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Reporting is taking off in France

Integrated Reporting is taking off in France

Posted
2 July, 2015

Here we are! The idea ofintegrated reportingis significantly growing in France. It does not mean that numerous
integrated reports will be published next year, but that most major French companies have now assimilated the
idea. Most are at least pondering what it could mean for them over the next few years.
It was about time. According to theIIRC, 1,000 companies worldwide have published a report qualified
integrated. Even though the practices remain heterogeneous and are sometimes far from the original
philosophy, this number illustrates a growing interest for this new approach. Integrated reporting has already
become a reality for some years inSouth Africawhere it is recommended in the governance code. It also won its
nobility title in the UK where, since October 2013, boards are requested to publish an annual Strategic report
(http://www.google.fr/url?q=https://www.frc.org.uk/Our-Work/Publications/Accounting-and-ReportingPolicy/Guidance-on-the-StrategicReport.pdf&sa=U&ei=Il2IVda2MYPvUqing9AF&ved=0CBQQFjAA&usg=AFQjCNHTLA6LGOTioM8vUnUhX5Vqlr0B2g)
which guidelines are largely inspired by theIIRC framework. And many other countries have expressed a strong
interest in the concept.
TheInternational Corporate Governance Network(formed by the worlds largest investment funds which
collectively represent $26 trillion of AUM) has been interested for several years in providing shareholders with
non-financial information. It clearly states in its2014 General Governance Principles (http://www.google.fr/url?
q=http://www.fsa.go.jp/en/refer/councils/corporategovernance/reference/icgn.pdf&sa=U&ei=sF2IVZe1EMrkUYKgaAP&ved=0CBQQFjAA&usg=AFQjCNFSe7urRYc7uHatys3ppYybNEg_Fg)that: The Board should provide an
integrated report that puts historical performance into context and portrays the risks, opportunities and prospects
for the company in the future, helping shareholders understand a companys strategic objectives and its progress
toward meeting them.
France is still lagging behind with only a handful of so-called integrated reports published in 2015
(likeEngie,VivendiorEurazeo PMEwhose reports reflect the diversity of the possible approaches). Given
theimportanceof the non-resident shareholders in the share capital of French listed companies and especially
the Anglo-Saxon funds, it is urgent to accelerate the renovation of shareholder information, catch up with the
international evolution and capitalize on our companies growing interest in this idea.
The starting point is a very mundane and old observation: the information currently provided to investors is not
always sufficient to help them take their investment decisions properly (see TheKPMG Survey of business
reporting (http://bit.ly/1Ha6oHm), 2014). The information is too complex, accounting focused, huge, historical and
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technical to allow investors to answer the only critical question they have: Will the companys management
strategy contribute to creating extra value over time beyond that already embedded in the share price?
Answering this question is particularly challenging in adigital economywhere value creation relies on the
companys ability to extract the greatest possible economic benefits from its ecosystem and constantly recreate
an increasingly transient competitive advantage. Boundaries of companies are becoming porous and value
migration from and to the environment must be identified and ideally quantified.
That is the reason why major active investors meet at least once a year with the management board of companies
in which they have invested. This direct dialogue primarily focuses on medium and long-term corporate strategy
and the risks and opportunities in their business models, while the review of financial results comes later, as
recently identified in aKPMG / AFG study.
Listed companies must realize that aligning their share price on their intrinsic value depends on their ability to
provide investors with relevant information about their short, medium and long term value creation strategy.
This is why integrated reporting (<IR>) is an important source of inspiration for CFOs and IROs. This initiative is in
line with the reports and reflections of many professional organizations (ICAEW, ICAS) and institutions (IASB,
FASB, FRC) about the necessary adaptation of financial information (see for example: Towards clear and concise
reporting (http://bit.ly/1e8l56E), FRC, 2014). Adopted by the IIRC in 2013, <IR> is probably the best synthesis of
what should be a real strategic communication when it comes to value creation. The reason why France remains
behind is because the debate has been continuously conducted on the basis of three mistakes.
The first one concerns the objective of <IR>. The subtitle of the original framework was Communicating value in
the 21st century. The word value is particularly ambiguous and misleading. Some ideologists see in integrated
reporting yet another argument to denounce shareholder value, which they depict as antithetical to the true
value supposed to be delivered to the other stakeholders of the company. According to this black and white story,
there would be on one side the good guys, concerned with the long-term viability of the company, and on the
other side, the greedy short-term shareholders.
Actually, if we look at facts, we realize that this is a highly prejudiced view. Contrary to common belief, share price
is indicative of thelong-term valueof the company. It is true that traders are primarily interested in short-term
performance and influence daily prices. They constantly monitor the news flow and bet on how the market could
react on short-term issues. When share prices depart too significantly from the companys fundamental value,
long-term investors show up. They invest less frequently than traders do, but when they decide to build a position
after a careful due diligence review, their daily investment is7-30 times higherthan traders, and this occurs over
a period of 10 to 15 days. Therefore, these sophisticated investors, whose decisions are based on long-term
expectations of the quality of a companys management and the strength of its business model, are the main
driver of share prices over time.
In a liberal economy where real and financial markets perform reasonably well, shareholder value isnot
