The Evolution of Corporate Disclosure: Insights on Traditional and Modern Corporate Communication (Contributions to Management Science) 3030422984, 9783030422981

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Contributions to Management Science

Alessandro Ghio Roberto Verona

The Evolution of Corporate Disclosure Insights on Traditional and Modern Corporate Communication

Contributions to Management Science

The series Contributions to Management Science contains research publications in all fields of business and management science. These publications are primarily monographs and multiple author works containing new research results, and also feature selected conference-based publications are also considered. The focus of the series lies in presenting the development of latest theoretical and empirical research across different viewpoints. This book series is indexed in Scopus.

More information about this series at http://www.springer.com/series/1505

Alessandro Ghio • Roberto Verona

The Evolution of Corporate Disclosure Insights on Traditional and Modern Corporate Communication

Alessandro Ghio Department of Accounting Monash University Caulfield East - Melbourne, VIC, Australia

Roberto Verona Department of Economics and Management University of Pisa Pisa, Italy

ISSN 1431-1941 ISSN 2197-716X (electronic) Contributions to Management Science ISBN 978-3-030-42298-1 ISBN 978-3-030-42299-8 (eBook) https://doi.org/10.1007/978-3-030-42299-8 © Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

Reporting is of increasing relevance for today’s companies. While reporting has, for a long time, mostly represented a compliance duty, companies are devoting a growing amount of human and financial resources to the reporting process. This change is mostly the result of the stakeholders’ growing expectations of corporate activities. Fast economic, social, and environmental changes require more holistic and integrated reporting. The exclusive focus on financial capitals appears completely outdated and unable to remain relevant in a society where shareholders, employees, and local communities value information other than corporate financial performance. The integration and reporting of manufactured, intellectual, human, social and relationship, and natural capitals are key to ensure short-, medium-, and long-term corporate sustainability. The evolution of reporting also concerns how corporate information is disseminated. For a long time, access to corporate information was strictly structured by accounting standards and limited to specific periods during the year, mostly around the earnings announcements. From the supply side, the press—for a long time— controlled the dissemination of information through its discretionary power to decide when and what to report. Business press and analysts tend to cover larger-sized firms, given the potentially larger audience who is interested in this set of information, limiting investors’ recognition of smaller-sized firms with lower visibility or limited resources. More recently, however, it is no longer a small group of actors consisting mainly of analysts and business press who monopolize the communication. Companies can convey information directly to investors via social media without using intermediaries. This book sheds light on the evolution of corporate reporting by combining a critical review of academic literature and empirical analyses. In Chap. 1, the authors introduce the readers to the key topics, which are analyzed and discussed, the theoretical framework and the adopted methodology. Chapter 2 examines a pillar of corporate reporting, such as mandatory financial reporting. After discussing the main consequences of introducing the International Accounting Standards (IAS) and the International Financial Reporting Standards (IFRS) in terms of financial v

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reporting quality, the authors critically assess the current one-size-fits-all approach to mandatory reporting and report numerous red flags in the regulatory process. Chapter 3 starts the analysis of voluntary disclosure, with a particular focus on the associated costs and benefits. The discussion then turns to the role of corporate governance in enhancing high-quality corporate information. The chapter then concludes with the discussion of increasingly relevant types of voluntary corporate disclosure, namely conference calls, management forecasts, and intellectual capital. Chapter 4 further expands the discussion on voluntary disclosure to social and environmental accounting. This chapter provides an in-depth analysis of the European Union (EU) Directive 2014/95/EU on the disclosure of non-financial and diversity information. The chapter highlights the critical decoupling between corporate reporting and actions and discusses the current demand for dialogic accounting. This chapter includes a comparative case study analysis examining how firm size affects the content and form of sustainability reports. Chapter 5 examines how the dissemination of corporate reporting has changed. The focus is on the rise of the Internet and social media platforms, particularly Twitter and Facebook, which allow companies to continuously communicate with their stakeholders at low costs. The authors then present an empirical analysis of the determinants of corporate presence and communication on social media around earnings announcements. The authors analyze whether social media activity is associated with business press coverage. Lastly, the concluding chapter highlights this book’s key takeaways and presents numerous research avenues concerning corporate reporting. This study makes several contributions. Firstly, it contributes to the literature on disclosure. The theoretical and empirical analyses show a clear trend pointing toward the expansion of the role of corporate reporting. Companies face pressure from external stakeholders concerning their reporting content and dissemination. As such, companies’ reporting decisions reflect the demand for more timely and relevant information. Secondly, the study contributes to the discussion on the use of new communication channels by showing their relevance to firms, investors, and stakeholders and the uses to which they may be put. Findings also have implications with regard to the need for additional information on firms of different size. This book is informative for investors and corporate stakeholders to understand firms’ communication strategies. Findings also facilitate a more integrated and holistic view of corporate reporting. Finally, this study is relevant to policymakers, regulators, and standard-setters who need to quickly update their regulatory and monitoring processes to the extremely dynamic corporate reporting environment in order to ensure meaningful and reliable corporate information. Melbourne, Australia Pisa, Italy November 2019

Alessandro Ghio Roberto Verona

Contents

1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 An Overview of the Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Theoretical Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3 Methodological Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 Target Audience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5 Structure of the Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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1 1 5 9 10 12 14

2

An Analysis of Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The Role of Mandatory Financial Reporting: Theoretical Reflections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 The Accounting Standards Regulatory Process . . . . . . . . . . . . . . 2.4 Thoughts on the Accounting Standards . . . . . . . . . . . . . . . . . . . 2.4.1 Quality of Accounting Information . . . . . . . . . . . . . . . . . 2.4.2 Financial Reporting and Managerial Compensation . . . . . 2.4.3 Accounting Value Relevance . . . . . . . . . . . . . . . . . . . . . 2.5 Auditing Accounting Information . . . . . . . . . . . . . . . . . . . . . . . 2.5.1 Audit Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5.2 Auditing Regulatory Process . . . . . . . . . . . . . . . . . . . . . 2.6 Challenges and Opportunities for Mandatory Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. .

17 17

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20 23 26 29 33 35 39 39 42

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44 47

Voluntary Corporate Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Costs and Benefits of Voluntary Corporate Disclosure . . . . . . . . . 3.2.1 Proprietary Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.2 Disclosure Credibility . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.3 Preparation and Dissemination Costs . . . . . . . . . . . . . . . . 3.2.4 Political Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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55 55 59 59 61 63 64

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3.2.5 Litigation Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.6 Signal of Firm Quality . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.7 Agency Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.8 Stock Liquidity, Firm Value, and Cost of Capital . . . . . . . 3.3 The Role of Corporate Governance . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Board Characteristics and Voluntary Disclosure . . . . . . . . 3.3.2 Firm Characteristics, Monitoring Environment, and Voluntary Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.3 Ownership Composition and Voluntary Disclosure . . . . . 3.4 Management Forecasts and Conference Calls . . . . . . . . . . . . . . . 3.5 Intellectual Capital Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6 Challenges and Opportunities for Voluntary Corporate Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

5

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65 67 68 70 72 73

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74 76 77 80

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85 88 94

Social and Environmental Reporting . . . . . . . . . . . . . . . . . . . . . . . 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Theoretical Reasons for Social and Environmental Reporting . . . 4.3 Multiple Case Study: The Food and Beverage Industry in Italy . . 4.3.1 Social and Environmental Reporting by Small/Medium Entities: The Case of Centrale del Latte della Toscana S.p.a (Mukki) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.2 Social and Environmental Reporting by Large Entities: The Case of Lavazza . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.3 Social and Environmental Reporting by Multinational Entities: The Case of Gruppo Campari . . . . . . . . . . . . . . 4.4 Challenges and Opportunities for Social and Environmental Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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101 101 105 107

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135 138 144 147

New Communication Channels . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2 Web Communication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3 Social Media . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4 Empirical Analysis of Corporate Social Media Adoption . . . . . . . 5.5 Challenges and Opportunities for New Communication Channels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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149 149 152 154 158

. 109 . 121 . 128

. 165 . 166

Contents

6

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Research Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3 Contributions of the Manuscript . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.1 Theoretical Contributions . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.2 Practical Implications for Academic Literature . . . . . . . . . . 6.3.3 Practical Implications for Managers, Preparers, Users, and Standard Setters . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.4 Limitations and Future Challenges . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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169 169 170 173 173 175 176 177 181

Chapter 1

Introduction

Abstract Corporate reporting is at the core of business decisions. It allows organizations to support their decision-making process and externally communicate their decisions and performance. Over the last couple of decades, corporate reporting has also become extremely dynamic. This chapter provides the theoretical foundations for a critical analysis of how the content and form of corporate reporting evolved. This chapter also describes the methodological approach that the authors adopted, highlighting the importance of mixing theoretical and empirical analyses to identify research gaps and future research avenues. This chapter then discusses this study’s key audience, such as academics, corporate stakeholders, practitioners, standardsetters, policymakers, and regulators. To conclude, the authors briefly present the structure of the remaining chapters.

1.1

An Overview of the Book

Reporting as the production and dissemination of information is at the core of business decision-making (Deegan 2013; Scott 2012). In an exchange-based economy, business organizations keep track of their transactions in order to have an understanding of their activities and make informed decisions (Hopwood 1987). Pacioli (1494), with his seminal work entitled Summa de arithmetica, geometria, proportioni et proportionalita, created an efficient and easily understandable system of codification for business transactions, allowing multiple actors to use such information. In fact, managers produce accounting information, capital providers consume accounting information and regulators and auditors monitor that such information is free from material misstatements. The system of corporate reporting based on the accounting system aiming to record assets, liabilities, equity, revenues, and expenses has lasted for centuries, appearing as the natural system. However, accounting is a reality construction and not an objective technique (Hines 1988). Accounting information often appears objective as it relates to numbers, but in reality it is the result of highly subjective choices (Verona 2006). For instance, the method used to record a certain transaction and the managerial and auditing professional judgements affect the type of items © Springer Nature Switzerland AG 2020 A. Ghio, R. Verona, The Evolution of Corporate Disclosure, Contributions to Management Science, https://doi.org/10.1007/978-3-030-42299-8_1

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1 Introduction

included in the financial statements and their values. It is complex and multidimensional, meaning that accounting information embeds more than numbers (Chapman et al. 2009; Hopwood 1987, 1994). An accounting system could look like Hand with Reflecting Sphere also known as Self-Portrait in Spherical Mirror by the Dutch artist Escher, first printed in January 1935. In this lithograph, the artist creates the illusion that the observer is standing in the same position as the artist. From an epistemological perspective, the artist is forcing the audience to adopt a certain perspective, providing the illusion of what reality looks like. Similarly, the idea that assets need to balance with liabilities and equity in corporate disclosure1 is an accounting reality construction. Accountants allow users of corporate reporting to only see a certain reality, which the accountants carefully constructed. This reality also reflects the accountants’ worldviews and backgrounds, because two people/ accountants could value and/or report items differently and still comply with accounting standards. In sum, accountants, as much as artists, provide a limited representation of reality—and corporate reality—and they often perpetuate their personal interests. Accounting contributes to creating a fictitious reality that the everyday can penetrate. Accounting carries specific ideologies, language, politics, and history (Hopwood 1994; Morgan 1988). The accounting system as commonly known, reflects past information by accurately recording past organizational transactions; through its concepts and frameworks, it mirrors the current economic systems, perpetuating an economic model based on capitalist principles. Moreover, accounting plays a key role in exercising control over organizational activities and creates visibility for financial accounts (Burchell et al. 1980). In this manner, accounting reproduces an ideology based on the idea that a society can continuously carry on producing and reproducing itself. Ultimately, accounting information supports a model for the extraction of wealth from society in favour of elite business interest groups. Specifically, the focus on financial capitals may impair environmental and social activities. Placing accounting within the broader society context, debates on climate change, population growth and migration, artificial intelligence and machine learning are constantly in the headlines (McGuigan and Ghio 2019; Schmitz and Leoni 2019; Marrone and Hazelton 2019). Living in a period of extremely disruptive economic, social, and cultural changes requires to completely rethink how business is conducted. Accounting is key to supporting relevant and up-to-date decisionmaking. Moreover, firms are increasingly expected to be accountable for their decisions and the related impacts on society and the environment. The neoliberal approach to profit maximization appears outdated at present. The traditional reporting model was developed for an industrial world, with a particular emphasis on the stewardship role of financial capital (Friedman 1970). The whole focus of traditional reporting is on the narrow account of historical financial performance.

1

In this book, the authors use the terms “disclosure” and “reporting” interchangeably.

1.1 An Overview of the Book

3

Stakeholders are increasingly pressuring firms to disclose more information on financial and non-financial performance. Businesses are becoming more complex as a consequence of the increasing regulatory requirements, for example laws, standards, codes, guidance, and stock exchange listing requirements. Despite the substantial increase in annual report length (Li 2008; Bloomfield 2008), mandatory financial reporting is no longer the only suitable format to ensure economic and social sustainability to firms. In this light, the last decade has been characterized by an increasing movement towards more integrated, interconnected, and holistic reporting. Accounts are the language of modern terms and corporate reporting offers a unique opportunity for companies to address stakeholders’ expectations and legitimize their activities (McGuigan and Ghio 2019). In this context, reporting is at the centre of corporate communication and risk management. When studying corporate reporting, key concepts are accountability, credibility, transparency, and relevance. Users need to critically assess all corporate reporting and should not accept at face value what preparers disclose externally. Today, firms need to be accountable to a large plethora of stakeholders. The Enron, WorldCom, and Parmalat fraud cases are seminal examples of financial misstatements and limited reporting credibility (Unerman and O’Dwyer 2004; Gendron and Spira 2009; Melis 2005). The type of remuneration, the reasons for directorship change, and the presence of a conflict of interests are questions that companies are today expected to address in their reporting. In conclusion, the range of topics about companies’ activities that matters is increasingly expanding. This change also reflects the substantial sociocultural changes happening at the society level. Figure 1.1 provides a graphic representation of the current changes in corporate reporting. In 2010, the International Integrated Reporting Council (IIRC) consisting of ten members, was established. The IIRC aims to achieve a reporting framework that communicates the strategy, business model, performance, and plans for companies via integrated reporting (Adams 2015; De Villiers et al. 2014, 2017). Its objective is meeting the needs of a broad range of stakeholders. The positive activist, Mervyn King, supports the international development of the IIRC in his life-long activity of connecting an organization’s success to the value it creates (Ghio and McGuigan 2020). In this manner, reporting would reflect the use of and effect on all resources and the aforementioned six capitals on which an organization and also society rely. For instance, Jane Diplock, former chairman of the International Organization of Securities Commissions and director of Singapore Exchange Limited, affirms that “Capitalism needs financial stability and sustainability to succeed. Integrated Reporting will underpin them both, leading to a more resilient global economy” (Thomson 2015). Financial capitals represent only one of the potential capitals companies use in running their activities. The integrated reporting framework identifies the other five capitals contributing to value creation, such as manufactured, intellectual, human, social and relationship, and natural capitals (De Villiers et al. 2014, 2017; Deloitte 2011). The integration and reporting of these multiple capitals are only possible through integrated thinking and integrated analysis. This approach to value creation then leads to better decisions, better actions, better capital and resource allocation,

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1 Introduction

Old Reporting System Financial Statements

Governance Remuneration

Management Commentary

New Reporting System

Integrated Reporting

Financial Statements

Social and Environmental Reporting

Fig. 1.1 Evolution of the content of corporate reporting (Source: Authors’ elaboration)

and ultimately to long-term sustainable value. Furthermore, the six capitals considered as inputs are also the outcomes of an organization. This change reflects the idea that accounting, and therefore corporate reporting, shapes the environment and the environment shapes them (Hopwood 1994; Chapman et al. 2009). Thus, accounting can change and will need to change to remain relevant for decision makers. The analysis of corporate reporting’s evolution includes not only its content but also how corporate reporting is disseminated. For a long time, the access to corporate information has been limited to annual reports, usually accessible only upon requests to the company or, in certain countries, available at public repositories, for instance in Italy at the Chamber of Commerce. Alternatively, a small number of large companies were selectively covered by the business press who acted as gatekeepers of the firms’ visibility (Bushee et al. 2010; Bushee and Miller 2012). Internet and, more recently, social media have substantially expanded the audience and reduced the cost of producing and disseminating corporate information (Blankespoor 2018; Blankespoor et al. 2013; Jung et al. 2017). At the same time, stakeholders can directly engage in a dialogue with companies or start forums where they discuss and forecast their future performance (Bartov et al. 2017; Lee et al. 2015; Cade 2018). Figure 1.2 provides a graphical representation of how corporate disclosure is changing. Corporates opening up to discussions, especially concerning non-financial matters, on social media is still very critical. Their engagement appears selected and

1.2 Theoretical Approach

Annual Report

Business press

Shareholders

5

Mandatory + Voluntary Disclosure

Business

Social media

Stakeholders

Fig. 1.2 Evolution of the dissemination of corporate reporting (Source: Authors’ elaboration)

limited to only a few positive news items (Bellucci and Manetti 2017; Manetti and Bellucci 2016). This book aims to provide critical lenses to examine corporate disclosure and its evolution over time. Stakeholders only have access to limited corporate information and, therefore, to a narrow perspective. However, the expansion of corporate communication outside of financial reporting, for example integrated reporting, sustainability reporting, and corporate social media represent a revolution in the manner shareholders and stakeholders can use corporate reporting. Whereas bookkeeping and the equivalence between assets, liabilities, and equity have lasted for centuries, the authors observe and discuss the substantial changes in corporate reporting over the last couple of decades.

1.2

Theoretical Approach

Information asymmetry arises between investors and managers, due to the divide between control and ownership (Berle and Means 1932). As insiders within a firm, managers hold an information advantage not only over investors but also suppliers and finance providers, such as banks, policymakers, and local communities. Considering a firm as a nexus of contracts, Jensen and Meckling (1976) argue that information asymmetries between contractual parties (principal versus agent) generate agency costs, which are further exacerbated in conditions of complexity and uncertainty. To mitigate these information asymmetries, corporate reporting proved to be useful (Healy and Palepu 2001). A level of information asymmetry remains, since company disclosure may be biased and/or manipulated by managers who could either convey useful information to the market or misrepresent and reduce the transparency of information disclosed (Watts and Zimmerman 1986). It is, thus, necessary to question the relationship between managerial incentives and disclosure, and the effectiveness of the latter in facilitating credible communication between managers, investors, and other stakeholders.

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1 Introduction

In the traditional relationship between managers and shareholders, efficiency represents a model of how a securities market works. However, under nonideal conditions, information is not free, as it can be difficult to obtain and process. Investors tend to react quickly to relevant new information that would lead to the market being efficient. It is possible to observe three forms of the efficient market hypotheses (Fama 1970): • Strong: Share prices reflect all information, public and private, and no one can earn excess returns. • Semi-strong: Share prices adjust to publicly available new information. • Weak: Past security market prices are of no help to predict future prices. The efficient market is considered indifferent to the accounting policies adopted, as investors are able to process the different sets of information and then to compare firms. Moreover, it assumes that if firms have relevant information that can be disclosed at no costs, managers will disclose them on a timely base. Another key element is that firms assume that naïve investors play a limited role. At the same time, naïve investors can fully rely on the prices that are traded on the stock market, as they reflect all publicly available information (investors are price protected). The common assumption is that market efficiency is semi-strong. This approach to information based on financial economics is at the core of the accounting standard-setting process (Pucci and Skærbæk 2020). The argument is that the stock of information may be incomplete and, therefore, security prices would not fully reflect firm value. At the same time, market efficiency ensures that prices are not biased towards what concerns publicly available information. Investors would have to process information received via corporate reporting according to their beliefs and, therefore, they will have different interpretations. To fill the information gap between publicly available information and inside information, firms may decide to issue voluntary disclosures, which means that they provide further information additional to what was mandated by accounting standards and regulatory requirements. The conjecture is that supplementary information (e.g. MD&A) can be useful to investors to improve the stock price’s amount, timing, and accuracy (Scott 2012). The economic theory affirms that corporate disclosure is a technique to mitigate market problems due to information asymmetry (Healy and Palepu 2001). Dye (1985) argues that the disclosure principle has two, potentially conflicting, goals, such as the disclosure of information for investors and contracting purposes. The seminal paper of Verrecchia (1983) shows that managers must also consider both the costs to disseminate information and proprietary costs when they decide the level of disclosure [for further insights, see Einhorn (2007) and Pae (2005)]. The main economic consequences of additional information are that investors can make better decisions and then funds are allocated to the most productive uses. In fact, firms may have incentives to disclose information. Lambert et al. (2007) show that more information will reduce the risk associated with a company and, therefore, its cost of capital. Biddle et al. (2009) show that higher reporting quality reduces

1.2 Theoretical Approach

7

both underinvestment and overinvestment, which would imply a stronger efficiency in the economy. At the same time, accounting information competes with other sources and, therefore, firms and investors both have to balance costs and benefits to produce and access all possible sources. A key notion is the disclosure principle, which relies on the conjecture that managers release all information, good or bad (the “unravelling result”) (Grossman 1981; Milgrom 1981). Rational investors assume that if managers have information, which they do not release, it is bad news and, thus, the market would react negatively. According to Beyer et al. (2010, pp. 300–301), six conditions must be met in order that firms voluntarily disclose all their private information: “(1) disclosures are costless; (2) investors know that firms have, in fact, private information; (3) all investors interpret the firms’ disclosure in the same way and firms know how investors will interpret that disclosure; (4) managers want to maximize their firms’ share prices; (5) firms can credibly disclose their private information; and (6) firms cannot commit ex-ante to a specific disclosure policy. The unravelling result is a consequence of investors rationally inferring that if managers do not disclose any information, that information would have caused investors to revise their beliefs about firm value downwards”. The Coase (1937) theorem affirms that the presence of transaction costs will affect the outcome of a certain bargain. He defines the firm’s boundary as “the range of exchanges over which the market system is suppressed and resource allocation is accomplished by authority and direction”. Moreover, when property rights are involved, the parties will reach the most efficient and beneficial result. Therefore, the existence of transaction costs leaves room for contracting (Jensen and Meckling 1976). Accounting is definitely part of the contracts that describe a firm (Watts and Zimmerman 1986). Organizations are facing a substantial expansion of the types of transaction costs, as well as contracts. This is reflected in the increasing reporting of financial and non-financial information. Figure 1.3 shows a market that reflects publicly available information (semistrong efficiency), as the presence of inside information does not allow market value to reflect all information. Adverse selection can lead to an increase in the estimation risk for investors and if it is not diversifiable, it would imply an increase in the cost of capital. It shows that reporting can address the information gap concerning shareholders’ demands. Moreover, the increasing relevance assigned to stakeholders’ demands leads to expanding the role of reporting. This book bases on the idea that a firm is a fundamental unit and part of a larger economic and social system (Giannessi 1960). As such, the authors adopt a holistic and integrated approach to firms’ decisions (Ferramosca and Ghio 2018; Signori and Rusconi 2009), particularly by emphasizing the connectivity between core aspects. In this context, Zappa (1927) argues that “the foundation of a unitary science, from every doctrine investigating the economic content of the azienda’s2 life, is to be

2 In line with several historical studies, the authors do not translate the term azienda, because of its specificities that does not allow finding a matching translation in English (Ferramosca 2019). Zappa

8

1 Introduction

Stakeholders’ demands

Efficient market price of firm Role of reporting

Publicly available information

Shareholders’ demands Fig. 1.3 Corporate information and the role of corporate reporting

reconnected in our minds to the notion of the azienda itself, i.e. to the notion of the economic coordination in action, which is set up and run to satisfy human needs. The varied and only apparently heterogeneous phenomena in which the multiform life of the aziende appear, seems, ideally, to spring from the same source”.3 Financials, management commentaries, governance, remuneration, and sustainability all assist to create and sustain value in short, medium, and long term. As such, the analysis of corporate reporting requires integrated thinking to further understand the collective mind of those in management and governance positions. Users of corporate reporting can, thus, understand the organization’s past, its current performance, and its future resilience. Ghio and Verona acknowledge the changing nature of the firm (Amaduzzi 1936; Onida 1971) and, therefore, of its reporting. In this context, the authors track the evolution of corporate reporting, of both its substance and its form. Over the last couple of decades, organizations have started to see the limits of mandatory financial reporting, both for their decision-making process and to meet shareholders’ and stakeholders’ expectations. This book, therefore, examines how corporate reporting is increasingly incorporating external factors, resources, and relationships to create and sustain value over time.

