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The International Integrated Reporting Council: A story of failure John Flower In this paper I set out the history of an important initiative that initially promised to revolutionize the practice of financial reporting – the project to develop a new form of reporting (integrated reporting) through the International Integrated Reporting Council (IIRC). As the paper’s title makes clear, I judge that this initiative has failed. 1. The IIRC’s origins The IIRC was founded at the initiative of two leading organizations in the field of accounting for sustainability: the Prince’s Accounting for Sustainability Project (A4S)1 and the Global Reporting Initiative (GRI). A4S’s commitment to sustainability is obvious from its title: GRI claims on its web-site to be ‘a leading organization in the sustainability field’ that ‘promotes the use of sustainability accounting’.2 According to the A4S web-site, the IIRC’s foundation is to be traced to a speech made by the Prince of Wales in December 2009 in which he called for the establishment of this body. In his speech, he mentioned the GRI and, Critical Perspectives on Accounting 27 (2015) 1–17 A R T I C L E I N F O Article history: Received 7 September 2013 Received in revised form 1 July 2014 Accepted 2 July 2014 Available online 24 July 2014 Keywords: Sustainability Environmental Stakeholder Capitalism A B S T R A C T This paper traces the history of the International Integrated Reporting Council (IIRC) over the four years since its formation in 2010. The paper demonstrates that, on its foundation, the IIRC’s principal objective was the promotion of sustainability accounting. The IIRC’s current approach to sustainability is analyzed on the basis of the Framework which it issued in December 2013. The paper argues that, in the Framework, the IIRC has abandoned sustainability accounting. It bases this conclusion on two considerations: that the IIRC’s concept of value is ‘value for investors’ and not ‘value for society’; and that the IIRC places no obligation on firms to report harm inflicted on entities outside the firm (such as the environment) where there is no subsequent impact on the firm. The paper also concludes that the IIRC’s proposals will have little impact on corporate reporting practice, because of their lack of force. The paper attributes the IIRC’s abandoning of sustainability accounting to the composition of the IIRC’s governing council, which is dominated by the accountancy profession and multinational enterprises, which are determined to control an initiative that threatened their established position. In effect, the IIRC has been the victim of ‘regulatory capture’. ! 2014 Elsevier Ltd. All rights reserved. E-mail address: John.Flower@t-online.de. 1 The ‘Prince’ in the title is the Prince of Wales, the heir to the British throne. 2 www.globalreporting.org [accessed 15.10.13]. Contents lists available at ScienceDirect Critical Perspectives on Accounting journal homepage: www.elsevier.com/locate/cpa http://dx.doi.org/10.1016/j.cpa.2014.07.002 1045-2354/! 2014 Elsevier Ltd. All rights reserved.when the IIRC was formally set up in August 2010, A4S and the GRI issued a joint press release, which set out the rationale for the creation of the IIRC in the following terms: The world has never faced greater challenges: over-consumption of finite natural resources, climate change, and the need to provide clean water, food and a better standard of living for a growing global population. Decisions taken in tackling these issues need to be based on clear and comprehensive information; but, as the Prince of Wales has said, we are at present ‘‘battling to meet 21st century challenges with, at best, 20th century decision making and reporting systems’’. The IIRC’s remit is to create a globally accepted framework for accounting for sustainability. . . The intention is to help with the development of more comprehensive and comprehensible information about an organization’s total performance, prospective as well as retrospective, to meet the needs of the emerging, more sustainable, global economic model’’.3 This press release bears unmistakable signs of the Prince’s idealism: accounting is to be given the task of saving the planet! The IIRC was formally incorporated in August 2010. The IIRC’s most remarkable feature at its incorporation was the extraordinarily high-powered character of its governing body, its Council. Among its 40 members were the heads of the IASB,4 FASB,5 IFAC6 and IOSCO,7 the CEOs of the ‘Big Four’,8 the heads of the major British professional accountancy bodies, and the CFOs of major multi-internationals, such as Nestle ´, Tata and HSBC. The Council was dominated by the accountancy profession, preparers and regulators, who made up more than half its members.9 They outnumbered by far the few representatives of organizations that promoted social and environmental accounting.10 The strong representation of conventional accountants11 sent an ambiguous message: either they were genuinely interested in reforming financial reporting or they were determined to control a new initiative that threatened their established position. Over time it has become clear which interpretation is correct. 2. The IIRC’s 2011 Discussion Paper The IIRC’s first action of any note was the publication of a Discussion Paper (IIRC, 2011) in which it set out in broad terms what it proposed to do. The discussion paper gives the following answer to the question: ‘What is integrated reporting?’: ‘Integrated reporting brings together material information about an organization’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It provides a clear and concise representation of how an organization demonstrates stewardship and how it creates and sustains value’ (IIRC, 2011, p. 2). It further states that ‘the main output of Integrated Reporting is an Integrated Report: a single report that the IIRC anticipates will become an organization’s primary report, replacing rather than adding to existing requirements’ (IIRC, 2011, p. 6). The IIRC justifies the need for a new reporting model with reference to how corporate reporting has developed in recent years. It argues: ‘As business has become more complex and gaps in traditional reporting have become prominent, new reporting requirements have been added through a patchwork of laws, regulations, standards, codes, guidance and stock exchange listing requirements. This has led to an increase in the information provided through: ! Longer and more complex financial reports and management commentaries ! Increased reporting on governance and remuneration ! Standalone sustainability reporting Many currently perceive a reporting landscape of confusion, clutter and fragmentation. Much of the information now provided is disconnected and key disclosure gaps remain’ (IIRC, 2011, p. 4). 3 See Press Release ‘Formation of the International Integrated Accounting Committee ‘available of the IIRC’s web-site at www.theiirc.org/22010/08/02 [accessed 20.07.13]. 4 The International Accounting Standards Board, the world’s leading standard-setting body. 5 The Financial Accounting Standards Board, the USA’s standard-setting body. 6 The International Federation of Accountants represents the accountancy profession at the global level. 7 The International Organization of Securities Commissions represents the regulators of securities markets at the global level. 8 The ‘Big Four’ are the four largest private accountancy firms: Deloitte, Ernst & Young, KPMG and PWC. 9 Of the Council’s initial 40 members, 10 represented the accountancy profession (institutes and firms), 10 represented preparers (companies and pension funds) and 8 represented regulators and other public bodies. 10 The only council members who were truly independent of the accountancy profession and big business were, apart from the representatives of A4S and the GRI, John Elkington of the Triple Bottom Line (who soon left), Hugette Labelle of Transparency International and David Nussbaum of WWF. There were no representatives from Greenpeace, Friends of the Earth or radical academic bodies, such as Rob Gray’s Centre for Social and Environmental Accounting Research. 11 Exactly half of the council’s initial members were qualified accountants. 2 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17The IIRC specifically refers to four different strands of reports provided by firms: ! Traditional financial statements ! Management commentaries ! Governance and remuneration reports ! Sustainability reports The IIRC’s basic thesis is that these four strands needed to be better integrated. It claims that, ‘integrated reporting combines the most material elements of information currently reported in separate reporting strands. . . in a coherent whole, and importantly shows the connectivity between them and explains how they affect the ability of an organization to create and sustain value in the short, medium and long term’ (IIRC, 2011, p. 6). It states that it seeks to achieve a reporting framework that: ‘reflects the use of and effect on all the resources and relationships or ‘‘capitals’’ (human, natural and social, as well as financial, manufactured and intellectual) on which the organization and society depend for prosperity; and reflects and communicates the interdependence between the success of the organization and the value it creates for investors, employees, customers and, more broadly, society’ (IIRC, 2011, p. 5). A close reading of this passage reveals that the IIRC accepted the basic tenets of social and environmental accounting: the firm’s reporting should reflect the effect on all the resources on which society depends for prosperity (my emphasis). Hence the firm should report on the using up of non-renewable resources and on the impact of its activities on the environment, on its employees, on its customers and on society in general. The concept of different categories of ‘capital’ lies at the heart of the IIRC’s approach to integrated reporting and, for this reason, it is considered in more detail in the next section. 