Will Integrated Reporting improve sustainability? Part III – Integrated Thinking

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dreamstime_s_33567037Dr Dale Tweedie and Prof. Nonna Martinov-Bennie.

This is the third of five blogs on whether and how Integrated Reporting might contribute to sustainability.

In this blog, we consider the International Integrated Reporting’s Council’s (IIRC) objective of promoting ‘integrated thinking’.

In a sense, integrated thinking is more fundamental to Integrated Reporting than the final report itself, because the IIRC has defined Integrated Reporting as ‘a process founded on integrated thinking’.

In other word, the primary function of the Integrated Report is to communicate the changes in outlook and organisational practice that Integrated Reporting processes should have generated.

What is integrated thinking?

The IIRC defines integrated thinking as ‘the active consideration by an organisation of the relationships between its various operating units’.

As we explore in a recent article, integrated thinking has two main parts:

  1. Understanding and dialogue that stretches across an organisation’s operating units. For example, reporting and assurance on carbon emissions in mining operations might facilitate integrated thinking by requiring the accounting team to collaborate with scientific experts to measure and document carbon output.
  2. A more holistic understanding of how the organisation interacts with internal and external stakeholders. In particular, the IIRC claims that integrated thinking involves a ‘fuller consideration of stakeholders’ legitimate needs and interests’.

This suggests that integrated thinking should change both how managers see their organisation and how their organisation functions. Indeed, these two types of changes are inextricably linked: Integrated reporting should help managers better understand their organisations precisely because it stimulates more open dialogue across its constituent parts (or ‘silos’) and external stakeholders.

What are the implications for sustainability?

Early research has questioned whether integrated reporting is so far creating the type of changes the IIRC envisages. For instance, Stubbs and Higgin’s (2014) study of early adopters found incremental changes to sustainability reporting practices, rather than the more extensive and transformative organisational changes that integrated thinking seems to imply. A recent IIRC report also finds incremental changes in many organisations, but emphasizes the potential for integrated thinking to emerge over time. One of the IIRC’s participants suggests that – in practical terms – integrated thinking typically develops through producing multiple integrated reports.  

Nonetheless, it is possible to identify both positive and negative aspects of the IIRC’s approach to integrated thinking for sustainability.

POSTIVE: The IIRC’s emphasis on Integrated thinking is entirely consistent with its focus on improving how organisations communicate. Since a key part of integrated thinking is understanding other stakeholders’ views and interests, integrated thinking might improve organisations’ awareness – and the awareness of managers in particular – of sustainability issues.

NEGATIVE: Integrated thinking is a relatively weak accountability mechanism, because whether integrated thinking is occurring, and how well, cannot be directly disclosed, measured or audited (despite the IIRC’s growing focus on assurance). For example, integrated thinking may prompt management to better understand the ‘legitimate needs and interests’ of their organisations’ workers. However, it is difficult to measure or enforce this understanding, especially compared to the Global Reporting Initiatives requirement for organisations to report against International Labour Organisation benchmarks.

Moreover, and as previously discussed, the IIRC is yet to clarify what concrete processes organisations should use to engage their stakeholders. Hence, more could be done to explain what management can do to gain the broader understanding of stakeholders’ views and interests that integrated thinking entails.

In our next blog, we will consider in more detail to what extent Integrated Reporting might improve sustainability by capturing stakeholders’ ‘legitimate interests and needs’ better than alternative reporting frameworks.

As always, any comments or thoughts most welcome. If you wish to be e-mailed future blogs, please subscribe to this blog.

Will Integrated Reporting improve sustainability? Part II – Communicating Value

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dreamstime_s_42615032Dr Dale Tweedie and Prof. Nonna Martinov-Bennie.

This is the second in a series of blogs that asks whether Integrated Reporting can contribute to sustainability, where sustainability means a replicable and just use of natural and social resources.

Our last blog highlighted one key difference between an Integrated Report and a sustainability report: That an Integrated Report describes natural and social resources from the company’s point of view.

This blog explores a second difference, which is that an Integrated Report is more about helping companies communicate than holding companies accountable. As a result, whether Integrated Reporting makes companies more sustainable depends on what and to whom companies choose to communicate.

Reporting and corporate change.

There are at least two ways that any report might change a company’s behaviour:

  1. A report may enable someone – a shareholder, an employee or a regulator – to hold a company accountable for its actions. Sustainability reporting is often viewed this way. For instance, having multi-national companies report against global labour rights may enable civil society to better enforce these standards.
  2. A report may change behaviour by changing relationships, or by starting new conversations. For example, GRI 4 requires companies to engage with stakeholders to determine their concerns. If this discussion changes how companies act, then the process of GRI reporting could change companies’ behaviour by initiating structured conversations between the company and the people it affects.

