THE IMPACT OF CORPORATE GOVERNANCE AND SUSTAINABILITY REPORTING ON INTEGRATED REPORTING DISCLOSURE LEVEL

 

1 INTRODUCTION

1.1 Background of the study

The complexity and the dynamism in the external business environment have challenged the traditional financial reporting in many ways. Absence of nonfinancial information, interim reporting and shortness of coherency are such major drawbacks of traditional financial reporting. With the need of overcoming these limitations Integrated Reporting (IR) has been considered as an emerging approach to corporate communication. 

Improved quality, enhanced accountability and stewardship which accomplish the stakeholder’s demand have given IR a significant attention. Contribution to effective resource allocation in decision making process and more cohesive and efficient financial reporting ensures the ability to create value over time.

Though IR is considered as the most contemporary corporate reporting drive, many countries have already have brought IR a reality by integrating financial and non-financial information in their annual reports. Over thousand six hundred business organizations over seventy countries support their financial reporting process by International Integrated Reporting Framework (IIRF). This has taken attention of academics and practitioners as an evolutionary step toward global IR adoption.

With the financial crisis in Asia in 1997 many organizations understood the importance in Corporate Governance (CG). CG aims to bridge the information gap between business organizations and the stakeholders resulting in increasing the stewardship and transparency. Organizations achieve these benefits by doing more voluntary disclosures.

Investors considers IR as an indicator of effective CG and governance disclosures plays a major role in IR content presentation.  Moreover, CG structure has a significant impact on IR adaptation and voluntary disclosure.

Sustainability Reporting (SR) is considered as a fundamental element and a vital step toward IR adaptation. The economic, social and environment nonfinancial information providing through SR disclosures indicates the depth of the role played by SR in IR.

Chamber of commerce and professional accounting bodies motivates the SR among Sri Lankan organizations by conducting awareness programs, seminars and workshops. As at 2019, 30% of the public listed companies published their sustainability reports following the guidelines published by Global Reporting Initiative (GRI). SEC of Sri Lanka and ICASL jointly issued the voluntary Code of Best Practice on Corporate Governance in 2017.

Even though there is no regulation need to be followed by the companies, National Green Reporting System of Sri Lanka, GRI guidelines, AA 1000 Framework and stakeholder Engagement Standard, United Nations Global Compact, ISO 9000 Quality Management Assurance Standard, ISO 14000 Environmental Standard, ISO 26000 on Social Responsibility and OHSAS 18000 Occupational Health and Safety are accepted for reporting purpose as described in Principle G1.7 Code.

The increasing trend towards non-financial information such as Triple Bottom Line reporting (TBL), SR, and Corporate Social Responsibility (CSR) indicates the rapid changes happened in voluntary disclosures in Sri Lankan business organizations. In July 2016 Integrated Reporting Council (IRC) was formed by the Institute of Charted Accountants of Sri Lanka (ICASL) with the aim of promoting IR and share knowledge related to the issues arise related to IR.

Further, introduction of “Code of Best Practices on Corporate Governance” in 2008, 2013 and in 2017 by Securities and Exchange Commission in Sri Lanka (SEC) together with ICASL encouraged the business organizations to adopt IR.

1.2 Problem Statement

Integrated Reporting is considered as a new technique of disclosure that give a holistic picture of the financial and non-financial information of the organization. These financial reports includes economic, social environmental and governance issue related information. IR indicates how organizations create value overtime. Although IR is much popular in the Western and American organizations, it is a relatively new concept to Sri Lanka.

Due to the novelty of this concept to Sri Lanka, still ICASL have not prepared an accounting standard for IR. Therefore, Integrated Reporting will take many years to establish in daily accounting practice in Sri Lankan corporate sector.

The support of professional accounting bodies and business schools have created an environment to evaluate whether and to what extent those integrated reports of companies have complied with the IIRF. However, the knowledge and awareness of IR is comparatively low.

Traditional accounting framework does not provide any nonfinancial information and it is difficult to convey what the organization wish to provide the stakeholders. However with the trend of exceeding the stakeholder expectation, have emphasize the need of IR since gives the holistic picture of the organization.