3. The IIRC’s concept of capitals The Discussion Paper explains the role of the different categories of ‘capital’ in the following terms: ‘All organizations depend on a variety of resources and relationships for their success. The extent to which organizations are running them down or building them up has an important impact on the availability of the resources and the strength of the relationships that support the long-term viability of those organizations. These resources and relationships can be conceived as different forms of ‘‘capital’’’ (IIRC, 2011, p. 11). The Discussion Paper lists six different categories of ‘capital’: financial capital, manufactured capital, human capital, intellectual capital, natural capital and social capital. I set out my interpretation of the IIRC’s concept of capitals in Table 1, in which I have classified these capitals as being either internal or external to the firm, with further sub-divisions – of internal capital between capitals owned by the legal entity and those not so owned, and of external capital between renewable and non-renewable. In assuming that the firm and the legal entity are not identical, I am adopting a specific theory of the firm – the stakeholder theory. This table does not appear in the Discussion Paper. I have created it myself, and thus it presents my interpretation of the IIRC’s concepts. The cells in the table present examples of the various forms of capital; these examples are in no way exhaustive. The concepts on which most of the categories of capital are based are reasonably clear; thus financial capital is the firm’s ‘pool of funds’ (IIRC, 2013a, paragraph 2.17) and manufactured capital comprises material objects created by man. The trickiest category is social and relationship capital; this is based on the idea that the viability of the firm (and the welfare of mankind) depends, in part, on well-functioning relationships between people, as demonstrated, for example, in the existence of an effective government that maintains law and order. The boundaries between the various categories are often fuzzy; the knowledge of the firm’s work force may reasonably be classified as either human capital or intellectual capital. Whether or not an item of capital may be owned by the firm depends on a country’s law of property; thus slaves could be owned in ante-bellum America. As Table 1 makes clear, not all classifications apply to all categories; financial capital is always internal to the legal entity and the only instances of non-renewable capital are the natural resources of the planet Table 1 Categories of capital. Internal to the firm External to the firm Type of capital Owned by the legal entity Not owned by the legal entity Renewable Not renewable Financial Cash, debts Manufactured Factories, machines Public roads, schools Human Slaves The firm’s work force Intellectual Patents, management systems The knowledge of its workers Natural Cows on a farm, stocks of cotton and oil Agricultural crops, flora and fauna Air, water, land, fossil fuels Social and Relationship Brands Reputation with customers A cohesive society and an effective government J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 3(although strictly-speaking fossil fuels are renewable – in a million years!). The usefulness of the schema is not that it sets out a completely logical and comprehensive framework, but rather that it directs the attention of those responsible for the preparation of the integrated report to the matters that need to be covered. The basic idea is that a firm’s integrated report should indicate how the firm, through its activities, has created value, as measured by the increase less the decrease in the value of these capitals. In its Discussion Paper, the IIRC adopts a balance sheet approach to the assessment of performance; the firm’s performance is measured as the net increase in the value of its assets, but with a far wider definition of ‘asset’ than that used in the conventional balance sheet, in that it covers all the resources on which society depends for prosperity. Thus the IIRC’s concept of ‘capitals’ covers not only the firm’s capital in the conventional sense, but also the capital of society, for example the environment. Hence many of the capitals included in the integrated report are not owned by the firm. As stated in the Discussion Paper, the integrated report ‘reflectstheuse ofand effect of all the. . . ‘capitals’. . . on which the organization and society depend for prosperity and. . .communicates. . . the value that it [the organization] creates for investors, employees, customers and, more broadly, society’ (IIRC, 2011, p. 5). This idea is directly related to sustainability. The GRI, one of the IIRC’s founding organizations, explains the importance of sustainability reporting in the following terms: ‘the underlying question of sustainability reporting is how an organization contributes, or aims to contribute in the future, to the improvement or deterioration of economic, environmental, and social conditions, developments and trends at the local, regional and global level’ (GRI, 2013, p. 17). The concept of sustainability is derived from the Bruntland report, which defined the goal of sustainable development as ‘to meet the needs of the present without compromising the ability of future generations to meet their own needs’ (World Commission on Environment and Development, 1987, p. 43). According to the GRI’s statement, sustainability reporting should cover ‘the improvement or deterioration of economic, social and environmental conditions’. The GRI’s term ‘conditions’ and the IIRC’s term ‘capitals’ seem very similar. The IIRC’s aim to report ‘the effect on all the. . . capitals’ and the GRI’s aim to report ‘the improvement or deterioration of. . . conditions’ seem virtually identical. Furthermore, the IIRC’s reporting of capitals is consistent with the Bruntland’s report definition of sustainable development. If, to use the IIRC’s terms, a firm has maintained the value of these capitals, it has achieved that the resources and capabilities available for future generations have not been diminished as a result of the firm’s activities. There are frequent references to sustainability in the Discussion Paper, although, curiously, the link between sustainability and the capitals approach is not developed. The question of whether the IIRC’s concept of integrated reporting incorporates sustainability is discussed later. 4. The IIRC’s Framework The IIRC, in its 2011 Discussion Paper, stated that it planned to issue an exposure draft of an Integrated Reporting Framework in 2012 (IIRC, 2011, p. 25). It did not do so; instead the IIRC Secretariat issued a ‘Draft Framework Outline’ in June 2012 (IIRC, 2012). This document was not approved by the IIRC’s Council (as required by the IIRC’s constitution) and therefore its status was not clear. In fact, it added very little to what had already stated in the 2011 Discussion Paper. The IIRC finally issued its official proposals in April 2013, when it issued a ‘Consultation Draft of the International Framework’ (IIRC, 2013a). The IIRC invited comments on its Consultation Draft and received over 350 responses. It finally issued the definitive text of its Framework in December 2013. The Framework’s first paragraph defines an integrated report as ‘a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term’ (IIRC, 2013b, paragraph 1.1). The Framework’s purpose is ‘to establish Guiding Principles and Content Elements of an integrated report, and to explain the concepts that underpin them’ (IIRC, 2013b, paragraph 1.3). Thus the Framework may be considered to be the authoritative statement of the IIRC’s concept of integrated reporting. The Framework’s provisions are now considered in detail. 4.1. The single report In its Discussion Paper, the IIRC proposed that the integrated report would be an organization’s primary report, replacing rather than adding to existing requirements. This proposal has been dropped, although the IIRC does not admit this directly. It sets out the status of the integrated report in a series of paragraphs (1.13–1.16) whose primary purpose seems to be to obfuscate the fact that it is no longer advocating that the integrated report should be an organization’s principal, and ultimately its only, report. Thus an integrated report may be either a standalone report or part of another report (paragraph 1.15) or simply refer to other reports (paragraph 1.16). What is abundantly clear is that there is no obligation to present a single integrated report. This represents a highly significant retreat on the IIRC’s part; the integrated report loses its status as the organization’s primary report; it becomes simply another report, adding to the clutter of reports which the IIRC so graphically condemned in its Discussion Paper (IIRC, 2011, p. 4). It would seem that the IIRC finally appreciated the incompatibility of the single report with the principle of conciseness – one of the guiding principles put forward in its Discussion Paper (IIRC, 2011, p. 13). It is inevitable that, if the Integrated Report is to be concise (and this principle is retained and emphasized in the Framework) then much information must be presented in other reports. The significance of this retreat is that the IIRC accepts that firms may issue separate reports on such matters as social and environmental accounting and sustainability. Hence the need for a firm’s integrated report to cover these matters is greatly 4 J. Flower/Critical Perspectives on Accounting 27 (2015) 1–17reduced with far-reaching consequence for the integrated report, as becomes clear when the content of this report is analyzed later in this paper. 4.2. Sustainability There is only one reference to sustainability in the Framework, which is to a separate sustainability report that is not part of the integrated report (IIRC, 2013b, paragraph 1.13); most commonly this separate report would be a report drawn up in accordance with the GRI’s Guidelines. This is an extraordinary development, given that the principal motivation of the bodies that founded the IIRC (the GRI and A4S) was to improve the reporting of sustainability, as evidenced by the wording of the press release referred to in Section 1 above. In Section 3, it was suggested that reporting on the increases and decreases of the values of the different categories of capital could be a valid method of reporting on sustainability. In this case the integrated report would cover sustainability without using the term. But, for this to be the case, three conditions have to be met: (i) The term ‘value’ should be interpreted very widely, for example as ‘value to society’. (ii) The firm should report comprehensively on all the categories of capital listed in Table 1. (iii) If all six capitals (valued appropriately) show no decrease resulting from the firm’s activities, then one may confidently affirm that sustainability has been achieved. But, if one or more capitals shows a decrease, then overall sustainability is only achieved, if this decrease in value may be compensated by the increase in the value of other capitals; hence tradeoffs between capitals should be meaningful. These conditions are now considered. 4.2.1. Value to whom? The Framework makes clear that the principal function of integrated reporting is the reporting of ‘value’. Paragraph 1.7 states that ‘The primary purpose of an integrated report to explain to providers of financial capital how an organization creates value over time.’ The crucial point is the meaning given to the word ‘value’; possible alternative interpretations are ‘value to society’ (which is consistent with social and environmental accounting), ‘value to stakeholders’ (which is consistent with the stakeholder theory of the firm), and ‘value to present and future generations’ (which is consistent with sustainability). The words ‘providers of financial capital’ in Paragraph 1.7 suggest that the IIRC’s focus is ‘value to investors’. But the Framework recognizes alternatives concepts of value, notably in the following two paragraphs, which, in view of their importance, are quoted in full: ‘2.4 Value created by an organization over time manifests itself in increases, decreases or transformations of the capitals caused by the organization’s business activities and outputs. That value has two aspects – value created for: ! The organization itself, which enables financial returns to the providers of financial capital ! Others (i.e. stakeholders and society at large). 2.5 Providers of financial capital are interested in the value an organization creates for itself. They are also interested in the value an organization creates for others when it affects the ability of the organization to create value for itself, or relates to a stated objective of the organization (e.g. an explicit social purpose) that affects their assessments.’ The following conclusions may be drawn from these paragraphs: 1. The Framework adopts the balance sheet approach to the measure of performance that was set out in the Discussion Paper (see Section 3). 2. The reference to ‘others’ in paragraph 2.4 seems to imply that a very wide interpretation is to be given to the word ‘value’. However paragraph 2.5 has the effect of severely limiting ‘value for others’ as a component of value created by the firm. The primary purpose of an integrated report is to explain the firm’s value creation to providers of financial capital and hence ‘value’ has to be interpreted according to their interests. Paragraph 2.5 makes clear that the providers of financial capital are primarily interested in the value that an organization creates for itself. They are interested in the value that an organization creates for others in only two circumstances: (a) when this affects the ability of the organization to create value for itself. (b) when the creation of value for others is a stated objective of the organization. 3. Condition 2(a) is further expounded in the Framework’s paragraphs 2.6–2.8, which state: ‘The ability of an organization to create value for itself is linked to the value that it creates for others. . . this happens through a wide range of activities, interactions and relationships. . . for example, the effects of the organization’s business activities on customer satisfaction, suppliers’ willingness to trade with the organization. . . When these interactions, activities and relationships are material to the organization’s ability to create value for itself, they are included in the integrated report. This includes taking account of the extent to which effects on the capitals have been externalized (i.e. the costs and other effects on capitals that are not owned by the organization). . . Externalities may ultimately increase or decrease value created for the organization; therefore providers of J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 5financial capital need information about material externalities to assess their effects and to allocate capital accordingly’ (IIRC, 2013a, paragraphs 2.6–2.8). These paragraphs make clear that the IIRC considers that the integrated report should cover ‘value to others’ only to the extent that this is ‘material to the organization’s ability to create value for itself’. Moreover, the reference to the information needs of providers of financial capital reinforces the suspicion that ‘value for itself’ should be interpreted as ‘value for investors’. 4. Since condition 2(b) above applies to few organizations other than charities and only in highly exceptional cases to business firms, one may confidently conclude that, when the Framework refers to ‘value’ this should be interpreted as ‘value to the firm’ and, more precisely as ‘value to investors’, given that the primary purposes of the integrated report is to explain value creation to the providers of financial capital. The Framework accepts that providers of capital are principally interested in the benefits that they can expect from the firm (in the form of dividends and other returns on capital), referring in paragraph 2.4 specifically to ‘financial returns to the providers of financial capital’. Hence it is reasonable to presume that the investors’ principal interest in other capitals is in enabling them to make a better estimate of future cash flows, ‘better’ in the sense that it is likely to be more accurate in that takes into account such factors as the quality of the workforce, possible future material shortages, and customer relations. Essentially the values of other capitals are assessed solely on their contribution to the firm’s profit-making activities. From the firm’s viewpoint, other capitals have value only in so far as they contribute to the firm’s value. The IIRC’s investor orientation essentially determines the content of the integrated report. In deciding whether a matter is material and hence should be reported, an organization should follow the principle that, ‘an integrated report should disclose information about matters that substantially affect the organization’s ability to create value over the short, medium and long-term.’ (IIRC, 2013a, paragraph 3.17). Furthermore the Framework states that ‘to be most effective, the materiality process is integrated into the organization’s management processes and includes regular engagement with providers of financial capital and others to ensure the integrated report meets its primary purpose as noted in paragraph 1.7.’ (IIRC, 2013a, paragraph 320). As already noted, paragraph 1.7 states that the primary purpose of an integrated report is to explain to the providers of financial capital how an organization creates value over time. The creation of value by the firm is the Framework’s central theme – it is mentioned over fifty times in the Framework’s 168 paragraphs. In reading these paragraphs it should always be kept in mind that ‘value’ should be interpreted as ‘value to investors’. 4.2.2. Comprehensive reporting of capitals The IIRC’s concept of different capital, if applied appropriately, would certainly facilitate the reporting of the firm’s impact on society and the environment, and hence on sustainability. As already mentioned in Section 2 above, this seems to have been the IIRC’s original intention, as set out in its 2011 Discussion Paper, which states that ‘The IIRC seeks. . . to achieve a reporting framework that. . . reflects the use and effect on all the resources and relationships or ‘‘capitals’’. . . on which the organization and society depend for prosperity. . . and reflects and communicates the interdependencies between the success of the organization and the value it creates for investors, employees, customers, and, more broadly, society’ (IIRC, 2011, p. 5). However, for the integrated report to cover sustainability, it is essential that the firm should report on all the capitals that are affected by its activities. The Framework’s provisions in respect of specific categories of capital are now considered. Manufactured capital: The Framework describes manufactured capital as ‘manufactured physical objects. . . that are available to an organization for use in the production of goods or the provision of services, including buildings, equipment, infrastructure (such as roads, ports, bridges, and waste and water treatment plants)’ (IIRC, 2013b, paragraph 2.15) It is clear that manufactured capital includes objects that are not owned by the firm (such as public roads) but only to the extent that they are inputs to the firm’s production process. Objects that are not inputs to the firm’s production process are excluded; examples of such objects are hospitals and schools. Thus, when these objects are damaged as a result of the firm’s operations (say from pollution emanating from the firm), such damage is not reported in the firm’s integrated report. Essentially external objects are only reported on if they provide value to the firm. Human capital: The Framework describes human capital as ‘people’s competencies, capabilities and experience, and their motivation to innovate including their alignment and support for an organization’s governance framework, risk management approach, and ethical values, ability to understand and implement an organization’s strategy, loyalties and motivations for improving processes, goods and services’ (IIRC, 2013a, paragraph 2.15). As with manufactured capital, human capital is viewed exclusively from the firm’s viewpoint. From the firm’s viewpoint, people have no intrinsic value: their value depends exclusively on the contribution that they make to the firm’s success. This is a very narrow definition of human capital. It excludes persons who are not inputs to the firm’s business model. Consider the example of people living in the local community who are killed by poisonous gases released by the firm. This is a clear example of a decrease in human capital. But, according to the IIRC, this decrease would only be reported by the firm if it had an impact on its future profitability, for example if the people killed were its own employees, the firm suffered such damage to its reputation that future sales were affected, or the firm incurred costs in paying compensation or fines. Natural capital: The Framework describes natural capital as ‘all renewable and non-renewable environmental resources and processes that provide goods or services that support the past, current or future prosperity of an organization. It includes air, water, land, minerals and forests, bio-diversity and eco-system health’ (IIRC, 2013b, paragraph 2.15). The important phrase in this description is ‘prosperity of an organization’; there is no reference to the prosperity of society as originally envisaged by the 6 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17IIRC in its 2011 Discussion Paper. The IIRC is interested only in those elements of natural capital that are used by the firm. It notes that ‘many organizations rely on raw materials to ensure production continuity. . . Eco-system services such as water purification. . . may also feature prominently in the business model. It is important to explain how secure the availability, quality and affordability of these components of natural capital are.’ (IIRC, 2013b, paragraph 2.28). The Integrated Report covers natural capital only to the extent that it is an input to the firm’s production process. It does not cover the firm’s impact on the broader environment. For example a firm emits large quantities of green-house gases which lead to climate change with a catastrophic impact on the environment, such as the rise in the sea-level that inundates many islands. The disappearance of these islands is clearly a loss of natural capital, but the IIRC does not require that it be reported. It would only be reported if the firm depended on these islands, say for the supply of raw materials. The fundamental point is that IIRC accepts that the Integrated Report should cover the impact of the capitals on the firm, but ignores the firm’s impact on these capitals, except to the extent that this impact rebounds on the firm – for example, when the people killed by the firm’s release of poisonous gases include the firm’s employees. The IIRC does accept that a firm may have a wider stewardship responsibility in relation to those elements of capitals that are not inputs to its productive processes. Where such a responsibility is imposed by law or contract, then clearly the firm should report. The Framework states that ‘where a stewardship responsibility is not imposed by law or regulation, the organization may nonetheless accept stewardship responsibilities in accordance with growing stakeholder expectations’. (IIRC, 2013b, paragraph 3.21, emphasis added). The significant word is ‘may’; there is no obligation to report. In my opinion, the above analysis makes it abundantly clear that the IIRC requires a firm to report on the effect on its activities on stakeholders, on society and on the environment only to the extent that there is a material impact on its own operations. Moreover, the Framework places no obligation to report on any specific category of capital, stating ‘the Framework does not require an integrated report to adopt the categories identified above [as in Table 1]’. (IIRC, 2013b, paragraph 3.21). The Consultation Draft included a requirement that, when a firm did not use the IIRC’s categories of capital, it should give the reason (IIRC, 2013a, paragraph 4.5). This requirement has been dropped. This greatly