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South African Journal of Economic and Management Sciences

versão On-line ISSN 2222-3436
versão impressa ISSN 1015-8812

S. Afr. j. econ. manag. sci. vol.20 no.1 Pretoria  2017

http://dx.doi.org/10.4102/sajems.v20i1.1307 

ORIGINAL RESEARCH

 

Firm characteristics and excellence in integrated reporting

 

 

Natasha Buitendag; Gail S. Fortuin; Amber de Laan

School of Accountancy, University of Stellenbosch, South Africa

Correspondence

 

 


ABSTRACT

BACKGROUND: Integrated reporting has attracted much attention in the past few years, and South Africa has taken the lead in its development worldwide. An annual survey is published by Ernst & Young regarding the quality of the integrated reports of the top 100 entities listed on the Johannesburg Stock Exchange (JSE).
AIM: The study on which this article is based was aimed at determining whether the assessment of an entity's characteristics can predetermine the quality of the integrated report generated by that entity.
SETTING: This article focuses on an analysis of the integrated reporting of the top 100 entities listed on JSE for the financial years ending in 2013, 2014 and 2015.
METHODS: Comparison of categorical variables, mixed-model repeated measures ANOVA and generalised estimating equations were applied to identify the best classificators to distinguish between excellent integrated reporting and those reports where progress could still be made.
RESULTS: The results show that the type of industry the entity finds itself in, the size and profitability of the entity, as well as the composition of the members of the board, have an effect on the quality of the integrated report.
CONCLUSION: Our results indicated that the type of industry, size of an entity, the profitability and composition of the board of directors, all have an effect on the quality of the integrated reporting. Our evidence will assist current and prospective stakeholders in evaluating the expected quality of an entity's integrated report, through the evaluation of certain firm characteristics.


 

 

Introduction

Integrated reporting has evolved quite rapidly in South Africa since 2010, leading to the release of the world's first International Integrated Reporting Framework at the end of 2013. South Africa has contributed significantly to the development of integrated reporting worldwide, starting with the establishment of the King Commission by Nelson Mandela and Professor Mervyn King. The King report has grown from a report disclosing a balanced overview of the business to one defined as 'a holistic and integrated representation of the entity's performance in terms of both its finance and stability' (Druckman 2013). Professor Mervyn King has also contributed to integrated reporting on a global basis as chairman of the International Integrated Reporting Council, promoting the adoption of integrated reporting by businesses worldwide.

Since 2010, Ernst & Young (EY) South Africa has given all listed and state-owned South African entities the opportunity to have their integrated reports analysed to improve the quality of these reports in the future (Ernst & Young 2013, 2014, 2015). The annual EY Excellence in Integrated Reporting Survey is realised as a result of this opportunity, where the top 100 entities as listed on the Johannesburg Stock Exchange (JSE) are evaluated (with reference to their market capitalisation) based on their integrated reports (Ernst & Young 2013, 2014, 2015). The entities' integrated reports were ranked as 'Excellent', 'Good', 'Average' or 'Progress to be made', and the top 10 entities in the 'Excellent' category were also identified to enable a separate discussion of their reports (Ernst & Young 2013, 2014, 2015).

This study carried out an empirical evaluation of the firm characteristics of the entities that produced an 'Excellent' report, as well as the entities that produced a report where progress can be made in the future. This study, therefore, made the following contribution to the accounting literature: Stakeholders are interested in obtaining sufficient information from an entity's integrated report to facilitate efficient decision-making. Our evidence will assist current and prospective stakeholders in evaluating the expected quality of an entity's integrated report, through the evaluation of certain firm characteristics.

The purpose of this study was to determine whether the assessment of an entity's characteristics such as entity size, profitability, generation of cash flow and number of directors can predetermine the quality of the integrated report generated by that entity.

The rest of the article is structured as follows: 'Literature review' section provides a critical overview of previous literature regarding integrated reporting in the industry, as well as a description of the different entity characteristics evaluated in the study. 'Research methodology' section focuses on the research methodology of the study, followed by a discussion of the findings in 'Results' section. In 'Conclusion' section, the final section, some conclusions are offered.