1.3 Problem Justification

Except Brazil and South Africa, IR is considered as a voluntary disclosure. However, after identifying the ability to create long term value to the stakeholder, organizations moving toward IR was a trend.

Contrary to the prior studies, this study have specifically study the impact of CG and SR on IR in Sri Lanka (Gunarathne and Herath (2016), Tarquinio and Posadas, 2020), (Haji and Anifowose, 2016), (Herath et al., 2019),(Attanayake Mudiyanselage, 2018).

Regardless of the voluntary practice, Sri Lankan companies also have started using IR in recent years (Herath et al., 2019). Even though for the early adopters, it is an efficient choice, late adopters considers the IR adoption as a fashionable choice (Herath et al., 2019). Hence Realization of true benefits of IR adaptation was questionable since the companies have not understood the guiding principles laid down by the IIRF.

No standard have been established by the ICASL or legal framework address the issue of IR so far (Gunarathne and Herath, 2016). So it is questionable that the integrated reports prepared by the companies convey the adequate information to decision making.

With that it is clear that limited number of studies have been carried out in the Sri Lanka context and the existing literature shows mixed results.

1.4 Objectives

1.      To find out the degree of disclosures practices of Integrated Reporting among corporate sector.

2.      To determine the relationship of Corporate Governance mechanism and Integrated Reporting.

3.      To determine the moderating effect of SR on the relationship between CG mechanism and IR disclosure level for Sri Lankan public listed companies.

4.      To evaluate the obstacles of implementing Integrated Reporting practices to the corporate sector.

5.      To identify the managers’ perception on the Integrated Reporting.

1.5 Significance

IR is a novel reporting practice for a sound decision making. Although it is a new concept for Sri Lanka, it has become an emerging trend in the world. IR is considered as the story narrated the value created by the business. This provides financial, management, governance policy, environmental and social information related to the organization. This study will provide useful information for the managers as this will address the need for such a concept in Sri Lanka and how it will affect the effective decision making.

Further this study will bring about the insight that Corporate Governance and Sustainability Reporting need to be treated explicitly since it is a major concern of the stakeholders. With the findings of this study the corporate sector will find the existing level disclosure practices of IR, CG and SR among the corporate sectors and the practicability of introducing such concepts to their workplace which will help them to develop a better corporate image which will subsequently lead to larger profits and steadiness in the long run.

1.6 Scope and Limitation of the Study

This study is a descriptive analysis based on the Integrated Reporting. The proposed study will be conducted for a population derived from the Colombo Stock Exchange listed companies in Sri Lanka. The Colombo Stock Exchange (CSE) has 297 companies representing 20 GICS industry groups as at 31st January 2022 but it is not practical to use the whole population to study the impact of CG and SR on the IR.

Therefore, this study will be conducted only for the LMD most respected 50 companies for year 2020/2021 with at least three companies in each sector. However after categorizing these companies CSE’s GIS industry categorization it is evident that only 5 sectors are represented.

Therefore this study will be limited to Materials, Industrials, Consumer Discretionary, Consumer Staples and Financials. The published annual reports of these selected companies will be used in data collection.

2 LITERATURE REVIEW

“ Social, environmental and sustainability reports have become ever more popular and attention is now moving to Integrated Reporting (IR) in a recognition that traditional capitals (manufactured and financial) do not provide a sufficient account not only of sustainability issues, but also of value creation opportunities” (Iacuzzi et al., 2020) . With the understanding of the importance of having financial and non-financial information in decision making, organization moved to word a novel concept: Integrated Reporting.

Integrated Reporting can be defined 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 in the short, medium, and long term” (IIRC, 2016). According to Liu et al. (2019) IR is a single tool which provide comprehensive information relevant to create long term value to the stakeholders.

Even though IR had accepted globally, except South Africa and Brazil still adaptation of IR was considered as a voluntary practice (Hamad et al., 2020a). According to KPMG (2019) there was an increasing trend in adopting IR practice over the past years among many countries in Asia, Europe and USA. Connecting financial and sustainability information is one of the greatest advantage a company can enjoy through adopting IR (Baboukardos and Rimmel, 2016). Further, Lee and Yeo (2016) stated that IR reduces information processing cost and IIRC (2013) stated that IR reduces information asymmetries. According to Obeng et al. (2020) and Cortesi and Vena (2019) earns higher earnings quality and EPS, minimize regulatory risk (Pavlopoulos et al., 2017).

