Quality and effects of integrated reporting

The International Integrated Reporting Council (IIRC) published its first international report in 2013 establishing the basic principles of this reporting method. The primary objective of IR is to compile a clear, concise document that explains how the organization creates value over time. What’s more, it differs from other types of disclosure because it combines financial and non-financial information, incorporating issues relating to ESG (Environmental, Social, Governance) Governance) in a single document. By doing so, IR allows the company to clearly communicate its business model and to map out the complex interconnections between the various resources it uses to create value.  

This new approach is gaining ground in part because disclosure of non-financial information is already mandatory in a number of countries (see Europe, the UK, Japan and India). Beyond that, by adopting this method, companies see an opportunity to set up a more transparent, innovative reporting system. In light of this, we see IR constantly proliferating around the world. In fact, in 2017, of the 250 biggest Fortune 500 companies, 14% published this type of report (Coca-Cola Company, General Electric and Microsoft Corporation, to name a few).  

Since 2010, is has been obligatory for companies listed on the Johannesburg Stock Exchange (JSE) to publish an integrated report. In fact, based on the King III Code of Corporate Governance, South Africa was the first country to require all listed firms to produce an IR, albeit with no obligation to demonstrate having adopted this method. Moreover, listed firms can opt to include an “assurance statement” along with the IR. This is a document compiled by a competent third party that draws independent conclusions on the reliability of the report’s content.  By making this optional, the JSE ensures that companies have a certain degree of discretion in terms of what to report and how to report it, as well as if/how to offer external corroboration on the IR. However, this has led to quite a heterogeneous situation as far as quality of the reports presented by companies, and the adoption of external assurance.  

For these reasons, the sample we chose for our study consists of the top 160 companies listed on the JSE, which together represent over 97% of market capitalization. We collected our data from 2011 to 2016, after the IR requirement took effect. The key factors we considered were three: length, readability, and tone. These are the sources of potential economic consequences as well as effects on the capital market, like market value of the company, stock liquidity, and analysts’ forecast accuracy.  

Our findings show that different characteristics are associated with different economic benefits: a concise report is linked to greater stock liquidity, readability with a higher market valuation, and tone with less dispersion in analysts’ estimates.  So a high quality IR is concise, straight forward, and readable, offering a neutral representation of company performance without manipulating information. 

When companies resort to an external audit, they want to shield themselves from inaccuracies, whether intentional or accidental. In addition, by verifying the accuracy of financial information, the external auditor also gives management’s claims greater credibility. As far as (non-financial) reports on sustainability or CSR, the positive effects of external assurance accumulate with those linked to certain textual features, such as conciseness and readability. By the same token, these positive effects can attenuate the negative repercussions arising from a report with low linguistic quality. 

By supplementing the information disclosed by the company, IR should mitigate uncertainty, enhance transparency, and improve analysts’ forecasts of future firm performance. Our findings confirm our basic hypotheses: first, a report that is illegible, verbose or biased in tone does not generate economic benefits (and vice versa); and second, external assurance mitigates the possible negative association between low-quality IR and its presumed economic effects. 

Our study shows that low-quality IR (i.e. reports that hard to read and verbose) are associated with negative economic effects in terms of market valuation and liquidity.  Put simply, this means that the financial market values readable reports that are clear and concise. What’s more, we demonstrate that external assurance mitigates possible negative economic repercussions from reports with low textual quality. If a company publishes a report that is hard to read, but then assures it, this would offset the negative impact of poor readability on the market value. If instead the report in question is too long but it is assured, the negative effect of this wordiness on stock liquidity is tempered. 

Our study has managerial and political implications. It suggests possible strategies based on “tone management” and addresses expert readers of corporate reports. What’s more, our work verifies that external assurance boosts the market’s faith in the credibility of the information in the report, in particular if the people doing the certification are professional auditors. The International Federation of Accountants (IFAC) recently approved the work of the IIRC done in 2013, attesting to the fact that assured reporting could serve the public interest and satisfy the needs of interested parties. Insight from our findings would be interesting to competent authorities and regulatory bodies who wish to promote and implement a requirement on integrated reporting. In fact, we remind readers that some stock markets have already made IR mandatory, following the lead of the JSE; these include San Paolo, Singapore, Kuala Lumpur and Copenhagen.