In our view, the potential of Integrated Reporting to change behaviour is more through the second mechanism than the first. That is, the potential for Integrated Reports to improve sustainability is less about making organisations more accountable, and more about creating different discussions between organisations and their stakeholders.

Communication into action

Viewed in this light, whether Integrated Reporting improves sustainability depends on what kinds of conversations an Integrated Report enables, and whether companies choose to use Integrated Reporting to initiate these conversations.

Internal conversations

Integrated Reporting might provide space and vocabulary within firms to have conversations that might not otherwise occur, especially at board and management level.

There are many people within most companies who are genuinely committed to sustainability, but whose companies may not have a culture of discussing sustainability issues. The language of six capitals might enable more serious discussions about long-term connections between companies and social and environmental issues, especially at senior levels.

External conversations

Although targeted at investors, the six capitals framework might allow organisations to more rigorously engage with stakeholders’ concerns.

For example, a common view amongst academics is that companies need social legitimacy to operate over the long term, sometimes called a social licence to operate. Integrated Reporting might allow organisations to have better conversations about preserving their social licence to operate by creating a common vocabulary in which these conversations can occur.

Implications for Integrated Reporting

Thinking about Integrated Reporting as more a vocabulary than an accountability mechanism has three implications for how companies should use an Integrated Report.

  1. There is no value in simply delegating an Integrated Report to the sustainability reporting team. Since the potential value of an Integrated Report is the conversations it could enable, the only substantive reason to produce an Integrated report is to start discussions between the sustainability team and finance, marketing, management and the board, especially about where the company, environment and society will be in five, ten or twenty years’ time.
  2. Issuing an Integrated Report is unlikely to satisfy public critics of a company’s sustainability record. On present evidence, Integrated Reports are not comparable enough to hold companies accountable on their social and environmental performance. Instead, the value of an Integrated Report is if companies are able to use the reporting framework – and the idea of six capitals it contains – to engage rather than placate concerned stakeholders.
  3. Stakeholder engagement is a key area for future development of the Integrated Reporting Framework. The current Framework requires companies to consider the ‘legitimate interests’ of stakeholders, and provides a language and format for this consideration. But – unlike GRI 4 for instance – there is little guidance on how this engagement should occur in practice.

Next time…

Based on our recent article, our next blog will consider the claim that Integrated Reporting encourages ‘integrated thinking’. What does this mean, and how – if at all – is it relevant to sustainability?

In the meantime, any thoughts or questions most welcome.

Will Integrated Reporting improve sustainability?

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– Dr Dale Tweedie and Prof. Nonna Martinov-Bennie.

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If the Integrated Reporting Framework is successful in engaging business and investors, how – if at all – will this success affect sustainability?

This is the first of a series of short blogs that address this question, based on a new article published in the Social and Environmental Accountability Journal in February, 2015.

What is sustainability?

The word ‘sustainability’ has many different meaningsWe use the term to refer to a replicable and just use of social and natural resources. This is the ideal of sustainability made famous by the World Commission on Environment and Development’s definition of sustainability as ‘meet[ing] the needs of the present without compromising the ability of future generations to meet their own needs’.

One difficulty with assessing how the Integrated Reporting framework will affect sustainability is that the International Integrated Reporting Council (IIRC) itself uses the word ‘sustainable’ to mean two quite different things:

  • Sustained value creation; which refers to a company’s ability to continually create value over time; and
  • Natural and social sustainability; which refers to companies that consider how their actions are connected to, or impact, society and the environment.

These two ideas are linked, but they are not synonymous. For example, an energy company might profitably sustain itself extracting and selling fossil fuels for many years, without necessarily considering its impacts on global warming or accounting for the costs that future generations will bear.

How Integrated Reporting will not affect sustainability

Integrated Reports require companies to consider natural and social capital, but an Integrated Report is not a sustainability report.

Sustainability reports typically require businesses to explain more fully how their activities impact societies (e.g. work, health and safety reporting) and natural environments (e.g. recycling and energy use).

In a sense, Integrated Reporting does the reverse: An Integrated Report aims to better explain how society impacts business.

One partial but useful way of thinking about Integrated Reporting is as expanding companies’ balance sheets to better represent how companies depend on non-financial resources, including resources or ‘capitals’ the company does not or cannot own. For example, in an Integrated Report, social capital might reflect how companies’ supply chains and sales depend on a hidden web of trust and goodwill, as well as on its monetary wealth and physical assets.

But an Integrated Reporting ‘balance sheet’ is still organised from the companies’ point of view, rather than from external stakeholders’ view of how the company impacts them. More precisely, an Integrated Report is organised from the point of view of how social, natural and other capitals enable companies to create financial value, especially over the longer term.

So if Integrated Reporting is to improve sustainability, it can’t be in the same way as sustainability reports.

How Integrated Reporting might affect sustainability.