(1956) defines azienda as “the economic institution destined to last for the satisfaction of human needs by organising and carrying out—in continuous coordination—the production or procurement and consumption of wealth” (p. 37). Amongst others, see, for example Antonelli (2004), Capalbo and Clarke (2006), Alexander and Servalli (2011), Sargiacomo et al. (2012), and Coronella (2014). 3 Ferramosca and Ghio (2018) translated this quotation from Italian.

1.3 Methodological Approach

9

Furthermore, how firms disclose and disseminate information has changed substantially with the wide spread of Internet. Particularly, social media platforms like Twitter represent a game changer for corporate information. Users can have instantaneous and free access to almost unlimited news, increasing the pressure on companies to interact and engage with them. Business press no longer has the monopoly of deciding the relevant news and the time of release (Kaplan and Haenlein 2010). Overall, this theoretical framework allows the authors to undertake a critical review of the evolution of corporate reporting. Ghio and Verona believe that the analysis of both what corporate reporting includes and how corporate reporting is disseminated helps understand why managers take certain reporting decisions. Furthermore, the complementary empirical analyses help identify the underlying theoretical constructs discussed and support the discussion of this book’s contributions, as well as the challenges and opportunities for future research.

1.3

Methodological Approach

The analysis of corporate reporting’s evolution requires an extensive theoretical analysis of previous literature on accounting, management, and finance. The authors focus on academic literature to ensure high-quality standards and scientific rigour. Studies included in the review refer mostly to the management, financial accounting, management accounting, social and environmental accounting, auditing and finance disciplines, and adopt both qualitative and quantitative methodologies. In this manner, it is not only possible to understand the process mechanisms concerning corporate disclosure but also to provide further information on the external validity of the findings discussed. The authors review more than 500 works. Most prior literature on corporate reporting is published after the mid-1990s. After this period, firms started providing more voluntary disclosures to meet increasingly high stakeholder pressure. This change in reporting behaviour has also been possible thanks to the substantial decrease in the cost of producing disclosures, as well as new technologies facilitating the dissemination of information without the need of press intermediaries, such as the business press. Another major change has been the increasing attention towards social and environmental corporate externalities. Organizations have started to respond to this call by preparing ad hoc disclosures on topics other than their financial performance. As a result, these changes in organizational behaviours have attracted significant scholars’ attention. It is, thus, clear that the period analyzed witnessed substantial corporate reporting changes, allowing the authors to identify not only changes in corporate behaviours but also in how academic research has evolved. Specifically, particular attention is dedicated to patterns of theoretical frameworks, methodologies, and findings. To triangulate and support the theoretical insights drawn from the critical review, the authors include a comparative case study on social and environmental reporting

10

1 Introduction

and a quantitative analysis of the determinants and consequences of the adoption of corporate social media. Given the intrinsic dynamic nature of the topic analyzed, the empirical analyses of current phenomena contribute to the in-depth understanding of corporate decision-making. Moreover, the results reported also help further situate the discussion within the current changes in the economy and society. The sustainable reports analyzed in Chap. 4 and the data, as well as the coding, used in the Chap. 5 are freely available upon request to the authors. This ensures a transparent data analysis process, as well as high-quality and reliable results. Furthermore, the authors complement their theoretical reflections with professional reports and regulatory changes to provide practitioners’ insights into today’s corporate reporting. This approach enables the authors to provide a state-of-the-art analysis of corporate disclosure. Appendices with the analysis of relevant regulatory changes are also included in selected chapters. This material is often summarized through tables to improve its accessibility to this book’s large audience. Full reference to the different regulations analyzed is always available to ensure open access to the original sources. Overall, the authors draw on academic and professional publications to depict the changes in corporate reporting over the last couple of decades. The empirical analyses provide contextual evidence for current topical discussions on corporate reporting. Taken together, these rigorous and complementary theoretical and empirical analyses allow the authors to identify current gaps in the literature and challenges in corporate reporting. Despite the substantial and positive changes in the content and how organizations report externally, the authors identify relevant open questions and future research avenues concerning corporate disclosure.

1.4

Target Audience

This book on the evolution of corporate reporting is of interest to a large audience. Corporate decisions have increasingly received external attention and scrutiny. The increasing stakeholder pressure for more corporate accountability highlights the importance of the content and how firms externally disclose their activities. Moreover, corporate reporting is at the core of the accounting discipline. Next, the authors discuss the different audiences who may be interested in the findings of this book. The findings of this book particularly concern academics, researchers, and students. Since its emergence as an academic discipline instead of a technical skill, accounting scholars have been interested in studying corporate disclosure (Coronella 2010). This book critically analyses multiple waves of research on corporate reporting, connects the different topics, and identifies numerous research gaps. At the end of each chapter, as well as in the concluding part of this book, the authors discuss multiple future research avenues. The exciting technological changes, as well as the growing sensitivity to social and environmental information, represent unique opportunities for accounting research, instead of threats as they are too often depicted.

1.4 Target Audience

11

Whereas corporate reporting has often been of interest to the accounting academic community, all researchers in the business and economics field substantially rely on corporate disclosure. This book makes the understanding of changes in corporate reporting accessible to researchers without in-depth knowledge of accounting research. It also opens avenues for potential interdisciplinary research between accounting and other disciplines. In the current wake of the increasing importance of an interdisciplinary or transdisciplinary approach to social phenomena, recent changes in corporate reporting present numerous opportunities for studies by environmental and information technology scientists. The study of the evolution of corporate reporting also enables business students to appreciate the importance of responsible leadership in accounting, think critically of their discipline and explore how accounting fits within the world around them (McGuigan 2017). Highlighting the implications of regulatory and social changes on corporate reporting, this book demonstrates to students how accounting is artificially constructed and the limitations of double-entry bookkeeping. The authors hope that students and early researchers reading this book feel motivated to support the development of a more dialogic accounting and the ideas of multiple accounts beyond the old-fashioned dichotomous debits and credits approach. This book is also of interest to corporate stakeholders, including local communities, employees, suppliers, customers, and investors. Corporate reporting encompasses corporate financial, managerial, auditing, and ethics information. Through the theoretical and empirical analysis of corporate disclosure, the authors enable stakeholders to critically evaluate accounting information and further support their reflective capacity, i.e. to think, question, evaluate, and analyze. A growing concern is the decoupling between what firms disclose and what they are doing. Greenwashing, pinkwashing, and bluewashing are all terms used to describe the hypocritical corporate commitment to respect and support society and the environment. Actually, more information is not necessarily synonymous with greater corporate accountability. Stakeholders still need to develop their own judgement in analyzing corporate disclosure. Social media platforms could facilitate the discussion amongst stakeholders and the aggregation to social movements. For instance, the financial community is active on StockTweets, a microblogging social media platform that facilitates the interaction and discussion of corporate financial performance. The understanding of what and how firms disclose their information can provide further support to social movements and communities with less developed financial knowledge. This book is also informative to practitioners. Corporate reporting represents accountants’ and controllers’ core activities, as they often represent the preparers of such information. Whereas automation is substantially decreasing, the demand for human force in the preparation of corporate reporting and the analysis of large amounts of data is becoming more important in practitioners’ activities. This book represents a valuable resource to develop the holistic and integrated view needed in today’s complex and fast-changing society. The study of corporate reporting is also of particular interest to standard setters, policymakers, and regulators. Standard setters, such as the International Accounting

12

1 Introduction

Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have dictated the content of mandatory corporate disclosure for a long time. However, the official documents, such as the annual report, appear having decreasing value relevance (Barth et al. 2018; Srivastava 2014; Lev 2018). This book helps explain the reasons behind the shareholders’ and stakeholders’ increasing lack of interest in annual reports prepared according to international accounting standards and the limits of the current standardization process. This book also highlights the growing need for corporate reporting flexibility, providing ground for policymakers to make substantial changes in the regulatory requirements. The recent European Union (EU) directive on the disclosure of non-financial and diversity information (Directive 2014/95/EU) paves the way for many other jurisdictions to ask for more corporate transparency with regard to social and environmental impact. Interestingly, this new directive allows EU member states, as well as companies, a certain degree of flexibility so that all organizations can better tailor their disclosure, considering the costs associated with the production of information. Regulators will have the difficult task of identifying patterns of opportunistic behaviour and penalize firms that are only driven by rent seeking to the detriment of other organizations or stakeholders. Chapters 4 and 5 provide evidence that firms report relevant and timely information both in social and environmental disclosures, as well as in corporate social media disclosure. Nonetheless, firms often voluntarily disclose selectively and opportunistically, providing an incomplete representation of their activities.

1.5

Structure of the Book

In the first part of this book, the authors present a critical analysis of prior research on corporate reporting. Chapter 2 focuses on mandatory corporate disclosure. The authors analyze the main evolutions in the content of financial reporting, and the regulatory and monitoring process. The analysis of the enforcement and consequences of the International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) covers a large part of the discussion. The authors highlight the criticalities of the one size fits all and raise multiple red flags associated with the current monitoring—or limited—process. Ghio and Verona are particularly concerned with potential conflicts of interest amongst the key players in the accounting industry, particularly the Big Four accounting firms, as well as the privatization of the regulatory process through the delegation to a transnational body, i.e. the IFRS, to issue accounting standards. Furthermore, these accounting standards rely on a single conceptual framework strongly influenced by the Anglo-Saxon accounting doctrine, with an excessive focus on investors. The inadequacy of this approach is already evident in the emerging limited usefulness of financial reporting information to value firms and in the decision-making process. The authors, therefore, argue for a more holistic and integrated approach to corporate reporting and regulation.

1.5 Structure of the Book

13

Chapter 3 examines multiple forms of voluntary corporate reporting. Given the intrinsic lack of normative aspects associated with this type of disclosure, the question of the cost–benefit balance is central and discussed in depth. This chapter discusses the main determinants of voluntary disclosure, with a particular focus on corporate governance. Next, it explores forms of voluntary reporting, such as conference calls and management forecasts. It also starts exploring non-financial corporate disclosure, such as the intellectual capital reports. This chapter shows that shareholders who increasingly demand more timely and relevant information drive the demand for corporate information. Chapter 4 further expands the discussion on new forms of disclosure by focusing on social and environmental reporting. Firms are increasingly reporting social and environmental information to address stakeholder pressure and legitimize their activities. Sustainability reports, integrated reports, and triple bottom lines are the most widespread types of social and environmental disclosure. It is also interesting to highlight that regulators are introducing requirements for companies on this topic too. In this chapter, the authors provide a detailed analysis of the recent implementation and enforcement of the European Directive 2014/95/EU. Using a comparative case study analysis, Ghio and Verona empirically analyze how firm size impacts on sustainability reporting. Specifically, they examine the source of social and environmental reporting, alternative sources of information, the age of social and environmental reporting, the structure of the reports analyzed, the content of the social and environmental information, as well as the Global Reporting Initiative (GRI) indicators referred to by a small, large, and multinational company. Chapter 5 expands the analysis of the evolution of corporate reporting to the communication channels that the companies use. The authors show the revolutionary impact of, first, Internet and, in more recent times, social media platforms. Stakeholders now have an almost unlimited amount of information that they can process. However, social media information is often not verifiable and, thus, of limited reliability. The authors tackle the relevant issue of corporate social media by empirically examining the determinants of social media presence and activity on Twitter and Facebook for firms listed on the fast-growing stock exchange, i.e. the Alternative Investment Market (AIM) London. They then study the association between corporate social media and business press activity to shed light on the connection between traditional and modern communication channels. Chapter 6 of this book provides a discussion of the main findings of this book. It highlights the main contributions and implications for academics, managers, practitioners, and policymakers. Whilst at the end of each chapter, the authors identify specific challenges and opportunities related to the specific topics discussed in the chapter, in this concluding chapter Ghio and Verona provide a research agenda to further investigate the dynamic nature of corporate reporting.

14

1 Introduction

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Pacioli L (1494) Summa de Arithmetica Geometria Proportioni et Proportionalita. Paganino de Paganini, Venice Pae S (2005) Selective disclosures in the presence of uncertainty about information endowment. J Account Econ 39(3):383–409 Pucci R, Skærbæk P (2020) The co-performation of financial economics in accounting standardsetting: a study of the translation of the expected credit loss model in IFRS 9. Acc Organ Soc 81:1–22 Sargiacomo M, Servalli S, Andrei P (2012) Fabio Besta: accounting thinker and accounting history pioneer. Account Hist Rev 22(3):249–267 Schmitz J, Leoni G (2019) Accounting and auditing at the time of blockchain technology: a research agenda. Aust Account Rev 29(2):331–342 Scott WR (2012) Financial accounting theory. Prentice Hall, Toronto Signori S, Rusconi G (2009) Ethical thinking in traditional Italian Economia Aziendale and the stakeholder management theory: the search for possible interactions. J Bus Ethics 89 (3):303–318 Srivastava A (2014) Why have measures of earnings quality changed over time? J Account Econ 57 (2):196–217 Thomson I (2015) ‘But does sustainability need capitalism or an integrated report’ a commentary on ‘The international integrated reporting council: A story of failure’ by Flower, J. Crit Perspect Account 27:18–22 Unerman J, O’Dwyer B (2004) Enron, WorldCom, Andersen et al.: a challenge to modernity. Crit Perspect Account 15(6–7):971–993 Verona R (2006) Le politiche di bilancio. Motivazioni e riflessi economico-aziendali. Giuffrè Editore, Milan Verrecchia RE (1983) Discretionary disclosure. J Account Econ 5:179–194 Watts RL, Zimmerman JL (1986) Positive accounting theory. Prentice-Hall, Hoboken, NJ Zappa G (1927) Tendenze nuove negli studi di ragioneria: discorso. Istituto Editoriale Scientifico, Milan Zappa G (1956) Le produzioni nell’economia dell’impresa. Giuffré Editore, Milan

Chapter 2

An Analysis of Financial Reporting

Abstract This chapter examines mandatory disclosure as a form of corporate information. We show that, both from a theoretical and an empirical perspective, prior research documents mandatory disclosure’s usefulness for mitigating the information asymmetry between insiders and outsiders. Nonetheless, the current accounting system presents substantial limitations with regard to the production and use of corporate disclosure. We document that mandatory corporate disclosure is investor focused and may privilege either its information role, i.e. the relevant disclosure to investors, or its contracting role, i.e. monitoring and evaluating managers’ performance. We observe substantial variability in the quality of corporate information produced and discuss the main patterns for opportunistic reporting. We also show a decreasing value relevance of corporate information, in particular for the New Economy firms. The analysis of the accounting standards regulatory process and the assurance process shows the limits of the ongoing one size fits all approach. We, therefore, urge the need for a more dynamic and holistic approach to corporate regulation and assurance. We conclude this chapter by suggesting numerous future avenues for research, particularly in terms of empirical questions and research design.

2.1

Introduction

Accounting’s final goal is to provide information, which is generally usually considered a complex commodity. The ideal situation is a model under conditions of certainty, which means that the firm’s future cash flows and the cash flows’ probabilities would be known. Markets would be perfect and complete. The arbitrage process ensures that there are no discrepancies between the market value of an asset and the present value of its future cash flows. In this situation, a firm’s market value equals the value of its net financial assets plus the value of its capital assets less liabilities. Thus, there would be no misalignment between managers and investors.

© Springer Nature Switzerland AG 2020 A. Ghio, R. Verona, The Evolution of Corporate Disclosure, Contributions to Management Science, https://doi.org/10.1007/978-3-030-42299-8_2

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2 An Analysis of Financial Reporting

The need for financial reporting originates from the fact that these conditions do not reflect reality. Therefore, financial reporting can be useful to improve the process of investment decision-making. Then, the value of financial reporting is mirrored in the potential or actual amount of increased social efficiency. Information asymmetry, defined as the different sets of information that individuals may have, is a key notion when discussing systems of information (Brüggemann et al. 2013). In the business context, adverse selection refers to the situation in which one or more parties involved in a transaction have an information advantage over the other parties. The usual example is the disparity of position between managers and other insiders vis-à-vis outsiders on assessing a firm’s future performance. Managers and other insiders have more information, which they could use to increase their wealth and harm other stakeholders, for instance, through insider trading. Financial reporting can mitigate adverse selection because it transforms internal information into outside information, i.e. financial reporting plays a valuation role. Financial reporting should be timely, comprehensive, and in line with the decision-usefulness principle. Moral hazard refers to the business situation in which one or more parties involved in a transaction are good at observing the actions in fulfilment of a certain transaction, whilst others cannot. In the case of separation between managers and owners, the owners cannot directly observe all the activities that the managers perform. The potential misalignment between management’s and ownership’s interests and incentives exacerbates this situation. Financial reporting can include a valuable indication of managerial performance, considering that managers’ efforts are not directly observable and that managers could be tempted to shirk effective effort. Thus, managers’ compensation is often connected to financial reporting information, i.e. the stewardship role of financial information. A good measure of managers’ performance should, therefore, be sensitive and precise (KoralunBereźnicka 2013). In line with the agency theory, financial reporting is useful to mitigate information asymmetry between principals and agents (Jensen and Meckling 1976). Accounting information has to find the right balance between its information role, i.e. disclosing the relevant information to investors, and its contracting role, i.e. monitoring and evaluating managers’ performance. Investors, therefore, expect financial reporting information to be relevant and reliable. Relevance means that the financial statement information informs investors about a firm’s future economic prospects (e.g. cash flows, dividends, profits). This objective often influences management control information which aims to provide to management unique information for strategy formulation (Nilsson and Stockenstrand 2015; Trucco 2015). Reliability implies that financial statement information faithfully represents what it intends to represent and that the information is precise, i.e. free from noise, accounting system errors, and estimation errors, and with only a limited variation between the actual value and the expected value. The relationship between relevance and reliability is complex. An example of the trade-off between relevance and reliability is the ongoing debate between historical cost, which is considered a more reliable and less volatile estimation approach, and

2.1 Introduction Fig. 2.1 The relationship between information asymmetry and financial reporting (Source: Authors’ elaboration)

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Adverse Selection

Moral Hazard

Valuation Role

Stewardship role

Relevance

Reliability

fair value, which provides market value information, but could also be biased and manipulated by managers (Landsman 2007; Ronen 2008). For instance, the decision to value assets at historical costs is considered more reliable because estimates can be easily verified (Ijiri 1981). The probability of estimation errors is lower. At the same time, historical values often exhibit lower relevance, because values continuously change over time. Figure 2.1 shows how the agency costs, i.e. adverse selection and moral hazard, due to the information asymmetry between managers and owners, are then reflected in the role of financial reporting information (valuation versus stewardship) and in the expected characteristics of financial reporting information (relevance versus reliability). In this context, standard-setting bodies are in charge of preparing accounting standards. Regulators face the challenge that to produce the optimal amount and quality of information, the marginal social cost of new accounting standards should equal the related marginal social benefit. Owing to the presence of uncertainty, financial reporting preparers are aware of the limits in preparing theoretically correct financial statements. Therefore, they mostly attempt to provide useful information. Considering the decision usefulness approach, two main questions need to be raised. First, it is necessary to understand who the users of financial statements are. Multiple, diverse constituencies may be interested in this set of information. Second, each user has different and potentially conflicting interests, which need to be examined and taken into account. In the current Anglo Saxon-based accounting system, investors are considered the main users of financial reporting information. Consistent with decision theory (Staubus 2013), information plays a crucial role in defining investors’ decisions. Individuals are expected to be rational, meaning that their decisions target the highest possible expected utility. In this context, investment decision variations may occur, because individuals exhibit different attitudes towards risk, such as risk-averse, risk-neutral, and risk-seeking. Risk-averse individuals demand a higher expected return for bearing risk and they require more information in their decisionmaking process than risk-seeking individuals. Financial reporting contains news that may persist into the future. Investors revise subjective probabilities based on the financial reporting information and subsequently, change their investment decisions. Decision usefulness is also the approach that the two main standard-setting bodies, i.e. the International Accounting Standards Board (IASB) and the Financial

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2 An Analysis of Financial Reporting

Accounting Standards Board (FASB), adopted. The IASB conceptual framework reports that “The objective of financial statements is to provide information about an entity’s assets, liabilities, equity, income and expenses that is useful to financial statements users in assessing the prospects for future net cash inflows to the entity and in assessing management’s stewardship of the entity’s resources”. The ideal information set should be able to link current financial disclosures to future realizations. Indeed, the standard-setting bodies gravitate towards a system that emphasizes relevance rather than reliability. The financial reporting’s economic consequences, which Zeff (1978) defines as “the impact of accounting reports on the decision-making behaviour of business, government and creditors” (p. 56) represent the result of reality construction, and these results are not immune from political bias. Even in a situation of efficient securities market theory, contracts may be incomplete, as it is not possible to anticipate all state realizations. Signed contracts are difficult to change. Therefore, stakeholders often have different preferences towards accounting policies, due to the potential impact on firm value. The remainder of this chapter is organized as follows: Sect. 2.2 provides theoretical reflections on the role of financial reporting. Section 2.3 critically analyses the regulatory process around today’s accounting standards. Section 2.4 examines the determinants and consequences associated with the implementation of new accounting standards, with a focus on the IAS/IFRS. Section 2.5 discusses auditors’ monitoring activities with regard to financial reporting preparation. Finally, Sect. 2.6 highlights the current challenges in research concerning financial reporting, and it develops promising avenues for future research.