contradictorywith stakeholder value. How can one think that long-term shareholder value could be maximized
with unhappy clients, demotivated staff, strangled suppliers and rebelled communities? It is in the shareholders
best interest to satisfy these stakeholders enough to get their by-in and ensure future expected returns.
The second mistake, less ideological but equally pernicious, is to conceive <IR> as a merger between the
sustainability report and the financial report. For sustainability proponents it is a long time awaited legitimization
of the CSR function that has always struggled to find its place within the company. This idea of merged document
builds on the previously mentioned idea that the true value is not shareholder value and that more relevant
indicators of essentially non-financial nature should be developed and communicated. This approach reflects a
misunderstanding of the mechanisms of value creation. Long-term financial value is based on a complex mix of
tangible and intangible resources of the company properly allocated to support its strategic vision. It depends on
the positioning of the company in a moving and easily disrupted business web, with risks as well as opportunities.
It is this complex mechanism that should be presented to the market in a synthetic and convincing manner and
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with an understandable language. The question is not to promote classical CSRs indicators, which for the most
part have no real relationship with shareholder value, but to identifysoft informationrepresentative of financial
value creation, alongside hard information.
The third misconception is based on the belief that a standardized approach should be put into place. It is an
illusion. Indeed, value creation comes from the companys transientcompetitive advantages, which are by
definition unique. How can uniqueness be standardized? An assurance given by an independent auditor could be
considered, but it would remain limited to the few key indicators that the company decides to reveal to the
market. The IIRC framework is an inspiration for companies. It should not be a corset. At most, a comply or
explain logic could be implemented.
These three misunderstandings must be dissipated in order to give way to a more positive and realistic view of
the integrated report. Companies must realize that this report is intended primarily for investors and meets an
essential need in terms of financial market information. They must understand that this is a matter of investors
relations, not sustainable development. The objective is to create and promote a more rigorous equity story.
Still skeptical? Consider the benefits of integrated reporting which are beginning to be fairly well documented.
First, it favors the alignment of the fundamental value and the share price. The firststudies
(http://bit.ly/1e8p2s2)carried out show that its adoption by a company changes its shareholders ecology: a
growing number of long-term investors replacing short-term investors. Hence, a greater influence is given to the
fundamental component of the share price. It does not necessarily mean that its short-term volatility is reduced,
but in the medium and long term, the likelihood of a gap between fundamental value and the share price is lower.
In addition, and this is a well-documented fact, information asymmetry is reduced when the weight of soft
information is increased relative to that of the hard information (the latter explains only 10% of the price
changes after the announcement of results). This leads to more reliable analysts forecasts, a reduction of opacity
discount, a positive effect on the cost of capital, etc. However, abalancemust be maintained between the two
categories of information to give credibility to the process. Replacing hard information by soft information could
create a distrust reaction in a financial community who wants to ensure that the company meets its anticipated
milestones regularly.
The second category of benefits affects thebusiness itself. Experience shows that integrated thinking (a necessary
preliminary step towards integrated reporting) is not trivial. It changes the culture of a company by building
bridges between the organizations silos, identifying the relationship between non-financial performance and
shareholder value and instilling the perspective of the investor in key decisions of the company. In the logic
ofShared Value (http://bit.ly/1e8q3jT)developed by Michael Porter, companies can also rationalize financial
decisions related to their ESG strategy.
Overall, the process of strategic thinking and rigorous capital allocation decisions can be improved. This cultural
change has a positive impact on shareholder value, and if properly explained to the markets, it will be increasingly
integrated into the investors expectations.
But be careful! This approach is not as simple as it seems. First, it requires having aclear plan of how the
company will create valueover short, medium and long term, identifying key parameters to measure the
execution progress, and setting up an organization and tools to integrate shareholder perspective in major capital
allocation decisions and risk management. The aphorism created by the French poet Nicolas Boileau: What is
well understood is expressed clearly and the words to say it come easily applies perfectly. Before communicating,
companies must reach a clear consensus on their value creation strategy.
But a clear value creation project is not sufficient. The company must also develop a strong empathy towards
investors who are the main targets of this communication. They must understand themental modelsof their
investors, which, contrary to the belief of many leaders, are not reducible to financial analysts views. It is through

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a genuine dialogue with fundamental investors that a company can understand their expectations, check its
ability to meet them and decide what to do in case those expectations are far off what the company can
reasonably do.
The integrated report is not an additional standard or fashion. The success of this approach requires a discipline
and a mobilization of all the organization around long-term value creation. Led by the CFO, it requires the full
support of the top management and should be put under the control of theBoard of Directorsthat is ultimately
responsible for the quality of information given to the market.

Author: Jean-Florent Rerolle, Partner, KPMG

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