 

Literature review

Integrated reporting

We find ourselves living in a day and age where large entities dictate important and often crucial facets of our daily lives. Big supermarkets dictate, directly or indirectly, our eating habits with premiums on select foods. Corporate infrastructure giants dictate our lives by supplying 'necessities' such as electricity and communication. One might even go so far as to say that such corporations dictate what society deems acceptable through their use of social and other media (Eccles & Armbrester 2011).

The question is: What guides these corporations to lead us in a certain direction? Many believe that the boards of major entities are stakeholder-driven. Academics and commentators may still be arguing about what constitutes a stakeholder. A further question might be whether a 'Stakeholder Approach' is feasible. Should we rather say that management is focused on 'Stakeholder Return' (Scholes & Clutterbuck 1998)? This begs the question: How do we as users prevent corporates from trading without morals and values?

In recent years, the focus has shifted to reporting. Increasingly, markets around the world are focusing their accountability on more detailed disclosures. On the forefront of these disclosures is the principle of integrated reporting. Many economic pundits believe that for an entity to be sustainable, one can not only focus on financial disclosures or only disclose information needed by financial stakeholders. It is rather believed that sustainability requires disclosure of a much broader spectrum of information.

A country taking the lead in this regard is South Africa. Through the King Commission, headed by Professor Mervyn King, South Africa has been focusing heavily on this type of reporting. The first report presented by the King Commission is known today as the King I report. The findings in this report led to further investigations, upon which the King II and finally the King III report were published in 2009. The King III report does not constitute legislation, but rather encourages entities to make use of good integrated reporting. The findings in the King III report focus mainly on maximising shareholder information and providing disclosure to enable a user to obtain a better understanding of the entity as a whole.

Integrated reporting attempts to reveal the relationship between financial and non-financial performance and how these interrelated dimensions create or destroy value for shareholders and other stakeholders (Institute of Directors in Southern Africa, IoDSA 2009).

Firm characteristics

Firm size

Kansal, Joshi and Batra (2014) stated that larger entities need to disclose more because they receive more attention from the general public, undertake more activities and make a greater impact on society, and therefore need to exhibit greater social responsibility and improve their corporate image due to their higher visibility. Larger entities also experience more pressure from various stakeholder groups to disclose their social activities. It can be expected that the entity size will have an influence on the corporate social responsibility disclosure, which forms part of the integrated report. It was found that larger entities disclose corporate social responsibility information to a greater extent than smaller entities (Aras, Aybars & Kutlu 2010; Hossain & Reaz 2007; Kansal et al. 2014; Siregar & Bachtiar 2010).

Firm size can be represented by total assets, net sales or market capitalisation. These three measures have been used in numerous previous studies to determine the associational relationship between corporate size and the level of disclosure in corporate annual reports (Wallace & Naser 1995). It is also noted that market capitalisation represents an externally determined measure of an entity's importance as seen by the investing public, whereas asset size and sales are internally determined measures.

The following hypotheses were tested in order to determine the prevailing situation in South Africa during the period under examination:

H1a: Entities with a higher level of revenue can be expected to deliver more excellence in integrated reporting than entities with a lower level of revenue.

H1b: Entities with a higher level of net assets can be expected to deliver more excellence in integrated reporting than entities with a lower level of net assets.

H1c: Entities with a higher level of market capitalisation can be expected to deliver more excellence in integrated reporting than entities with a lower level of market capitalisation.

Growth

It is expected that entities with greater growth opportunities tend to disclose more information than entities with lower growth opportunities (Murcia & dos Santos 2012). Entities that have greater growth opportunities are likely to need resources in the near future. These entities tend to adopt better corporate governance mechanisms, through better disclosure practices, to be more transparent for better investor protection. Entities with good growth opportunities that need to raise external financing will improve their governance mechanisms as better governance and minority shareholder protection will be likely to lower their costs of capital (Khancel 2007). Consequently, investors would be more likely to finance these types of entities.

The following hypothesis was tested in order to determine the prevailing situation in South Africa during the period under examination:

H2: The quality of the integrated report of entities with a higher growth rate can be expected to deliver more excellence in integrated reporting than entities with a lower growth rate.