2.2

The Role of Mandatory Financial Reporting: Theoretical Reflections

The full disclosure principle (Grossman 1981; Milgrom 1981) states that companies will release all information that would affect investors’ decisions. If rational investors know that managers withhold information, the investors will assume that the managers withhold bad news. Verrecchia (1983) reconciles reality with the disclosure principle because he first assumes that any disclosure released is truthful. In his analysis, Verrecchia also includes the cost of disclosure, for instance, proprietary costs. Firms assess whether the costs associated with additional disclosures make up for the potential benefits. Capital markets strongly encourage voluntary disclosure, but it is not possible to ensure that the parties involved will release all information, which may result in partial disclosures. The seminal work of Merton (1987) documents that better disclosure expands the portion of informed investors and improves risk diversification. Diamond and Verrecchia (1991) similarly show that better disclosure has positive effects, such as increasing liquidity, attracting institutional investors, and increasing share prices. Along the same line, Easley and O’hara

2.2 The Role of Mandatory Financial Reporting: Theoretical Reflections

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(2004) find that better disclosure reduces estimation risk. Taken together, the main incentives for producing financial reporting information are: • Contractual incentives: Financial reporting information results from the contractual agreements’ demand to mitigate the information asymmetry amongst different parties. For instance, compensation contracts and debt covenants rely on financial reporting information. • Market incentives: Organizations prepare financial reporting information to reduce the estimation risk and the high cost of capital associated with poor disclosure. Low financial reporting quality negatively affects managers’ reputation and firms’ takeovers might be easier. Markets seemingly present failure in producing information. First, contractual incentives could not function properly, because there are different users and the relevant parties do not fully enforce truth telling (moral hazard). Not all users need the same type of information and it might be too costly to negotiate specific financial reporting information with each party. Second, market incentives present weaknesses, as the market may not know that a manager has information, disclosed information may not be verified subsequently, and proprietary and contracting costs may be particularly high (adverse selection). Certain information is not verifiable, for example managers could attribute poor results to contextual economic conditions rather than untruthful disclosures, and organizations cannot disclose certain information, due to proprietary costs. Therefore, regulation in the form of accounting standards is necessary to compensate market failures, improve investors’ decision-making processes, and provide further indications with regard to managerial labour markets. Nonetheless, regulation also presents a few limitations. Regulation specifically generates direct costs, such as rulemaking and rule compliance costs, and indirect costs, such as a reduced signalling ability, as well as over or under regulation, with the risk of providing investors with information that is detrimental to contract efficiency. Finally, the information process’s complexity and political interests play an important role in the regulatory process. This complex situation leads to the impossibility of a priori knowing the optimal degree of regulation. Having considered the multilayered and complex set of research on the regulatory process we separate the research streams according to the source of demand, the role of the accounting standards, and the role of accounting theory. • Source of demand: What is the primary explanatory variable for accounting regulation adopted in this type of research? • Role of standards: What roles do accounting standards play? • Role of accounting theory: What role does accounting theory play in this type of research? According to the normative theory (Mattessich 1992), accounting standards support the accounting profession. Normative accounting research focuses on the relationship between theory and practice. Accounting has a functional role and it has to produce rules for accounting practice. The strong focus on the accounting

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profession resulted in viewing accounting standards and theoretical frameworks as a technical topic. Professionals are perceived as gatekeepers (professional jurisdictions). Accounting is a means through which professionals legitimate their activity. With the increasing discussion of the economic consequences associated with financial reporting in the 1970s, people started to perceive accounting as a dynamic knowledge system and as an interface between the State and business enterprises. Accounting theory increasingly paid attention to the political process, based on arguments that particular interests, and rarely public interest, drive the regulatory process (Stigler 1971). In developing positive accounting theory, Watts and Zimmerman (1978) argue that normative judgments are, first of all, excuses for advancing the interests of particular constituents. Accounting standards are institutions that alter costs and benefits, and parties use these standards to justify certain constituencies’ lobbying activity (market for excuses). Since the 1980s, and particularly owing to Anthony Hopwood’s impressive work, accounting standards were no longer perceived only as a source of legitimating certain interests or professionals, but rather as a means to understand the society in which we live. Accounting contributes to the construction of an organizational order (Hopwood 1987). Accounting information shapes and is shaped by the environment in which society operates. The debate is not simply limited to the professionals, but involves a larger number of actors, the purported regulatory arena. Robson (1991) considers accounting regulation as a process through which visibility is created by translating the actions and activities into financial quantities. The reality in which standard-setting bodies issue accounting standards cannot be described as a static element. Puxty et al. (1987) identify different systems of social order, i.e. market, state, and community. In the liberalism system, organizations only provide financial reporting information if the market demands it; in the legalism system, the behaviour related to accounting standards is sanctioned only if the behaviour does not follow the letter of the law; in the associative system, the presence and influence of professional bodies determine the issuing and monitoring of accounting standards; in corporatism, the State’s hierarchical control over organized interest groups defines the accounting standards’ content and monitoring. Considering the information distribution, the public interest theory assumes that regulation should maximize social welfare and limit market failures (Dellaportas and Davenport 2008; Neu and Graham 2005). However, it is often challenging to define this kind of rules, as it is difficult to calculate the optimal amount of regulation that maximizes social welfare. Moreover, the government often faces serious difficulties in enforcing and monitoring this set of rules. The interest group theory of regulation states that individuals, usually within groups and coalitions, should predict and promote their interests through lobbying the government (Stigler 1971). Since potential conflicts amongst the multiple actors may arise, the approach indicated by this theory is often considered a second-best situation. Regulators themselves will take their decisions, balancing the different interests. For instance, investors may demand full disclosure and transparency to predict firms’ future performance. Managers may demand reporting flexibility in order to control the reported net income and to simultaneously indicate that net

2.3 The Accounting Standards Regulatory Process

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income is highly informative of their effort. Both the valuation use and contracting use of accounting play a crucial role in defining the targets of accounting standards. Other constituencies can lobby for or against a certain regulation. Becker et al. (1998) observe that interest groups compete to influence the final accounting standards regulatory outcome in multiple arenas, such as legislation, courts, media, and public opinion. Our discussion points towards a demand for a more dynamic approach to accounting regulation. To achieve this goal, the regulatory systems have to go beyond the equilibrium model. The integrated order is illusory and in advanced capitalist countries, there are always contradictions that lead to continual ruptures and crises. A possible solution is to pay attention to how social inequality and conflicts can be mediated, modified, and transformed, by answering the following question: Which forces or principles dominate or determine the constitution of accounting regulation and regulation in modern society?

2.3

The Accounting Standards Regulatory Process

Over the last decades, the definition of accounting rules has generated a number of important changes and different actors have been involved. The two main accounting standard-setting bodies are the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). The IASB represents the continuation of the International Accounting Standards Committee, which was established in 1973. The IASB issues the IAS/IFRS, which is a set of standards that more than 100 countries all over the world adopt.1 The FASB issues accounting standards that are used in the United States, i.e. the Generally Accepted Accounting Principles (U.S. GAAP). The IASB and the FASB usually try to consider a broad representation of the different actors. As part of their regular procedure, the IASB prepares multiple drafts, asking for written comments, which can come from all over the world and from any person/organization. To assess whether a standard can be considered successful, it is necessary to analyze it via different perspectives. The decision process has to include elements of decision usefulness, reduction of information asymmetry, and related economic consequences. Since its origins, the IASB has worked at harmonizing the accounting standards. This activity has been enforced mainly through an Anglo-American perspective. Similarly, the International Auditing and Assurance Standards Board (IAASB) issues auditing standards, which a large number of countries have adopted. A private or quasi-private standard-setting regime aiming to address the needs of developed capital markets characterizes this Anglo-American view. The implementation of accounting standards is also strongly linked to the punitive system, which is strongly connected to the underlying legal and cultural system.

1

For further information, please refer to https://www.ifrs.org/

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Furthermore, with the Norwalk agreement in 2001, the two accounting standardsetting bodies, the IASB and the FASB, began developing a process of convergence their accounting standards. However, there are still substantial differences between the two sets of standards and currently the discussion proceeds slowly. The main benefits of a unique set of standards would be a preparation cost reduction and greater comparability amongst financial reports. A key question in the harmonization process is whether accounting standards should be rule-based or principle-based. Rule-based standards (e.g. U.S. GAAP) define, in detail, all the elements within a certain rule, whereas principle-based standards allow users more room for interpretation, as the standards only provide the general principles (e.g. IAS/IFRS). Principle-based standards also rely substantially on the auditors’ professional judgment to prevent opportunistic manager behaviour. The FASB also supports the neutrality of information concept, trying to limit accounting conservatism through financial reporting. The American standard setters motivate this decision by arguing that conservatism could affect value estimates, even if the lack of verifiability may induce managers to manipulate their earnings (Watts 2003). High-quality standards do not necessarily imply better financial reporting. The environment in which accounting standards are implemented plays a key role in defining reporting quality. National regulations also influence the new accounting standards’ adoption process. When the accounting standards’ enforcement process is inadequate, high-quality standards would have little impact on the local business systems. For instance, auditing plays a fundamental role in the enforcement mechanism, because it contributes to reinforce investors’ confidence and improve an efficient contracting process. At the same time, personal and institutional incentives could influence the auditors’ monitoring activities, with potentially detrimental effects on the auditors’ degree of reliability. Ball et al. (2003) show the importance of institutional factors in the accounting quality of Hong Kong, Singapore, Malaysia, and Thailand. The presence of previous local accounting standards also influences the IAS/IFRS adoption. Ball et al. (2000) compare the quality of financial disclosure in countries with a common law system and countries with a code law system. Accounting information is more investor oriented, information asymmetry is lower, and financial reporting is less conservative in common law systems than code law systems (Ferramosca and Ghio 2018). The convergence towards a unique set of standards has benefits and costs. Presently, standard-setting bodies must not only consider investor–manager conflicts, i.e. adverse selection and moral hazard issues, but new constituencies increasingly play a relevant role in the debate. In this context, research shifted its focus from seeking good standards to studying standard setting, which can be considered as political lobbying, professional jurisdictions, and regulatory arenas. Moreover, research increasingly focuses on the social context in which accounting standards are implemented, leaving room for interpreting the regulatory process to integrate different perspectives, such as economics, sociology, and psychology. Young (1994) examines how different accounting issues emerge in the FASB’s agenda and how these issues are discussed. This study explores the regulatory space

2.3 The Accounting Standards Regulatory Process

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and the logic of appropriateness in relation to the issues discussed. The regulatory space can be defined as the range of regulatory issues that are subject to public decisions. The number of different actors that are involved in the decision-making process highlights the complexity of the regulatory process. For instance, the FASB operates within an institutional nexus that is located between the accounting profession and the State. At the same time, the FASB is embedded in a broader social and economic environment. Several actors, such as the Securities and Exchange Commission (SEC), the American Institute of Certified Public Accountants, and the American Congress interact in the regulatory space with dissimilar authority, and often with conflicting views. Moreover, accounting topics have to be constructed and interpreted as appropriate for FASB standard-setting action to ensure the emergence of a project in the FASB agenda. The notion of appropriateness bases on the contractual theory that defines an organization as a nexus of contracts (Jensen and Meckling 1976). Financial reporting can represent a viaticum to understand the globalization process and the changes in today’s society. The accounting harmonization is perceived as an Americanization process and neoliberalism as a hegemonic logic. Furthermore, the continuous shift between private and public accounting regulations bases on a broader discussion on the business and private firms’ role in society (Friedman 1970; Matten and Moon 2008). For a considerable time, the State ruled the main accounting standards strictly in order to protect the public interest. The increasing role of a private institution, such as the IASB, in preparing accounting standards, is mostly the result of the globalization process and the development of soft law agreements. In the current implementation system, the states adopt the accounting standards only at a later stage. Thus, commentators often criticize the IASB heavily for being a private institution that follows an invest-based view, de facto making rules that are adopted worldwide. Despite the increasing privatization of the accounting standard-setting process, private actors still rely substantially on the State’s coercive power to enforce accounting rules. In view of the limited evidence on the role of soft law, the boundaries between private and public seem increasingly blurred (Chiapello and Medjad 2009; Suddaby et al. 2007). Suddaby et al. (2007), as well as Huault and Richard (2012), show that the Big Four accounting firms (Deloitte Touche Tomatsu, Ernst & Young, KPMG, and PricewaterhouseCoopers) are the current key players in the accounting regulation setting and they contributed strongly to the emergence of a transnational regulatory field in professional services. Chiapello and Medjad (2009) study the IAS/IFRS adoption and implementation process in Europe. They show that the European Union has embarked on a path of privatizing and subcontracting to the IASB, resulting in the European Union having almost no statutory control over the accounting standard-setting process. This situation results from decades of comitology practices within the European Union, generating a crisis of sovereign legitimacy. However, with regard to the accounting standards, the delegation process has gone too far, beyond the usual boundaries, which is also why the European Union currently tries to partially restrain its influence. Apparently, this process is extremely expensive in terms of financial

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and human resources. The IASB’s activities require consistent resources in order to bring about effective implementation and enforcement. Moreover, multiple consulting bodies have been established to discuss alternative implementation processes. Overall, accounting’s relevant impact on the economy and, on a broader perspective, on society, justifies an analysis of the accounting standards regulation process. Thus, the convergence process should definitely consider a country’s social, legal, and institutional environment. It is, therefore, necessary to question the ongoing one-size-fits-all approach. The political process should be responsible for protecting and pursuing the public interest, as this responsibility is part of the political process’s nature and the political process should delegate only the technical issues to external parties. In this accounting regulatory process, one can notice that the State actually fails to fulfil its role, as private actors have increasingly replaced the State.

2.4

Thoughts on the Accounting Standards

The desire to increase financial reporting quality encourages the adoption of the IAS/IFRS via a large number of countries. Widely distributed, high-quality accounting standards can have positive effects, such as reducing the cost of equity (Hail and Leuz 2006), increasing liquidity and better developing the stock market (Frost et al. 2006), higher earnings quality (Barth et al. 2008), and more foreign investments (Covrig et al. 2007). Comparability is considered a major alleged benefit of the IAS/IFRS implementation. A unique and consistent set of rules should enable investors to make better decisions. In the last few years, the harmonization process has moved quickly. Several countries are adopting the IAS/IFRS. Despite all the discussions and efforts made thus far, the accounting standards harmonization process still lags behind the final accomplishment. The implementation of new standards, in particular, is quite difficult and past research increasingly observes discrepancies between the de iure situation and the de facto reality (Kvaal and Nobes 2010; Ghio and Verona 2015). Comparability studies mostly adopt two alternative perspectives. On the one hand, the studies can be input based such that they can compare the selection and use of different accounting methods amongst firms in a similar setting. On the other hand, output-based measures rely on earnings measures, keeping the economic environment stable. De Franco et al. (2011) state that two firms show comparable accounting systems when they produce similar financial reporting results. Drake et al. (2012) find that the positive effect of mandatory IFRS adoption on liquidity is due to comparability rather than improved accounting information quality. Cascino and Gassen (2015) show that IAS/IFRS adoption increases the cross-country comparability of financial statements, owing to the strong compliance incentives at the firm level. Amongst the other papers that consider post-IFRS comparability, Lang and Maffett (2011) show a decrease in the degree of earnings comparability. They show that, after the first year, financial reports become less comparable. Zhang (2018) finds that comparability depends strongly on other factors, in primis audit

2.4 Thoughts on the Accounting Standards

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quality. The author also finds that comparability is a characteristic that is directly linked to earnings manipulation. According to Brüggemann et al. (2013), the new international accounting standards do not improve comparability and they present several shortcomings, such as limited transparency and comparability. However, the new international accounting standards appear leading to higher liquidity. The key confounding factors in cross-country studies are the type of capital market (bank versus stock market systems), legal system (code versus civil law), fiscal system (connections to taxation), primary user of accounting information (creditors and tax authorities versus investors), and the accounting and audit profession status. In continental Europe, the accounting profession tends to be under the State’s supervision, whereas in Anglo-Saxon accounting systems it enjoys a substantial amount of self-regulatory powers. In this context, Kvaal and Nobes (2010) identify substantial limits to comparability, even in the event that all companies use the same accounting standards. They state that these discrepancies are mainly due to national characteristics. Walton (1986) shows that the IAS/IFRS adoption usually follows a certain pattern amongst countries. Financial reporting differences appear, owing to (1) the existence of previous differences between national accounting practices, (2) IFRS consolidated statements from unconsolidated statements that, in many cases, are prepared in accordance with national GAAP, (3) companies’ demands to keep accounting policies constant and use the same rules for many years, and (4) companies’ demands to reduce IFRS transition costs by not introducing new options for their financial reports. Nobes (2006) identifies six possible reasons for differences in IFRS practice, such as using different versions of accounting standards, different translations, gaps in the IFRS, measurement estimations, transitional issues, and imperfect enforcement. He shows that it is still not possible to have perfect comparability, despite its relevance in motivating the adoption of the IAS/IFRS. Djelic and Kleiner (2006) raise doubts with regard to the real level of harmonization, as they state that “[. . .] there is still a fair amount of decoupling between principles and local implementation. National regimes still differ significantly from each other; interpretation and implementation are still very much shaped and influenced by local conditions, national legacies, pre-existing institutional constraints and available resources” (p. 20). Another key characteristic of the IAS/IFRS is that these standards intrinsically support the concept of conditional conservatism, whilst trying to discourage unconditional conservatism. Nevertheless, the IAS/IFRS is usually criticized for being less prudent than the national GAAP. The IAS/IFRS do not include the term “prudence” in their key concepts of the conceptual framework and they assign a primary role to the fair value approach. The relationship between the IAS/IFRS and conditional conservatism is still controversial (Lawrence et al. 2013; Christensen et al. 2008). Gassen and Sellhorn (2006) state that the IAS/IFRS are more conservative than certain local GAAP and may, therefore, limit opportunistic discretionary management. André et al. (2015) show that the level of conditional conservatism decreased after the IFRS adoption in Europe. They also document that the institutional environment, i.e. the auditing

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Table 2.1 Snapshot of the main studies examining the capital market consequences of the IAS/IFRS adoption IFRS consequences Analysts’ information Cost of debt and debt market Cost of equity Credit rating Cross-border and international information, and capital flows transfer Earnings comparability

Earnings transparency

Investment efficiency

Macroeconomic effect—foreign investment Stock market reactions Value relevance

Seminal works Li and Yang (2015), Byard et al. (2011), Tan et al. (2011), and Horton and Serafeim (2010) Ball et al. (2015), Donelson et al. (2015), Florou and Kosi (2015), and Christensen and Nikolaev (2013) Hong et al. (2014), Li (2010), Daske et al. (2008), Daske (2006), and Leuz and Verrecchia (2000) Wu and Zhang (2014) Florou and Pope (2012), DeFond et al. (2011), Khurana and Michas (2011), and Brüggemann et al. (2010) Cascino and Gassen (2015), Lang and Stice-Lawrence (2015), Brochet et al. (2013), Gus De Franco et al. (2011), Lang et al. (2010), Barth et al. (2012), and Yip and Young (2012) Capkun et al. (2016), André et al. (2015), Christensen et al. (2015), Li and Yang (2015), Ahmed et al. (2013), Lin et al. (2012), Atwood et al. (2011), Barth et al. (2008), and Jeanjean and Stolowy (2008) Biddle et al. (2016), Francis et al. (2016), André et al. (2014), Louis and Urcan (2014), and Schleicher et al. (2010) Amiram (2012), Beneish et al. (2012), Chen et al. (2012), and Márquez-Ramos (2011) Chen and Khurana (2014), Kim and Li (2011), Armstrong et al. (2010a), and Chen and Sami (2008) Aharony et al. (2010), Hung and Subramanyam (2007), and Bartov et al. (2005)

Source: Authors’ elaboration

quality and accounting enforcement, plays a mitigating role. This result is consistent with the study of Ahmed et al. (2013) who show that IFRS flexibility can be identified as the main source of this decrease in conditional conservatism. Demaria and Dufour (2007) find that the convergence with the IAS/IFRS did not affect the level of conservatism. Overall, it is difficult to distinguish between unconditional and conditional conservatism in the IASB’s conceptual framework. In a context of high uncertainty, conditional conservatism improves financial reporting quality for external users. Several studies investigate the mandatory IFRS adoption’s capital market consequences, for example stock market liquidity, cost of equity, and cost of debt. Considering the extensive research in this field, the authors summarize the main findings in Table 2.1. A full discussion of the IFRS adoption’s capital market consequences is beyond the scope of this chapter. Numerous excellent academic papers and books, such as those by Ball (2006), Brüggemann et al. (2013), Christensen et al. (2015), De

2.4 Thoughts on the Accounting Standards

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Fig. 2.2 Word frequency in the six literature review papers analyzed (Source: Authors’ elaboration)

George et al. (2016), Leuz and Wysocki (2008), and Soderstrom and Sun (2007) may help reviewing this topic. We provide a visual representation of the main topics discussed in these six literature review papers by analyzing the frequency of the main words used in the papers with the help of the software Nvivo 12 (Fig. 2.2). Larger words indicate more frequent words.

2.4.1

Quality of Accounting Information

The quality of financial reporting information varies substantially across firms. In line with the Statement of Financial Accounting Concepts No. 1, Dechow et al. (2010) state that “higher quality earnings provide more information about the features of a firm’s financial performance that are relevant to a specific decision made by a specific decision-maker” (p. 344). This definition of earnings quality suggests that quality could be evaluated with respect to any decision that depends on an informative representation of financial performance. The authors indicate that

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earnings quality should be assessed from the decision usefulness perspective and the informativeness perspective. Higher financial reporting quality can reduce the information asymmetry between investors and firms, which would lead to lower cost of capital. For instance, Lambert et al. (2007) document that accounting information can also affect a firm’s systematic, non-diversifiable risk. Francis et al. (2005) show that firms with poor accruals quality have higher costs of capital, meaning that the information risk is a priced risk factor. They distinguish between the innate factors (i.e. economic fundamentals) and the discretionary factors (i.e. managerial choices). The first group has a larger pricing effect, which means that investors are not indifferent to the source of information risk. Core et al. (2008) analyze the relationship between excess return and factor return and they find that accruals quality is not a priced risk. Investigating investment efficiency, Biddle and Hilary (2006) show that high reporting quality leads to higher investment efficiency. Biddle et al. (2009) extended prior research on investment efficiency by showing the negative relationship between earnings quality and overinvestment, and earnings quality and underinvestment. Several accounting scandals provoked criticism of accounting information reliability. Historically, the Wall Street Crash of 1929 represented a critical turnaround at the beginning of the twentieth century. More recently, accounting scandals, such as Enron and the failure of Arthur Andersen, WorldCom, and Parmalat show the limits of financial reporting. Ethical behaviour, best described as the attitude to do the right thing, represent a key issue in addressing accounting scandals (Watkins 2003; Low et al. 2008). Individuals act within groups who are entrenched in our society and the individuals rely strongly on these groups’ shared beliefs and common values.2 Accountants and auditors have often been involved in reporting irregularities. In their decision-making process, accountants and auditors have to consider the short- and long-term effects of their financial reporting decisions. In the short term, they could gain benefits, such as job retention, promotion, and a higher salary; however, negative effects may emerge in the long term, affecting elements like their reputation. In the long run, self-interest and public interest tend to converge. The idea of understanding managers’ choices in relation to accounting policies and their response to new accounting standards resonates with positive accounting theory. Aiming to explain managers’ accounting choices, positive accounting theory assumes efficient markets and rational managers. Conflicts of interest appear to result from agency problems, which may be mitigated via contracts. Accounting choices will then reflect preferences for certain contracts, which result from agreements between organizations and their stakeholders. An organization tries to minimize the different contracting costs related to all these contracts. Positive accounting theory implies that management can adopt a variety of accounting policies through the flexibility of the accounting standards.

2 For further discussion on this specific topic, Thomas Hobbes’ book, The Leviathan, provides interesting and relevant points, particularly with regard to the limited role that regulation plays.

