The Routledge Companion to Intellectual Capital

Integrated reporting (IR) is a form of disclosure that focuses on communicating the interactions between financial and non-financial information. There is a particular emphasis on telling the future value creation story of the reporting organization with reference to the organization’s strategy, business plan, and the six capitals: financial, manufactured, intellectual, human, social and relationship, and natural capital (IIRC, 2013). Others in this book have recognized the close relationship of IR with intellectual capital (IC) (Dumay et al., 2017). IC’s structural capital resembles IR’s intellectual capital, human capital remains human capital, and IC’s relational capital maps to IR’s social and relationship capital.

This chapter provides details on the origins and developments of IR, and the connections between IR and IC. It discusses prior literature and points to research opportunities at the intersection between IR and IC. Conclusions are presented on the advantages for proponents of IC to collaborate with and benefit from the efforts of the IR movement.

The International Integrated Reporting Council (IIRC) was established in 2010 based on the initiative of the Prince of Wales’ Accounting for Sustainability Project and the Global Reporting Initiative (GRI) (IIRC, 2010). As such IR was founded on the concept of sustainability. The timing of IIRC’s foundation in the aftermath of the global financial crisis also points to the dissatisfaction of players in the capital markets, and perhaps society as a whole, with existing forms of corporate reporting. Accounting and reporting were seen as deficient in terms of their focus on the past instead of future value creation plans, and on financial information as opposed to a balanced disclosure of both financial and non-financial information. There has been growing acknowledgement that future oriented and non-financial information may be more meaningful in explaining current corporate valuations.

The IIRC engaged in a wide-ranging consultation process in an effort to finalize the International Integrated Reporting Framework (IIR framework), which was achieved in December 2013. The framework emphasizes future value creation and the need to integrate financial and non-financial information in a single report, instead of providing information as separate sections/reports. The IIRC encourages the IR process to be driven by integrated thinking, which is meant to promote a long-term outlook, countering the short-termism of both managers and investors, which some commentators see as the cause of the global financial crisis.

The IIRC promotes IR by visiting and presenting at conferences and universities, and engaging with regulators and corporates. The IIRC has various boards and activities that involve the CEOs of multinationals, representatives of the large audit firms, and regulators and other influential individuals. For example, IIRC participates in the Corporate Reporting Dialogue, an initiative aimed at improving corporate disclosure, working alongside the United Kingdom’s Carbon Disclosure Project, the Climate Disclosure Standards Board, the Financial Accounting Standards Board, the GRI, the International Accounting Standards Board, the International Organization for Standardization, and the US Sustainability Accounting Standards Board (SASB) (Corporate Reporting Dialogue, 2015).

Apart from regulators, corporate preparers, the accounting profession, and investors have taken note of the IR movement. For example, Business 20 (2014), consisting of business leaders from the G20 countries, subscribe to IR. While IR is a listing requirement in South Africa, on an apply or explain basis, Australian funds (Kitney, 2014), the Securities and Exchange Board of India (Business Standard Reporters, 2014), and the accountancy profession in Singapore (Kee et al. 2014) have expressed intentions to support IR. In addition, more than 100 multinationals participate in the IIRC’s pilot programme and many others, for example General Electric, are now issuing integrated reports (Fairfield, 2016).

The IIR framework is a voluntary principles-based framework that guides the preparation of an integrated report. An integrated report prepared according to the IIR framework focuses on connecting financial with non-financial information to communicate the organization’s future value creation plans to capital providers, specifically referring to strategy and the business model (IIRC, 2013). The framework includes seven guiding principles, eight content elements, and introduces the concepts of integrated thinking and the six capitals. Although the IIR framework provides report preparers with a direction for implementing the IR process, it does not prescribe specific or technical instructions. The IIRC does not suggest any key performance indicators or metrics for managers to consider and therefore the IIR framework needs to be supplemented by other reporting guidance.

As one of the IIRC’s co-founders, the GRI is an international organization that champions sustainability reporting by continuously developing and promoting its own sustainability reporting standards. The GRI’s voluntary disclosure standards are meant to help report preparers understand and communicate their impacts on sustainability issues. Sustainability reporting is “an intrinsic element of integrated reporting” (GRI, 2013, p. 85); hence, one of the main objectives during the development of the GRI G4 Sustainability Reporting Guidelines (G4) was to offer guidance on linking the sustainability reporting process to the preparation of an integrated report (GRI, 2015). GRI G4 provides specific economic, environmental, and social indicators for reporters to consider.

