Integrating reporting, disintegrating values?

<IR> for the 21^st Century

Since the 16^th April the International Integrated Reporting Council (IIRC) has been consulting on its draft framework for integrated reporting to which it gives the cutesy abbreviation <IR>. It aims, it says, to create a framework that can help businesses communicate value in the 21^st century. It defines an ‘integrated’ corporate report as:

“a concise communication about how an organisation’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.”

The <IR> Framework is a principals-based approach. It is not prescriptive of measurement methodologies but conceives value-creation strictly in terms of an extended economic metaphor of ‘capital’. Capital is defined in multi-various forms: financial, manufactured, intellectual, human, social, and natural. They are each conceived as ‘stores of value’ and value creation as a circular process of ‘uses and effects’ of the capitals. Thus, the capitals are an input, output and outcome of the value-creation cycle. The six forms of capital are “increased, decreased or transformed through the activities and outputs of the organisation in that they are enhanced, consumed, modified, destroyed, or otherwise affected by those activities and outputs.”

Although organisations may create value overall, the process may involve destruction of value stored in some capitals or a net decrease to the total stock. Whether the net effect is positive or negative, the consultative Framework warns, will depend on the perspective chosen: different agents or stakeholders may value things differently. Somewhat confusingly, value creation, it says, includes instances when the overall stock of capitals is reduced – when value is diminished or destroyed.

Recognising natural limits..

The <IR> Framework seeks to guide a “Comprehensive Value Creation Story” in the form of narrative, qualitative and quantitative information. It doesn’t try to over-reach itself by seeking to attach numbers to everything but adopts a practical and pragmatic tone. The story should however show the ‘combination, inter-relatedness, and dependencies between the components that are material’ to value creation over time. It is this ‘integration’ of information beyond financial and historical matters that distinguishes <IR> from  traditional corporate reporting.

If anything, the Framework restrains its ambitions in the face of the apparent difficulties involved. It acknowledges that it is not practical to require quantification of all the uses and effects on the capitals or to provide an exhaustive account of inter-dependencies between them. Reporters must, however, disclose how the latter have been considered in determining the reporting boundary and trade-offs that influence value creation.  It says that <IR> is not intended to measure the value of an organisation or all of the capitals. Rather, it is to enable the intended users of the report to assess the ability of the organisation to create value over time. But, one might legitimately ask, if <IR> does not – or cannot – actually measure the use, effects, and inter-dependencies of capital, does the ‘capitals approach’ to integrated reporting mark real progress in the quest for sustainable capitalism?

The Value Creation Story

The <IR> Framework offers little guidance on how trade-offs or conflicts that inevitably arise in the value creation process may be resolved. The purpose of integrated reporting is simply to assist its intended users to assess value creation, rather than to attempt to measure the value created ‘through’, ‘in’, or ‘of’ all the capitals. It proposes that an organisation can ‘create and maximise value by serving the interests of its key stakeholders’. Value created in this way, it maintains, ‘manifests itself in financial returns to providers of financial capital’. But, equally, in so doing it also has ‘positive or negative effects on other capitals and (hence) on other stakeholders’. Value, it says, is created over different time horizons and for different stakeholders through different capitals.

The Framework therefore acknowledges the existence of ‘other forms of value’, albeit confined to those created through effects on the capitals, and that these may ultimately affect financial returns. As such, it comes close to admitting a plurality of perhaps incommensurable conceptions of value into the value creation framework. But, at the same time, it does not regard a 'single-value’ definition of business success as a problem for stakeholder legitimacy. 

While not exclusively so, it is clear that the intended users of integrated reporting are primarily providers of financial capital. According to the Framework, <IR> can assist providers of financial capital to assess value creation over time, supporting decision-making and engagement. It ‘also supports broader societal interests’ by encouraging the allocation of financial capital to value creation ‘within planetary limits and societal expectations.’