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Actually, the positive accounting theory’s three fundamental assumptions with regard to earnings quality are (Watts and Zimmerman 1986): 1. The bonus plan hypothesis: All things being equal, managers with bonus plans are more likely to make accounting choices that shift reported earnings from future periods to the current period. Healy (1985) investigates the bonus plan hypothesis and shows that between the lower and upper bonus bound, managers try to increase the reported income artificially; in other circumstances, managers try to decrease the reported income artificially. 2. The debt covenant hypothesis: All things being equal, the closer a firm is to violating accounting-based debt covenants, the more likely the management will select accounting procedures that shift reported earnings from future periods to the current period. For instance, Dichev and Skinner (2002) show that the number of firms with zero or slightly positive covenant slack is higher than expected and the number of slightly negative slack is less than expected. Sweeney (1994) shows that firms are more likely to increase their income artificially before default. DeFond and Jiambalvo (1994) document that firms exhibiting debt covenant violations report positive discretionary accruals in the year prior to and in the year of the debt covenant violation. 3. The political costs: All things being equal, the greater the political costs a firm faces, the higher the likelihood that a firm would adopt accounting procedures deferring reported earnings from current to future periods. Jones (1991) investigates firms that reported lower net income during import relief investigation and she finds that firms use discretionary accruals to report lower earnings. The positive accounting theory’s three reported hypotheses follow an opportunistic perspective, which means that managers use financial reporting to maximize their benefits. At the same time, it is possible to investigate discretionary accounting choices from an efficient contracting or stewardship perspective. Contracts, for instance, compensation schemes, aim to reduce opportunistic behaviour and align managers’ and owners’ interests. The efficient contracting version is true only if all interests are aligned (e.g. a choice is mutually beneficial) or other mechanisms constrain opportunistic behaviour (e.g. reputation cost and mandated conservative accounting). Taken together, earnings manipulation can be analyzed from two different perspectives: • Financial reporting (bad earnings management): Managers aim at improving—or not damaging—their reputation, for example by meeting analysts’ forecasts. Another possible reason to manage earnings is the avoidance of a debt covenant violation (Dechow et al. 1995). In a widely cited paper, Leuz et al. (2003) investigate countries’ earnings management variability and they find that lower investor protection is associated with more earnings management. Therefore, firms in countries where investors have weak protection are more likely to experience opportunistic earnings management. • Contracting theory (good earnings management): Managers use earnings to convey inside information to the market, supporting investors in making

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informed decisions. Earnings management can represent an effective method for disclosing private information (Demski and Sappington 1987). Moreover, it is costly to use earnings management to convey inside information, because earnings may represent low reliability. Accounting standard flexibility can lead to a reduced risk and additional information to the market. Nonetheless, an excessive level of flexibility may lead to the risk of having firms with managers who exhibit little effort. To reduce bad earnings management, firms need to improve their disclosure. High quality disclosure allows investors to reduce the risk of uninformed decisions and decreases managers’ incentives to exploit poor corporate governance. For instance, accounting standards could improve the disclosure of low persistence items and can also better document the effects of previous write-offs (Scott 2012). The broad definition of earnings management is accounting choices or real actions that affect earnings in order to achieve a certain earnings objective. A variety of patterns can be adopted to manage earnings: • Income increasing: Managers increase the reported earnings artificially to receive/ increase their bonus or to avoid debt covenant violation. • Income decreasing: Managers decrease their reported income artificially in order to avoid disclosing current excessively high profits, creating a reserve for future poor periods. • Big bath: Firms that cannot avoid reporting a loss will report a very large loss. For instance, they write-off assets or they expense future costs, thereby maximizing the probability of reporting future profits. • Income smoothing: Managers may prefer to smooth earnings in order to report a stable level of earnings. Traditionally, one can distinguish between three main forms of earnings management (McVay 2006): • Accruals management: The recognition of financial benefits and obligations accruing over the reporting period regardless of cash flows characterize accrual accounting. This system should provide a better indication of performance than current cash receipts and payments. At the same time, accrual accounting necessarily raises concerns about its subjectivity, assumptions, and discretion. Examples of accruals management are expense amortization (e.g. a change in the estimation of useful life), an increase in net account receivables (e.g. flexibility to account for doubtful accounts), an increase in the inventory (e.g. including fixed overhead costs in the inventory), and a decrease in accounts payable and accrual liabilities (e.g. optimism about warrant claims). One cannot always think of accruals management per se as GAAP violations, especially because accounting standards tend to be relatively flexible. A fundamental rule of earnings management through accruals is the iron law: If a firm manages earnings upward in a certain period through accruals, it will have to reverse them in the following periods.

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• Manipulation of real economic activities: This relates to organizational decisions and activities affecting the bottom line, such as overproduction, cutting discretionary expense (e.g. research and development (R&D) and advertising), stock repurchase, sales of profitable assets, sale price reduction, derivative hedging, debt–equity swaps, and securitization. • Classification shifting: This relates to the misclassification of items within the income statement by exploiting the GAAP flexibility to alter the different financial reporting results. Studying the relationship between earnings quality and IFRS adoption, Barth et al. (2008) research resulted in a well-known and widely cited paper. They show that the IAS/IFRS adoption is associated with less earnings management, more timely loss recognition, and more value relevance of accounting. Christensen et al. (2008) find different results for voluntary and mandatory IAS/IFRS adoption. In the case of voluntary adoption, Christensen et al. show that IFRS adoption has positive effects, such as a lower level of earnings management and more accounting conservatism. In the case of mandatory IFRS adoption, firms do not gain the same benefits. Capkun et al. (2016) show that the IFRS adoption’s effects on earnings quality differ further with regard to the IAS/IFRS adoption time and type of enforcement. Nevertheless, the introduction of the IFRS, at least in Europe, does not represent a complete exogenous shock, as their implementation was already decided in 2002. Companies could have incorporated certain accounting standards whilst preparing their financial statements pre-2002. Moreover, in many European countries, local standards were converging towards IFRS prior to 2005. Although the IAS/IFRS differ on important points from the local GAAPS, the regulatory shock might not represent a clear cut-off time to rule out alternative explanations for the earnings quality changes that followed the IFRS adoption.

2.4.2

Financial Reporting and Managerial Compensation

Managers and owners often make decisions according to different incentive systems, which may cause conflict between the two parties. Financial reporting plays a fundamental role in monitoring and motivating managers’ performance (Aldogan Eklund 2019). Managers, therefore, care about accounting policies, because their wealth often depends on accounting indicators. Accounting choices also matter because contracts are rigid. Since rational managers may try to reduce their efforts, owners rely on performance measures that strongly depend on the possibility to observe managers’ actions. Moreover, agents are usually risk averse. By increasing the compensation risk, the principal is expected to increase the associated rewards. Owners may use different accounting measures to stimulate different types of managerial effort and achieve different objectives. A good performance measure has to be sensitive and precise. The time horizon and risk are two key elements when management compensation bases on financial

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reporting (Bushman et al. 1996). For instance, short-run activities can be observed through cost control and earnings. Earnings precision is high as earnings are relatively unaffected by economy-wide and other events, although earnings are usually considered weakly sensitive to managers’ efforts. Managers may manipulate earnings in order to conceal their limited effort. High quality accounting standards may limit this opportunistic behaviour even if the complete elimination of earnings management is not cost effective. Inversely, share prices are considered sensitive to management’s effort, because efficient markets recognize the expected economic effects of managers’ effort without waiting for realization, reducing the recognition lag. Moreover, markets are expected to process corporate information efficiently, detecting potential opportunistic behaviour. In the long run, investments in research and development (R&D), planning, and capital expenditures are better measured through the share price. However, share price precision is low because economy-wide events, for example interest rate changes, deregulation, booms, and recessions, impact its trend, reducing the informativeness of managerial effort (Lambert 2001). Furthermore, the risk component has to be carefully balanced. A low level of risk will reduce the incentives to make efforts, whereas excessive risk implies a higher expected compensation. Moreover, managers may be tempted to avoid risky projects and excessively hedge their risk. Therefore, to control for risk, the performance measure has to be precise and it usually includes lower and upper thresholds. Hölmstrom (1979) provides a widely used extension of the agency model by including different performance measures. He finds that the most efficient contract to reduce the agency costs includes net income and share price. Lambert and Larcker (1987) find that return on equity relates more to cash compensation than a return on shares. This relationship is stronger when net income is less noisy than the return on shares. Bushman et al. (1996) find that growth firms and firms with long product development and life cycles use specific performance measures, because other measures would be uninformative. Baber et al. (1999) show that the earnings changes’ effect on compensation increases along with the persistence of earnings changes. Jensen and Murphy (1990) provide evidence that CEOs are not overpaid, although their compensations often relate poorly to their performance. Owing to a size effect, large firms also show a weak relationship between pay and performance. A major concern is that top executives managing very large firms cannot be responsible for all the factors that may lead to a decrease in firm value. Gaver and Gaver (1998) show that the average executive compensation is increased over time to balance the costs associated with moral hazard in compensation contracts. They argue that such a change in executive compensation results from rebalancing the risk and effort. Thus, according to the authors, today’s managers are not overpaid for their effort. When it is difficult to observe the managers’ effort directly, assigning a share of the net income to the agent is a possible solution. This approach is clearly a risky performance measure for managers, but it also better aligns the different incentives between the agent and the principal. When managers’ actions cannot be observed,

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the optimal contract is a rental contract whereby the principal rents the company to the managers. However, it may transpire that managers do not act in the lenders’ best interests. The main risk associated with this approach is that the agent pays excessive dividends and/or invests in risky projects to maximize her utility. The principal may anticipate such opportunistic behaviour. He/she needs to hedge the negative consequences of this opportunistic behaviour by insisting on higher interest. Managers may try to decrease this cost by showing their commitment, for instance, by using debt covenants (Beatty et al. 2008).

2.4.3

Accounting Value Relevance

Empirical research questions the link between accounting information (e.g. earnings and accruals) and market responses (e.g. volume, price, and returns). The stock market may respond differently to financial reporting information for multiple reasons: • Each investor has his/her prior belief. • Financial reporting information alters an investor’s state probabilities, expected returns and risk, expected utilities, and investment decision (buy/sell). • Investors trade on the market according to their new revised beliefs, thereby creating volume and new prices. The paper by Ball and Brown (1968) is the first study that shows how share price responds to reported net income. Ball and Brown examined share price trends around the month of the earnings release and they assume that the expected earnings are equal to the previous year’s earnings. They then measure the earnings’ information content as the difference between the reported earnings and the expected earnings by differentiating between good news (positive difference) and bad news (negative difference) at the earnings announcement. They find that the average abnormal share return for good news firms is strongly positive, whilst the average abnormal share return for bad news firms is strongly negative. Good news firms outperformed the total sample, whereas bad news firms underperformed during the 18 months window. This seminal study shows that financial reporting information can be useful for investors to predict the expected values and risk of future returns. More recently, empirical research focused on the earnings response coefficient (ERC), which measures the magnitude of market response to unexpected earnings. Multiple measures have been used to identify expected earnings, for instance, accretion of discount (ideal), previous earnings (permanent), zero (zero persistence), and analyst forecast (could be biased). The ERC could differ across firms as unexpected earnings may imply different amounts of expected future payoffs and risks. Amongst the factors affecting the ERC, higher earnings quality allows investors to predict future earnings better and the relative ERC is higher. An important attribute of earnings quality is the persistence of earnings. More persistent earnings provide better information on how firms will perform in the future and, thus, the

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associated earnings response coefficient is higher. Ramakrishnan and Thomas (1992) state that not all earnings components present the same level of persistence. It is possible to identify three possible types of earnings situations: • Permanent: Infinite persistence • Transitory: It affects earnings in the current year, but not future years • Price irrelevant: Zero persistence Higher risk (proxy: Beta) is also often associated with lower ERC (Collins and Kothari 1989). Similarly, an investigation of the capital structure shows that highly leveraged firms (Debt/Equity) exhibit lower ERC (Dhaliwal et al. 1991). Inversely, high earnings persistence and quality will lead to higher ERC. Growth opportunities and precision in the analysts’ forecasts are positively associated with ERC, whereas the informativeness of price (e.g. the size of the firm) is negatively associated with ERC. Strictly related to the ERC concept is the notion of value relevance, which uses changes in share prices around earnings releases in order to understand the usefulness of financial information to predict future firm value. Value relevance studies further demonstrate the relevance of accounting information (Barth et al. 2001). Aggregate measures (e.g. earnings), as well as single accounts and methods (e.g. capitalization versus expensing of R&D expenses), may influence the share price. In their study of valuation models, Holthausen and Watts (2001) identify three main methods based on financial reporting information, namely the balance sheet model, the earnings model, and the Ohlson model. The balance sheet approach states that the market value of equity is equal to the market value of assets less than the market value of liabilities. This model relies on the use of the fair value estimation method. The earnings approach uses earnings as input for valuation models, for instance, the price-to-earnings ratio. Earnings are also used by analysts to forecast cash flows or even in the discounted cash flow models (DCFM). In the Ohlson valuation model, the firm value is defined as the sum of the equity’s book value and the expected future abnormal earnings’ present value. Ohlson (1995) is grounded in the measurement approach. A firm’s market value can be expressed via values from the balance sheet and the income statement (accounting variables). The clean surplus theory, also called the residual income model, states that firm value depends on fundamental accounting values, which is fully consistent with the measurement approach. The fundamental assumption of Feltham and Ohlson (1995) is that all gains and losses go through net income (clean surplus). The model can be summarized as: Firm value ¼ book value of net assets þ present value of expected future abnormal earnings ð, i:e:, , goodwill, Þ ð2:1Þ

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Abnormal earnings ¼ actual earnings  accretion of discount ð, i:e:, , cost of capital  opening book value, Þ ð2:2Þ If no abnormal earnings are expected, value ¼ book value (unbiased accounting), which represents an extreme case of the measurement approach. Past research on value relevance shows that the real impact of financial reporting information on the market is still unclear. For instance, Lev (1989) argues that the market’s response to the good or bad news in earnings is quite small. In this context, Zach (2003) highlights the relevance of accounting anomalies in the study of the relationship between financial reporting information and market reactions. Post-earnings-announcement drift is considered one of the main accounting anomalies (Bernard and Thomas 1989). It occurs when financial reporting news is not quickly incorporated by the market. Abnormal security returns tend to drift upwards after the earnings announcement for a certain period—or downwards in the case of bad news. Investors may underreact to earnings announcements, because they underestimate the current news’ impact on future earnings and, thus, prices appear to not reflect all the information that was released. Bernard and Thomas (1989) show that underestimating the persistence of earnings (i.e. inefficiency) may cause 18% of abnormal returns. Unsophisticated investors seem to strongly drive the misunderstanding of the current news (Bartov et al. 2000). The systematic error in assessing current earnings based on future earnings represents another accounting anomaly (Sloan 1996). Accrual anomalies have been widely investigated since Sloan (1996) who initially showed that firms with high levels of accruals tend to show abnormal low future returns. According to Sloan (1996), a large share of investors cannot differentiate amongst the different components of the earnings (cash flow versus accruals) and, therefore, they misprice securities. Furthermore, since accruals tend to reverse in future periods, the mispricing influences the forecasting process. Further extensions of the Sloan (1996) model investigate the degree to which investors are sophisticated (e.g. Ali et al. 2000), and the relationship between earnings management and accounting distortions (e.g. Richardson et al. 2005). Cash flows and accruals seem to impact differently on future earnings predictions, especially from a persistence perspective. Cash flow components are considered more persistent than accrual components. Other explanations for the negative relationship between accruals and future stock returns are due to different levels of risk (Wu et al. 2010). Another interesting and possibly relevant topic is the transaction costs’ impact on accounting anomalies. Nevertheless, little research has been done in this area, especially due to the lack of high-quality trading data (Richardson et al. 2010). The paper by Richardson et al. (2005) is a major extension of the paper by Sloan (1996). Richardson et al.’s study investigates the relationship between accrual reliability and earnings persistence further. In particular, this study identifies

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different types of accruals, finding that less reliable accruals will trigger lower earnings persistence. In a later study, Richardson et al. (2010) implement a more comprehensive measure and they also included financing activities and non-current accruals, such as intangibles, property, plant, and equipment (PPE), and deferred employment obligations in their analysis. This study provides further evidence for the accounting numbers’ reliability aspect, which is usually considered one of the two key elements, together with relevance, in the assessment of investments. As usual, there is a trade-off between these two accounting characteristics. For instance, the recognition of less reliable accruals will lead to security mispricing as a result of the measurement error. Finally, Richardson et al. (2010) help corroborate the Sloan (1996) paper’s findings by showing that the estimation error associated with accruals still affects investors’ decisions. Overall, it is possible to identify the following explanations for earnings anomalies: • Investors fail to distinguish between the multiple contents of earnings information, i.e. an accrual anomaly. • Investors fail to incorporate growth changes, assuming that once a firm is growing, it will maintain a similar trend, i.e. a growth anomaly. In particular, Fairfield et al. (2003) state that this anomaly is merely a special case of a general growth effect, which is due to diminishing marginal returns on investment and/or conservative accounting. Another major concern about the relevance of accounting information is the increasing relevance of intangibles. Already in the 1990s, Nobel laureate Joseph Stiglitz argues that “learning about the firm’s investments in intangibles is important for understanding how firms create (or destroy) value” (Stiglitz 1996). Nonetheless, the lack of physical substance for intangible assets makes their recognition and valuation particularly difficult. The current accounting system values intangible assets at cost and requires their amortization over their useful life when they are either purchased or self-developed. In the latter case, an organization needs to show with reasonable certainty that the intangible assets will generate future benefits. Intangible assets are also recognized when they form part of an acquisition in a business combination transaction and their fair value can be reasonably determined. Srivastava (2014) states that earnings quality is decreased over time, particularly earnings are more volatile and less value relevant. The increasing relevance of intangibles mainly drives this change (Lev and Gu 2016), whereas new accounting standards seem to play a minor role in the definition of the overall accounting quality. The uncertainty about the future benefits for firms with a high level of intangible assets, as well as the immediate expense of research and development, may trigger earnings and expense volatility. Moreover, the decreased value relevance is stronger for newly listed firms. The business model of newly listed firms tends to be knowledge based rather than material intensive, as was the case for the business model in the season firms. Intangibles that are not recognized, for instance internally generated goodwill, may represent a significant amount and may be relevant to investors. A key question

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is to understand whether the recognition of off-balance-sheet goodwill would provide sufficient, relevant information to investors to compensate for the possible lack of reliability. Thus far, the US standards (SFAF 142) and the IAS/IFRS (IAS 36) allow organizations to only record purchased goodwill and they require its periodic assessment. The adoption of new standards also influences the financial reporting information’s value relevance. Past evidence is mixed and it is difficult to infer that the IFRS adoption has led to incremental financial reporting value relevance. Aharony et al. (2010) show that the IFRS adoption affected the value relevance of certain specific accounting elements, particularly goodwill, research and development expenses, and asset revaluation, even if there were differences across institutional environments and different incentives. Results of studies examining the relationship between IFRS and value relevance in debt markets are mixed. Bhat et al. (2011) show no relationship between post-IFRS adoption accounting information and sensitivity to credit default swap spreads, whereas Wu and Zhang (2009) document that credit ratings are more sensitive to post-IFRS accounting information. To conclude, transaction costs and idiosyncratic risk are the main reasons for the persistence of market inefficiencies with regard to financial reporting information. The main issue is not whether markets are efficient or not, but to what extent they are efficient. It is not possible to identify a black and white situation; however, different nuances of the accounting standards and market characteristics have to be considered in assessing the relevance of accounting decisions.

2.5 2.5.1

Auditing Accounting Information Audit Activity

The information asymmetry between insiders and outsiders in the organization naturally influences the financial reporting preparation. To assure the owners that financial reporting truthfully reflects the ongoing organization’s activities, independent third parties, i.e. auditors, are hired to monitor the financial reporting systems. The implications of such auditing for the financial reporting system is that “managers, shareholders, directors, and other contracting parties all have an interest, ex ante, in structuring an auditing process that provides external parties with confidence that the financial reporting system produces timely, relevant, and credible information about the firm’s current and future cash flows and their riskiness” (Armstrong et al. 2010a, b, p. 191). High audit quality is fundamentally important to provide an effective system that monitors the potential conflict of interest between owners and managers, and also amongst different types of investors. The legal framework defines audit quality as a dichotomy between audit failure and no audit failure. Francis (2011) argues that audit quality is a continuum, since audit failures are quite rare and the litigation risk is often low. DeAngelo (1981) defines audit quality as the “joint probability that an

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existing problem is discovered and reported by the auditor” (p. 186). The two concepts that are highlighted in this definition are: 1. Auditors’ capabilities/competencies (e.g. ability to detect material misstatements and anomalies) 2. Auditor’s independence (ability to report and reveal anomalies) Auditors have to gather sufficient, appropriate evidence in order to issue their final audit report. Furthermore, they have to avoid committing a type I error (false positive, such as issuing a going concern opinion without any immediate risk of default) or a type II error (false negative, such as not issuing a going concern opinion to the organization then experiencing a default). Different units of analysis can be used to understand audit practice (Francis 2011) because both micro (inputs) and macro-level (firms, markets, institutions) factors influence audit quality. Figure 2.3 describes and summarizes the areas of study concerning the audit process and its potential impact on audit quality. The analysis of audit inputs concerns auditors (people) and audit tests (best practices); the analysis of auditing firms; the examination of audit industry, and/or other potentially relevant institutions that may affect the audit process and the analysis of the audit process’s economic consequences. The audit process is complex and continuously evolving, meaning that the four highlighted categories interact and mutually influence the audit process and with internal control systems (Arwinge 2012). Audit quality is usually considered heterogeneous across firms. The Big Four accounting firms, on average, show better audit quality, owing to their potential higher human and financial resources, and since they are less one client dependent, considering the number of clients and the total fees level. However, a remarkable, if not dangerous, exception is Enron, which represented less than 2% of Arthur Andersen’s total fees, but more than 30% of their Houston office’s fees. Despite the high expected external monitoring, clients are willing to pay a fee premium to the Big Four for their large effort and the associated signal of higher financial reporting quality. Big 4 accounting firms are also sued less often and are less sanctioned by legislators, even if they can also afford better lawyers, they are more conservative, and they provide more informative reports than the non-Big Four accounting firms (Weber and Willenborg 2003). Looking into the BigFour black box, it is even possible to identify differences amongst them, due to industry expertise, geographical variation, offices, and countries. Finally, the non-audit service’s role is particularly relevant in the assessment of audit quality. On the one hand, non-audit services can lead to a decrease in market concentration. On the other hand, non-audit services raise concerns about the potential conflicts of interest, negatively affecting audit opinions and auditors’ independence. In their examination of audit fees, Hay et al. (2006) show synergies between audit services and non-audit services in terms of the cross-subsidization of fees. However, non-audit services might require additional audit effort, which may lead to higher audit fees. In their archival study, Sharma and Sidhu (2001) show that

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Fig. 2.3 Factors influencing audit quality (Source: Authors’ elaboration)

auditors who are more commercially oriented and less independent, proxy by non-audit services, tend to issue less going concern opinions, which means lower audit quality.