weakens the incentive for firms to report comprehensively on all the capitals that they use or affect. In fact the Framework acknowledges that there is no requirement for a firm to report comprehensively on its capitals. It states: ‘This Framework does not requires an integrated report to provide an exhaustive account of all the complex interdependencies between the capitals such that an organization’s net impact on the global stock of capitals could be tallied’. (IIRC, 2013b, paragraph 4.58). However, the IIRC is aware of the importance of firms adopting a wider concept of capital than has conventionally been the case. It considers that a firm should report on capitals that it uses, even if they are not owned or controlled by the firm – in flat contradiction of the IASB’s definition of an asset. The Framework deals with this topic in a long section entitled ‘The Reporting Boundary’. In principle the IIRC argues that the firm should report on entities and activities that are beyond the boundary of the financial reporting entity – the boundary used in conventional financial reporting. According to the Framework, the integrated report should cover ‘risks, opportunities and outcomes attributable or associated with other entities/ stakeholders beyond the financial reporting entity that have a significant effect on the ability of the financial reporting entity to create value’ (IIRC, 2013b, paragraph 3.30) and further specifies that ‘the entities/stakeholders within this section of the reporting boundary [that is the section that is outside the reporting boundary of conventional financial reporting] are not related to the financial reporting entity by virtue of control or significant influence, but rather by the nature and proximity of the risks, opportunities and outcomes. . . that have a significant effect on the ability of the financial reporting entity to create value.’ (IIRC, 2013b, paragraphs 3.34 and 3.35). Hence, the firm should report on capitals that it does not control if they have a significant effect on the firm’s ability to create value. But, as previously argued, ‘value’ should be interpreted as ‘value to investors’. Hence it is in order for a firm not to report on the impact of its activities on natural capital (for example in polluting the environment), where this has no significant impact on its own long-term profitability. In general the firm is obliged to report on capitals that are inputs to its production process, since the firm’s profitability will generally be affected by the condition of these capitals. But it will often be the case that a firm’s activities have a negative impact on other capitals but have no significant impact on the firm’s longterm profitability. In such a case, according to the Framework, there is no requirement to report this negative impact. This conclusion is based on the interpretation of ‘value’ as ‘value to investors’; if the IIRC had adopted a wider concept of value, such as ‘value to society’ then it would have been necessary for the firm to report on its impact of its activities on all capitals, irrespective of the impact on its own profitability. In my opinion, financial capital should not be included in the IIRC’s list of capitals. The reason is that it is not a component of global capital. The IIRC defines financial capital as a ‘pool of funds’ (IIRC, 2013b, paragraph 2.15). All the elements of this pool of funds are claims against other persons and firms,12 with the consequence that, from the view-point of society, their net value is nil. This is clearly the case with bank balances, derivatives and debts. Where the firm owns assets that are real assets from the view-point of society, such as its machines, its ‘know-how’ and its skilled labour force, these are properly 12 Cash (notes and coins) may be considered to be a claim against the Bank of England and hence is a claim against ‘other persons or firms’. J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 7accounted for under the other categories of capital. Hence, if financial capital is treated as part of global capital, there is a serious risk of double-counting. The inclusion of financial capital in the IIRC’s list is further proof that the IIRC has adopted the concept of ‘value to investor’ rather than ‘value to society’. 4.2.3. Trade-offs between capitals IIRC accepts that it is appropriate to trade-off a decrease in the value of one category of capital against an increase in another category. For example, the Framework states that ‘an integrated report. . . may also include a discussion of the nature and magnitude of the significant trade-offs that influence the selection of inputs’ (IIRC, 2013b, paragraph 4.16). All trade-offs are problematic in view of the difficulty of measuring the different capitals in consistent and comparable ways. But trade-offs involving natural capital are surely highly unlikely to be in the interests of society as a whole, particularly future generations, who may reasonably expect that the present generation should not leave the planet in a worse state than it received it – a key principle of sustainability. It could be argued that a decline in natural capital may be off-set by an increase in manufactured capital or intellectual capital from which future generations will benefit. Personally I am very skeptical of such a claim. But I am certain that a decline in natural capital can never be off-set by an increase in financial capital. Future generations cannot live off the profits of today’s companies. Surely, most people would consider that, where a firm’s activities lead to a decline in natural capital, this cannot be justified by the increase in its profits. One has the impression that, in permitting trade-offs between different categories of capital, the IIRC is making it easy for firms to justify their negative impact on the environment. The Framework states that integrated report should disclose ‘the important trade-offs that influence value creation’ giving as an example ‘creating employment through an activity that negatively affects the environment’ (IIRC, 2013b, paragraph 4.56). I feel that this quotation gives the game away. The IIRC has developed the concept of different capitals as a means of enabling firms to justify damaging the environment. Such damage may be justified by an increase in another category of capital, including financial capital. 4.2.4. The abandoning of sustainability The previous three sections have clearly demonstrated that the three conditions for the IIRC’s reporting of capitals to lead to the reporting of sustainability have not been met. In particular the IIRC does not require that firms report on the full impact of their activities on stakeholders, society and the environment. It is evident that the IIRC has abandoned the goal of reporting sustainability. It has apparently assigned this task to other organizations, notably the GRI. Some figures relating to the IIRC’s abandoning of sustainability over time are presented in Table 2, This shows the number of times that the word ‘sustainability’ (or ‘sustainable’ or ‘sustain’) is mentioned in three documents: the Press Release of 2010 (dealt with in Section 1), the IIRC’s Discussion paper of 2011 (the subject of Section 2) and the IIRC’s Framework of 2013. The table gives the number of pages in each document and the average number of mentions per page. This last statistic is very crude as there is considerable variation in the number of words per page. But the story is very clear: there were many mentions (13) of sustainability in the press release issued at the time of the IIRC’s foundation; a year later there were again a substantial number (27), but in a far longer document with the effect that there was a marked fall in the average number per page; finally in 2013, there is only a single reference in the Framework (an even longer document) with the result that the average number of mentions per page is just one-hundredth of what it had been at the start. Why did the IIRC abandon sustainability? One can conceive of a number of possible reasons: ! The reporting of sustainability would place too great a burden on firms, in collecting the data and so on. ! In reporting on sustainability, firms would be obliged to reveal too much about the negative aspects of their activities. ! The reporting of sustainability at the level of the individual firm is simply not feasible, for the reasons given by Rob Gray (2010): the connection between the firm’s actions and the degradation of the environment is too diffuse, and the impact is likely to be imperceptible. I set out later my opinion on this matter. 4.3. Lack of compulsion In my opinion, the IIRC is consistently too deferential to the firm’s management, in giving it very wide discretion in what is to be reported. The obligations of preparers are set out in the following very broad terms: ‘any communication claiming to be Table 2 References to sustainability. Number of mentions of sustainabilitya Number of pages in the document Number of mentions per page Press release 2010 13 3 4.3 Discussion Paper 2011 27 22b 1.2 Framework 2013 1 27c .004 a Instances of the words ‘sustainability’, ‘sustainable’ and ‘sustain’. b Excluding the pages of examples from published accounts. c Excluding the executive summary and the glossary. 8 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17an integrated report and referencing the Framework should apply all the requirements identified in broad italic type, unless the unavailability of reliable information or specific legal prohibitions result in an inability to disclose material information’ or ‘disclosure of material information would cause significant competitive harm.’ (IIRC, 2013b, paragraph 1.17). Only 19 of the Framework’s 168 paragraphs are set in bold italic type (which renders them binding on preparers) and all of these are couched in very broad terms that impose no specific reporting obligations. An example is paragraph 3.36: ‘An integrated report should be concise’. Furthermore, even these obligations are only conditionally binding, for preparers may disregard them on any of three grounds: ! Legal prohibition ! Unavailability of data ! Competitive harm In the case of non-disclosure of information for the first two reasons (unavailability of data and legal prohibition), the report should indicate the nature of the information that has been omitted and explain why it has been omitted. The Consultation Draft included a requirement to give this information also in respect of information that is omitted on the grounds of competitive harm, but this has been omitted from the Framework’s text. The Framework suggests that firms should consider how to describe the essence of the matter without identifying specific information that might cause a significant loss of competitive advantage (IIRC, 2013b, paragraph 3.51). This is hardly an onerous imposition, given the vagueness of the word ‘consider’. Moreover the paragraph in question is not set in bold italic type and is therefore not binding. The binding obligation is set out in paragraph 3.39 which reads: ‘An integrated report should include all material matters, both positive and negative, in a balanced way and without material error’. This paragraph is phrased in very general terms and imposes no obligation to provide any specific information. One has the impression that the IIRC is reluctant to place any onerous reporting obligations on the firm’s management. The IIRC would undoubtedly respond to the criticism by referring