Similar to GRI guidelines, the sustainability accounting standards developed by the SASB offers guidance on sustainability indicators. The SASB signed a memorandum of understanding with the IIRC, agreeing to work in unison to strengthen corporate sustainability reporting and disclosure practices (IIRC, 2014). The SASB standards provide publicly traded US corporations with industry-specific guidance for the disclosure of environmental, social, and governance information to be used in statutory filings.

Specifically focused on IC, the World Intellectual Capital/Assets Initiative (WICI) is an international organization focused on improving the reporting of intangible assets. The WICI has been working in collaboration with the IIRC, focusing its efforts on providing industry-specific guidance on the disclosure of intellectual, relational, and human capitals. The WICI (2016) developed the WICI Intangibles Reporting Framework (WIRF), which shares several characteristics with the IIR framework. The purposes of both frameworks are to guide reporting practices in communicating how organizations generate value and achieve business sustainability, and to encourage more efficient allocation of resources. WIRF is a voluntary principles-based framework that defines and classifies intangibles. WIRF identifies five principles for intangibles reporting, provides examples of indicators, and suggests a structure for intangibles reporting.

The efforts of the IIRC, the GRI, the SASB, and the WICI contribute to a common goal: the alignment of organizational operations with sustainable value creation, and the enhancement of the efficiency of the resource allocation decisions of both internal and external stakeholders. While the IIR framework provides an overarching direction, reporters may find it useful to use it in combination with other guidelines, such as those provided by the GRI, the SASB, and the WICI, to take steps towards IR.

Corporations do not typically disclose separate IC reports (Dumay, 2016). This is attributed to the prominence of other forms of disclosure, such as sustainability reporting and IR, which also communicates IC and value creation (Dumay, 2016). As IC management and reporting falls under the broad scope of IR, management’s focus on the communication of specific IC information may experience a resurgence. IC is reflected in three of the IIR framework’s six capitals, and both IC and the IIR framework emphasize value creation and the business model.

The IIR framework encourages the assessment and disclosure of resources and relationships related to organizational operations in six capitals, namely: financial, manufactured, intellectual, human, social and relationship, and natural capitals. The capitals represent stocks of values that change or are transformed by the activities and outputs of the organization. Three intangible capitals defined in the IIR framework as intellectual, human, and social and relationship broadly align with the three components of IC, respectively, structural capital, human capital, and relational capital (WICI, 2016).

The notion of corporate value has departed from the traditional short-term focus on shareholder returns to incorporate impacts on long-term sustainability and societal wellbeing. A core focus of IR is on understanding and communicating “the ability of an organization to create value in the short, medium and long term” (IIRC, 2013, p. 2). This focus correlates with the function of IC, which reflects organizational knowledge, intellectual property, and experience that contributes to value creation (Dumay, 2016). The IIRC (2013) emphasizes that the focus of integrated reports is to explain how value is created for capital providers; however, focusing attention on one capital, such as financial capital, at the expense of others is unlikely to maximize value creation in the long term. An organization’s external environment affects its ability to create value and therefore managers need to attain an optimal balance of the six capitals. Knowledge-based resources are a critical component of value creation in modern economies (Bini et al., 2016), suggesting that the measurement and management of IC lies at the core of understanding and communicating value creation.

Business models explain how strategy is implemented and are a representation of an organization’s value creation processes. The business model shows how resources are transformed into value and highlights the interrelationships between various elements in the value creation process (Beattie and Smith, 2013; Bini et al., 2016). The business model is one of the IIR framework’s content elements. The IIR framework suggests disclosing key inputs, business activities, outputs, and outcomes, and connecting such information with other framework elements such as strategy and performance. Similarly, the IC concept is concerned with the transformation of resources into value and is often related to the concepts of strategy, competences, and activities (Beattie and Smith, 2013). IC is therefore embodied in an overarching business model, and the business model is a way to make sense of IC complexity (Bini et al., 2016).