Integrated Reporting might affect sustainability if bringing new types of capital into mainstream business reporting and business models helps to improve how companies interact with their communities and natural environment; such as by being more responsive to harmful effects that are not priced into conventional markets.

Our recent article considers four possible ways that IR could impact natural and social sustainability in this way:

  • By changing how organisations communicate
  • By encouraging integrated thinking
  • By better representing stakeholders’ ‘legitimate interests and needs’
  • By better capturing the long-term impacts of how organisations use resources.

In our upcoming blogs, we will review each of these possibilities in more detail.

If you are interested in being alerted to new posts, please sign up to IGAP’s blog below.

Any comments or thoughts are most welcome.

What does the market expect of audit committees? Michael Coleman at the joint IGAP & CPA Australia Annual Forum.

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MC picWhat does the market expect of audit committees? Increasingly, ‘everything’, Michael Coleman told the Annual Forum, held in October, 2014.

The joint IGAP and CPA Australia Annual Forum gathers leaders from industry, the accounting profession and academia to address key issues in contemporary governance and performance.

This year’s topic – ‘The  evolving role of audit committees’ – explored how audit committees are responding to rapidly evolving risks, liability, technological advancements and complexity in reporting, among a myriad of other challenges.

Coleman was Chair of the Financial Reporting Council (FRC), sits on a number of prestigious boards and has also had 30 years as an audit partner. He used his keynote address to highlight a potential expectations gap between what markets expect of audit committees and what directors can reasonably deliver.

Coleman highlighted several key challenges that audit committees are facing:

  • Changing expectations of regulators and the market; for example, that audit committees should be satisfied that auditors are doing their job or commenting on financial reviews;
  • A greater focus on risk; and
  • The proliferation of reports (e.g. Integrated Reporting).

A particular difficulty Coleman highlighted is the expectations for audit committees to form a judgement on audit quality:

“So whether it’s a good audit or not a good audit is a tough one and this is something that as audit committees we’re probably going to have to take a reasonable amount of time to consider.”

“We need to question amongst other things whether or not the auditor has been sufficiently sceptical. Now, how does an auditor demonstrate to the board that they’ve been sceptical?”

Coleman also highlighted how Australia has to some extent followed the United States trend of increasing the responsibilities of audit committees:

“In particular in my experience it’s become common for audit committees to approve fees over a certain level in relation to non-audit services provided by the auditor and audit committees have taken on a far more extensive role in relation to overseeing the financials.”

However, unlike in the United States, Australia still sees the audit committee as a sub-committee of the board:

“It’s not a separate creature, it’s not a separate animal and so therefore, and especially following Centro, we have the situation where boards, very, very rigorously in my experience, are actually as a whole considering the financials.

“The audit committee might look at the detail, but then the board as a whole still wishes to satisfy itself that it’s actually doing the right thing.”

Finally, Coleman observed how the expectations on audit committees would continue to evolve in the future with the release of a new auditing reporting standard in June 2016, which “will require the auditor’s report to include commentary on their key audit matters”. The new standards are likely to some interesting discussions, and to some changes to the dynamic of the relationship between the auditor and audit committee.

Communicating Safety: Avoiding common mistakes

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???????????????????????????????????????????????????????????????????????????????????????????????A discussion by James Harkness (for Zenergy Recruitment), headed Reporting on WHS: where companies go wrong, illustrates how IGAP’s Dr Sharron O’Neill’s research on work health and safety (WHS) can improve how organisations communicate their safety practices.

Harkness cites Dr O’Neill’s presentation at Safe Work Australia’s Virtual Seminar Series in October, which found a large gap between the WHS information stakeholders want and what annual reports provide.

Some common mistakes organisations make are:

  • Providing a generic statement of commitment to WHS, but without detailed information on WHS governance;
  • Failing to provide key lead and lag indicators, which can deliver important evidence on whether WHS practices are effective;
  • Providing limited evidence on whether audits and training sessions are effective;
  • A lack of consistent indicators and evidence e.g. Using different names for the same indicator, failing to define their indicators or failing to stick to their definitions;
  • Being reluctant to talk about the severity of injuries, effectively hiding the impact of gaps in companies’ health and safety systems; and
  • Building inaccurate narratives around their data.

By contrast, for best-practice WHS reporting in annual reports, organisations should:

  • Recognise who the users of the report are;
  • Clearly articulate their WHS vision;
  • Identify their critical risks;
  • Outline how risks are being managed; and
  • Acknowledge the consequences of failure;
  • Provide analysis where there has been a serious injury or illness: What happened, what was the cause, what is the lesson, what is being done to prevent this occurring again.

Where poor WHS reporting can be confusing or misleading, Dr O’Neill’s address highlighted how best-practice WHS reporting in annual reports can help instil confidence in an organisation’s WHS performance and practices in its stakeholders.

