It is a clear expectation that board members are financially literate and any board using a skills matrix will encapsulate this in some way. But what about an understanding of value beyond profit? Or of the broader risks and opportunities that lead to, or threaten, value creation?
Integrated reports are designed to convey to investors and other readers information about the short, medium and, most importantly, the long-term value created by an organisation and the process by which that is achieved. Value is much more broadly defined than profit, or financial gain, recognising that an increasingly smaller part of a company’s value can be measured in financial terms and included on its balance sheet.
Creating value in the long term requires an understanding of sustainable development issues. Boards should ask questions regarding the reliability of water and energy supply, if needed for manufacturing when they set up a new site; or consider whether social unrest due to inequality in a particular area might make it a risky place in which to do business.
But very few boards would include this skill on their skills matrix. When I interviewed non-executive directors of some of the largest companies in the world, one talked about their first board meeting in connection with their integrated report:
“The first meeting actually changed my whole attitude, which scared me. Scared is not a bad thing…scared in the right sense that it actually triggers your mind into action…”
This interviewee went on to elaborate further how thinking about value creation in terms broader than financial statements changed his thinking about how to do business, focusing more on the long term and thinking about opportunities and risks. He was not alone in these sentiments—the point being that the ability to acknowledge the wider meaning of value is an important skill, a need to which boards are poorly attuned.
Following the Framework
This lack of skills and even awareness of their necessity has implications for the quality of board engagement with the integrated reporting process. Yet, the current version of the International <IR> Framework requires their involvement.
Further, conducting a good strategic review in the UK (or OFR in Australia, for example) requires these skills. Following the <IR> framework helps boards and management understand how they create value and develop the integrated thinking required to prepare a good strategic review.
Apart from having the skills required to think holistically about risks and opportunities and their implications for long-term value creation, there are other things boards can do to ensure the integrity of their integrated reports. Incidentally, it’s worth noting that a couple of male board directors interviewed in the same study said women were particularly good at thinking holistically.
Much of the data in these reports is qualitative, and where it is quantitative it is usually non-financial (think customer satisfaction survey results, for example). But that doesn’t mean that organisations can’t put in place rigorous internal control processes to ensure information accuracy. This might be done under the purview of the CFO, whose team have a good understanding of processes to ensure data rigour.
Companies can also get an expert to review their processes or, as I have done, to work with them as they develop their statement on how they create value, articulate their business model, the external factors impacting on their ability to create value and other aspects of the Framework. This role can be seen as that of a “critical friend”, challenging the organisation’s thinking, and helping to bring considered consensus on the main ingredients of the integrated report.
The board should be involved at various stages in the process of developing an integrated report, either through an established board sub-committee or an integrated report working group. The first step in the development of an integrated report should ideally be the value-creation statement, followed by articulation of the business model. The working group should be involved in that, as well as approving proposed content and checking for connectivity in the draft. The whole board should then approve the finished product.
Board strategy days are an opportunity to think about value creation in terms of the multiple capitals (human, natural, intellectual, social and relationship, etc.) of integrated reporting and to review the key externalities which create risks and opportunities.
External assurance can add credibility to corporate reporting. In the case of integrated reporting you will need to be very clear about what you want to get out of the exercise—that is, what you want assurance providers to do to add credibility. Assurance of integrated reports, like integrated reporting, is new so you need to specify what you want carefully, rather than get what the assurors want to provide.
The reader of an integrated report surely, as a starting point, wants to know how a company defines value and to whom, and have confidence in that statement.
So, one of the most important roles for assurance of an integrated report, beyond the role currently fulfilled by financial audit and sustainability assurance engagements, is to provide users with information which allows an assessment of whether the company concerned is working to maximise value creation according to its own definition.
How is it balancing short, medium and long-term thinking? Is it incorporating all material external factors into its analysis of risk and opportunity to inform strategy? These are important questions to readers of an organisation’s integrated report.
Boards and management might want an assurance engagement to tell them how well the organisation is tracking towards integrated thinking, and what the next steps are that need to be taken to maximise long-term value creation (broadly defined) for all stakeholders.
So in summary, boards can enhance the credibility of integrated reports by:
• having people on the board who understand a broad range of risks, including social and environmental risks;
• including people who can think in an integrated way on the board;
• governing internal controls over non-financial and qualitative data;
• drawing on the skills of experts to guide and critique;
• linking strategy development with the integrated reporting process; and
• engaging external assurors, paying special regard to the scope of the engagement.
Dr Carol Adams PhD CA FAICD is a professor at Durham University Business School, UK, and consults on corporate reporting.