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Opportunities and necessities from a long-term investor's view

Posted 3 July, 2015

While the annual report remains the most important information source for investors, the reports in their present form do not provide a sufficiently true and fair picture of the company. This is due to the intensive weight factors like ESG, brand values, customer and employee loyalty, market position (concept of capitals) that increasingly impact the long-term viability of the business models: for example, ‘Intangible Assets’ today account for over 80 per cent of S&P 500’s market value.

Investors clearly recognise this and expect companies to explain their business model and the management concept as well as to state their strategy and their execution plans. Investors are much more interested in how the company generates value rather than only concentrating on the return. This is also confirmed by a recent PwC study; but most investors say that companies do not disclose enough information on their strategic plans and do not incorporate more than financial information (e.g. ESG) adequately in executive remuneration.

The keen interest of investors in non-financial issues is explained by their fiduciary duty to pursue opportunities for sustainable outperformance. A recent analysis of the impact of ESG confirmed that companies with higher ESG-standards benefit from lower cost of capital resp. higher share price performance. The Integrated Reporting approach covers aspects further than ESG (e.g. impact of employee loyalty on revenues, etc.) and relates them to economic outcomes, but there are overlaps and synergies that strive for the same aim and from which both can benefit.

To achieve a holistic picture of a company’s total strengths and to offer investors a sufficient basis for making investment decisions the following elements are vital:

  • identification of the most relevant, material aspects of the business model, strategy, governance and how they are interrelated,
  • describing the expected impact and
  • measuring and monetizing the impacts.

Despite the notion that monetization will be quite subjective for certain issues, it is important to describe the material value drivers and their impacts as precisely as possible so that investors can appreciate their value.

Integrated Reporting is the reflection of an integrated approach to manage and control a corporation. Companies should therefore relate to <IR>’s concept of capitals and incorporate material information on all of their resources (i.e. ESG and other non financial matters) in an integrated way in the running of their business.

To establish a solid basis to gain a holistic picture through Integrated Reporting (<IR>) and its Reporting Framework, three crucial points have to be fulfilled that will also be crucial for its global acceptance:

  • Concise materiality:

With information density of corporate reporting at all time highs, it is vital that corporations focus on concise materiality in their reporting as investors can otherwise not differentiate between just more and materially relevant information. The definition of materiality should be well reasoned and explained also via stakeholder dialogues/forums to ensure mutual understanding. Management especially the CFO have to put high emphasis on this issue to ensure full understanding of this superior way of reporting.

  • Sufficient connectivity:

The added value of an integrated approach to reporting can only be realised with sufficient connectivity. This requires to demonstrate how the company’s investments and expectations translate into measurable returns in a company-specific but also comparable context. Today there are few examples of how this can be achieved: among them there is SAP’s connectivity-ellipse which shows existing interrelations and their impact. Especially here further improvements are necessary and formats that connect all material topics. Intensive emphasis has to be put on the development of tools that allow investors and other stakeholders a better assessment of the business model and its decisive factors.

  • Consistency in focus and over time:

Due to the long-term horizon of portfolios, Integrated Reporting must be consistent over many years for the key material issues. Consistency also requires companies to choose KPIs that allow comparisons over time, between companies, and across the sectors.

The clear evidence of lower cost of capital through better appreciation of the full value potential should be a strong incentive to pursue an integrated business approach and to implement integrated reporting. This should also be encouraged by management compensation systems that include appropriate non-financial KPIs. Too often companies state that factors like customer and employee loyalty are key for their business, but their remuneration policies are only related to financial KPIs.