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2.5.2

2 An Analysis of Financial Reporting

Auditing Regulatory Process

Two possible perspectives trigger the need for auditing. According to the agency theory, auditors contribute towards a decrease in agency costs. By monitoring the agents, the auditors reduce the information asymmetry between the managers and the owners. From the social reason perspective, auditing is the process for providing credibility to financial results. Auditing is not only a technique, but represents a larger comprehensive phenomenon embedded in an organization. Auditing helps reinforce the trust between managers and owners. Thus, the accounting profession needs to be perceived as trustful. Formal (e.g. membership of a professional association) and informal (e.g. insurance) elements can accomplish this goal. In the audit process, the three main actors that interplay are the auditors, the shareholders, and the managers. The shareholders rely on the auditor to assess management’s activity, since the shareholders are not directly involved in the business and they cannot observe the managers (monitoring process). Moreover, this control system raises a number of issues, such as the control over auditors (Quis custodiet ipsos custodes? Who will guard the guards themselves?). Usually, a good auditor is independent and competent and its monitoring activities instil trust. Dirsmith and Haskins (1991) argue that an audit is performed for legitimacy and control, and for better or more efficient auditing. Auditors need to manage contradictory pressures without showing it (Guénin-Paracini et al. 2014). Thus, the audit process mostly carries the following meanings: 1. Production of legitimacy: The audit process is often perceived as a black box. Thus, a great level of transparency can enhance auditors’ legitimacy. Scientific approaches, i.e. statistical sampling, have been implemented in order to legitimize audit practice rather than to actually improve audit efficiency. Changes in techniques might provide incremental value to the overall audit activities, but these techniques often represent an attempt to increase audit credibility. 2. Emotional management: Pentland (1993) argues that “auditors need to achieve an emotional state with respect to their work, not just a cognitive one” (p. 619) and, more generally, the main outcome of auditing activity is to provide comfort. 3. Audit as rationality: Information asymmetry characterizes the relationship between shareholders and managers, generating agency costs between the two parties. Principals may try to personalize the principal–agent relationship in order to avoid possible abuse by agents, but it is not always possible. Auditors may find opportunities to abuse the trust that others placed in them. Regulation, therefore, represents another mechanism that can limit potential frauds. In this context, auditors have to increasingly follow international auditing standards in performing their audits rather than merely relying on professional judgment. On the one hand, this shift may signal a lack of confidence in their activities and expertise. On the other hand, the use of standards in their activities legitimizes their work substantially. International Standards on Auditing (ISA) has been promoted as a means to increase the quality, uniformity, and international comparability

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of audit practice. Therefore, the International Standards on Auditing play an important role in establishing auditors’ international recognition and legitimacy. Nonetheless, International Standards on Auditing have been incorporated in a hierarchy of credibility led by the large, global audit networks. Mennicken (2008) investigates the impact of new auditing standards in the postSoviet Russian audit firms. Different from previous papers that merely investigated the macro-level process, Mennicken (2008) analyses the day-to-day audit activities in order to fully contextualize and understand the expansion of the global auditing model. The new standards connect the global harmonization process and the Soviet audit world. However, the interests of the two worlds do not always match, impairing audit quality. Actually, phenomena like practices of power and exclusion, as well as intraprofessional distinction, are all key elements that shape the daily implementation of the new auditing standards. Repeated scandals and lack of compliance with the duties can deplete professionals’ legitimacy. Maroun and Solomon (2014), studying the whistleblowing program required by the legislation for external auditors in South Africa, show how the regulations can contribute to maintaining institutional legitimization. In this context, the Big Four accounting firms are the key actors in today’s accounting regulatory process, because of the following reasons: 1. They are de iure and de facto in charge of the accounting and auditing standardization process of large listed firms. 2. They represent a transnational community of experts. 3. They are able to link their expertise in service to multinational companies with their expertise in the accounting and auditing standardization (standardization lato sensu). The Big Four accounting firms are also the developers, interpreters, and inspectors of accounting rules. This system of three tasks in one body raises substantial concerns about the preparation, implementation, and monitoring of accounting and auditing standards (Huault and Richard 2012). The Big Four accounting firms create complexity, which they then have to solve. Thus, their decisions could be driven by their interests and not by the intention to protect the public interest. Moreover, the different activities they are involved in are not always perfect complements. This potential conflict of interest could be difficult to detect, due to the information asymmetry and the paucity of evidence on the standardization process (Chiapello and Medjad 2009). Controllability boundaries surrounding the financial audit function have been substantially called into question in the aftermath of the downfall of the accounting firm Arthur Andersen. Gendron and Spira (2009), examining the failure of Arthur Andersen, question whether financial auditing is controllable and controlled. Two complementary perspectives, such as the internal company perspective (organizational controllability) and the external regulatory perspective (regulatory controllability), define audit controllability. Gendron and Spira (2009), consistent with Gendron (2001), find that the accounting profession is not homogenous (partners versus juniors) and they observed multiple layers of complexity within it.

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The analysis of the controllability in audit activities has to be interpreted through the lens of the current shift in the audit profession from professionalism to commercialism (Ghio and Verona 2018). For a long time, the accounting profession has been perceived as a gentleman’s profession. The key characteristics of professionalism are independence, protection of the public interest, competence, and technical expertise. Today, professionals are accused of being money driven, of undertaking audit activities purely to sell non-audit services, such as consultancy, and of only pursuing their personal interests. From the professionalism perspective, ethical and deontological principals usually drive the audit process. Under the commercialism approach, the market determines the main audit choices. In this context, Macintosh and Shearer (2000) argue that the audit profession shifted from being perceived as total dedication and service to humanity (vocation) to marketers of financial services. The main values that drive accountants seemingly relate to monetary gain and may constrain auditors’ independence (Barrett and Gendron 2006). Humphrey and Moizer (1990), investigating auditing as a socially constituted activity, state that auditing also has an ideological meaning, i.e. to legitimize the choice and extent of audit work and marketing functions, such as maintaining and, if possible, increasing the fees they receive from clients. In this context, auditing neither primarily delivers the audit services nor undertakes the public watchdog function that society traditionally demanded. Roberts (2001) questions the public interest ideal in auditing. He finds that commercialism erodes the fiduciary relationship between the auditor and the client, questioning the functionalist role of the auditor. Accounting firms appear to be only self-interested, despite the growing trend of the U.S. professions to highlight their professional values. Nevertheless, a number of authors argue that professionalism and commercialism are not necessarily incompatible. For instance, Bamber and Iyer (2002) identify a shift from an audit-driven culture towards an idea that is more focused on multiple professional services. This alternative idea is not incompatible with concepts like auditing and independence. The conflict of ideas would rather be between the firm’s idea of professionalism and that of the regulators and other stakeholders.

2.6

Challenges and Opportunities for Mandatory Financial Reporting

To conclude this chapter, the authors highlight a number of potential future avenues for research to address a number of critical theoretical and empirical challenges in the literature. Despite the large body of literature in the financial reporting field, the authors believe that the results of the suggested studies would make a substantial academic contribution and would have significant implications for policymakers and practitioners. In this chapter, we discussed high information asymmetry between managers and owners, due to uncertainty and complexity that leaves room for managerial

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discretion. Investors face serious difficulties when assessing managers’ decisions and the future performance of firms, raising the risk of moral hazard and adverse selection (Dechow et al. 2010; Dechow and Skinner 2000). These conditions are particularly exacerbated in the New Economy firms (Barth et al. 2017), innovative firms, high-growth firms, and small- and medium-sized entities. These types of firms also have to find finance to develop their businesses and the presence of intangibles is particularly significant (Smith and Cordina 2014). First, considering the growing question of accounting value relevance across different types of firms (Srivastava 2014; Barth et al. 2017; Lev and Gu 2016), future research could investigate what type of accounting information, i.e. earnings versus cash flows, is relevant to the investors of the New Economy firms. Second, the market participants’ awareness of financial reporting information other than earnings may reduce the incentives for New Economy firms to manage earnings and focus to maximize other financial reporting items, such as cash flows. Future empirical studies could further address certain critical questions that emerge from the IAS/IFRS-related literature: • Differences between voluntary and mandatory adoption. To what extent does the type of adoption and enforcement influence earnings quality and generate spillover effects on reporting transparency, thereby reducing the transaction costs? • Evolving quality of adopters that comply with IFRS. Most of the studies focus on the pre- and post-IAS/IFRS adoption in the short window around the European Union’s mandatory adoption in 2005. Considering the relatively long period of adoption, it could be interesting to investigate the medium-term effects of the new accounting standards. • Unintended consequences of the IAS/IFRS adoption. Although of great interests, most of the papers investigate the intended consequences of the IAS/IFRS adoption. The new accounting standards may also have caused unintended consequences at micro level (e.g. new negotiations or renegotiations of compensation or debt contracts) and at macro level. Moreover, it is necessary to disentangle the effects of the accounting changes from those due to economic changes. Research based on experiments, particularly randomized field experiments, may help assess new accounting standards that are proposed ex ante. • Role of the different organizations (e.g. IASB, EFRAG, the Big Four, and governments) in the implementation and enforcement process. It would be particularly interesting to further investigate the relationships amongst the actors, such as governments, private regulators, multinational companies, and the Big 4 accounting firms in the accounting standard-setting process and, more broadly, their role in the accounting standards’ globalization process. For instance, the accounting treatment of goodwill is still very controversial from an academic and a practitioner’s perspective. First, the real usefulness of the information provided via the adoption of the impairment-only approach is unclear. The future-oriented information, which determines the impairment process, is strongly subjective (Glaum et al. 2018). Moreover, preparers and auditors argue that the current accounting method is too costly. Finally, impairment could have

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played a role in the 2008–2010 financial crisis. As a matter of fact, impairment losses are often deducted too late. Therefore, a group of standard setters (i.e. the Accounting Standards Board of Japan, the European Financial Reporting Advisory Group, and the Italian Standards Setter) has recently suggested reintroducing goodwill amortization, because it is a better reflection of the economic resource consumption, it can be better verified, and it is more reliable. Future research could gather further evidence on whether the impairment enforcement has improved the decision usefulness of goodwill accounting or whether the impairment enforcement only conveys discretionary and unreliable information. From a policy perspective, it would also be interesting to understand the trade-off between the impairment and the amortization approach in the post-implementation period. Moreover, it would be relevant to investigate the roles different actors play (managers, auditors, audit committees, etc.) and their interactions in the different phases (allocation, valuation, impairment, etc.) related to goodwill. Finally, past research mostly focuses on the Anglo-Saxon contexts. Different incentives and institutional factors are likely to influence goodwill-related decisions. In particular, managers’ discretion can vary according to the different capital market oversights and accounting enforcement, highlighting the need for additional research on nonAnglo-Saxon settings. Examining the current accounting harmonization process, it would be useful to further understand whether limits emerge in the accounting standardization process and what the relationship is between political and technical bodies within the European Union. Future research could investigate whether the European Union plays a legitimization role or whether it only tries to minimize the external dominant model. Moreover, it would be interesting to gather further evidence on the impact of external pressures on the final decisions to adopt, amend, or reject certain standards in the implementation process at the European level. The monitoring activities of financial reporting still face substantial criticalities mostly due to (1) the gap between academic research and auditing in practice and (2) the growing relevance of technology and changes in the macroeconomic environment that also affect the audit process. Future research could further investigate the relationship between auditing and corporate governance, particularly whether they complement or substitute each other. Additional areas of research concern the impact of diversity (e.g. gender, ethnic background, sexual orientation) and technology (e.g., blockchain) on the level of professional scepticism. The analysis of more granular data, for instance, partner compensation structure, could shed light on the incentives affecting audit quality. Finally, the Big Four accounting firms face substantial challenges in developing countries where their activities have been suspended in a few cases (Economist 2019). These exogenous shocks may provide an interesting setting to investigate changes in the audit market concentration. A growing area of research concerns the use of accounting information in predicting macroeconomic factors. The informativeness of accounting data for economic activity may be used at the firm level and aggregate level. Accounting earnings tend to predict future cash flows better than current cash flows, which

References

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implies better future taxable income forecasts.3 Konchitchki and Patatoukas (2014) argue that the link between accounting earnings and macroeconomy is still underdeveloped despite the potential for interesting synergies. They show that aggregate accounting earnings can be useful to predict the growth in the nominal gross domestic product (GDP), especially for the one-quarter-ahead window. They also find that professional macro forecasters do not use this set of information in their analyses, which could reduce forecast errors. In an earlier study, Konchitchki and Patatoukas (2013) similarly show that accounting data on profitability for the 100 largest firms have predictive content in order to forecast real gross domestic product growth. Moreover, accounting information has incremental information content with respect to annual stock market returns. They suggest that professional macro forecasters should include aggregate accounting profitability in their forecasting of real economic activity, since financial reporting systems are able to timely capture changes in economic activity at the firm level and, therefore, on the overall U.S. real economy. Future research could expand these first sets of results by examining which categories of firms and associated characteristics may better contribute towards forecasting gross domestic product growth.

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3

Corporate profits are part of the gross domestic product.

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Chapter 3

Voluntary Corporate Disclosure

Abstract This chapter presents and discusses the literature on voluntary corporate disclosure. It pays attention to the costs and benefits of voluntary disclosure. The discourse also considers the leading role that corporate governance structures play in shaping firms’ voluntary information environment. This discussion focuses on the literature on corporate board, firm characteristics, and ownership structures that have the biggest influence on corporate voluntary disclosure. Furthermore, to date it appears increasingly relevant to examine the channels that companies use to disseminate information voluntarily, such as conference calls and management forecasts, as well as certain specific types of disclosures like those related to intellectual capital. Finally, the chapter concludes with an analysis of the challenges and opportunities of voluntary disclosure, trying to track the number of paths for future research.

3.1

Introduction

The corporate finance and accounting information theories contend that firms are interested in enhancing the information environment by means of disclosure practices, as well as corporate governance and management incentives, to attain the ultimate goal of maximizing firm value (Core 2001). In Chap. 2, we extensively describe the mandatory corporate disclosure intended as the minimum level of disclosure derived from certain legal and statutory provisions required by regulators, professional organizations, and multiple governmental authorities. In short, a major goal of compulsory disclosure is achieving the purported public interest, namely satisfying the users’ informational needs. Chapter 2 shows how and why the capital markets, securities, and exchange regulators, as well as the international and national regulatory bodies, direct that companies convey certain minimum disclosures.1 A key feature of mandatory disclosure is its periodicity and temporal continuity. 1 The relevance of public interest already arises in Chambers (1966: 293) where the author highlights: “Statutes and regulations secure the rights of investors, potential investors, their

© Springer Nature Switzerland AG 2020 A. Ghio, R. Verona, The Evolution of Corporate Disclosure, Contributions to Management Science, https://doi.org/10.1007/978-3-030-42299-8_3

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Voluntary Corporate Disclosure

This chapter extends the view of corporate information, providing a big picture of voluntary disclosure, which is information that firms provide beyond the minimum requirements or in excess of mandatory disclosure (e.g. Healy and Palepu 1993; Wang et al. 2008).2 Simply put, voluntary disclosure begins where regulations end. Actually, any firm can voluntarily disclose supplementary information without abiding by any formal, prescribed presentation format, or communication channel. The lack of a universally agreed schema to voluntarily communicate corporate information, endorses the freedom of choice in terms of what exactly, to whom, and how companies should release these disclosures. Akerlof’s (1970) pivotal study sets the foundation for the research on voluntary disclosure, demystifying via the market for lemons paradox the information asymmetry in the market, especially when the seller has a greater amount of information about the good/product offered to the buyer. Extensive literature recognizes selected solutions for information or lemon concerns. For instance, Healy and Palepu (2001: 408) proposes the optimal inter-party contracts, which moderate the misvaluation drawback, providing incentives for full disclosure of private information. A second solution, even if hardly attainable, maybe a regulation requiring managers to fully disclose any private information. The third solution to alleviate the information asymmetries may be to resort to information intermediaries, such as rating agencies or financial analysts, in order to uncover and reveal managers’ superior information. Of course, it is not sufficient to disclose all information. Indeed, not only the quantity, but also the quality of the corporate disclosure inevitably impacts on the level of information asymmetries, generating economic consequences on, e.g. the cost of capital (Lambert et al. 2007), litigations costs (Francis et al. 1994; Skinner 1994), and proprietary costs (Verrecchia 1983, 1990a, 1990b). This introduction unavoidably leads to a discussion of the reasons for and against voluntary disclosure. Elliott and Jacobson (1994) dedicate an entire study to the costs and benefits of business information disclosure. Costs and benefits may be of economic, political, social, or ethical type. The authors, i.e. Elliott and Jacobson, then categorize these costs and benefits into three groups according to the interests involved. Besides making a voluntary disclosure, there are indeed the entity’s interests, the non-owner investors’ interests, and the national interest. Focusing at this juncture specifically on the entity’s interests, prior studies deeply examined the merits deriving from voluntary disclosure, such as proprietary costs, disclosure credibility, preparation and dissemination costs, political costs, and litigation costs. With reference to the overall merits of voluntary corporate disclosures, firms are interested in providing information voluntarily in order to realize economic benefits. The provision of information is a signal of a firm’s quality, which may be

advisers, their agents, and the public generally, to authenticated financial information, with the object of creating a fair and informed market in securities”. 2 We use the terms “voluntary disclosure”, “voluntary communication”, and “voluntary information” interchangeably. Similarly, the terms “compulsory disclosure” and “mandatory information” assume the same meaning.

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Fig. 3.1 Trade-off between the costs and benefits of corporate voluntary disclosure (Source: Authors’ elaboration)

Benefits • Signal of firm quality • Lower agency costs • Higher stock liquidity • Lower cost of capital • Higher firm value

Costs • Proprietary costs • Disclosure credibility • Preparation and dissemination costs • Political costs • Litigation costs

used to diminish the risk of adverse selection (Jensen and Meckling 1976; Morris 1987). Consequently, the provision of information limits the agency costs deriving from the separation of management and the providers of funds. All in all, the bulk of the literature ascribes the benefits of corporate voluntary disclosure to mitigation of information asymmetry, which results in increased stock liquidity and lower cost of capital, and ultimately redirects to higher firm value. Figure 3.1 summarizes the trade-off between the costs and benefits of corporate voluntary disclosure. To sum up, the incentives for disclosing information voluntarily can be justified under multiple economic and managerial theories, including agency theory, legitimacy theory, signalling theory, and stakeholder theory (Morris 1987; Guthrie and Parker 1989; Deegan et al. 2002; Huang and Kung 2010). To date, the disclosure landscape embraces countless reports and frameworks within the mandatory and voluntary fields in order to disseminate financial and non-financial information to most of the interested stakeholders. Non-mandatory information can be disclosed across multiple communication channels, such as annual and interim reports, management forecasts, investor meetings, conference calls, analysts’ presentations, letters to shareholders, media, press releases, and monthly newsletters (Graham et al. 2005). Therefore, within the broad spectrum of corporate voluntary disclosure, the reporting overdose or the disclosure jungle resulting from the numerous existing frameworks is amongst the greatest challenges that still exist (Ferramosca and Ghio 2018a; KPMG 2019). In the knowledge and information era, the above-mentioned frameworks act as a necessary first step to filter the information; these frameworks help at selecting information pertaining to the relevance, reliability, and comprehensiveness of the disclosures. In this context, the following play a key role: – Integrated reporting (IR), a framework developed by the International Integrated Reporting Council (IIRC).

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– The Global Reporting Initiative3 that developed the GRI Reporting Framework releasing guidelines and sector information for sustainability reporting on the triple bottom line of economic, social, and environmental metres (ESG). – The Sustainable Development Goals (SDGs) comprising 17 global objectives established by the United Nations General Assembly and founded on the Millennium Development Goals. This list comprises only a few of the best known examples of the developed frameworks to which corporations may voluntarily refer when organizing their disclosure. Prior literature emphasizes that flexibility allowing to shape the voluntary information environment according to the firms’ characteristics, corporate governance arrangements, and business models is one of the most valuable characteristics with regard to voluntary disclosure. Accordingly, Ferramosca and Ghio (2018a) refer to the eight loci argumentorum, which were widely employed in the classical methodology from Aristotele to Cicero and Saint Tommaso D’Aquino, and contend that “voluntary disclosure is flexible on eight dimensions: 1) Quis (Who and to whom to disclose), 2) Quid (What to disclose), 3) Quando (When to disclose), 4) Ubi (Where to disclose), 5) Cur (Why to disclose), 6) Quantum (How much to disclose), 7) Quomodo (How to disclose), and 8) Quibus auxiliis (Through which means to disclose)”. They (2018a) conclude that the different combinations of the various loci argomentorum cause an indefinite multiplication of disclosures which clearly explains the use of the term “disclosure jungle” when dealing with the heterogeneity of corporate voluntary disclosure. The remainder of this chapter proceeds as follows. Section 3.2 critically reviews the literature on the costs and benefits of voluntary corporate disclosure, including a subparagraph with a specific focus on most of these costs and benefits. Section 3.3 briefly depicts the corporate governance’s role in shaping the corporate voluntary disclosure; this section is further divided into three subparagraphs reviewing the literature on the relationships between corporate voluntary disclosure and (1) corporate board characteristics, (2) firm and control environment characteristics, and (3) ownership structures. Section 3.4 shows two specific types of voluntary disclosure, i.e. management forecasts and conference calls. Section 3.5 focuses on intellectual capital reporting and, finally, Sect 3.6 identifies challenges and opportunities of voluntary corporate disclosure, providing a link with the following empirical chapters and future research.

3

The GRI is an international independent organization that pioneered corporate sustainability reporting since 1997. It supports organizations with understanding and disclosing their impact on critical sustainability matters, such as human rights, climate change, corruption, and others. The GRI has thousands of reporting practitioners in over 90 countries and provides the world’s most trusted and widely used standards on sustainability reporting. It is grounded in a unique multistakeholder principle, ensuring the participation and expertise of diverse stakeholders in order to develop agreed-upon standards (KPMG et al. 2016).

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Costs and Benefits of Voluntary Corporate Disclosure

Before analyzing the voluntary disclosure practices and processes, it is important to understand what might be the arguments for and against them. Therefore, it is convenient to mention the work by Graham et al. (2005) who dedicate an extensive portion of their survey and interviews to voluntary disclosure in order to understand corporate voluntary decisions to disseminate private information. Graham et al. (2005: 53 et seq.) focus on six core reasons recognized as drivers of voluntary disclosure, i.e. information asymmetry, increased analyst coverage, corporate control contests, stock compensation, management talent, and limitations of mandatory disclosure. With reference to the limitations, they (2005) consider litigation risk, proprietary costs, political costs, agency costs, and setting a disclosure precedent that may be hard to maintain in the future. When evaluating the results, it is interesting to note that more than 90% of the respondents believed that also bad news are helpful with regard to developing firm reputation for transparent reporting (i.e. signal of firm quality/image), more than 80% perceived voluntary disclosure worthwhile in order to reduce the information risk assigned to the stock (i.e. lower agency costs), and more than 70% agrees that voluntary disclosure is relevant in order to provide important information that are not included in mandatory financial disclosures (i.e. lower information asymmetries). First, when asked about the limitation of voluntary disclosure, almost two-thirds of the respondents agree that a limitation of voluntary disclosure is to avoid setting a disclosure precedent that may be difficult to maintain in the future (i.e. preparation and dissemination costs). Second, a substantial number of respondents also believed that it is important to avoid betraying company secrets, which may harm their competitive position (i.e. proprietary costs). Third, increased voluntary disclosure can possibly trigger lawsuits when future results do not satisfy the expectations derived from the forward-looking disclosures (i.e. litigation costs).4 In the following subsection, we consider and comment on most of these advantages and disadvantages, and, furthermore, introduce other advantages and disadvantages that emerged from prior literature.

3.2.1

Proprietary Costs

In corporate financing and investment decisions, it is not good enough for the firm to convey information about the company’s great prospects without providing the appropriate details, as this kind of undetailed communication would not be considered relevant information (Barrett 1976). Only informative disclosure is useful in the 4

For an analysis of the advantages and disadvantages of voluntary disclosure, see also, amongst others, Elliott and Jacobson (1994), Healy and Palepu (2001), Beyer et al. (2010), and Berger (2011).