to its principles-based approach. This is a valid argument and it is certainly difficult to strike the right balance between detailed rules and broad principles. In my opinion, there is a significant danger that unscrupulous managers will use the discretion offered by the IIRC to not report on matters that they prefer to keep secret. I prefer the approach of the GRI which insists that firms report on certain matters of obvious public interest, such as emissions of green-house gases. The IIRC’s deferential attitude towards the firm’s management is most evident in its provisions relating to KPIs. The IIRC does not require firms to report on any specific KPIs (key performance indicators). It states ‘the Framework does not prescribe specific key performance indicators (KPIs), measurement methods or the disclosure of individual matters. Those responsible for the preparation and presentation of the integrated report therefore need to exercise judgement, given the specific circumstances of the organization’ (IIRC, 2013b, paragraph 1.10). The Framework leaves the decision of what information on performance (if any) should be reported to the firm’s management. The IIRC’s approach is at odds with that taken by the GRI, one of the IIRC’s two founding organizations. In its guidelines, the GRI specifies no less than 34 environment performance indicators and 48 social performance indicators; for example guideline EN15 requires firms to ‘report gross direct GHG [greenhouse gas] emissions in metric tonnes of CO2 equivalent, independent of any GHG trades, such as purchases, sales, or transfers of offsets or allowances’ (GRI, 2013. page 57), as well as six additional items of information relating to greenhouse gas emissions. If a firm does not report this information (or provide a valid reason for not reporting), it is forbidden to state that its report has been drawn up in accordance with the GRI’s guidelines. The IIRC places no such obligation on the firm’s management. 4.4. The legal position in Britain The Framework permits firms not to disclose information if this is prohibited by law. In Britain the law is generally sympathetic to the IIRC’s approach to reporting. Under section 172 of the Companies Act 2006, company directors are required ‘to promote the success of the company for the benefit of its members [that is shareholders] as a whole’. The IIRC’s objective is that firms should maximize their long-term value, value being interpreted as ‘value for itself’ (see Section 4.2.1 above), which seems completely consistent with the duty imposed on the management by law. The Companies Act lists a number of factors that directors should regard in promoting the company’s success, including: ! The long term consequences of their decisions; ! The interests of employees; ! The need to foster the company’s business relationships with suppliers, customers and others; ! The impact on the community and the environment; ! The need to maintain a reputation for high standards of business conduct. All of these factors are mentioned as important by the IIRC, as contributing to the long term success of the organization. In effect the IIRC and the Companies Act adopt the same approach: the firm should maximize long-term value for shareholders, and, to achieve this, it should have proper regard for the interest of others. The following quote from a leading expert on J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 9British company law summarizes the position very well: ‘The fundamental duty of the company is to its shareholders and the interests of other parties derive from that primary duty’ (Mayer, 2013, p. 31). With respect to financial reporting, British companies are required by law to issue a number of formal reports, including a balance sheet and a profit & loss account, these reports being drawn up in conformity with the IASB’s standards, as adopted by the European Union. Certainly these standards, in their present form, make it impossible for a company to report fully in their conventional financial statements on the impact of their activities on other parties: for example on the environment and on society at large. Thus, under the IASB’s standards, the firm only reports in its profit & loss account the damage that it has inflicted on the natural environment, when the firm itself bears the cost, for example when the state levies a fine or the firm expends resources in repairing the damage. However, there is no prohibition on a company issuing supplementary reports and the Framework provides specifically for this eventuality (IIRC, 2013b, paragraph 1.15). Hence the Framework’s provision regarding the legal prohibition of disclosing certain information would seem to have no application in Britain. 4.5. The impact of the IIRC’s Framework on reporting practice For firms to publish complete, correct and comparable information on their performance relating to sustainability, and their impact on stakeholders, society and the environment, two conditions must be met: (a) A body (such as the IIRC or the GRI) should publish reporting standards which, if applied by firms, would assure that the firms’ reports were comparable and complete. (b) Firms, in preparing their reports, should apply these standards correctly and consistently. Based on my analysis of the IIRC’s Framework, I conclude that it fails the first condition – for two reasons: (i) The Framework does not provide that firms should report on the full impact of their activities on stakeholders, society and the environment (see Section 4.2). (ii) The Framework leaves far too much discretion to the firm’s management (see Section 4.3). Hence, even if firms were to apply the Framework faithfully in preparing their reports, these reports would nevertheless be seriously deficient. Moreover, the IIRC is completely silent on how assurance can be achieved that firms, in preparing their reports, have faithfully applied the Framework’s standards. Thus neither of the two conditions is fulfilled. One may confidently predict that the IIRC’s initiative will not result in firms publishing complete, correct and comparable information on their performance relating to sustainability and their impact on stakeholders, society and the environment. This does not mean that firms will not expend considerable resources in preparing and publishing elaborate ‘integrated reports’, full of self-congratulatory messages on how well the firm is fulfilling its responsibilities towards its stakeholders, society and the environment, and copiously illustrated with pictures of happy workers, satisfied customers and unspoiled countryside. But it does mean that these reports will not provide the information that society needs to assess the firm’s performance. Of course, the first integrated report based on the Framework’s provisions has yet to be published. What I have written in the previous paragraph is a prediction and, in the immortal words of Yogi Berra, ‘it is always difficult to make predictions, but especially difficult about the future’. No doubt many readers will consider my predictions to be outrageously biased and thoroughly unrealistic. But some recent research on reports that were drawn up in accordance with the GRI’s guidelines gives grounds for believing that my prediction will come true. Although the research involved GRI based reports, it gives an insight on how firms are likely to respect the IIRC’s provisions. In my opinion the GRI’s Sustainability Reporting Guidelines13 largely meet condition (a) above. They consist of a balanced mixture of general principles and specific reporting requirements. ! General principles: In reporting of sustainability, a firm should follow a number of principles, including completeness, balance, transparency, clarity, reliability, stakeholder inclusiveness and sustainability context. These principles are defined in general terms; for example ‘balance’ is defined as ‘the report should reflect positive and negative aspect of the organization’s performance to enable a reasoned assessment of overall performance’, and ‘stakeholder inclusiveness’ is defined as ‘the reporting organization should identify its stakeholders and explain in the report how it has responded to their reasonable expectations and interests’. ! Specific reporting requirements: The G4 Guidelines specify no less than 92 performance indicators on which the organization should report. These indicators cover the three elements of the triple bottom line: economic, environmental and social, with the social category sub-divided into four sub-categories: labour practices & decent work, human rights, society and product responsibility. Mention has already been made of indicator EN-15; further examples of specific 13 The GRI’s Guidelines may be consulted on the GRI’s web-site (www.globalreporting.org/resourcelibrary/GRIG4-Part1-Reporting-Principles-andStandard-Disclosures.pdf). The organization has periodically revised and updated these guidelines. The analysis in this paper is based on the latest version (G4), issued in May 2013. 10 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17indicators are: ‘LA13 Ratio of basic salary and remuneration of women to men by employee category, by significant locations of operation’; and ‘SO5 Confirmed incidents of corruption and actions taken’. Hence the GRI’s guidelines do define a report that sets out comprehensively the firm’s sustainability performance; they fulfil condition (a) above. The significant question is whether condition (b) above is met – whether firms in issuing reports which they claim follow the GRI’s Guidelines, do in fact faithfully apply these guidelines. This question was investigated by Olivier Boiral, using the research technique of counter accounting, which, drawing on the previous work of Adams (2004), O’Dwyer (2005) and Gallhofer and Haslam (2006), he defined as follows: ‘Counter accounting in the area of sustainability reporting can be defined as the process of identifying and reporting information on organizations’ significant economic, environmental and social issues that comes from external or unofficial sources (expert reports, research papers, online journals, studies from NGOs, government publications, legal proceedings, etc.) in view of verifying, complementing or countering organization’s official reports on their performance and achievements.’ (Boiral, 2013, p. 1037). The significant word in the above quotation is ‘external’. The organization’s report is to be judged as to its conformity to the GRI’s Guidelines with reference to information external to the firm. Boiral selected the sustainability reports for the year 2007 of 23 firms for detailed investigation. All the reports were graded ‘A’, indicating that they fulfilled all the requirements of the GRI’s Guidelines and, in addition, all but 4 were graded A+, indicating that they had been externally verified. All the firms were large multinational enterprises (MNEs) and included several well-known companies such as BP, Shell, Repsol and BHP Billiton. Boiral and his team then searched the external sources mentioned in the above quotation for news items about the 23 MNEs, which were relevant to their sustainability performance. These items often related to events, such as an oil spill, a fine levied by a government, a conflict with local residents or legal cases involving the firm. In order to ensure a certain degree of objectivity each event had to be mentioned in two different independent sources and be evaluated as relevant by two researchers, acting independently. The researchers identified 116 events, relating to the 23 MNEs which they considered to be of such significance that they should have been mentioned in the firms’ sustainability reports. They then examined these reports to ascertain how they had been reported. The results are presented in Table 3. Personally I am shocked by the figures presented in Table 3. In only 10% of the cases were the events reported in a way that the researchers judged to be adequate, although often not ideal. An example is the following extract from BP’s Sustainability Report: ‘In relation to Alaska, we have paid a $12 million fine and are subject to one to three years’ probation. We also paid $4 million restitution to the State of Alaska and an additional $4 million to support Artic environmental research’14. The researchers classified this extract as ‘rather clearly reported’ despite the complete absence of any information about the company’s actions that led to these payments, commenting ‘disclosure of this type of information allows the reader to recognize that a problem or negative impact exists; however, given the length of the report (46 pages) it is easy to overlook very short passages concerning adverse events’. Personally I consider that the researchers were rather generous in their judgement, as I feel that BP’s report fails to satisfy the GRI’s principle of completeness. Certainly the researchers cannot be accused as being excessively critical of the firms. In a further 36% of cases, the event was judged to be ‘partially or poorly reported’. Boiral gives the following example from the report of RWE, the German energy supplier: ‘In Germany, where RWE owns transportation and transmission networks, unrestricted access to these networks has a key role to play in promoting genuine competition. We therefore guarantee every power generator unrestricted, discrimination free access to our transportation and distribution network subject to fair terms and conditions, and will continue to do so in the future, too. The European Commission is nevertheless demanding that these distribution networks be run by independent companies’ (RWE’s 2007 report, quoted in Boiral, 2013, p. 1053). The European Commission’s web-site (the researchers’ principal source of information) gives a rather different picture of the event: ‘The European Commission has decided to open antitrust proceedings against the German energy company RWE. . . The Commission proceedings focus on possible exclusion of potential competitors from the market by RWE Group through Table 3 Reporting of identified events. Number of reports Percentage of total Rather clearly reported 12 10% Partially or poorly reported 42 36% Not reported 62 54% Total 116 100% 14 BP’s Sustainability Report 2007, quoted in Boiral (2013, p. 1051). J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 11the putting in place of artificial obstacles to access by other companies to its gas transport network in its core area, North Rhine-Westphalia’.15 There are clearly two sides to the dispute between the European Commission and RWE. The European Commission considers that RWE is restricting competition, whereas RWE claims that it is promoting competition. It is not impossible that what RWE wrote was roughly correct, given that, at the time that RWE’s report was written, the issue had not been resolved. But I feel that it is thoroughly misleading for RWE to refer to the Commission opening antitrust proceedings (the first step in a legal process that often leads to very large fines) as the Commission ‘demanding’. Furthermore RWE’s report clearly lacks balance (one of the GRI’s fundamental principles) which requires that ‘the report should reflect positive and negative aspects of the organization’s performance’. Boiral gives other examples of MNEs’ sustainability reports that give a thoroughly biased and one-sided account of an event or dispute. In most cases, the principal criticism of a firm’s report is not that it commits an outright falsehood but that it fails to present fully all the aspects of the event or dispute, notably those which reflect negatively on the firm. But the most shocking figure in Table 3 is that 54% of the events were not mentioned in the firms’ reports. According to the researchers’ judgement, all these events satisfied the GRI’s principle of materiality, which states that ‘the report should cover aspects that reflect the organization’s economic, environmental and social impacts; or substantively influence the assessments and decisions of stakeholders’. Boiral gives the example of three such significant events concerning Shell in 2007 which were not mentioned in that firm’s report (Boiral, 2013, p. 1054). ! Shell was accused by the French competition authorities of colluding with other oil companies in pricing kerosene on Re ´ union island; ! Shell was being sued by some of its Ethiopian and Malaysian employees for discriminatory hiring practices; ! The British Advertising Standards Authority accused Shell of improperly using the term ‘sustainable development’ in connection with its exploitation of the Athabasca oil-sands. In each case, the event was covered by a specific GRI indicator which required that it be reported. Sixteen of the twenty-three companies failed to report at least one material event that the researchers had identified. Boiral commented: ‘This lack of reporting through omission involved all of the sustainable development issues covered by the GRI – issues which could also potentially damage the firm’s image – including illegal pricing cartels, discrimination, forced labour, spills that were the subject of legal action, relocation of populations, corruption, worker deaths implicating inadequate health and safety measures, and violation of the rights of indigenous peoples. The number and severity of these events, and their relationship to specific GRI indicators, makes it implausible that these omissions were the result of errors or oversights’ (Boiral, 2013, footnote 19, p. 1066). It is obvious that many of the sustainability reports were seriously defective. This raises grave doubts about the effectiveness of the assurance process, for all but four of the reports had been reviewed by an external independent assurance provider.16 A possible explanation is that it is more difficult for the reviewer of a report to identify a matter that has been omitted than it is to comment on the truth of an item that has been included. But this does not alter the conclusion that in these cases the assurance process has been revealed to be inadequate. It can be argued that it is not possible to draw scientifically valid conclusions from such a small sample. But, at the very least, Boiral’s research has revealed a thoroughly unsatisfactory state of affairs, given that his sample included many prestigious firms – firms who may be expected to set the tone for business as a whole, such as Shell, BP, Petrobas, RWE, Repsol, Anglo-American, BHP Billiton, Teck Cominco and Rio Tinto. One may reasonably conclude that, at least in 2007, it was very common for a sustainability report not to present a true and fair view of a firm’s performance. Does this conclusion mean that the efforts of a body such as the GRI in issuing general guidance are a waste of time? The answer is an emphatic ‘No’. As explained at the start of this section, for firms to publish complete, correct and comparable information on their performance relating to sustainability, two conditions must be met: (a) A body (such as the IIRC or the GRI) should publish reporting standards that, if applied by firms, would assure that the firms’ reports were comparable and complete. (b) Firms, in preparing their reports, should apply these standards correctly and consistently. Both conditions must be met. The function of the IIRC’s Framework relates to the first condition. Such a framework is absolutely essential to ensure comparability and very helpful in assuring completeness – regrettably not achieved by the IIRC’s Framework, But also it is evident that much still needs to be done to ensure that the second condition is met, notably to improve the effectiveness of the assurance process. The IIRC may be justly criticized for ignoring this aspect. 15 Quote from the European Commission’s press release of 11 May 2007, europa.eu/rapid/press-release_MEMO-07-186_en.htm [accessed 17.01.14]. 16 Of the 62 material events that were not reported, 60 related to reports that had received the A+ grade. 12 J. Flower/Critical Perspectives on Accounting 27 (2015) 1–175. The IIRC’s approach to corporate reporting In this section, I set out my understanding of the IIRC’s approach to corporate reporting, as evidenced in the organization’s public pronouncements. 5.1. The business case The IIRC makes a basic assumption that there is no fundamental conflict between the well-being of the firm and that of society as a whole; it advocates the ‘business case’ for integrated reporting – that the firm, in maximizing its profits, also benefits society Thus Mervyn King, the IIRC’s Chairman,17 wrote that the Discussion Paper ‘sets out the business case for the development of an Integrated Reporting framework’ (IIRC, 2010, p. 3). Jane Diplock, the chairman of IOSCO, who was at the time a founding member of the IIRC, was even more specific, in writing, ‘Acting ethically isn’t more important than making a profit, but the key to making a profit in the first place. . . It isn’t that behaving well is more important than making a profit. It’s that it’s necessary to behave well in order to make a profit. Good corporate governance is good business’ (IIRC, 2010, p. 4). The IIRC’s approach may be neatly summarized in the following quotation: ‘Integrated reporting has brought with it a broad range of business benefits, ranging from richer access to capital markets and identification of cost savings to an increase in employee engagement’ (IIRC, 2011, p. 20). The IIRC’s approach is completely consistent with British company law. As already discussed in Section 4.4 above, the Companies Act 2006 requires the directors of a company ‘to promote the success of the company for the benefit of the members [that is shareholders] as a whole’. The directors should have regard to a number of other factors, including ‘the need to foster the company’s business relationships with suppliers, customers and others’. The inclusion of the word ‘business’ in this provision suggests that the British legislator endorses the business case. 5.2. The capitalistic theory of the firm The IIRC’s advocacy of the ‘business case’ is based on a specific theory of the firm, the capitalistic theory of the firm, of which the principal elements are: (a) The firm is an entity owned by capitalists who supply its financial capital. The capitalists are entitled to appoint the firm’s management which is obliged to run the firm in their interests. It is assumed that the capitalists seek the greatest possible return on their investment. (b) The firm buys factors of production (raw materials, labour services, etc.) at market prices and transforms them into finished goods and services, which it sells at market prices. (c) If the revenue that the firm receives from the sale of the finished goods and services is greater that the costs that it incurred in acquiring factors of production, the firm records a profit. It has transformed a set of factors with a certain market price into a set of finished goods and services with a higher market price; by its actions, it has increased the overall market value of the goods and services in the economy. Hence the firm’s profit is a measure of the value that it has created for society. The opposite applies when the firm records a loss. Hence the firm should strive to maximize its profits and minimize its losses. (d) The most important factor of production is capital. In order to maximize society’s stock of goods and services, capital should be allocated to activities that yield the highest profit. (e) Investors need information on firms’ profits in order to allocate capital efficiently. Hence information for investors should be the primary focus of a firm’s reporting. The capitalistic theory of the firm assumes that there is an identity of interest between the firm’s owners (who seek the greatest possible return on their investment) and society (which desires that the total value of society’s goods and services be maximized). Some commentators, while endorsing capitalism and accepting the gist of the above analysis, argue that it is too simplistic to consider that the firm’s principal aim is to maximize profits. Thus Enderle (2004) argues for ‘corporate objectives with rich economic content: the creation of wealth and employment, the provision of marketable products and services to consumers at a reasonable price commensurate with quality, the making of profit, etc.’ In my opinion, the difference between the capitalistic theory of the firm and that evinced in the above quotation is not significant, as, when there is a conflict between two different objectives (say between employment and the provision of products at a reasonable price), it will be resolved with reference to the overriding need to make a profit. There is an alternative to the capitalistic theory of the firm: the stakeholder theory of the firm. Under this theory, the suppliers of factors of production are not independent of the firm but are more or less closely associated with it. The firm is a cooperative venture of many persons, who, through their collaboration, ensure that the firm survives and hopefully prospers. They include suppliers of capital (capitalists), of materials (suppliers) and of labour (employees), but also customers, for without customers the firm could not survive. They are given the generic title ‘stakeholders’. There is no generally accepted 17 Mervyn King of the IIRC is a former South African judge and is not the same person as Mervyn King, the former governor of the bank of England. J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 13definition of the term ‘stakeholder’. Some scholars prefer a narrow definition, such as the group of persons without whose cooperation the firm would cease to exist (Clarkson, 1995); others prefer a wider definition such as ‘any group or individual who can affect (or is affected by) the achievement of the firm’s objectives’ (Freeman, 1984, p. 46). There are many variants of stakeholder theory. Jones and Wicks (1999) mention two: (a) Normative stakeholder theory: this theory is based on the categorical imperative of the German philosopher, Immanuel Kant, that one should never treat another human being solely as a means, but always as an end, as being valuable in his or her own right (see Evan and Freeman, 1993). Stakeholders should be treated as human beings and their rights respected. (b) Instrumental stakeholder theory: this theory argues that the firm will do better if they take proper account of the interests of their stakeholders. For example Jones (1995) argues that firms who deal with their stakeholders on the basis of mutual trust and cooperation will have a competitive advantage over those who do not. The firm’s overriding interest in its dealings with stakeholders is the continued prosperity of the firm; the firm has no other interest in the welfare of its stakeholders. Essentially this involves treating stakeholders solely as a means, in flat contradiction to Kant’s categorical imperative. Instrumental stakeholder theory is completely consistent with the capitalistic theory of the firm, in that it proposes a more realistic and effective way in which the firm can maximize shareholder value. Hence only normative stakeholder theory offers a true alternative to the capitalistic theory of the firm. Initially the IIRC gave the impression that it favoured a normative approach to reporting on stakeholders. The Discussion paper includes, as a guiding principle, ‘Responsiveness and stakeholder inclusiveness’. The word ‘inclusiveness’ suggests that the IIRC accepted the principle that stakeholders were part of the coalition that made up the firm – an essential feature of normative stakeholder theory. However two years later in the Consultation Draft, the principle had become ‘Stakeholder responsiveness’, and finally, in the Framework’, ‘Stakeholder relationships’, a neutral term which is fully consistent with instrumental stakeholder theory. In the Framework, the IIRC recognizes the existence of stakeholders other than investors and seeks to give the impression that it takes into account their needs. But it is abundantly clear that the IIRC takes an instrumental view of stakeholders – that, for investors, the relevance of other stakeholders is that the firm’s prosperity depends, in part, on their continued cooperation; hence it is important that the firm should treat stakeholders properly because this will result in higher profits for investors. Thus the IIRC states: ‘value is not created by or within an organization alone, but is created through relationships with others’. (IIRC, 2013b, paragraph 3.11). As already noted, in determining the content of the integrated report, priority is given to serving the information needs of capital providers. The IIRC claims that the information will be of benefit to other stakeholders, as they, in common with capital providers, are interested in the organization’s ability to create value (IIRC, 2013b, paragraph 1.8). But there is no obligation on firms to consult with stakeholders on the content of the integrated report (as the GRI requires with respect to its report). The sole obligation is to report on relations with stakeholders, which, for all the IIRC is concerned, may be terrible. It provides that ‘an integrated report contains qualitative and quantitative information that may include matters such as. . . the state of key stakeholder relationships and how the organization has responded to key stakeholders’ legitimate needs and interests’ (IIRC, 2013b, paragraph 4.31) but ‘it does not mean that an integrated report should attempt to satisfy the information needs of all stakeholders’ (IIRC, 2013b, paragraph 3.11). The reader is left with the strong impression that the IIRC pays lip-service to the need to consider the interests of other stakeholders but its primary interest is the needs of investors. This impression is confirmed by the results of an investigation by two New Zealand researchers who examined the integrated reports issued in 2011 and 2012 by a small sample (58) of companies. Presumably the reports were based on the IIRC’s 2011 Discussion Paper.18 They found that only a third of the companies reported on relationships with stakeholders and commented on ‘the generally low level of responsiveness to stakeholder inclusiveness, suggesting that the reports (and indeed business operations) are still only focused primarily on the shareholder group’s needs’ (Wild and van Staden, 2013). My claim that the IIRC’s concept of integrated reporting is founded on the capitalistic theory of the firm is based on the following aspects of its proposals. (a) Capital allocation. The IIRC stresses the importance of efficient capital allocation; it writes: ‘Integrated Reporting promotes a more cohesive and efficient approach to corporate reporting. . . to enable a more efficient and productive allocation of capital’ (IIRC, 2013a, p. 4). (b) Primary focus: investors. The IIRC states that ‘The primary purpose of an integrated report is to explain to providers of financial capital how an organization creates value over time’ (IIRC, 2013a, paragraph 1.7). (c) Neglect of other stakeholders. The IIRC recognizes the existence of stakeholders other than investors and seeks to give the impression that it takes into account their needs. But it is abundantly clear that the IIRC considers that reporting to stakeholders takes second place after reporting to investors and that its interest in stakeholders (other than investors) is solely as a means of assuring the future prosperity of the firm. 18 A small number of the reports (3 of the 58) related to 2010. 14 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–175.3. What’s wrong with the business case? The business case accepts that the ultimate objective of the firm is to make a profit for the benefit of capital providers and that the managers are obliged to follow this objective in running the firm. The firm’s profit is the surplus of its revenues over its costs, with revenue and costs being calculated from the viewpoint of the capital providers. For example, if the firm’s managers succeed in beating down the amount of wages paid to employees, this represents a reduction in the firm’s costs – the loss suffered by the employees is not taken into account. This approach to the calculation of costs is accepted by the champions of the business case. They simply argue that, in the long run, it is more profitable for the firm to treat its employees humanely as this will lead to greater productivity. As long as the firm’s objective remains the minimization of its costs (so calculated) then the business case is vulnerable to the ‘free rider’ problem. This may be illustrated with the example of air pollution. A firm uses a production process that causes the emission of large quantities of CO2. It is well established that this gas is major cause of global warming. But the contribution that the individual firm makes to global warming is insignificant. If the firm stopped emitting CO2 there would be no perceptible impact on the concentration of this gas in the atmosphere. On the other hand to reduce its emissions of CO2 costs the firm money, for example in the installation of pollution control equipment. The reduction of the firm’s pollution causes an increase in the firm’s costs with no perceptible benefit to the firm. The basic problem is the discrepancy between social costs (the loss suffered by society as a whole) and private costs (the losses suffered by the firm). Conventional accounting recognizes only private costs. According to the IASB’s standards, social costs (such as pollution) should be reported by the firm only when they have been converted into private costs, for example by the state levying a fine on a polluting firm. As already analyzed in Section 4.2.1 above, the IIRC recognizes the existence of social costs or externalities (that is costs to other persons caused by the firm’s activities, costs which are not borne by the firm), but considers that they should only be reported when they have an impact on the firms’ ability to create value. According to the IIRC, investors need information on external costs only in so far as they may impact the firm’s profitability in the longer run. There is no suggestion that the firm should use social costs (rather than its private costs) in its Integrated Report. In fact the IIRC refuses to endorse any specific measurement method (IIRC, 2013a, paragraph 1.19). 5.4. Criticism of the IIRC’s approach In my opinion the approach to financial reporting that has been adopted by the IIRC is inconsistent with full reporting by the firm of the impact of its activities on stakeholders, on society and on the environment. 