In its account of value creation, the <IR> Framework notes that externalities may ultimately increase or decrease value to providers of financial capital. They need information about ‘material’ externalities to ‘assess their effects and allocate resources accordingly.’ That does not guarantee of course that externalities will be internalised by the organisation, or even that financial capital providers will encourage them to do so. Indeed, materiality is defined in the Framework as any matter which ‘could substantively influence the assessments of the primary intended report users with regard to the organisation’s ability to create value over the short, medium, and long-term.’ It also includes any matters which substantially affects the organisation’s strategy, business model, or one or more of the capitals it uses or effects. We should expect integrated reporting to be expansive in its coverage of the externalities of business activities. But it will be left to stakeholders to take their own view on how corporations should respond to them. A reminder that reporting is just reporting, not a policy instrument.

Overall, the Framework appeals roughly to a notion of ‘shared value’ grounded in an economics-based variant of stakeholder theory. Although it sounds at times very close to simply presenting the case for enlightened shareholder value, the <IR> Framework avoids becoming ensnared by the ambiguities of fiduciary law. It is left to the ‘intended users’ – providers of financial capital - to grapple with a familiar problem: how to strike the right balance between financial value creation and a range of other values which may or may not be measurable?

Relational Value Drivers

According to the Framework, the organisation’s value drivers include relationships with others, including employees, customers and suppliers, as well as its responses to societal expectations and values such as integrity, trust and teamwork. This richer account of the relational aspects of business activities marks a curious departure from the strictly ‘resource view’ in the prevailing capitals narrative. Relational values do not fit as neatly into the narrow economic metaphor. 

Despite the potential risk of incoherence, the Framework seems content to encourages organisations to connect economic values to societal ones. An integrated report should tell us, it says, how the organisation’s culture, ethics, and values are reflected in its use of, and effects on, the various capitals. Including, it adds, its relationships with key stakeholders. This, the Framework suggests, should include insights into the extent to which it ‘understands, takes into account, and responds to their legitimate needs, interests, and expectations’ and helps the organisation to understand ‘how stakeholders perceive value’.

Searching for an ethical foundation

The awkward juxtaposition of transactional and relational 'goods' in the account of value creation continues in the Framework’s discussion of stewardship. Again, one can detect an equivocation between the narrow (financial, instrumental) conception of value and a wider normative or moral (perhaps intrinsic) sense of ‘values’. According to the Framework, <IR> enhances transparency and accountability. The latter it says is ‘closely associated with the concept of stewardship’. It defines stewardship broadly in terms of an organisation’s responsibility to ‘care for or use responsibly the capitals that its activities and outputs effect’.

This is nevertheless a somewhat truncated account. Stewardship certainly involves ‘accountability’ in its ethic of corporate responsibility. Stewardship theory seeks to resolve the the familiar agency problem by assuming the interests (and values) of the agent are, or can be, aligned with those he serves. Ethical stewardship as a theory of management emphasises service over self-interest, and examines the conditions in which loyalty and trust can be established in a stewardship relationship. Thus, accountability in a stewardship relationship exists in a context of mutually-held values, interests and goals. Accountability in a principal-agent model of governance performs a monitoring role, defending the former's interests from moral hazard in a relationship threatened by opportunism.   

The Framework suggests that in the case of capitals owned by the organisation, stewardship responsibility is imposed on management via their legal responsibilities to it. Even so, the organisation may nonetheless ‘accept stewardship responsibilities in accordance with growing stakeholder expectations to do so’. In other words, stakeholders want and expect corporations and their managers to behave as good or trustworthy stewards of the resources, power and influence that have been granted, not only by financial capital providers but by wider society too (here represented by the other capitals).

  

According to the Framework, as it responds to the ‘legitimate needs, interests and expectations’ of stakeholders organisations can ‘create and maximise value’ by serving them and working with them. This comes very close to a more authentic description of stewardship responsibility, if by ‘maximise value’ it is referring to both stakeholder and societal values: the 'goods' they jointly pursue.