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decision-making process (Elliott and Jacobson 1994).5 Managers have an all-around perspective on firms’ operations and accumulate private information about the firms’ future cash flows, because of their proximity to the operating, financing, and investment activities. Therefore, managers are expected to provide sufficient facts and specifics in order to enable investors to verify and ascertain firms’ activities. However, the counterbalance of increased transparency is that all the firms’ competitors would have private information at their disposal in the form of plans, budgets, forecasts, cash flow projections, etc., thereby giving shape to the purported proprietary costs (Myers and Majluf 1984).6 Competitors, labour unions, and regulators can use proprietary information, which can potentially damage a firm’s competitive position and value. Ultimately, proprietary information motivates the management decisions not to disclose or to disclose selectively (Verrecchia 1983; Dye 1986). Darrough and Stoughton (1990), using a static entry game, demonstrate that full disclosure equilibria are realized when the prior market is optimistic or the entry cost is relatively low. As the number of rivals increases, voluntary disclosure is discouraged, because proprietary costs become greater. Similarly, Wagenhofer (1990) shows that favourable information increases the market price, but also imposes proprietary costs resulting from the opponents’ actions. Correspondingly, a large body of more recent empirical studies provides evidence about using the disclosure of proprietary information selectively. The empirical results show that managers are more likely to withhold information about sales and costs if they perceive that current or potential competition is strong (Dedman and Lennox 2009). Furthermore, in line with the argument that disclosure is more onerous for successful firms, more profitable companies prove to be more likely to withhold information (Dedman and Lennox 2009). Li (2010) provides evidence that product market competition shapes corporate behaviour with regard to voluntary

5 Elliott and Jacobson (1994: 95) offer a thorough interpretation of disclosure informativesness where “the information content of a message is defined as its capacity to reduce uncertainty (i.e. increasing informativeness of disclosure equates to decreasing investor uncertainty, which leads to a decreasing information risk premium demanded by investors). Uncertainty reduction is inversely related to the ex ante probability of receiving a particular true and relevant message: the more improbable the message ex ante, the more informative. For example, the reliable message that a particle moved faster than the speed of light has zero probability ex ante, thus infinite information value to a theoretical physicist (but not a teeny bopper). The reliable message that a building is on fire has very low ex ante probability, thus very high informativeness to an occupant. The response “fine” to the question “how are you?” has very high ex ante probability, thus very low information content. It is well known, for example that stock prices do not respond to earnings-per-share announcements that equal the expected amounts, but do respond to surprising earnings-per-share announcements”. 6 Dye (1986) presents a theory for the disclosure policies adopted when managers trade-off between protecting proprietary information and making value-increasing disclosures. In the same work, Dye defines proprietary information “as information whose disclosure reduces the present value of cash flows of the firm endowed with the information”.

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disclosure, owing to proprietary costs. Similarly, Aobdia and Cheng (2018) find that non-unionized firms disseminate more information and more good news when renegotiations of their rivals are ongoing. These findings suggest that managers not only select the content, but also the timing to disclose (Aobdia and Cheng 2018). Prencipe (2004) documents that proprietary costs are relevant to segment reporting, constraining the motivation for companies to externally provide this kind of information externally. In a related study, Ellis et al. (2012) find that the likelihood of a firm concealing a major customer’s identity varies significantly depending on the potential proprietary costs that a firm face. These results indicate that larger firms, firms with prominent auditors, larger research and development expenditures, greater levels of intangible assets net of goodwill, and larger advertising expenditures are significantly more likely to conceal the names of major customers.

3.2.2

Disclosure Credibility

Accounting scandals and the diverse types of worldwide frauds and misappropriations (e.g. Enron, Parmalat, Petrobras, and Toshiba) caused the investors’ and other stakeholders’ confidence to collapse (Agrawal and Cooper 2017). Moreover, considering the potential conflicts of interest between managers and investors, the latter may not perceive management releases as trustworthy (Healy et al. 1999). Jennings (1987) argued as follows: “The reaction of investors’ beliefs to the release of a manager’s earnings forecast depends on the unexpected component (surprise) of the forecast and its believability”. To be useful, all the released information needs to be perceived as credible. Therefore, disclosure credibility is defined as “investors’ perceptions of the believability of a particular disclosure” (Mercer 2004). Management credibility is only one of the factors impacting on disclosure credibility, as other elements may impact on information credibility.7 Disclosure credibility is the result of situational incentives, management credibility, external and internal assurance, and disclosure characteristics. The situational incentives refer to the scenarios in which management may have stronger/lower motives to misrepresent, whilst management credibility reflects managerial reputation. Regarding external and internal assurance, the independent assurance of a firm’s disclosure influences its credibility. Finally, any disclosure feature can produce an effect on its credibility, for example the source of information, the precision, and timeliness (Mercer 2004: 194). Rahman (2012) demonstrates that investors rely on four factors when evaluating the reliability of information, i.e. the situational incentives at the time of the disclosure, management’s trustworthiness and competence, the degree of assurance for the message from internal and external sources, and several characteristics of the

7 In a successive work, management’s reporting credibility is defined as “investors’ beliefs about management’s trustworthiness and competence in financial disclosure” (Mercer 2005).

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disclosure, such as its precision, venue of release, and time horizon. Another research paper documents that the extent to which users rely on managerial information depends on the level of discretion in the reporting environment and management’s reporting reputation. The authors of the paper show that the lower the level of discretion or the higher the management’s reporting reputation, the less the users tend to rely on information (Hodge et al. 2006). All the above-cited elements point to the cost associated with the credibility of the disclosure. In fact, assuming that investors and other stakeholders are innately suspicious, corporate voluntary disclosure will hardly convince them unless it is credible. However, the credibility may have a high cost in terms of, for example reputation building, assurance, and preparation (Demartini and Trucco 2017). Fully aware that the assurance of non-mandatory information is relevant, the International Auditing and Assurance Standards Board (IAASB) launched (2019) a consultation paper with the support of the World Business Council for Sustainable Development (WBCSD)8 to gain feedback on the work carried out regarding the development of a non-authoritative guidance9 in applying ISAE 3000 (Revised) over Emerging Forms of External Reporting (EER).10 The key objective of the IAASB EER project is to enhance trust in the emerging assurance reports by the EER users. To this end, the IAASB established the Integrated Reporting Working Group (IRWG), which issued a discussion paper entitled “Supporting Credibility and Trust in Emerging Forms of External Reporting: Ten Key Challenges for Assurance Engagements” already in August 2016. This discussion paper explored the concept of credibility and trust from the perspectives of internal and external stakeholders. More specifically, credibility is defined as a “user-perceived attribute of information that engenders in the mind of the user an attitude of trust in the information”. Subsequently, four factors are identified as factors that are able to enhance credibility and trust, such as (1) a sound reporting framework, (2) strong governance, (3) consistent wider information, (4) external professional services, and other reports. We understand that a sound reporting framework implies transparency and user confidence with regard to the same framework’s output. The second point related to strong corporate governance in this context is mainly about the processes and controls over the reporting processes, including the competence and independence of the people involved. The information provided should, of course, be internally consistent and made available with the users’ knowledge. Ultimately, the issue of independent external professional

This project is part of a conservation and financial markets collaboration among Ceres, the World Business Council for Sustainable Development, the World Wildlife Fund, and the Gordon and Betty Moore Foundation. 9 Although the majority of respondents who participated in a prior discussion paper (2016) promoted the development of non-authoritative guidance, but not a new assurance standard including mandatory requirements at this time, the IAASB consultation paper (2019) recognizes that the latter may be appropriate in the future. 10 This IAASB consultation paper was issued during February 2019 and is entitled “Extended External Reporting (EER) Assurance”. 8

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services and other external inputs relating to the EER is considered desirable. The users indeed have access to any information disclosed under external assurance or other professional service engagements. It is relevant to remind the readers that EER differs substantially from financial reporting with relevant repercussions on its assurance. The EER’s assurance, thus, involves many challenges, starting with a wider range of underlying topics, a more diverse group of users, and a larger variety of content elements, each having different metrics. Often, the EER’s assurance also involves more judgemental areas with a risk of bias, and it requires broader expertise on subject matters in preparing it. Furthermore, the scope and content elements of the EER frameworks often address a variety of matters, and many of them are still evolving. From the governance and control perspectives, overall, organizations may need to design a new control environment, which is broader and more flexible in relation to the EER specificities (IAASB 2016).

3.2.3

Preparation and Dissemination Costs

Information production is not costless, neither for the production of regulated disclosure (e.g. bookkeeping) (Watts and Zimmerman 1978), and a fortiori unregulated disclosure may be high priced. Hence, the preparation of voluntary disclosure requires substantial organizational efforts and its dissemination is not always manageable without additional costs. Actually, methodological (form) issues and content (substance) issues must be addressed, owing to a lack of consensus on what is relevant for disclosure and what is the most effective method to communicate such information. The preparation and dissemination costs are deeply investigated within the voluntary segment reporting literature (Kelly 1994; Edwards and Smith 1996; Prencipe 2004), due to such information’s proprietary nature and marketable sensitivity (Leuz 2004). The external costs primarily relate to the dissemination of private information, which may threaten the firm’s competitive advantage, to the outside world. The internal costs mainly relate to the production of information, and these costs comprise the cost of (1) collecting data and information, (2) processing and oversight procedures, (3) assessing and auditing to ensure credibility, and (4) disseminating the information (Elliott and Jacobson 1994). The preparation of unstandardized information requires a higher degree of expertise, going well beyond the routinary and regulated disclosure. It appears more difficult to prepare information about matters that, by their nature, are more subjective. Therefore, an appropriate internal control system that covers at least the firm’s strategy, resource allocation, and business model (IAASB 2019) is recommendable. Such internal controls should also ensure proper information management and reporting processes in order to safeguard the disclosure’s integrity, accuracy, and fairness (IIRC 2019).

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The board’s effort is a relevant part of the preparation and dissemination costs. In this logic, evidence suggests that board disclosure is positively associated with the extent of time and resources devoted to the board tasks. More specifically, both the board and compensation committees’ meeting frequency and size are positively associated with the voluntary disclosure of executive compensation practices (Laksmana 2008). Overall, firms are encouraged to disseminate private information voluntarily when the benefits of the increased, unregulated disclosure exceed at least the proprietary costs and does not damage the firm’s stock prices, instead facilitating the information asymmetry reduction (Cotter et al. 2011).

3.2.4

Political Costs

The political cost hypothesis helps explain why organizations provide voluntary disclosures (Milne 2002). The works of Watts (1977), as well as Watts and Zimmerman (1978, 1986), are the theoretical foundations of numerous disclosure studies. Watts (1977: 1) thinks of “Financial statements (. . .) as products of both markets and political processes and the interactions among individuals and groups in these processes”. Organizations are expected to implement a number of disclosure strategies to manage the political wealth transfer’s effect amongst various groups (Watts and Zimmerman 1978). Firms are pliable to political wealth distributions (e.g. through corporate taxes, subsidies, nationalization, expropriation, and regulation), which also depends on the voting groups’ interests. Corporate voluntary disclosure, consequently, constitutes one device worth at raising awareness about, for example the firm’s social responsibility, and countering political interference. Watts and Zimmerman (1978) explicitly recognize the firm’s size as a likely surrogate for measuring the political costs. Bigger and more profitable firms are more visible and, thus, they are more politically vulnerable. Extensive research determines further proxies for political costs, including profits, rates of return, risk, capital intensity, industry concentration, industry membership, effective tax rates, number of employees, number of shareholders, labour intensity, press coverage, and, last but not least, social responsibility disclosures (Milne 2002). In the voluntary disclosure context, several empirical works establish the connection between the political cost hypothesis and the firm’s reasons for disclosing. Along this line of research, Belkaoui and Karpik (1989: 38) suggested that “imagebuilding and public interest concerns may govern the decision to spend for social performance and to disclose social information”. As a result of the political costs inflicted by the authority, its governing agencies and private interest group firms operating in the mining and oil industry are more likely to voluntarily disclose additional segment information to boost their corporate image (Craswell and Taylor 1992: 300). Consistent with the political costs hypothesis, Wong (1988) shows that firms that are vulnerable to wealth transfer by means of taxes and government regulation struggle to steer such transfers via the voluntary release of supplementary

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current cost financial statements. Similarly, Deegan and Hallam (1991), employing a sample of Australian listed companies and applying the political costs theory, a document that the decision to voluntarily disclose Value Added Statements depends on the firm’s size, the tax payments, and the type of industry. More recently, Piotroski et al. (2015) underline the key role that transitory political incentives have in determining the listed firms’ information flows. Specifically, Chinese listed firms are sensitive to political incentives for opacity, suppressing negative disclosures around two visible political events, meetings of the National Congress of the Chinese Communist Party and promotions of highlevel provincial politicians, both of these events being likely to asymmetrically increase the costs of releasing bad news. According to the authors of this book, the political costs hypothesis can explain the reasons for and against voluntary disclosure and improved transparency. In this context, the disclosure decisions depend on the consequential political costs/benefits. The political cost hypothesis is also related to the stakeholder theory. Accordingly, organizations may provide supplementary information in order to satisfy the pressure that a broad range of stakeholders exerts on firms. Along this line of research, prior literature indicates that not only is the association between firm size and voluntary environmental disclosure positive (Patten 2002), but the quality of this information is also higher for bigger firms (Brammer and Pavelin 2006). As suggested, this latter result is consistent with the idea that larger firms experience higher pressure for extensive and superior disclosure (Brammer and Pavelin 2006: 1185).

3.2.5

Litigation Costs

Voluntary disclosure can either exacerbate or mitigate litigation costs. The seminal work testing for a relationship between disclosures and the incidence of litigation is Francis et al.’s (1994) paper, which was published in the Journal of Accounting Research. Francis et al. (1994) did not find evidence for a simple causal relationship between the presence or magnitude of adverse earnings reports and the frequency of shareholder litigation, suggesting that voluntary and early disclosures, often promoted as an ex ante shielding mechanism, may not be effective protection against litigation. However, Francis et al. (1994) recognize that the possibility cannot be ruled out that the examined disclosures were not timely or persuasive enough to limit the adverse earnings news, which then caused the litigation. Approximately 3 years later, Skinner (1997) finds that managers cannot reduce stockholders’ litigation costs by disclosing adverse earnings news earlier. Indeed, Skinner provides evidence that voluntary disclosure is more likely to occur in lawsuit quarters than quarters that are not affected by litigation. Specifically, his study indicates that 25% of firms with large, negative earnings news voluntarily warn about the bad news, compared to 6% of the firms with large, positive news. Nonetheless, this result may originate from managers’ fear of legal liability (Billings and Cedergren 2015), leading managers to anticipate earnings news when the news

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is more adverse, and trying to reduce the settling cost that the firm may incur in bad news quarters. In fact, there is evidence to a certain extent that a timelier disclosure is associated with lower litigation costs (Skinner 1994). Along this stream of literature, Kasznik and Lev (1995) examine management’s discretionary disclosures prior to a large earnings surprise and they find that the possibility of a voluntary disclosure of warnings (negative information) occurring is twice that of positive information. They also find that the likelihood of issuing a warning depends on the extent of the earnings surprise, the existence of an earlier prospective disclosure, membership of a high-technology industry, and the firm size. Ultimately, managers are more inclined to issue warnings for permanent earnings disappointments rather than transitory disappointments. Apart from these interesting findings, Kaszink and Lev (1995: 115) ponder why, if warnings should really be beneficial (e.g. a deterrent of litigation), half of their sample remains silent prior to surprising the investors. Their arguments suggest that firms are concerned about “an overreaction to warnings” and as a result, they prefer “prevalent corporate silence”. Overall, a firm’s desire to boost its image and value encourages the disclosure of good news, whilst the desire to mitigate litigation costs mainly drives the release of bad news. Empirical evidence also shows that when managers have the discretion to either fully disclose or only release a noisy description of the event, they will prefer to fully disclose if the news is good or sufficiently bad. Furthermore, negative information is less precise, because managers balance their contribution against reducing the probability of being sued, with the risk of a fall in the stock price (Trueman 1997). With regard to the relationship between litigation costs and voluntary disclosure, Field et al. (2005) confirmed that voluntary disclosure has a preemptive effect, as the firms with an increased litigation risk are more likely to issue a warning. In this sense, the results provided by Field et al. (2005) do not indicate that disclosure triggers litigation, whilst it may deter certain types of lawsuits. Somewhat similar conclusions were derived by Francis et al. (1994) who neither found supportive evidence for disclosure’s preemptive effect over litigation nor that a failure to disclose inevitably triggers litigation. Donelson et al. (2012) extend Field et al. (2005) by finding that a timelier revelation of bad earnings news prevents not only lawsuits that are eventually settled, but also those that are dismissed by the court. Moreover, Donelson et al.’s results endorse the importance of contemplating multiple channels of communication. The only use of press releases produces a partial representation of managerial disclosure, which can lead to inaccurate inferences. Whilst the above literature explores the ex ante disclosure behaviour of firms that suffered from litigation, an interesting study by Rogers and Van Buskirk (2009) explore the variation in the disclosure behaviour of firms that were involved in litigation. There is no evidence that firms successively react to litigation by increasing their disclosure. Conversely, the extent of disclosure is reduced post-litigation. Rogers and Buskirk assume that this result suggests that “managers emerge from the litigation process with a belief that a higher level of voluntary disclosure does not reduce the expected cost of litigation. Rather, our findings are consistent with managers adopting the belief that plaintiff attorneys will use voluntary disclosures

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to accuse managers of misconduct, even when the disclosures were made in good faith”. This study is in line with the stream of literature maintaining a negative association between litigation risk and voluntary disclosure (e.g. Frost and Pownall 1994; Johnson et al. 2001). Baginski et al. (2002) similarly compare the disclosure behaviour of firms residing in the more litigious environment of the United States to those residing in a less litigious environment, for example Canada. It emerges that Canadian firms are more likely to disclose earnings forecasts—both in periods of good and bad news—and their forecasts are also more precise and for longer horizons. Furthermore, Baginski et al. corroborate prior findings that U.S. forecasts appear more often, are less precise, and are of a shorter horizon when related to bad earnings news, whilst Canadian forecasts are less likely to display these bad news-related tendencies.

3.2.6

Signal of Firm Quality

Making voluntary disclosures can moderate the information asymmetries in markets when the more informed party signals private information to the outside world (Watson et al. 2002). In this respect, following the signalling theory, firms with above average characteristics suffer an opportunity loss, because these properties could increase the stock prices if investors knew about the firm’s superiority; in contrast, firms of below average properties would make an opportunity gain (Morris 1987: 48).11 Therefore, firms with superior properties or of higher quality have a convincing incentive to transfer their superior quality to investors in order to increase their stock prices. Investors learn about firms’ quality by means of signals that higher quality firms convey to the outside world. Already in 1990, Baruch Lev and Stephan Penman argued that, on average, firms with good news voluntarily disclose forecasts in order to differentiate themselves from firms with worse news. We understand, as underlined in the above Sect. 3.2.2, that the voluntary information conveyed must be considered adequately credible, otherwise the intended signal of quality cannot successfully produce the desired effect.12

11 The concept is strictly related to the adverse selection; in fact, as seen in the market for lemon paradox, the higher quality sellers leave the market unless they can convey the superior quality of their products and, as a consequence, increase the prices of their products (Akerlof 1970). 12 For a deeper analysis of the credibility perception from the eyes of the analysts and the investors, see Eccles et al. (2001), maintaining that “credibility and transparency go hand in hand. This proves especially true if management has made and delivered on past promises. Credibility, of course, ultimately depends on performance, but candour certainly enhances it. When objectives go unmet, or performance lags along some financial or nonfinancial dimension, management’s best tack always is candor. By consistently providing information in both good times and bad, management reinforces its credibility with the marketplace. The market hates surprises, especially negative ones”.

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Michael Spence, the father of the signalling theory, assumes—in the job markets context—that employers interpret potential signals (e.g. employee education) according to past experiences with the relationship between employee productivity and the particular signal, and based on this, they respond by offering the employee a certain level of remuneration (Spence 1974, 1976, 1978). Converting the situation to the relationship between managers and investors, the managers have incentives to signal firms’ future growths. In this sense, prior literature endorses the predictions derived from the signalling theory by showing, for instance, that managers use environmental disclosures to signal inimitable firm-specific resources (Toms 2002) or engage in upward revaluations of assets and voluntary disclosures about intangibles to signal the gap between the firm’s market value and book value to the stakeholders (Whiting and Miller 2008). From the signalling theory perspective, the firms’ size and industry membership can also explain why firms voluntarily disclose ratios with the intent of improving communication functions and quality (Watson et al. 2002). Elzahar and Hussainey (2012) explore the determinants of narrative risk disclosures in interim reports in the UK and their empirical analysis shows that larger firms are more likely to disclose more risk information, reducing information asymmetries. Furthermore, Elzahar and Hussainey show that the industry activity type is positively associated with the levels of narrative risk disclosure in interim reports. However, they fail to find that other firm-specific characteristics, such as liquidity, gearing, profitability, and cross-listing, as well as corporate governance mechanisms, have a statistically significant impact on narrative risk disclosure. From a theoretical perspective, prior literature agrees that the signalling theory and agency theory go hand in hand with significant overlaps between the two. Both theories predict a rational behaviour of all market participants and information asymmetries. Signalling costs are also implied in certain bonding tools of the agency theory (Morris 1987). Overall, both the agency and the signalling theories help explain the different issues that voluntary disclosure can address. From the signalling theory perspective, voluntary disclosure is a signal sent to the capital markets in order to limit the information asymmetry, optimize the cost of capital, and maximize the firm’s value. From the agency theory perspective, voluntary disclosure acts as a monitoring device that reduces information asymmetries, fostering the managers’ control and aligning their incentives with those of the shareholders (Watson et al. 2002; Gallego Álvarez et al. 2008; Sun et al. 2010; Elzahar and Hussainey 2012).

3.2.7

Agency Costs

A key aspect of the agency theory is that the principal operates with imperfect information whilst the agent has the full set of information, thus leading to unequal information, i.e. information asymmetry, which is to the agent’s advantage (Arrow 1984). Under the agency theory, both agent and principal are expected to be rational and take optimal decisions (Fama 1980; Fama and Jensen 1983). However, having

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reduced information, the principal may select the wrong agent for the task, leading to the question of the adverse selection problem.13 Assuming that both the principal and the agent aim at maximizing their own self-interests, we derive that the agent might behave opportunistically (Jensen and Meckling 1976). It is practically impossible for the principal to protect him against the agent’s behaviour. There are, nonetheless, few actions that can mitigate the agency problem, voluntary disclosure being one of them. Therefore, according to Leftwich et al. (1981: 57), firms are expected to exhibit one or more of the following monitoring mechanisms: “(i) publication of accounting reports, (ii) appointment of outside directors, (iii) listing requirements of stock exchanges”. However, managers are inherently unwilling to disclose private information, since these disclosures would weaken their private control advantages. Asymmetric or complete retention of information makes it tougher for capital providers and labour markets to actually discipline and control the entrenchment of management (Shleifer and Vishny 1989). In this context, Berger and Hann (2007) suggest that managers withhold poorly performing segment information when agency costs are the prime motivation. A strand of the literature contends that it is more likely that costlier monitoring devices are employed in relatively less transparent firms. In a scenario of increased information opaqueness, stronger corporate governance structures may act as a monitoring substitute and compensate for low timeliness of information (Bushman et al. 2004). Furthermore, there is evidence that lower managerial ownership and significant government ownership are associated with increased voluntary disclosure, whereas an increase in outside directors reduces voluntary disclosure. Altogether, these results corroborate the expected substitute relationship between corporate governance and voluntary disclosure for monitoring purposes (Eng and Mak 2003). To mitigate the agency concerns of managerial reluctance to disclosure, Nagar et al. (2003) suggest the use of stock price-based incentives to extract information from managers. The reasoning behind this is that stock-price incentives would encourage good and bad news. Issuing good news increases stock prices, but issuing bad news is also better than remaining silent, which would be interpreted worse from the perspective of a rational investor (Verrecchia 1983; Dye 1985; Nagar et al. 2003). It is worth noting that even if the agency theory is one of the major reasons for voluntary disclosure derived from prior research, it is not the only reason. In this regard, we recall Schipper who emphasized the following in 1981: “It may also be that agency and monitoring theory is not the best basis for explaining voluntary reporting frequency. Another potential source of explanation is the production13

Arrow (1984) invokes the adverse selection problem with the hidden-information problem. The Author (1984: 2) explains as follows: “In the hidden-knowledge problems, the agent has made some observation that the principal has not made. The agent uses (and should use) this observation in making decisions; however, the principal cannot check whether the agent has used his or her information in the way that best serves the principal’s interest”.