For more information on this research, or on improving WHS performance in your organisation, contact Dr O’Neill at: sharron.oneill@mq.edu.au.

Des Pearson on Public Sector Audit

DP PicThe International Governance and Performance (IGAP) Research Centre was pleased to host Mr Des Pearson, who recently retired as Auditor General of Victoria, as the IGAP Executive in Residence sponsored by CPA Australia. Des’s public sector career spanned over 40 years and 5 jurisdictions, with more than 30 years’ experience at senior, chief executive and statutory officer levels. Des has worked in governance, financial and program management, performance evaluation and accountability roles, including more than 21 years as an Auditor General across two jurisdictions.

During his time at IGAP, Des presented two seminars: at an IGAP/ CPA Australia Roundtable on performance reporting; and at Macquarie University’s Department of Accounting and Corporate Governance on public sector reporting. The slides and key points from Des’s presentations are below.

Performance Reporting (at CPA Australia)

  • Public sector audits include financial and non-financial audit: both financial ‘how much’ and performance ‘how well’, are critical.
  • While financial reporting in the public sector is well-developed, performance reporting is still ad-hoc.
  • Public sector audits have unique challenges: a democracy (and therefore adversarial governance); and the rationing of limited (taxpayer funded) resources against excess demand (from the community).
  • Other challenges include: adopting market models within the public sector; co-ordination between the government and other entities; and public sector timelines (3-4 year terms of office).
  • Possible responses to these challenges are: comprehensive performance reporting; sustainability and integrated reporting; and, building on the Productivity Commission’s Report of Government Services.

SLIDES: PERFORMANCE REPORTING CPA

Public Sector Reporting (at Macquarie University)

  • The Federal, NSW and Victorian state public sectors arguably represent Australia’s first, second and third largest businesses. The auditor general needs to provide assurance to Parliament that these sectors are performing and accountable.
  • Public sector clients are diverse, including local governments, water corporations, police, emergency services, financial institutions, and universities.
  • The key focus for all audits is accountability: that is, reporting back to those who have charged you with a responsibility. The funding of the public sector by a forcible extraction of funds via taxes and charges adds an extra layer of accountability as there is an obligation to apply these funds ‘in the public interest ‘.
  • The Australian public sector needs to be made accountable, not only for probity, integrity and performance management, but also for a working democracy. Quality in public service audit, means reliable assurance of efficiency, economy and effectiveness in program delivery.

SLIDES: PUBLIC SECTOR ACCOUNTING MACQUARIE UNIVERSITY

Four ideas for improving Integrated Reporting

The International Integrated Reporting Council (IIRC) recently completed the consultation period for its draft version of the International Integrated Reporting (<IR>) framework, with <IR> ‘Version 1’ to be released in December. IGAP researchers Dr Dale Tweedie and Prof. Nonna Martinov-Bennie raised four ideas for the IIRC to consider in its revisions.

????????????????????????????????????????????????????????????????????????????????????????1. Clarifying the relationship between <IR> and other reporting systems

The IIRC’s ‘value-creation’ approach to non-financial reporting is very different from the ‘impact-assessment’ approach used by the Global Reporting Initiative (GRI). Users of <IR> would benefit from greater guidance on how <IR> and GRI4 can be complementary in a practical reporting context; for example, by clarifying differences in the materiality determination processes of <IR> and GRI4 and which – if any – takes precedence.

2. Acknowledge and address stakeholder conflicts

The IIRC’s view that the interests of providers of financial capital – the primary audience of <IR> – and other stakeholders will align over the long term overlooks potential conflicts between these groups, and so how conflicts should be reported. An example in Australia is coal seam gas (CSG) exploration, which promises significant financial benefits to mining and energy organisations, but which other stakeholders have claimed is a long-term risk (e.g. to primary production and water supply). Given this perceived conflict, what should be reported by organisations engaged in CSG exploration? Further clarity on the ‘legitimate needs, interest and expectations’ of other stakeholders that an <IR> should acknowledge would help address these kinds of issues.

3. Increase comparability through a stronger ‘core’

As our earlier blog discussed, while a principles-based framework is a useful method of avoiding boiler-plate disclosures, <IR>s need sufficient commonalities to be comparable over time and between organisations. Providing a stronger ‘core’ of reporting requirements and methods, best practice guidance (e.g. on carbon reporting) and definitions of key terms could encourage comparability without sacrificing the principles-based approach.

4. Governance as accountability

The draft <IR> framework asks each organisation to explain how its ‘governance structure support[s] its ability to create value in the short, medium and long term’. While good governance is part of value creation, the key features of governance are accountability, transparency and ethics, which are fundamental to ensuring that the value that organisations create is managed and distributed in appropriate ways. Following the King Reports in South Africa, <IR> could play a greater role in emphasising and communicating the importance of these aspects of governance.