 

2.1 Integrated Reporting and Disclosure Level

Even though IR is relatively new to Asia, with the issuance of IIRC framework Malaysia, Indonesia and Singapore have started adopting IR (Dragu and Tiron-Tudor, 2013), (Hamad et al., 2020b). Haji and Anifowose (2016), Lee and Yeo (2016), Pistoni et al. (2018) have done studies to evaluate and measure the disclosure level of IR. They have used a checklist or index as a measurement tool to evaluate the IR disclosure quality following IIRC framework.

Hamad et al. (2020b) have found that elements that  focus in IR is different among countries. However, Luk et al. (2017) found that  over 50% of the Malaysian PLCs Luk et al. (2017) and a repaid growth among Sri Lankan companies Gunarathne and Herath (2016) of IR adaptation.

2.2 Corporate Governance and Integrated Reporting

 

Corporate Governance can be define as “the set of mechanisms that align objectives and interests between the providers of finance and company managers so that the former have a degree of certainty against the risk they take by making their funds available to managers, and can try to avoid opportunistic behavior by the latter”(Asensio-López et al., 2019).

Relationship between CG and IR has been widely researched during past years since many have identified the significance of voluntary disclosure. Frías-Aceituno et al. (2014), Hurghis (2017) and Velte and Stawinoga (2017) have tested the impact of CG and IR adaptation. According to Gunarathne and Herath (2016) since the primary users of the integrated reports are the investors, there is a pressure towards the companies to practice IR.

Literature shows that there is a significant positive impact of audit committee effectiveness and a strong positive impact on the quality and extent of IR practice (Haji and Anifowose, 2016).

Further Sallehuddin (2016) and Said et al. (2009) stated that there is a positive correlation between board size, board independency and voluntary disclosures while Hurghis (2017) found a weak relationship. In Parallel, Iredele (2019) found that there is no significant of Board chairman on IR disclosure level.

2.3 Sustainability Reporting and Integrated Reporting

A sustainability report cane be defined as “an organizational report that gives information about economic, environmental, social, and governance performance” (Perera and Yatigammana, 2021). There are no SR Standards in Sri Lanka and the handful of organizations who prepare sustainability reports use Global Reporting Initiatives (GRI) as an umbrella which provides guidelines on this.

Many organizations provide separate integrated report and a sustainability report as they are identical. These differences mainly lays on the objectives, target audience, standards and setters, adoption level, content elements, subjects, information provide, connectivity, time horizon and compliance(Hamad et al., 2020b).

With the understanding of the ability to safeguard the organization’s limited resources by SR this has become an increasingly relevant area of research. Some corporate issue two separate reports adhering GRI and IIRC guidelines and standards (Kılıç and Kuzey, 2018). Zahid et al. (2020) has measured Sustainability disclosure level using an Index which was followed by GRI and Hamad et al. (2020a) have studied the moderating impact of SR on IR. Similarly, this study also will measure SR using an index to study the impact of SR on the relationship between CG and IR.

 

2.4 Firm Size, Leverage, Listed Years and Integrated Reporting

Literature have studied other variables which would affect the IR. Firm size have recorded there is no impact of firm size on IR in the study of Vaz et al. (2016) while a significant positive impact on the IR disclosure level also been found in literature (Frías-Aceituno et al., 2014). According to Iredele (2019) there is no significant impact of Leverage on IR. Jamal and Ghani (2016) stated that there is a significant impact of firm’s age on the IR disclosure level.

3 METHODOLOGY

3.1 Research Philosophy

This quantitative research is based on the positivist paradigm within the deductive approach to examine the relationships between variables.

3.2 Conceptual Framework

 

To assess the IR disclosure practices level of Sri Lankan companies, an Integrated Reporting Index will be used. This study will follow the IR disclosure index of Haji and Anifowose (2016), Pistoni et al. (2018), Rivera-Arrubla et al. (2017) which has followed the IIRC framework.

To assess the SR disclosure practices level of Sri Lankan companies, a Sustainability Reporting Index will be used. This study will follow the SR disclosure index of Muhammad (2020) which has followed the GRI standards.

