November 10, 2009
In its 2008 report, United Technologies Corporation included corporate responsibility (CR) topics that have a direct impact on the company’s financial performance, such as energy efficiency, throughout the report. The company also devoted a separate section of its report to its overall CR strategy and performance.
UTC is just one example of a growing number of companies that have integrated their CR and annual reports to highlight the importance of the company’s non-financial as well as financial performance to investors. According to KPMG’s latest “International Corporate Responsibility Reporting Survey,” approximately 11 percent of the world’s 250 largest companies produced combined or integrated reports in 2008. And nearly 125 other companies in this sample referenced key environmental and social data in their 2008 annual reports.
While integrated reporting is not new—Novo Nordisk, for example, has been producing integrated reports since 2004—three converging trends are causing more companies to embrace the practice:
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Increasing integration of CR into business strategy: By speaking with one voice on business performance, companies can demonstrate how sustainability is integrated into core business strategy. Internal integration is also making it easier to talk about CR in terms of the business, and vice versa.
Vodafone‘s “One Strategy,” the company’s approach to creating inseparable CR and business strategies, exemplifies this trend. In addition to producing a detailed standalone CR report and dedicating a portion of the company website to sustainability issues, Vodafone also reports on its CR strategies and performance in its annual reports.
- Rising interest from investors: As described in the recent BSR report “ESG in the Mainstream: The Role for Companies and Investors in Environmental, Social, and Governance Integration,” more and more mainstream investors are considering companies’ CR performance in their valuations. Integrated reporting demonstrates to investors that businesses have a holistic view of their operating environment and are effectively managing their risks. Integrated reporting also provides investors with a more complete picture of companies’ current value and future potential, which, presumably, will help investors reward companies for their sustainability investments.
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Growing regulation on non-financial reporting: Over the last five years, six countries have passed legislation or issued directives mandating that companies include at least some CR data in their annual reports. In September, for instance, South Africa adopted the King III Code on Corporate Governance, which recommends that companies integrate sustainability reporting and disclosures into their financial reporting.
It’s possible that the EU and the United States will follow suit. Although the U.K. rescinded its proposed introduction of Operating and Financial Reviews into company law in 2005—which would have required public disclosure of companies’ most significant impacts on society and the environment—the country’s Company Act of 2006 requires that companies include a business review in their directors' report and is leading to an increase in non-financial disclosures. Meanwhile, the European Commission is planning a series of meetings to examine regional ESG disclosure policy, and SRI groups in the United States report that the U.S Securities and Exchange Commission may also be considering regulatory options for mandatory CR disclosures.
These trends raise some interesting questions for companies seeking the best way to communicate with stakeholders about their sustainability performance: How does the concept of materiality differ between CR and integrated reports? How can companies meet the information needs of a wider variety of stakeholders through more streamlined communications? And what are the standards for integrated reporting?
Three Approaches to Integrated Reporting
Before delving into the questions above, it’s instructive to consider the three main approaches companies adopt to incorporate CR disclosures into their annual reports:
- Aligned: Rather than producing two distinct reports that cover financial and non-financial data without reference to each other, some companies have begun producing aligned annual and CR reports. These reports reference each other, use consistent design and formatting to emphasize the interconnectedness of the topics, and are often released as a single package. Phillips-Van Heusen Corporation took this approach in 2008: The company published its annual and corporate responsibility reports at the same time and with a uniform design and format.
- Incorporated: Other companies include CR information as a supplement to financial performance data, either as a standalone section of the annual report or by integrating particular topics that have a material impact on the company’s business performance. Roche, for example, includes CR information as a separate, almost supplementary section of its annual report.
- Integrated: In integrated reports, CR strategies, risks, opportunities, and performance are incorporated into the main discussions of financial and business information. For instance, AstraZeneca produces a fully integrated report that articulates sustainability strategies, performance, and targets alongside and under the same headers as financial descriptions. In 2008, the company listed its non-financial performance indicators (including injury rates, sales and marketing breaches, and greenhouse gas emissions) alongside financial performance indicators.
Key Issues
While there are obvious benefits to integrated reporting, there are also several critical questions that companies and the CR reporting community must address to ensure that integrated reporting meets the needs of businesses and stakeholders.
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Materiality—one word, two definitions: The CR reporting community has become accustomed to thinking about materiality in terms of information that is significant to the future prospects of the business as well as to the decisions and judgments of stakeholders. However, in financial reporting, a fact is defined as material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote or invest. In practice, materiality in annual reporting generally follows the narrower definition based on the financial interpretation.
However, companies moving to an integrated report need to understand the critical difference between these two interpretations of materiality. The burden to report on both financial and non-financial data within a limited space—essentially to fit into one report information that could fill two reports—will compel companies to limit inclusion to those issues that impact the companies’ financial performance. While the investment community increasingly appreciates the impact of CR performance on company valuation, the reality is that in order for CR to be included in integrated reports, the issues must pass a higher significance threshold.
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Meeting audience expectations: Given this higher materiality hurdle, it’s not possible for integrated reports to be all things to all stakeholders. Financial audiences get a lesser product if integrated reports are too long, and CR audiences get a lesser product if information is left out. Consequently, at least for larger companies, integrated reports aren’t sufficient replacements for other CR communications.
Companies pursuing integrated reporting need to use additional venues to convey the information left out—information that may not be material to shareholders and investors, but certainly is to other stakeholders. Some companies, such as Novo Nordisk, supplement integrated reports with detailed and robust online communications about CR policies and programs. Others continue to produce standalone CR reports or short brochures. Novartis, for instance, releases a short CR review and publishes more detailed information based on Global Reporting Initiative (GRI) guidelines on its website.
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Creating comparability: CR and annual reports each have their own set of widely accepted standards that guide content—the GRI’s G3 guidelines for CR reporting, and national and international frameworks for financial reporting. However, there are currently no standards to guide companies on integrated reporting. At best, financial reporting regulations provide only vague guidelines for how companies should report on non-financial information, and the GRI recommendations are too extensive to be applied to the limited scope of an integrated report.
Furthermore, the stricter use of materiality in integrated reporting means that issues that should be included in one company’s integrated report wouldn’t be relevant in another company’s report. For example, a beverage company would want to include information on its water practices and performance, whereas a financial services company would be more likely to describe its approach to responsible lending. While this is a logical approach for individual companies, it can inhibit the ability of stakeholders and investors to compare companies and industries.
Implications for the Future of CR Communications and Reporting
We believe that integrated reporting offers companies the opportunity to make a strong statement about the importance of CR to their business. We expect that the possibility of required disclosures and the increasing financial importance of CR performance will continue to drive integration. We also predict that integrated reporting will ultimately become the principal summary of CR and business performance.
However, for integrated reporting to successfully meet the needs of business and stakeholders—from employees and NGOs to investors and shareholders—the CR reporting community needs to engage in a more deliberate debate on these issues, especially when it comes to the application of the materiality principle. The onus will be on companies to experiment with different methods of communicating their CR performance using integrated reporting. And stakeholders and investors will need to support this experimentation by providing constructive feedback and collaborating with companies to adjust or develop new reporting standards.
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