislated, then don't bother. And some will only move on this when they believe the majority of investors want this sort of information.
The danger for US firms who lag in adopting integrated reporting is twofold: not only will their investors lack complete information about their performance, but they also will lose out on the integrated thinking that integrated reporting drives: it reduces barriers between functional silos, aligns data systems and processes, and encourages a culture that focuses on the full spectrum of value drivers. This is all about innovation, and I am saddened to think that US companies, some of the world's most innovative businesses in their own right, might be held back because they are stuck in an out-of-date reporting model.
If integrated reporting can play its role in better corporate performance, holistic investor engagement and the proliferation of a longer-term model of capitalism, it will not have come a moment too soon.
Paul Druckman is the CEO of the International Integrated Reporting Council, a global coalition of regulators, investors, businesses, standard setters, accounting professionals and NGOs.
Analyses and commentary on The Grid are the views of the author and do not necessarily reflect the views of Bloomberg News.