While the body of academic literature on IR is growing, it is currently limited due to the novelty of the framework and the lack of long-term practical experience with IR as many organizations are still grappling with implementation issues. This section reviews selected works in the IR literature that are relevant to IC management and reporting. For a broader insight of available studies, De Villiers et al. (2014) discuss the development of IR in greater detail, De Villiers et al. (2016) provide a thematic discussion of the IR literature, and Dumay et al. (2016) provide a structured literature review.

There are few IR studies that relate to IC as it is common for researchers to focus on the environmental and social aspect of IR, rather than the IC related components (e.g. Knauer and Serafeim, 2014; Stubbs and Higgins, 2014; Atkins et al., 2015; Bernardi and Stark, 2016). Studies such as García-Sánchez et al. (2013) and Frías-Aceituno et al. (2013) have, in turn, interpreted their results based on a sustainability focus. Focused on identifying the determinants of IR, those two studies examined the impacts culture and institutional systems have on the preparation of integrated reports. García-Sánchez et al. (2013) found corporations operating in countries with stronger collectivist and feminist values are leaders in information integration. The findings are attributed to stakeholders in these cultures having greater demand for sustainability-related performance information as they place greater emphasis on improving the quality of life for broader society. Frías-Aceituno et al. (2013) found companies in code law systems are more likely to issue integrated reports, attributing the results to code law societies (e.g. France) being more communitarian and thus more accepting of broader stakeholder rights, compared to common law systems where shareholder interests take precedence (e.g. the US).

Evidence from Australia by Higgins et al. (2014) and Stubbs and Higgins (2014) suggests IR does not stimulate radical changes to reporting processes in the early stages of adoption. IR is seen as an extension to sustainability reporting, therefore leading to incremental changes rather than stimulating innovation in reporting processes (Stubbs and Higgins, 2014). Higgins et al. (2014) found managers consider IR to be about story-telling and meeting stakeholder expectations, resembling a means of communicating that a company’s strategy is sustainable and aligns with corporate responsibility. The findings of these two studies largely concentrate on the external reporting process and corporate social responsibility. While this may be affected by the interview prompts the researchers used, managers appear to lack consideration in terms of the internal effects IR has on IC.

A case study by Parrot and Tierney (2012) found IR and stakeholder engagement to be fundamental contributors to a corporation’s success. Although it is challenging for managers to achieve a balance between multiple stakeholder interests and financial, environmental, and social aspects, addressing ethical and relational considerations is seen as necessary for long-term value creation. Parrot and Tierney (2012) highlight the importance of stakeholder engagement and management, which can be seen as relational capital in IC terms.

Emerging evidence suggests that IR may have a positive effect on the amount of IC disclosed. Terblanche and De Villiers (2015) analysed locally listed and cross-listed South African companies and found companies that prepared an integrated report disclose more IC information. Moreover, regardless of whether the company was cross-listed on another bourse there was no significant difference to the level of IC disclosures. Setia et al. (2015) also investigated the context of South Africa and found that the introduction of IR has resulted in significant increases in the disclosure on intellectual, human, and social and relational capital. The extent of the increase in disclosure on social and relational capital has been greater than the disclosure on other capitals. Through an analysis of international corporations engaging in IR, Eccles et al. (2015) found corporations are emphasizing IC in their strategic focuses as there is a tendency for manufacturing corporations to link strategy to product innovation and non-manufacturing corporations linking strategy to developments in human capital and relational capital. However, Melloni (2015) found corporations focus on relational capital over human and structural capital in integrated reports. Furthermore, the tone of IC disclosure resembles opportunism, suggesting managers use it to manipulate corporate image.

Content analysis has been commonly used by researchers to assess the quality of integrated reports, often using the IIR framework as a basis for analysis. Eccles et al. (2015) suggests there needs to be clearer explanations on how managers determined stakeholder priority and to link risks to corporate goals. Moreover, more disclosure in terms of the projection of environmental, social, and governance performance and forward-looking information in general. Similarly, Stent and Dowler (2015) consider the best practice disclosures in New Zealand to be close to the requirements of the IIR framework; however, improvement should be made regarding the connectivity of information, reporting against industrial or regional benchmarks, and reporting on uncertainties and outlook. Melloni (2015) notes a lack of quantitative and forward-looking information, specifically in relation to IC disclosure. This finding is supported by Wild and Van Staden (2013), who found that although most companies in their sample of 58 addressed financial, human, natural, and social and relationship capitals in their reports, manufactured and IC were not widely addressed, being disclosed in only 40 per cent of the reports.