But, as we have seen, in the end the Framework falls back on enlightened self-interest to justify the steward’s role. By rehearsing the familiar argument, the <IR> Framework unnecessarily conflates fiduciary obligations with stewardship responsibilities. I would argue that these are not the same and ought not to be confused. But the extended capitals qua economic capital account of value creation in effect forces the <IR> framers back into a ‘single value’ world in which the return to financial capital is the ultimate measure of all things. If, however, value creation is genuinely shared as <IR> seems to intend, corporations must not only strive to understand and ‘take account’ of the diverse interests, values and expectations of stakeholders but make them actually count. It cannot truly ‘serve them’ if the ultimate goal is to create financial value for one privileged class of stakeholder.

Re-drawing the lines of responsibility

To be fair, the capitals account of value creation is entirely consistent with management’s fiduciary responsibilities to both the organisation and its legal owners. The best interests of financial capital providers are indeed served by increasing the economic return on the total capital base; growing or maintaining the stock of resources on which long-term sustainability rests.

A form of corporate reporting that can truly integrate multiple sources and conceptions of value in a pluralist society is an urgent task if trust in our economic institutions is to be properly re-established. But the chosen method of integration – the extended capitals approach - is unable to do this. It creates a useful accounting bridge into the economic theory of sustainability. But by re-casting stakeholders as ‘capital contributors’ the <IR> Framework reduces the richness of human experience, roles and relationships to a series of stock-and-flow transactions. In this model economic values alone matter in the end. Moral values are either absent or are only instrumental to a single ultimately measurable store of value. The purpose of a corporation therefore remains unchallenged: the creation of financial value accruing to one class of stakeholder.  

There is nothing wrong with this in our capitalist economy of course. It fulfills the fiduciary obligation. But financial returns should be the outcome or result of creating stakeholder value, not a goal in itself. The capitals account of value is therefore not compatible with an organisation’s separate and distinct stewardship responsibilities. These are established on quite different ethical foundations: a vision of a better future and a corporate purpose (or 'telos') aligned to this - an intrinsically valuable state of the world. The moral foundation of a 'common good' supplies the grounds for ethical obligations often missing in vague allusions to 'social responsibility'. It can provide meaning, foster moral motivation, and help our ethical commitments in business life to run rather deeper.

Stewardship values and virtues may re-integrate business and ethical goals in a richer narrative of economic and moral value. It can connect the world 'out there' to that 'in here' and 'in me'. In turn, as management seeks to balance the interests of multiple stakeholders in this larger context it must recognize these values as instrumental. Its task is to integrate and align as far as possible the intrinsic value-purpose of the corporation with stakeholder interests and ultimately shareholder value. This is an enlarged vision of a successful and sustainable business. In the end, it is a search for integrity - at the level of the collective, and of individual leaders and employees. It is a deliberative and participatory endeavour which takes corporate strategy and governance beyond a stakeholder balancing act of mutual advantage and 'enlightened' self-interest.  A company driven and governed by an ethic of stewardship honours a range of additional values: service, servanthood, care, relationship, inter-dependence, partnership, empowerment, character, human capacities and flourishing. None of these can be articulated in an account of value described only as the accumulated stock of economic benefits accruing to the owner/provider of capital.

Stewardship is a higher calling that requires strong moral leadership and a corporate commitment that goes further than accountability and reporting. And yet, reporting must play an important part in the process of creating a stewardship relationship with stakeholders. It can do so by fostering dialogue and participation in the quest for greater alignment and trust in a joint endeavour of discovering and creating meaning and value. Those of us hopeful that a revolution in corporate reporting could help re-align our measure of business success with the best interests of wider society may be disappointed. And yet in places <IR> comes tantalisingly close.

"The objectives of <IR> is to communicate the full range of factors that materially affect the ability of an organisation to create value over time; to inform decision-making and the allocation of financial capital to that end; and enhance accountability and stewardship.."