6. The IIRC’s failure In my opinion, the IIRC has failed. This judgement is based on a comparison of the IIRC’s current proposals with its objectives (as presented in the press release of its founders and its 2011 Discussion Paper). In four important areas the current proposals represent a repudiation of its original objectives: a. The single report: The Integrated Report is not to become the firm’s primary report; it is an extra report alongside conventional financial statements and sustainability reports, hence adding to the ‘reporting landscape of confusion, clutter and fragmentation’ which the IIRC so vividly criticized in its 2011 Discussion Paper. See Section 4.1 above. b. Sustainability: The Integrated Report is not to cover sustainability – see Section 4.2 above. c. Stakeholders: The Integrated Report is not to cover in a comprehensive fashion the impact of the firm’s activities on stakeholders – see Section 5.2 above. d. Lack of impact: The IIRC places very few specific obligations on the preparer of an Integrated Report. It seems highly likely that the IIRC’s proposals will have very little impact on the financial reporting of companies which will not change significantly. 7. The triumph of the realists Why has the IIRC failed so completely to fulfil its original objectives? In this section I present my own diagnosis, which many readers will probably find to be highly controversial and biased. But I consider that my analysis is plausible and should be considered seriously by all students of integrated reporting. The IIRC was founded in a flush of idealism, as is clear from the press release of the founding organizations. Their aim was to develop a model of accounting that would promote sustainability and protect the environment. As the foregoing analysis of the IIRC’s Framework has made abundantly clear, this has not been achieved. The reason for this failure can be traced to a division in the IIRC’s organization between the idealists (the advocates of social and environmental accounting) and the realists (representatives of the accountancy profession, preparers (notably multinational enterprises) and regulators). The realists make up a majority of the IIRC’s Council and have been able to secure the acceptance of their preferred proposals. J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 15In my opinion, the realists have been pursuing a hidden agenda. Since, by definition, their agenda is hidden, it is not possible to prove my claim conclusively. It is certainly possible that certain members of a new institution have a hidden agenda. Anthony Hopwood (1994) made this claim in respect of the formation of the IASC (the IASB’s predecessor) in 1973. He argued that the British accountancy profession was alarmed at the prospect of the European Community (the EU’s predecessor) imposing Continental style accounting on Britain. As recounted in Flower (2002), it was a leading British professional accountant, Henry Benson, who was instrumental in persuading the professional accountancy bodies of nine industrialized countries to come together to form the IASC. Hopwood analyzed the motives for the IASC’s formation in the following rather convoluted and ungrammatical passage: ‘Wanting to have a more institutional manifestation of British commitment to a wider transatlantic and Commonwealth mode of accounting, with the cooperation of its partners in the primarily English language audit community, the IASC was established. Its creation was intended to give a strong signal of Britain’s role in what was perceived as a global accounting community rather than a narrowly circumscribed European one’ (Hopwood, 1994, p. 243). In the case of the IIRC, the organizations with the hidden agenda were worried about the development of alternative forms of corporate reporting, principally sustainability reporting as championed by the GRI, but also the many other forms of non-financial reporting advocated by various public and private bodies.19 They had two main concerns: (a) That these new forms of reporting would undermine the capitalistic theory of the firm and replace it with a more sociallyoriented theory, such as the stakeholder theory of the firm; (b) That the accountancy profession would lose its predominant position as the leading authority in the field of corporate reporting. The organizations in question clearly include the professional accountancy bodies. But also many corporate managers were concerned that the demise of the capitalistic theory of the firm would undermine their power and authority; it would spell the end of their cosy relationship with investors (which most had succeeded in managing effectively) and necessitate developing relationships with all stakeholders, which would bring with it uncertainty and a probable dilution of their power and authority. These concerns explain the preponderance of the accountancy profession and preparers among the IIRC’s membership. A more prosaic explanation of why the realists abandoned sustainability is that they simply considered that it added to the firm’s costs and offered no off-setting value – in two respects: (i) It placed an additional burden on the firm in the need to gather information on the impacts of the firm’s activities on society and the environment. (ii) Where this impact did not rebound on the firm (such that it would have a negative effect on future profitability), it was considered to be irrelevant. Evidence of the influence of the realists is provided by the systematic weakening of the IIRC’s proposals over time. This has already been noted with respect to sustainability accounting (see Table 2) and the position of stakeholders. Also the dropping of the single report and allowing firms to report in any way that they find convenient greatly eases the firms’ reporting burden. But, in numerous other ways, life has made easier for preparers. Firms are not obliged to use the IIRC’s configuration of capitals (IIRC, 2013b, paragraph 2.17). They are not required to give information about matters omitted from the report for reasons of competitive harm; a requirement to give such information was included in the Consultation Draft, but was not included in the Framework, no doubt under pressure from the preparers. Above all, the complete lack of compulsion in the IIRC’s proposals, as demonstrated in Section 4.3, reflects the dominating influence of the realists. Strong evidence of the dominance of the ‘realists’ over the IIRC’s activities is provided by the wording of a press release that the IIRC issued on the publication of its Framework.20 The press release’s title already gives the game away: ‘The International Framework released with business and investor support’. The emphasis in the press release is on the needs of investors. It claims that integrated reporting ‘improves the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital.’ It mentions a host of MNEs that already apply integrated reporting (HSBC, Unilever, Deutsche Bank, China Light and Power, Hyundai, National Australia Bank and Tata Steel) and states ‘we will use the Framework, together with evidence of the business and investor case, to reach out to a wider pool of businesses’. The whole tone of the press release is that the IIRC is business and investor friendly and is not proposing anything that these parties would find unacceptable. There is absolutely no reference in the press release to bodies (such as A4S and GRI) that advocate a more revolutionary and burdensome form of reporting. 19 In its 2011 Discussion Paper (page 7), the IIRC refers, inter alia, to the work of the World Business Council for Sustainable Development, the World Resources Institute, the World Intellectual Capital Initiative, the Carbon Disclosure Project, the Carbon Disclosure Standards Board, the UN Conference on Trade and Development, the UN Global Compact, the International Corporate Governance Network, and the Collaborative Venture on Valuing Non-Financial Performance. 20 See press release available on the IIRC’s web-site: www.theiirc.org/2013/04/16. 16 J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17It would not an exaggeration to claim that the IIRC has been ‘captured’ by the preparers and the accountancy profession. The IIRC has come a long way since its formation in 2010 and it has developed in a way that represents a severe disappointment for those (including the author) who had hoped for a fundamental reform of financial reporting. References Adams C. The ethical: social and environmental reporting performance portrayal gap. Account Audit Account J 2004;17(5):731–57. Boiral O. Sustainability reports as simulacra? A counter-account of A and A+ GRI reports Account Audit Account J 2013;26(7):1036–71. Clarkson M. A stakeholder framework for analyzing and evaluating corporate social performance. Acad Manage Rev 1995;20(1):92–117. Enderle G. The ethics of financial reporting. In: Brenkert G, editor. Corporate integrity and accountability. London: Sage Publications; 2004. p. 87–99. Evan W, Freeman R. A stakeholder theory of the modern corporation. In: Beauchamp T, Bowie N, editors. Ethical theory and business. Englewood Cliffs: Prentice Hall; 1993. p. 75–84. Flower J. Global financial reporting. Basingstoke: Palgrave; 2002. Freeman RE. Strategic management, a stakeholder approach. Boston: Pitman Publishing; 1984. Gallhofer D, Haslam J. Online reporting: accounting in cybersociety. Account Audit Account J 2006;19(5):625–30. Gray R. Is accounting for sustainability actually accounting for sustainability. . . and how would we know? Account Org Soc 2010;35(1):47–62. GRI. G4. Sustainability Reporting Guidelines. 2013. Available on the GRI’s web-site, https://www.globalreporting.org/resourcelibrary/GRIG4-Part1-ReportingPrinciples-and-Standard-Disclosures.pdf. Hopwood A. Some reflections on the harmonization of accounting within the EU. Eur Account Rev 1994;3(2). IIRC. Newsletter (December (1))2010. Available on the IIRC’s web-site, www.theiirc.org/2010/12/15/test/2010. IIRC. Towards Integrated Reporting, Communicating value in the 21st Century. 2011. Available on the IIRC’s web-site, www.theiirc.org/wp-content/uploads/ 2011/09/IR-Discussion-Paper-2011_single.pdf. IIRC. Draft Framework Outline. 2012. Available on the IIRC’s web-site, www.theiirc.org/wp-content/uploads/2012/07/Draft-Framework-Outline.pdf/. IIRC. Consultation Draft of the International Integrated Reporting Framework. 2013a. Available of the IIRC’s web-site, www.theiirc.org/wp-content/uploads/ Consultation-Draft-of-the-InternationalIRFramework.pdf. IIRC. The International Framework. 2013b. Available of the IIRC’s web-site, www.theiirc.org/international-ir-framework/. Jones T. Instrumental stakeholder theory. Acad Manage Rev 1995;20(2):404–37. Jones T, Wicks A. Convergent stakeholder theory. Acad Manage Rev 1999;24(2):206–21. Mayer C. Firm commitment. Oxford: Oxford University Press; 2013. O’Dwyer B. Stakeholder democracy: challenges and contributions from social accounting. Bus Ethics Eur Rev 2005;14(1):28–41. Wild S, van Staden C. Integrated Reporting: initial analysis of early reporters – an institutional theory approach. Kobe, Japan: Paper presented at APIRA conference; 2013, July. World Commission on Environment and Development. Our Common Future. Oxford: Oxford University Press; 1987. J. Flower / Critical Perspectives on Accounting 27 (2015) 1–17 17

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