Profitability

It is expected from the signalling theory that where entity performance, measured by profitability (profit after tax) and return on investments, is good, entities would wish to signal their quality to investors (Watson, Shrives & Marston 2002). It is therefore expected that the entity performance would be an important determinant of ratio disclosure. Entities with high profitability disclose more information than those with lower returns. It may also be argued that entities performing poorly may disclose less information to conceal their performance from stakeholders.

This view is emphasised by Inchausti (1997) from the perspective of the agency theory that management of a very profitable entity will use information in order to obtain personal advantages. Therefore, management will disclose detailed information as a means of justifying their position and compensation package (Singhvi & Desai 1971).

Khlif and Souissi (2010) found that higher performance allows managers to be more convincing to shareholders of their superior managerial abilities. Therefore, by disclosing more information, managers can obtain higher degrees of confidence from investors. Better performance allows managers to distinguish themselves and their entities in the labour and stock markets. This is confirmed by Singhvi and Desai (1971) who revealed that profit margins and earnings returns are variables that both have a positive association with the extent of corporate disclosure.

Ng and Koh (1994) argued that more profitable entities will be subject to greater public scrutiny and will therefore apply self-regulation mechanisms, such as voluntary disclosures in an attempt to avoid external regulation.

The following hypothesis was therefore tested:

H3: The quality of entities with a higher profit margin can be expected to deliver more excellence in integrated reporting than entities with a lower profit margin.

Generation of cash flow

The ability of an entity to meet its short-term financial obligations without having to liquidate or cease operations is important for interested parties such as investors, lenders and regulatory authorities in the evaluation of an entity, because the inability of an entity to meet its current obligations may lead to bankruptcy (Wallace & Naser 1995). Entities therefore tend to give more detail in their annual reports about their ability to meet financial obligations as they fall due and about the fact that the entity is a going concern, in order to relieve the fears of interested parties. It is expected that a highly liquid entity is most likely to provide more information (Watson et al. 2002).

The cash-generating ability of the entity plays an immense role in the liquidity of the entity. The entity with the better cash-generating ability can be measured in two ways: firstly, as the entity with the ability to generate higher cash flow from operating activities relative to revenue, and secondly, as the entity that succeeds in transforming its profit into cash. The more liquid entity will be in a better financial position to allocate resources to the preparation of useful integrated reports.

The following hypotheses were therefore tested:

H4a: The quality of entities with a higher cash inflow from operating activities as a percentage to revenue can be expected to deliver more excellence in integrated reporting than entities with a lower cash inflow.

H4b: The quality of entities with a higher cash inflow from operating activities as a percentage to net assets can be expected to deliver more excellence in integrated reporting than entities with a lower cash inflow.

H4c: The quality of entities with a higher transformation of profits into cash can be expected to deliver more excellence in integrated reporting than entities with a lower cash inflow.

Governance

Entity governance has long been a topic of interest, and the impact of corporate governance is still largely unknown (Ntim & Soobaroyen 2013a). Prior studies have found that there are two large categories of corporate governance that have an effect on disclosure decisions, namely ownership structures and the board composition (Fifka 2011).

The disclosure of South African entities is largely affected by their ownership (Ntim & Soobaroyen 2013b; Ntim, Opong & Danbolt 2012a). Studies have found that depending on the shareholder make-up of an entity, the entity will choose different disclosure strategies. There should be a clear distinction between institutional, government and block shareholders (Eng & Mak 2003). Larger shareholders (such as block holders and institutional holders) can be expected to have larger managerial monitoring and to strive for less information asymmetry. They would therefore require more voluntary disclosure. Entities with government shareholding (for example the Public Investment Corporation) have access to resources and information other entities might not have, but also have the risk of increased political cost. One could therefore expect that entities with government shareholding disclose more information voluntarily (Ntim et al. 2012b).

Larger boards are seen to be less cohesive, and it could be expected that these entities have lower quality disclosure as there are no clear reporting structures or communication channels. On the contrary, larger boards will have increased managerial power and might increase the focus on reporting as the number of executive members on the board is increased. South Africa has a unique corporate environment, and one, therefore, needs to consider characteristics of the environment that might influence the disclosure decisions, such as duel leadership entiti