In
February 2017, Securities and Exchange Board of India (SEBI) had issued a
circular advising top 500 listed companies, which are required to publish
Business Responsibility Report (BRR) annually as a part of their annual report,
to voluntarily adopt integrated reporting from 2017-18. The International
Integrated Reporting Council (IIRC) has issued Integrated Reporting Framework.
IIRC is a global coalition of regulators, investors, companies, standard
setters, the accounting profession and NGOs.
Integrated
report is directed to investors, but is useful to other stakeholders as
well. It tells the complete story of
value creation holistically in a concise manner. It provides investors with
information that is relevant for assessing the sustainability of the business
model of the company. Integrated Reporting Framework identifies five types of
capital (resources): financial capital, manufactured capital, intellectual
capital (including organisational capital), human capital, social and
relationship capital, and natural capital (e.g., air, water, mineral, forest,
bio-diversity and eco-system health). All the resources that a company uses to
create value are not owned by it. For example, government or some third party might
own infrastructure (e.g., ports and bridges) that is used by the company. Some
natural resources (e.g. air) are not owned by anyone. In the process of creating value the company
transforms one form of capital into another form of capital and increases value
of some capital while reducing that of others. A company creates value only if
the net outcome is positive. The term ‘value as used in integrated reporting may
be perceived as ‘social value’, which is the total of value created for
shareholders and value created for other stakeholders. A business model that
destroys social value is not sustainable. It is true that in most situations it
is difficult to quantify the outcome, but a qualitative assessment is possible.
Therefore, integrated report provides a blend of quantitative and qualitative
information.
Integrated
report focuses on future and describes how well the company is managing environmental,
social and governance (ESG) issues. For example, integrated report provides
insight into how the company is managing its relationships with its key
stakeholders, including how and to what extent the company understands, takes
into account and responds to their legitimate needs and interests. Similarly,
it provides insight into how the business model affects natural capital.
Integrated
report also provides information on how the firm integrates different
components of the organisation and how it integrates short-term, medium-term
and long-term strategies.
Integrated
Reporting Framework requires that the report should include a statement from board
of directors (hereafter board) that includes: an acknowledgement of its responsibility
to ensure the integrity of the integrated report; an acknowledgement that it
has applied its collective mind to the preparation and presentation of the
integrated report; and its opinion or conclusion about whether the integrated
report is presented in accordance with the Integrated Reporting Framework.
Board’s involvement with the preparation of the integrated report adds value to
the board’s performance as it compels the board to understand the complete
process of value creation and ESG issues and inculcates the culture of
‘integrated thinking’. This culture percolates down to the lower levels in the
organisation.
The
construct of ‘social value’ is not in conflict with the construct of
‘shareholder value’. The fundamental value (also called intrinsic value) of a
business does not depend on its ability to generate short-term profits. It
depends on the perceived ability of the business to generate free cash flows
(FCF) over a long period. FCF refers to the cash flow that is available to
owners for spending on purposes other than the business purposes. If forces
(e.g., government, pressure groups, regulators, courts of law) that relate to
ESG issues are going to be material to the business, the board, management and
investors have to worry about those and the board and the management have to
decide what to do about those issues. Eventually, those things will affect FCF.
Therefore, a company that fails the address ESG issues and does not create
‘social value’ would not be able to create the shareholder value.
Integrated
report is an excellent tool to communicate to investors clearly how the company
is managing ESG issues. In absence of that clear communication the value of the
equity in the capital market lags the fundamental value of the company, as
investor perceives higher risks arising from poor management of ESG issues.
Integrated
reporting is evolving globally. The SEBI move will accelerate the evolution.
Over time, integrated report should replace Management Discussion and Analysis
and Business Responsibility Report, both of which, at present, form part of the
annual report.