To assess the CG disclosure practices level of Sri Lankan companies, a Corporate Governance Index will be used. This study will follow the CG disclosure index of Manawaduge (2012) which has followed the Code of Best Practice on Corporate Governance 2017 which was issued by the ICASL.

Firm Size, Leverage and Firm age will be used as control variables. Firm size will be measured using the value of total assets, Leverage will be measured using the debt to equity ratio and Firm age will be measured using the number of years since the firms’ shares were listed in CSE similar to Azeez (2015).

 

 

 

		Figure 3 1 Conceptual Framework

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3.3 List of Hypothesis Formulated

Table 3.1 List of Hypothesis

	Hypothesis
1	H0 1 – There is no significant positive relationship between corporate Governance and IR disclosure level.
	Ha 1 - There is a significant positive relationship between corporate Governance and IR disclosure level.
2	H0 2 -  SR positively moderates the relationship between CG proxies and IR disclosure level of Sri Lankan PLCs.
	Ha 2 - SR does not  positively moderates the relationship between CG proxies and IR disclosure level of Sri Lankan PLCs.

3.4 Population

The selected population for the study will be the 297 listed companies (CSE,2022) which covers all 11 sectors. This broader population will be further narrow downed to the Top 50 LMD companies for year 2021 (LMD, 2022) as the target population.

3.5 Sample

Using stratified systematic simple sampling method, the selected top 50 companies (LMD 2019/2020) will be categorized according to their industry/sector (Appendix 1). After categorizing companies in to the sectors, sectors with at least three companies will be selected as the sample. Therefore this study will consider 45 companies covering 5 Sectors.

Table 3.2 Selected number of companies from each sector.

Sector	Industry Group	Number of Organization
Materials	Materials	4
Industrials	Capital Goods , Commercial &Professional Services, Transportation	10
Consumer Discretionary	Automobiles & Components, Consumer Durables & Apparel, Consumer Services, Retailing	3
Consumer Staples	Food & Staples Retailing, Food, Beverage & Tobacco, Household & Personal Products	13
Financials	Banks , Diversified Financials, Insurance	15

3.6 Research Strategy

Annual reports from 2010 to 2020 will be studied for the selected companies for this study. Parallel to this, a questioner will be distributed among the finance managers of the selected 45 companies addressing the objectives and the conceptual framework. 

To study the two main relationships in the framework two regression models will be used. To study the impact of CG and SR on the level of IR disclosure level of the Sri Lankan companies following two ordinary least squares (OLS) models will be used.

 

Model 1

Model 2

 

3.7 Operationalization of Variables

Table 3 Operationalization Table

Type of the variable	Name of the variable	Definition	Measurement of data
Dependent Variable	IR Disclosure Level (IRD)	The average score of IR disclosure index	Interval
Independent Variable	Corporate Governance (CG)	The sum of Corporate Governance Index	Interval
Moderating Variable	Sustainability Reporting (SR)	The average score of SR disclosure index	Ordinal
Control Variable	Firm Size (FS)	The value of  Total Asset	Ratio
	Leverage	Debt to Equity Ratio	Ratio
	Firm Age	the number of years since the firms’ shares were listed in CSE	Ratio

4 CONCLUSION

Sound set of annual reports of a listed company have the ability to provide a long term value to the stakeholders. The companies understood the insufficiency of financial information to create over time value to the stakeholders moved toward providing non-financial information too. IR is a novel concept which plays a major role in this process. This concept gives a holistic picture of the economic, social and environmental activities of the organization. Along with this concept SR is considered as a value creating tool through the annual reports. Both these concepts have already taken the attention of various professional institutions and academics.

This will be studied the impact of Corporate Governance and Sustainability Reporting on Integrated Reporting disclosure level. This study will be grounded on the empirical and literature gap based problem and to data will be gathered through annual reports of 45 listed companies from 2010-2020 period.

The proposed study will provide a better understanding about the relationship between CG and IR and insights the about the role of GC and SR in the transition to IR. Even though IR is relatively new concept in Sri Lanka companies can create a long term value to the stakeholders through increasing the transparency and reduce information asymmetries. (Rivera-Arrubla et al., 2017) , (Tarquinio and Posadas, 2020).