Studies based on investors’ use of integrated reports have suggested that IC and sustainability-related information affects capital allocation decisions. A case study by Knauer and Serafeim (2014) found integrated thinking and reporting attracts long-term investors. It is suggested that long-term investors are attracted to increases in the transparency of policies and practices, and communication of human capital, leadership and governance, and environment performance information. Atkins and Maroun (2015) found South African investors view the connectivity between social, ethical, environmental, and governance issues with financial materiality as a core element to IR. Although investors view integrated reports as an improvement on traditional annual reports, reports have been criticized for being too lengthy, containing excessive repetition, and following a box-ticking approach to compliance.

Through examining the quality of IR disclosures, with IC disclosure being an integral part of the quality assessment, Barth et al. (2016) found a positive association between high quality integrated reports and stock liquidity and firm value, with the change in firm value mainly driven by changed future cash flow expectations, rather than changed risk assessments. Zhou et al. (2017) found a decrease in analyst forecast error when IR quality was higher, while no clear association was found between disclosure quality and analyst forecast dispersion.

While the IIR framework guides the preparation of an external report, IR is a process that concerns the restructuring of internal measurement systems as well as the provision of an integrated report (Rowbottom and Locke, 2016). As evident from the previous section, it is common for early IR research to focus on the external reporting component of IR. The long-term thinking encouraged by IR may need to be further emphasized, however complex it may be to think of value creation as broadly as that promoted by the IIRC. Van Bommel (2014) documents conflicting perspectives held by various stakeholder groups regarding the expected role of IR in society. The emphasis on value for capital providers ultimately means a focus on financial capital, which generates bias rather than legitimate compromise and diverts efforts from enhancing societal wellbeing and long-term sustainability (Van Bommel, 2014; Flower, 2015). The concerns expressed by Flower (2015), Brown and Dillard (2014), and Van Bommel (2014) over the IIR framework’s focus on value creation for capital providers and its promotion of IR as a business case could be welcomed by the proponents of IC. That is, IC has arguably always had a value creation and business case focus. In terms of the IR literature, IC does not appear to be a main focus despite IC disclosures potentially benefiting from the IR movement.

Adams (2015) views the IIR framework as a means to encourage managers to think about profit maximization and corporate success differently. There needs to be further developments in accounting regarding the measurement and reporting of non-financial capitals for integrated reports to bring about a meaningful change to corporate disclosures. Abhayawansa (2014) reviewed 20 guidelines and frameworks related to the external reporting of IC. The paper identifies that most of the IC guidelines and frameworks propose the disclosure of a separate IC document that elaborates on a company’s value creation process without integrating IC information with other non-financial information. Abhayawansa (2014) views the IIR framework as an opportunity for IC reporting to reinvent itself. As there is limited guidance provided in the IIR framework for the integration of IC information, the available IC frameworks could be useful in framing IC information within an integrated report.

The IR movement involves important players at all levels in society and the capital markets. Early evidence suggests that IR is being implemented and adopted at a more rapid rate than previous reporting initiatives. As such, and given the similarities between several of the characteristics and components between IC and IR, it is worth paying attention to IR and to consider the implications for the IC movement.

The three components of IC, structural, human, and relational capital, are three of the six capitals promoted by IR, albeit called by slightly different names. In addition, both the IR and the IC movements emphasize value creation and the business case for reporting. Therefore, any headway made by the IR movement in promoting IR can only benefit IC disclosure. Proponents of IC should consider ways to collaborate with the IR movement, as well as ways to leverage off the activities of the IIRC.

Given the small number of studies to date that address the intersection(s) between IC and IR, several research opportunities present themselves. For example, the following questions could be answered with the help of empirical data:

1 How does the advent of IR influence the IC movement?

i assessed on the basis of disclosures;

ii assessed on the basis of activities and agenda within reporters;

2 How are these answers influenced by whether IR is adopted voluntarily, as is the case in much of the world, or whether IR is mandatory, as is the case in South Africa?

Several other research opportunities are bound to become evident with the passage of time.

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