On May 11 I posted an interview with Mike Krzus discussing some of the broad issues affecting integrated reporting. In this new post, I’ve asked Mike to address in detail the practical questions that corporate leaders who want to create an integrated report might ask.
Mike Krzus is a senior adviser specialising in integrated reporting with BrownFlynn, Cleveland, Ohio-based corporate sustainability and governance consultants. A US Certified Public Accountant, Krzus has long been a prime mover in the push to get integrated reporting onto the corporate agenda.
Question: Mike Krzus, say you’re a CEO who wants the company to re-think its reporting, and wants to create a good integrated report to communicate with investors. What are the first two practical steps you’d take?
MK Send a strong message of support by appointing a respected senior executive (COO, CFO, or General Counsel) to lead the project. Insist that the first task of the project team is the development of a coherent strategy that addresses the following points.
(Image by geralt via pixabay. Integrated reporting takes a team …)
- What does the project team want to do and why?
- What facts have you gathered about whether and how to proceed?
- What have you done and what must you do to improve your likelihood of success?
- Why will your approach work?
- What makes your approach adaptable to changing circumstances?
Question: Senior management is familiar with financial statements. But give me a few examples of what a good integrated report can convey that financial statements alone cannot.
MK Three examples:
- A good integrated report explains the relationships between environmental, social, governance (ESG) performance, and financial performance. The report might demonstrate—perhaps in a graphic—how investments to improve energy efficiency or reduce water consumption relate to and have a positive impact on financial performance over the long term. In the future, I hope we see more quantitative metrics that, for example, specifically link the development of products and services that address the UN Sustainable Development Goals to revenue growth, entry into new markets, and increases in market share.
- Good integrated reports make it clear how and why material ESG risks and opportunities affect the business model and strategy.
- And a good integrated report explains how an entity prioritises material ESG risks and opportunities based on magnitude and importance. This helps shareowners and other stakeholders understand the trade-offs that management faces and the choices it makes.
Question: Assume representatives from finance (as well as sustainability, investor relations and others) are involved in this drive towards integrated reporting. What is the unique contribution that an accountant can make?
MK Accounting and finance bring credibility to an integrated reporting project, because their presence sends a message that the initiative matters to the CEO and to the board.
To give a specific example, the internal audit group can help elevate the quality of internal controls. It’s helpful to think of this in terms of financial reporting. Analysts and investors consider the financial statements and notes to be a reliable and fair presentation because robust controls, processes, and systems make it likely that the underlying data and therefore the statement are accurate.
Internal auditors can work with the sustainability team to build and test controls over ESG information so it meets the same standard of quality and consistency.
Question: In the previous Q&A we did together, you provided a good summary of connectivity. Are you able to point to a recent integrated report and spell out how, in your opinion, it got connectivity right?
MK This graphic [link opens in a new tab, then scroll down] shows the Integrated Performance Analysis in the SAP integrated Report 2015. It illustrates the link between financial and ESG performance.
If I click on the box Data Center Energy, the arrows show a link between Data Center Energy and GHG Footprint, and ultimately on Profit. A mouseover the GHG Footprint box notes that a 1 per cent reduction in GHG emissions would have a €4 million positive impact on operating profit. That’s language that grabs the attention of everyone in accounting and finance.
Question: What practical difficulties are the compilers of the integrated report likely to experience?
MK My personal big three issues to be overcome are:
- Establish a disciplined approach to quality control over ESG information.
- Materiality. In other words, deciding what is relevant to value creation.
- Understanding the relationships between financial and ESG performance.
Question: What’s the best way of assessing whether information is relevant? Is the Sustainability Accounting Standards Board materiality map [link opens in a new tab] a good guide to what sustainability information is relevant in an integrated report? What are some other guides?
MK SASB is a fantastic place to begin the process of identifying which ESG issues are most relevant within a sector and an industry. In addition, companies should talk with their four or five biggest investors to learn what matters to each one, and with data providers such as MSCI and Sustainalytics about which ESG issues they are tracking for the company.
Question: Do you have any specific examples of information you’ve seen in an integrated report that really doesn’t need to be there?
MK I’m going to answer this indirectly. The question highlights the importance of a concept the Eccles, Ribot, and I discussed in The Integrated Reporting Movement. We talked about “contextual reporting.” We said that an integrated report becomes context for the user. It’s not just a report, it’s a doorway to underlying data that provides more detailed information than is contained in the integrated report. Conversely, users who access information from outside the integrated report, such as a financial report or data supporting a GRI report, should be able to refer to the integrated report to put that data in context.
Question: What’s the biggest conceptual difficulty about integrated reporting, from the point of view of an accountant?
MK On one hand, people in accounting and finance don’t easily see an answer to questions such as: ‘Why are we doing this? Will – and how will – integrated reporting improve share price, help mitigate risks, or help the organisation attract investors with a long-term vision?’
On the other hand, sustainability directors and communications executives—where integrated reporting initiatives often originate—don’t intuitively speak in the language of risks and opportunities, or how ESG performance relates to financial performance.
Question: Can you characterise the way companies approach the integrated reporting journey, and the way they think about the impact of integrated reporting?
MK I see two schools of thought. Some companies see integrated reporting as informative, while others see the process as transformative. Informative means building a culture, governance mechanisms, and business strategy focused on balancing the profit motive with concerns for society. Natura, Novo Nordisk, and BASF are in this camp. Each of these three companies began its journey some twenty or more years before they made an first integrated report. For them, publishing an integrated report in the early 2000s was a reflection of the way they had been doing business for years.
In the transformative camp I would include Aegon and SAP. They adopted a new reporting method as one tool to drive changes in organisational behavior and decision-making. I haven’t had any recent conversations with these two companies to gauge just how much progress they have made towards an overarching goal of delivering shareholder value in an environmentally and socially responsible way.
Today, companies and the markets are so short-term focused that I wonder whether a long journey to change culture, governance, and strategy is possible. So I urge companies to just get started with the integrated report. Don’t put it off and don’t hesitate.
Question: Do you have a rule of thumb for how long the report should be – obviously it would be longer for a large company, but do you have a page range?
MK I remember a conversation I had with [International Integrated Reporting Council CEO] Paul Druckman a few years ago. He told me he had recently responded to a similar question by stating that an integrated report should be 20 pages in length. I never believed that Paul saw his statement as a hard rule, but rather as general guidance that emphasised the Integrated Reporting framework guiding principle of conciseness. That said, today I think of integrated reports less in terms of a paper document and much more in terms of a dedicated website or an app.
Question: How does the CEO decide whether the integrated reporting effort has been a success?
MK I’ll make an assumption that attracting more long-term focused investors is a measure of success. A little over two years ago, Andrew Knauer and George Serafeim wrote an article, “Attracting Long-Term Investors Through Integrated Thinking and Reporting: A Clinical Study of a Biopharmaceutical Company.” This was a study of how UK-listed Shire executed a plan to reshape its investor base.
Based on Shire’s experience, the authors’ believed that a commitment to integrated thinking and the adoption of integrated reporting could help companies attract the longer-term investors. So, my point is that if a CEO can see a shift in the investor base, then integrated reporting has been a success.
– October 10, 2016