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investment decisions of reporting firms. It may be that firms that report more frequently generate reportable information more rapidly, or that their underlying wealth-generating processes are better understood if sampled more often. I suggest these alternative explanations to make clear that while the monitoring function of accounting is no doubt very useful in developing positive theories of accounting, it is by no means the only explanation one should consider”. Next follows a discussion of three other related reasons why managers may engage in voluntary communications, namely to increase the stock liquidity, to increase the firm’s value, and to reduce the cost of capital.

3.2.8

Stock Liquidity, Firm Value, and Cost of Capital

The pivotal studies by Glosten and Milgrom (1985) and Kyle (1985) model market liquidity as a function of the market’s adverse selection where public disclosure is precluded from the models, as the disclosure would invalidate the privately informed agent’s informational advantage. Starting from these models, Welker (1995) examines how persistent disclosure practices,—which are different from isolated announcements,—impact on market liquidity. Welker expects that the adverse selection problem would decrease market liquidity in non-disclosure periods. The results confirm the expected relationship between disclosure practices and liquidity measured through the bid-ask spreads even after controlling for return volatility, trading volume, and share price. As such, we derive that disclosure reduces information asymmetries, which consequently increases the stock liquidity. Within this longstanding stream of literature, Healy et al. (1999) examine whether firms benefit from expanded voluntary disclosure by inspecting the changes in capital market factors that are associated with increases in the analyst disclosure ratings. Overall, the disclosure rating increases are associated with increases in stock returns, institutional ownership, analyst following, and stock liquidity. Botosan and Harris (2000) explore the factors influencing managers’ decisions to issue quarterly segment reporting and how these decisions affect information asymmetry and analyst following. The results suggest that the firm’s decision to initiate quarterly segment disclosures derives from the previous 2 years decline in liquidity and increase in information asymmetry, which led to a change in disclosure frequency. More recently, Schoenfeld (2017) documents that voluntary disclosure changes the level of information asymmetry amongst traders, and it will consequently also change the level of stock liquidity. He tests whether disclosure affects stock liquidity and derives, first, that when a firm enters the S&P 500 Index, voluntary disclosure rises with the level of ownership assumed by index funds. Second, the increase in disclosure is accompanied by an increase in stock liquidity, which denotes that voluntary disclosure increases stock liquidity. Research published in the Journal of Finance shows that, once corrected for endogeneity, firms can manage their share

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liquidity through voluntary disclosure. Moreover, there is evidence that greater liquidity increases firm value, which, in turn, means that voluntary disclosure decreases the firm’s cost of capital (Balakrishnan et al. 2014). The voluntary disclosure’s positive impact on the firms’ value is also verified in emerging countries. For instance, there is evidence that, in Jordan, the enhanced voluntary disclosure levels of privatized firms significantly affect the firm value of these firms (Al-Akra and Ali 2012). Considering the relationship between firm value and voluntary disclosure, Plumlee et al. (2015) focus on environmental disclosure quality. Consistent with their expectations, they find that voluntary environmental quality is positively associated with firm value through both the cash flow and the cost of equity components. With a similar intent, Orens et al. (2009) empirically investigate how web-based intellectual capital reporting impacts on the firm’s value and its cost of finance. They show that the extent of intellectual capital disclosure is positively associated with firm value. These findings suggest that firms in continental Europe disclosing more intellectual capital information exhibit lower information asymmetry, lower implied cost of equity capital, and lower rate of interest. Still in the stream of literature on intellectual capital, prior studies demonstrate that human capital information improves firms’ value. The relationship between labour cost disclosures and the market value of equity is significantly positive, overall implying that investors consider labour cost as a proxy to human capital investments and integrate this additional piece of information in their firm valuation (Lajili and Zéghal 2005). Relatedly, corporate responsibility reporting influences firms’ value. Firms with a higher extent of corporate responsibility reporting are likely to have higher share prices compared to firms having lower levels of corporate responsibility reporting (de Klerk and de Villiers 2012). In this context, a paper published in The Accounting Review, examines how carbon emissions and the act of voluntarily disclosing carbon emissions impact on firm value. After having corrected for self-selection bias from managers’ decisions to disclose carbon emissions, the results indicate that, on average, for every additional thousand metric tons of carbon emissions, firm value decreases, but the median value of firms that disclose their carbon emissions is higher than that of comparable non-disclosing firms (Matsumura et al. 2014). Lastly, a large body of literature argues and documents a negative association between voluntary disclosure and cost of capital (e.g. Diamond and Verrecchia 1991; Botosan 1997; Cheynel 2013). Francis et al. (2005) explore the disclosure incentives and effects on the cost of capital in a sample of 34 countries. They prove that industries characterized by greater external financing needs tend to have higher voluntary disclosure levels, and that this increased level of disclosure leads to a lower cost of debt and a lower cost of equity capital. In a comprehensive study, Dhaliwal et al. (2011) explore the benefits related to the launch of corporate social responsibility voluntary disclosures, specifically resulting in a reduced cost of capital. Moreover, they show that companies with a high cost of equity are likely to issue a corporate social responsibility disclosure in the following year and that those companies with superior social responsibility performance experience a subsequent decrease in the cost of capital. Furthermore, these firms attract institutional

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investors and analyst coverage. Finally, it is more likely that firms initiating voluntary disclosure exploit the benefit of a lower cost of capital that follows the voluntary communication by raising significantly larger amounts than firms who do not initiate such disclosures.

3.3

The Role of Corporate Governance

It is generally acknowledged that the lemons problem can be addressed or at least limited not only by enforcing of the regulation that requires disclosure, but also with softer mechanisms amongst which the corporate governance structures play a primary role (Armstrong et al. 2010). In a scenario of incomplete contracts and limited rationality, both corporate voluntary disclosure and good corporate governance practices compel managerial accountability. In fact, voluntary disclosure helps mitigate information asymmetries in smoky information environments. At the same time, when corporate governance structures follow best practices, it is possible that managerial opportunism is limited and, furthermore, that the good stewards are more inclined to voluntary disclose. On these premises, Enache and Hussainey (2019) explore the joint effect of corporate governance and voluntary disclosure on firm performance to understand whether they are independent, substitutive, or complementary. The results indicate that informative and reliable product-related voluntary disclosure and corporate governance have a positive effect on firm performance. However, the marginal beneficial impact of corporate governance decreases in the presence of voluntary disclosure and vice versa. Enache and Hussainey infer that, to the extent that both mechanisms are costly, in this context, firms with informative disclosures can substitute corporate governance for voluntary disclosure and vice versa. A few years earlier, Ernstberger and Grüning (2013) assess along parallel lines how a country’s regulatory environment interplays with firms’ corporate governance structures to determine the disclosure provided in the annual reports. The increased transparency brought about by robust corporate governance devices might have two effects. On the one hand, a strong legal environment may further increase the voluntary disclosure propensity, with the two tools,—legal environment and corporate governance,—having a complementary relationship with respect to transparency. On the other hand, robust corporate governance structures may serve as a substitutive tool in weak legal environments. Past research shows that corporate governance structures and the legal environment substitute each other with respect to their outcomes on corporate disclosure (Filatotchev et al. 2013). In a very recent scientometric analysis on corporate social responsibility, Ferramosca and Verona (2019) agree that corporate governance and disclosure are closely connected and that they are increasingly debated in recent times. Prior literature mostly focuses on the corporate governance drivers or brakes with regard to increased voluntary disclosure. The main thrust is that a better designed corporate governance structure improves the corporate voluntary disclosures. Prior studies on

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the relationship between voluntary disclosure and corporate governance are basically dedicated to specific corporate governance devices. These can be classified into three groups: 1. Board characteristics; 2. Firm characteristics and monitoring environment; and 3. Ownership composition. In the following subparagraphs, we organize our literature review of the relationship between voluntary disclosure and corporate governance according to the above tripartite classification.

3.3.1

Board Characteristics and Voluntary Disclosure

The characteristics of the management and the composition of the board of directors have the potential to influence firms’ disclosure choices. In an interesting piece of research, Bamber et al. (2010) document that top executives exert unique and economically significant influence on the firms’ voluntary disclosures. Furthermore, managers’ unique disclosure styles are related to the observable demographic characteristics of their personal experiences. Particularly, managers who were promoted from finance, accounting, and legal career tracks, managers born before World War II, and those with military experience display certain conservative disclosure styles; managers from finance and accounting and those having military experience also exhibit more precise disclosure styles. In an Australian sample, Lim et al. (2007) explore the relationship between the overall voluntary disclosure and the diverse components of voluntary disclosure, such as forward-looking, strategic, non-financial, and historical financial disclosures and board composition. Lim et al. find that board composition and the voluntary disclosure of information in annual reports are positively associated and that independent boards voluntarily disclose a larger amount of forward-looking information and strategic information. However, up till now it seems that board composition does not affect the voluntary disclosure of non-financial and historical financial information. In the specific context of forward-looking statements in the narratives of annual reports, Wang and Hussainey (2013) identified amongst the leading clinchers of voluntary disclosure the directors’ ownership, the board size and its composition, and the CEO duality. Analyses in the Hong Kong setting suggests that CEO duality is associated with lower levels of voluntary corporate disclosures. However, the negative association between CEO duality and voluntary disclosure is weaker when the proportion of expert, non-executive directors is higher (Gul and Leung 2004). Similarly, in the Chinese market, CEO duality is associated with decreased voluntary disclosure (Huafang and Jianguo 2007). Still in the Hong Kong setting, there is evidence that the appointment of an independent chairman is positively associated with the degree of voluntary disclosure and this also appears to mitigate the negative effect of family ownership on

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voluntary disclosures (Chau and Gray 2010). There is also evidence that companies with a higher proportion of independent directors are associated with increased voluntary disclosure (Cheng and Courtenay 2006; Huafang and Jianguo 2007). Furthermore, the presence of independent directors has a positive association with the attention to format presentation of internet disclosure and with the availability of English web pages in the Chinese context (Xiao et al. 2004). Voluntary disclosure is also positively associated with the number of non-executive directors on the board, and firms with a non-executive chairman release more voluntary disclosures than other firms (Donnelly and Mulcahy 2008). Conversely, Eng and Mak (2003) show that outside directors lead to less corporate voluntary disclosures. Similarly, the proportion of non-executive directors on the board is negatively associated with voluntary disclosure in a Kenyan sample of listed companies (Barako et al. 2006). After having divided companies between high and low ownership concentration (above and below 25%), Leung and Horwitz (2004) find that the proportion of outside directors is positively associated with voluntary segment disclosure, but only for the low director ownership sub-sample. Based on a sample of Italian, non-financial, listed companies characterized by a dominant shareholder, Patelli and Prencipe (2007) display a positive association between the proportion of independent directors and the extent of voluntary information disclosed in the annual reports. Examining the individual components of information, the presence of independent directors is more positively associated with information related to current performance than is the case with information concerning the past results or results expected in the future. From an agency perspective (see Sect. 3.2.7), the voluntary disclosure also reflects managerial incentives. In detail, top executives postpone good news and anticipate bad news for compensation-related incentives. This disclosure strategy allows managers to gain personal monetary returns. Indeed, they opportunistically disclose bad news, thereby decreasing the firm’s stock price before the award date, whilst the stock price increases after the award when the good news is disclosed (Aboody and Kasznik 2000).

3.3.2

Firm Characteristics, Monitoring Environment, and Voluntary Disclosure

The firm-monitoring environment, as well as the firm-specific characteristics, help explain the levels of disclosure. Ho and Wong (2001) and Barako et al. (2006) show that the presence of an audit committee is positively related to the extent of voluntary disclosure. According to Wang et al. (2008), Big Four accounting firms’ clients exhibit a higher quantity of corporate information disclosed. Wang et al. further uncover a positive association between voluntary disclosure and firms’ financial performance measured according to return on equity. In contrast, liquidity,

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profitability, and the type of external auditor do not significantly influence the level of voluntary disclosure by companies in Kenya (Barako et al. 2006). Accordingly, the larger the firms’ size (Eng and Mak 2003; Barako et al. 2006; Raffournier 2006) and its foreign activity (Depoers 2000; Raffournier 2006), the greater the disclosure. At the same time, firms with growth opportunities are unwilling to voluntarily disclose information (Huafang and Jianguo 2007). Firms with high labour charges and proprietary costs resulting from the potential entry of new competitors are more likely to hide their information (Depoers 2000). The results concerning the relationship between leverage and voluntary disclosure are mixed: The relationship can be either positive (Barako et al. 2006) or negative (Eng and Mak 2003). In the context of environmental disclosure, Brammer and Pavelin (2006) prove that larger and less leveraged firms are more likely to make voluntary disclosures. Larger firms are also associated with higher quality disclosure. Xiao et al. (2004), focusing on a sample of Chinese listed firms, explore what types of firms provide voluntary Internet-based corporate disclosures (ICD), whilst others do not. They find that larger, more leveraged firms are more likely to employ ICD. Moreover, Xiao et al. also suggest that the type of industry affects corporate disclosure. Indeed, firms in the IT industry disclose more information, and they have more extensive and sophisticated presentation formats. In contrast, the abovementioned authors do not find any association with firm performance, nor with the asset structures measured as the proportion of fixed assets to total assets. They, furthermore, explore what are the types and characteristics of information voluntarily disclosed on companies’ web sites and, if the content of the ICDs differs across companies, what are the determinants of the differences. In this context, along the same line of research exploring the relationship between external control and voluntary disclosure, Xiao et al. find that the companies audited by the Big Five accounting firms are not associated with the extent of disclosure nor with its content and format of presentation. However, they found a significant and positive association with the disclosure that falls outside of the scope required by the China Securities Regulatory Commission. All in all, the above-mentioned authors (2004) agree that Chinese firms’ ICD is responsive to the environment. Samaha et al. (2015), in a meta-analysis study, explore the link between board size, board composition, CEO duality, audit committee, and voluntary disclosure— and they verify whether these relationships are moderated by the differences in disclosure type, method, and construction, by the differences in research setting, and by the differences in the measurement of explanatory variables. Overall, Samaha et al. find a significant positive association between board size, board composition, audit committee, and voluntary disclosure, whereas the CEO duality has a negative impact on voluntary disclosure. This negative impact of CEO duality on voluntary disclosure is more prominent in high investor protection environments, signifying that the litigation process in high quality judicial systems moderates managers’ motivations to disclose. Furthermore, the type of disclosure and the method of disclosure moderate the association between voluntary disclosure and CEO duality. Moreover, their subgroup meta-analytic outcomes demonstrate that country location moderates the association between board size, board composition, CEO duality, and

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voluntary disclosure. Last but not least, the variances in the delineation of the explanatory variables moderate the relationship between board composition and voluntary disclosure.

3.3.3

Ownership Composition and Voluntary Disclosure

An extensive body of literature supports the notion that not only board-specific and firm-specific characteristics, but also the ownership composition, influence the firm’s propensity for voluntary disclosure. In this context, lower managerial ownership and significant government ownership contribute to increased voluntary disclosure (Eng and Mak 2003). Wang et al. (2008) consistently witness an expansion in voluntary disclosure by Chinese companies with higher stakes of ownership in the hands of the state. Similarly, past research shows a positive association between voluntary disclosure and foreign investors (Huafang and Jianguo 2007; Wang et al. 2008). Conversely, Xiao et al. (2004) exhibit that voluntary Internet-based disclosure is positively and significantly associated with the proportion of legal person ownership, but not with domestic private investors, foreign investors, and state ownership. Nevertheless, the presence of foreign investors has a positive association with whether a firm has an English web site. Leung and Horwitz (2004) document that the relationship between managerial ownership and voluntary disclosure is not linear. Specifically, voluntary segment disclosure is positively associated with director ownership when the percentage of managerial shares held is lower than 25%. Conversely, when the managerial ownership raises above 25%, the relationship with segment voluntary disclosure becomes negative, confirming the alignment of interests between owners and managers, as expected. Likewise, the percentage of family members on the board is negatively related to the extent of voluntary disclosure (Ho and Wong 2001). In a comparison study between disclosure practices of family and non-family firms, results again reveal that family firms make less voluntary disclosures about corporate governance practices in their filings, implying that family firms are interested in limiting the transparency of corporate governance practices to expedite family members’ appointment on boards without obstruction from non-family owners (Ali et al. 2007). Moreover, family firms provide fewer earnings forecasts and conference calls than non-family firms, confirming the idea that family shareholders have a longer investment horizon, monitor management better, and brings about lower information asymmetry between owners and managers, which makes the demand for voluntary disclosure less strong (Chen et al. 2008). In the Asian contexts of Hong Kong and Singapore, an investigation of annual reporting practices documents that more voluntary disclosure is provided in the case of larger outside ownership. These results further corroborate the idea that the level of disclosure is likely to be reduced in insider or family firms (Chau and Gray 2002). With the intent to extend prior research on voluntary disclosure by Hong Kong firms, Chau and Gray (2010) verify whether the association between the level of voluntary

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disclosure and the extent of family ownership is nonmonotonic based on the convergence of interest and management entrenchment hypotheses. The abovementioned authors show that at moderate to low degrees of family ownership (25% or less), the convergence of interest effect prevails and the level of voluntary disclosure is relatively low. However, at higher degrees of family ownership (more than 25%), the entrenchment effect predominates, leading to higher voluntary disclosure, thereby enabling outside investors to monitor effectively. Huafang and Jianguo (2007) similarly document a positive association between blockholder ownership and voluntary disclosure. Nonetheless, there is a stream of literature that failed to find a significant association between ownership composition and voluntary disclosure (e.g. Donnelly and Mulcahy 2008). In this sense, Huafang and Jianguo (2007) show a lack of association between voluntary disclosure and managerial, state, and legal-person ownerships. The study of Eng and Mak (2003), instead, indicate no associations between blockholder ownership and voluntary disclosure.

3.4

Management Forecasts and Conference Calls

Management forecasts fall into the voluntary disclosure and, as such, managers have freedom of choice in terms of form (i.e. quantitative vs. qualitative), horizon (e.g. quarterly and annual), and timing of the forecast (Beyer et al. 2010). Managers, because of their future perspective on and insider knowledge concerning the firm, are in the position to issue earnings forecasts in advance of actual earnings publications. These earlier announcements are not indifferent to the firm’s market value, as they enter into the stakeholders’ decision-making process, reducing the information asymmetries between insiders and outsiders. Management forecasts provide investors with an advanced assessment of the managers’ future plans and projects that can turn into increased firm value (Trueman 1986). Penman (1980) indicates that earnings forecasts, on average, retain information that is relevant to the valuation of firms and, hence, these forecasts contribute to the investors’ decision-making process. Penman demonstrates, through the results of the excess returns tests, that disclosure is actually transferred to investors via the forecast announcement. Another pivotal study explores the association between earnings volatility and corporate disclosure choices related to management forecasts in terms of frequency and timing. Firms releasing earnings forecasts more frequently enjoy less volatile earnings processes than firms releasing such forecasts infrequently. Furthermore, in the latter case, firms release their projections in later quarters, thereby shortening the length of the forecast horizon (Waymire 1985). More recent research confirms the market reaction to earnings forecasts. Earnings forecasts prove to be biased by both managerial incentives (i.e. litigation environment, insider trading activities, firms’ financial distress, and industry concentration) and the market’s ability to detect misrepresentation. The latter bias implies that the

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market’s response to the forecast news varies according to the type of forecast news. For good news forecasts, the market responds less (more) positively to forecasts with greater predicted optimism (pessimism), whilst for bad news forecasts, there is weak evidence of variation (Rogers and Stocken 2005). Managers can produce more credible earnings forecasts by including supplementary information. In this context, Hutton et al. (2003) document that managers augment their firms’ earnings forecasts with supplementary disclosures about two-thirds of the time and that good news forecasts are more likely to be accompanied by verifiable forward-looking statements. Furthermore, the reaction to bad news produces a stronger negative reaction than mostly positive reaction produced by good news forecasts. Nonetheless, good news forecasts are only informative if issued with other verifiable forward-looking statements. Otherwise, the stock price reaction is close to zero. In contrast, bad news earnings forecasts appear to be always informative and, therefore, credible (Hutton et al. 2003). Following the ambiguity theory, a recent work investigates how market uncertainty influences earnings guidance perception and behaviour. Empirical evidence shows a more pronounced negative stock reaction to negative earnings guidance; in addition, managers are less likely to release negative earnings guidance under greater market uncertainty. In contrast, the share price reaction to positive guidance is not related to the degree of market uncertainty and managers are less likely to issue positive guidance with higher market uncertainty (Agapova and Madura 2016). The earnings guidance relevance is highlighted also from another perspective, which considers both the causes and consequences of stopping quarterly earnings guidance (Houston et al. 2010). In fact, empirical evidence suggests that poor operating performance is a major reason for guidance interruption to the detriment of the firm’s overall information environment (Houston et al. 2010). Chen et al. (2011) further explore why certain firms, deciding to interrupt the provision of voluntary disclosure, prefer to publicly announce the guidance termination. The above-mentioned authors document that managers announce the cessation of guidance when they do not envisage good news to disclose in the future, and if the presence of long-term investors weakens the reason to disclose short-term information. Management forecasts are also crucial in addressing financial analysts’ estimates. In this sense, Cotter et al. (2006) show that analysts quickly revise their earnings forecasts in straight response to management guidance and they are more likely to produce final meetable or beatable earnings targets when management announces guidance. The use of conference calls represents another relevant channel for voluntary disclosure to affect investors’ and financial analysts’ estimates. Corporate conference calls take the form of large-scale telephone conference calls during which managers provide presentations to and may answer questions from many market participants, most often about earnings (Frankel et al. 1999). There is empirical evidence highlighting how the earnings-related conference calls can expand the amount of information available to financial analysts, thereby increasing their ability to forecast earnings accurately and decreasing dispersion amongst analysts. Conference calls can reduce analysts’ forecasting performance differences by levelling

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them amongst analysts (Bowen et al. 2002). Along this stream of literature, Kimbrough (2005) extends prior studies on conference calls providing evidence that the initiation of conference calls is associated with a significant reduction in the serial correlation of analyst forecast errors. Kimbrough further finds that the initiation of conference calls is negatively associated with two measures of initial investor underreaction, such as post-earnings announcement drift and the proportion of the total market’s reaction to firms’ delayed earnings announcements, especially for small and less traded firms. Similarly, Bassemir et al. (2013) document that conference calls expand analysts’ ability to forecast future earnings accurately. They argue that the commitment to additional disclosures is likely to yield greater effects in a less stringent disclosure system (Verrecchia 2001) by showing that the reduction in forecast error is significant and larger in Germany than in the United States (Bowen et al. 2002). Earlier studies on conference calls suggest that firms with less informative financial statements are more likely to host conference calls. These results underly the pivotal role of quarterly conference calls in limiting the information asymmetry between managers and outsiders (Tasker 1998). Frankel et al. (1999) describe the characteristics of firms hosting conference calls. These firms usually are larger, have a greater analyst following and access to capital markets more often than other firms. Moreover, Frankel et al. find that firms in high-tech industries and with higher-thanaverage market-to-book ratios and sales growth rates are more likely to host conference calls; this last result suggests that firms with higher expected growth are more likely to hold conference calls, maybe because they have greater information asymmetries. Brown et al. (2004) empirically document that information asymmetry is negatively associated with conference call activity. Indeed, firms regularly holding conference calls report significant decreases in information asymmetry, whereas one-time callers do not experience a significant decline in asymmetry. In line with prior literature displaying an increased cost of equity capital with an increased level of information asymmetry, Brown et al. (2004) suggest that firms hosting conference calls more frequently have lower costs of capital. Matsumoto et al. (2011) further examine the incremental information content of each segment of the conference calls, namely the presentation segment and the discussion segment. The latter mentioned authors verify that the presentation segment and the discussion segment have incremental information content over the accompanying press release, but that the discussion portion of the call produces statistically greater abnormal, absolute returns, implying its relative higher informativeness. Furthermore, this research documents that managers provide greater disclosures in the presentation and discussion segments when performance is poor and that relatively more information is issued during discussion periods in the poorer performance scenario. Overall, the results are consistent with the idea that active analysts’ involvement in conference calls increases the informativeness of the calls, especially for poor performing firms. An emerging path of research explores whether managers strategically manage firms’ information environment, leading to acceptance that financial reporting and

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other voluntary disclosures should become integrated into a bigger schema around disclosure decisions, capital structure, and payout policies (Miller and Skinner 2015).

3.5

Intellectual Capital Reporting

In a knowledge-based economy, the importance of intangible and intellectual resources is in the limelight. However, the majority of these resources are not and cannot be appropriately reported in the conventional and mandatory financial statements. Generally, accounting standards do not allow organizations to recognize intellectual capital resources as intangible assets unless they can be reliably measured, which realistically means unless they are purchased. This motivates the appeal for voluntary disclosure. Organizations that avoid to communicate their intellectual resources intensify the information asymmetries with the users of the disclosure (Vergauwen and van Alem 2005). A corollary of deficient or missing reporting on intellectual capital is the market’s efforts at assessing the firm’s value (Pantzalis and Park 2009). The concern around this informational gap can be bypassed by means of voluntary disclosure providing additional material on, for instance, the firm’s strategies, competencies, human resources skills, staff turnover, training, and customer satisfaction (Mouritsen et al. 2005). Very briefly, all these valuable resources outside of the statement of financial position’s scope are reduced to the wider intellectual capital concept. Prior literature on intellectual capital failed to find a broadly accepted definition of intellectual capital (Marr 2005). However, there seems to be consensus on the fact that most definitions, even from diverse perspectives, agree that intellectual capital is a multifaceted concept containing diverse, but related factors (de Frutos-Belizón et al. 2019). Intellectual capital traditionally includes three categories of capital: structural, relational (or customer), and human (Saint-Onge 1996; Bontis 1998; Kristandl and Bontis 2007; Martín-de-Castro et al. 2010; Ferramosca and Ghio 2018b).14 An accredited definition within the three-component interpretation can be derived from the project entitled “Measuring and reporting intangibles to understand and improve innovation management” (MERITUM 2002) involving six European countries (Denmark, Finland, France, Norway, Spain, and Sweden). This project tries to support the identification, management, and measurement of intellectual capital.

14

We admit that this is the traditional tripartition of intellectual capital; nonethless, there is countless alternative categorizations of intellectual capital (Blankenburg 2018) that include components, such as innovation capital (e.g. Joia 2000), process capital (e.g. Wang and Chang 2005), renewal capital (e.g. Kianto 2008), and entrepreneurial capital (Inkinen 2016), to cite but a few of the most debated components.

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Following the MERITUM (2002: 10) guidelines, “Intellectual capital is the combination of the human, organizational and relational resources of an organization”.15 The tripartition of intellectual capital into human, organizational, and relational capital is also fully acknowledged by the World Intellectual Capital/Assets Initiative (WICI 2016).16 If, on the one hand, the lack of a straightforward delineation of the intellectual capital construct leaves flexibility in identifying the factors contributing to it, then, on the other hand, the efforts required for measuring and successively disclosing it are more complex. In this context, flexibility assumes a prominent relevance, given that the intellectual capital properties are strongly derived from each organization’s business model and specific characteristics. Yet, the higher the flexibility, the lower the comparability and disclosure effectiveness may be. The intellectual capital reporting preferences, therefore, are tied to the uniqueness of the resources and the related values that should be disclosed. When considering how and what to report with reference to intellectual capital, it is enlightening to consider the words by Roos and Roos (1997: 415) who suggest that “Intellectual capital is the sum of the ‘hidden’ assets of the company not fully captured on the balance sheet, and thus includes both what is in the heads of organizational members, and what is left in the company when they leave”. Therefore, in the absence of clear-cut boundaries of what intellectual capital is, reporting it cannot be restricted to fix boundaries. Reporting on intellectual capital has to include all the organization-wide knowledge

The guidelines further specifically define all three components as follows: “Human capital is defined as the knowledge that employees take with them when they leave the firm. It includes the knowledge, skills, experiences, and abilities of people. Some of this knowledge is unique to the individual, some may be generic. Examples are innovation capacity, creativity, know-how and previous experience, teamwork capacity, employee flexibility, tolerance for ambiguity, motivation, satisfaction, learning capacity, loyalty, formal training, and education. Structural capital is defined as the knowledge that stays within the firm at the end of the working day. It comprises organizational routines, procedures, systems, cultures, databases, etc. Examples are organizational flexibility, a documentation service, the existence of a knowledge centre, the general use of Information Technologies, organizational learning capacity, etc. Some of them may be legally protected and become Intellectual Property Rights, legally owned by the firm under a separate title. Relational capital is defined as all resources linked to the external relationships of the firm, with customers, suppliers, or R&D partners. It comprises that part of Human and Structural Capital involved with the company’s relations with stakeholders (investors, creditors, customers, suppliers, etc.), plus the perceptions that they hold about the company. Examples of this category are image, customers loyalty, customer satisfaction, links with suppliers, commercial power, negotiating capacity with financial entities, environmental activities, etc.” (MERITUM 2002: 10–11). 16 WICI (the World Intellectual Capital/Assets Initiative) maintains the value for corporate reporting that integrates the communication of narrative and quantified information with regard to how organizations create value over the short, medium, and long term by creating, managing, combining, and utilizing intangibles. WICI was formed in October 2007, and its participants include organizations representing companies, analysts, and investors, the accounting profession, and academia who collaborate to promote better corporate reporting by recognizing the role of intangibles/intellectual capital in an organization’s sustainable value generation. 15

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resources, management activities, and their combined effects (Mouritsen et al. 2002). Even though there is consensus on the need of a model to report the dynamics of wealth creation, especially in intangible-intensive firms and industries (Blair and Wallman 2001), a variety of corporate reports are used to disseminate information about intellectual capital (Striukova et al. 2008). Amongst the pioneers to report intellectual capital disclosures, the literature mostly refers to the Swedish company, Skandia, and the Danish company, Rambull, who enhance their annual reporting with numerous quantities of their intellectual capital already in 1994 (Petty and Guthrie 2000). Ever since the initial prototypes of intellectual capital reporting, an interplay amongst narratives, sketches, and measurables are used in order to actively provide a complete outlook of the company and not merely report on past events (Mouritsen et al. 2001). Initially, in the Skandia case, the first document containing intellectual capital information was a supplement to the annual report highlighting the neglected aspects concerning intellectual capital that were not integrated with the financial information (Edvinsson 1997). With reference to the disclosure and reporting of intangibles, which the framework envisions as basically corresponding to the concept of intellectual capital, the WICI (2016: 10) hastens to add that intangibles can be “reported and employed in various forms of corporate reporting, including integrated reports and business reports for both internal and external use”. In 2004, the European Commission perceived the need to further promote intellectual capital reporting. Thus, it established an expert group in order to propose a set of tools to encourage the disclosure and facilitating standardization of intellectual capital, especially in research-intensive small and medium enterprises. Published in 2006 under the name RICARDIS (i.e. “Reporting Intellectual Capital to Augment Research, Development and Innovation in SMEs”), the project was intended to improve the consistency of definitions and approaches across Europe, assuming a multi-stakeholder perspective. Consistent with prior practices, the RICARDIS report confirms that the intellectual capital process should result in an intellectual capital statement in which numbers are combined with narratives and visualizations fulfilling two main objectives. The first objective achieves the internal management scope by completing financial management information. The intellectual capital information acts “as an internal navigation tool to help develop and allocate resources—create strategy, prioritise challenges to the SMEs development, monitor the development of the SMEs results and thus facilitate decision-making” (Ricardis 2006: 47). The second objective fulfils the scope of external reporting by accompanying the financial statement and functioning “as a communication device to the SMEs environment that can be used to attract resources—financial resources, human resources, relationships with partners and customers, and technological resources” (Ricardis 2006: 47–48). In a similar logic, the WICI framework (2016: 1) admits the value for corporate reporting that integrates the interaction of narrative and quantified information on

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how organizations generate value over the short, medium, and long term, especially leveraging and using their intangibles.17 Overall, dealing with the intellectual capital resources and in line with the voluntary spirit of this disclosure, organizations can produce either a stand-alone report or include information within other extant reports. The WICI (2016) recommends five principles as fundamental from an intangible reporting perspective, i.e. materiality, connectivity, conciseness, comparability, and future orientation. Materiality requires that the intangibles, which are considered key in creating value, should be reported. Connectivity implies to dynamically consider the combinatorial effects of tangible and intangible assets, as well as the links amongst strategy, business model, and financial performance. Reporting the essential points as simply and understandably as possible is necessary to endorse the conciseness principle. Comparability in time and space ensures consistency of intellectual capital communications. Finally, basing on past and current facts and events, a futureoriented perspective allows to predictively imply the firm’s ability to create value in the future and the related risks. These principles were already addressed in the “Principles for Effective Communication of Intellectual Capital” issued by the EFFAS Commission on Intellectual Capital (2008) and the “International Framework” issued by the International Integrated Reporting Council (2013). Still, very recently CDP,18 the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Accounting Standards Board, the International Integrated Reporting Council, the International Organization for Standardization, and the Sustainability Accounting Standards Board (2019) advise seven key principles that are crucially important for the transparency and accountability of corporate reporting, i.e. materiality, completeness, accuracy, balance, clarity, comparability, and reliability.19 Figure 3.2 summarizes the concept covered in the WICI Framework and in the WICI taxonomy

17 Up ahead, we can understand the WICI’s (2016: 7) broad interpretation, mainly emphasizing intangibles, of business reporting: “A form of reporting which focuses on qualitative (narrative), quantitative, financially and non-financially expressed information about the past, present and future value creation process of an organisation and the strategy, the resources (especially of intangible nature), the governance and the organisational model which support it”. 18 The CDP, formerly the Carbon Disclosure Project, is a not-for-profit charity that runs the global disclosure system for investors, companies, cities, states, and regions to manage their environmental impacts (for further information see: https://www.cdp.net/en). 19 According to the joint paper, materiality refers to relevant information that is (capable of) making a difference to the users’ decision-making process. Completeness requires that all material matters that are identified for the relevant topic(s) should be reported upon. Accuracy means that the information reported should be free from material errors. The balance (or neutrality) principle requires unbiased information, i.e. the information is not presented such that it would increase the probability of the users receiving the information favourably or unfavourably. Clarity concerns the understandability and accessibility of information in relation to the users, including a certain degree of conciseness. The comparability principle recommends consistent information over time and across organizations. Reliability of the information processes and internal controls ensure information quality and allows for its verifiability.

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Fig. 3.2 Concepts covered in the WICI Reporting Framework included in the WICI Taxonomy (Source: Authors’ elaboration)

published with the intent to enable the disclosure, utilization, and examination of crucial material.20 Following the WICI (2016) framework, a sample structure for intellectual capital reporting may be as represented in Fig. 3.2 and concisely summarized in three points: 1. Overview of the company, focusing on the value creation, which involves managing for value, the market overview, the operating and economic performance, and the company’s strategy and structure. 2. The role of intellectual capital in the value creation process measured via ad hoc KPIs (Key Performance Indicators) for brand and intellectual assets, customers, economic performance, financial assets, innovation, market strategy, people, physical assets, and supply chain. More specifically, each KPI allows organizations to connect the past and present to the future, displaying, for example the firm’s strategic resources, as well as the risks and actions to take for improving intellectual capital and business sustainability. 3. Outline of the company’s environmental, social, and governance (ESG) stance covering environmental matters such as climate change, social matters such as a In Appendix to this chapter, the reader can find Table 3.1 that classifies the major Key Performance Indicators (KPIs) and information included in the WICI XBRL Taxonomy available at: http://www.wici-global.com/framework

20

3.6 Challenges and Opportunities for Voluntary Corporate Disclosure

85

firm’s labour practices, product safety and data security, and governance matters such as board diversity, executive remuneration, and ethics. Therefore, we can easily derive that the framework does not only include intellectual capital reporting, but also several disclosure-related aspects that, directly or indirectly, contribute to the overall firm value, such as ESG disclosure. Overall, the accomplishment of a common language to disclose the intellectual capital can contribute to its usefulness and understandability (Mouritsen 2003). Furthermore, informational asymmetries are limited when multiple factors are in force. In particular, we agree that a strong reason to disclose derives from the demand-side pressures that emphasize the disclosure of forward-looking and contextualized information (Abhayawansa et al. 2018). Not long ago, the final report by a European expert group on intellectual capital valuation emphasized the need for fostering a more advanced form of narrative disclosure regarding intellectual capital, recommending that the route in the future should be from voluntary to mandatory disclosure of such information (European Union 2014: 45).

3.6

Challenges and Opportunities for Voluntary Corporate Disclosure

The reporting of voluntary disclosure can be a catalyst for businesses to establish a virtuous cycle, as it contributes to limiting information asymmetries, building trust, boosting corporate image, signalling transparency, and accompanying the organization itself at identifying the strategic path to success and sustainability. At the end of this chapter, a few challenges and opportunities come to light, intersecting the research on voluntary disclosure with several other fields of research, including corporate governance, intellectual capital, and other managerial means of communications. To date, the literature around the pros and cons of corporate voluntary disclosure appears well explored, but promising niches of research can still be identified within the broad voluntary disclosure subject. A number of relevant research questions could be, for instance, the following: How do stakeholders other than investors and analysts influence corporate voluntary disclosure? How are diverse types of voluntary disclosure strategically integrated by firms and for what possibilities? What role does voluntary disclosure play in the distribution of power amongst insiders and outsiders? What kind of new communication channels do firms currently use or are expected to use in the future and what are their predictable effects? When considering the specific intellectual capital research, it appears that, to date, the effects of declaring the reports, including the intellectual capital material, are still under-researched. Moreover, research on how the public sector implements reporting practices with regard to intellectual capital is of paramount importance. Furthermore, the relationship between voluntary intellectual capital reporting and mandatory financial reporting constitutes another footpath for future researchers. A

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question to respond to, is, for instance: Are intellectual capital disclosures more or less value relevant depending on the quality of mandatory financial reporting? A related point is the disclosure of forecasting intellectual capital. This kind of information, also known as intellectual capital mapping, maybe even more relevant than the traditional component-based intellectual capital reporting. Finally, the disclosure of intellectual capital can be of paramount importance when investors and other stakeholders assert the firms’ organizational risks and liabilities. In this chapter, the authors supported and documented the importance of voluntary disclosure. Nonetheless, a counterargument may be opposed. More disclosure does not necessarily mean better disclosure and effective communication. As a matter of fact, disclosing all information at hand causes issues of understanding and additional costs for the reader, whilst transparency is actually achieved by producing comparable information, which is also related to the company’s strategic intent (Nielsen and Madsen 2009). Therefore, future researchers may further investigate the issues around disclosure quality and its relationship with comprehensiveness and understandability. The authors observed several organizations involved in formulating common principles for voluntary corporate disclosure. Overall, the recent frameworks from several organizations share a number of commonalities in terms of fundamental principles, which the authors tried to summarize in Table 3.2 reported in Appendix. However, in the jungle of disclosure frameworks, an agreed-upon synthesis of useful principles and standards for practitioners when developing voluntary disclosure becomes most relevant. The authors caution the reader that Table 3.2 reported in Appendix simply refers to a few of the most well-known frameworks; the table should not be considered exhaustive, neither can it bring about a full understanding of certain differences within the framework, especially at the definitional and application levels. Instead, the table is intended to highlight a number of similar expectations and points of alignment at the basic level of the diverse frameworks analyzed. These shared principles are a definite signal of all the participating organizations’ comparable expectations regarding the corporate reporting dialogue, actually supporting companies in following a common and standardized structure for preparing their voluntary disclosure. Of course, as suggested in a very recent International Auditing and Assurance Standards Board consultation paper on extended external reporting (EER) (IAASB 2019), “to make criteria relevant, it may be important for the preparer to understand the general nature of decisions the intended users are likely to take based on, or influenced by, the information in the EER report”. Consequently, the authors emphasize that the transparency achieved owing to the voluntary disclosure of non-financial information may serve in the decision-making process of the wider society in general, of governments, regulators, and legislators, as well as of the existing and potential investors and other stakeholders. The voluntary disclosure may influence decisions in lifestyle or quality of life as a result of the entity’s activities, legislation and policymaking, and matters relating to the entity’s or shareholders’ voting decisions.

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87

To conclude, the authors argue that to be a good investor, supplier, customer, employee, lender, or representative of national and local government, in the future one needs to understand as much about sustainability as one knows about gross profits, EBIT margin, earnings per share and so on. One needs to understand as much about climate change as one does about cash flows and returns on equity. People cannot have a holistic perspective on the firms’ viability and future perspectives if they do not comprehend its hidden resources, its intellectual capital. For corporations and stakeholders, the failure to disseminate relevant voluntary information can be hazardous. Indeed, operations are unavoidably affected, for example by climate change, or, the firm’s image may likewise be threatened, for example by a claim over gender discrimination (PricewaterhouseCoopers 2019). The theories commonly used in the studies on voluntary disclosure involve agency theory, capital need theory, legitimacy theory, and signalling theory; however, future studies may challenge the revelation of diverse theoretical frameworks to interpret corporate voluntary disclosure. For instance, an idea may be to extend the agenda-setting theory exploring the differences in the business usage of social and non-social media and how they affect investors, analysts, auditors, and other stakeholders’ reactions. Another possibility is to explore, under a knowledge-based theory, the diverse effects that good and bad news have on firm performance, risk appetite, innovation strategies, and involvement with communities, to name but a few. Which communication channels do the more successful firms prefer? Or, how do more successful organizations share knowledge? Finally, in a society overwhelmed by information, has the impact of good and bad news changed compared to the pre-Internet era? The next chapters will focus on the growing literature on environmental and social reporting, and the new communication channels providing a number of empirical evidence on these matters.

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Appendix Table 3.1 Prospective corporate voluntary disclosure of intellectual capital Corporate overview; landscape; corporate strategy; resources and processes; performance; business segment; geography Corporate reporting framework with KPI Managing for value Financial assets and liabilities; physical assets; customers; people; innovation; brands and intellectual assets; supply chain Market overview Competitive environment; regulatory environment; macro environment Performance Operating; economics Strategy and structure Goals and objectives KPI by category KPI category Regulation of intellectual assets; brands and intellectual assets Brands and intellectual goals and objectives; brands and intellectual assets, risk manageassets ment goals and objectives; intellectual assets management, investment and development goals and objectives; brand management, investment and development goals and objectives; marketing and advertising goals and objectives; brands and intellectual assets value generation goals and objectives; brands and intellectual assets reputation goals and objectives; managing for value— brands and intellectual assets; managing brand management, investment and development; managing intellectual assets management, investment and development; managing marketing and advertising costs and effectiveness; managing brands and intellectual assets value generation; managing awareness and perception of brand/corporate name; managing brands and intellectual assets risks; performance—operating—brands and intellectual assets; brand management, investment and development statistics; intellectual assets management, investment and development statistics; marketing and advertising statistics; brands and intellectual assets value generation statistics; awareness and perception of brand/corporate name; brands and intellectual assets risk management statistics KPI category Competitive environment; market definition; market size; market Customer growth; level of current and future competition; demographic trends—customers; seasonality of demand; customer goals and objectives; customer demographics, penetration and dependence goals and objectives; customer satisfaction goals and objectives; customer retention, loyalty and advocacy goals and objectives; customer revenue generation goals and objectives; customer costs goals and objectives; customer service, communication and relationship management goals and objectives; managing for value— customers; managing customer demographics, penetration, and dependence; managing customer satisfaction; managing customer retention, loyalty, and advocacy; managing customer revenue generation; managing customer costs; managing customer service, communication, and relationships; performance—operating— customers; customer demographics, penetration, and dependence (continued)

Appendix

89

Table 3.1 (continued)

KPI category Economic performance

KPI category Financial assets

KPI category Innovation

KPI category Market and strategy

statistics; market share statistics; customer satisfaction statistics; customers retention, loyalty, and advocacy statistics; customers revenue generation statistics; customer costs statistics; customer service statistics Selling price/margins environment; economic goals and objectives; total shareholder return goals and objectives; returns in excess of cost of capital objective; segmental return in excess of cost of capital objective; other economic performance objectives; performance—economic; performance—economic—economic performance; Total shareholder return; returns in excess of cost of capital; internal shareholder value metric; share price volatility; return on capital; weighted average cost of capital; economic capital charge; cash flow forecast period; free cash flow statistics; revenue growth; significant costs; selling price growth; sales volume growth and mix; restructuring costs/benefits; cost reductions; share options expense statistics; margins; cash profit margin statistics; earnings per share; cash profit margin; accounting tax rate/ charge; cash tax rate Economic environment; financial assets/liabilities goals and objectives; financial risk management (including financial instruments) strategy; investments goals and objectives; funding goals and objectives; capital goals and objectives; financial risks— identification and assessment; managing for value—financial assets and liabilities; managing investments; managing capital; managing funding; managing financial risks; performance—economic—financial assets; investments statistics; funding statistics; capital statistics; financial risk management statistics Market innovations; technological environment; innovation goals and objectives; innovation and exploration—risk management goals and objectives; innovation and exploration—value generation goals and objectives; innovation and exploration—investment and partnerships goals and objectives; innovation and exploration portfolio efficiency goals and objectives; managing for value— innovation; managing innovation and exploration investment and partnerships; managing innovation and exploration efficiency; managing innovation and exploration value generation; managing innovation and exploration risks; performance—operating—innovation; innovation and exploration investment and partnership statistics; innovation and exploration efficiency statistics; innovation and exploration value generation statistics; innovation and exploration risk management statistics Regulatory environment; legal and regulatory environment; advocacy/lobby group action; macro environment; political and geopolitical environment; goals and objectives; general goals and objectives; strategic direction; strategic planning process; short-/ medium-term business and operational objectives, including targets and benchmark; segmental business and operational objectives, including targets and benchmark; growth strategy; Organizational; design; business model; business segmentation; governance; corporate governance model/policy; the board and (continued)

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Table 3.1 (continued)

KPI category People

KPI category Physical assets

management team; independence of board members; related parties; management accountability; nature and structure of board committees and meetings; participation of board members in meetings; evaluation of board effectiveness; board member’s training; stakeholder rights and engagement; ownership base of organization; communication and disclosure polices; risk framework; overall risk framework; internal controls (financial and other); political and geopolitical risks—identification and assessment; regulatory risks—identification and assessment; technology risks—identification and assessment Social and ethical environment; demographic trends—people; people goals and objectives; corporate culture and values; people demographics, diversity, and skills goals and objectives; people satisfaction goals and objectives; people recruitment goals and objectives; people retention and advocacy goals and objectives; people efficiency goals and objectives; people remuneration and incentives goals and objectives; people legacy/former business costs goals and objectives; people training and development goals and objectives; people communication/service goals and objectives; people risk management (social and ethical aspects) goals and objectives; people risk management (dependence on and quality of employees) goals and objectives; management/organization structure; quality of management team; succession planning; key employee remuneration and incentives; social and ethical risks—identification and assessment; managing for value—people; managing employee demographics, diversity, and skills; managing employee satisfaction; managing employee recruitment; managing employee retention and advocacy; managing employee efficiency; managing employee remuneration and incentives; managing employee legacy and former business costs including retirement benefits; managing employee training and development; managing employee communication and service; managing people risks— social and ethical aspects; managing people risks—dependence on and quality of employees; performance—operating—people; people demographics, diversity, and skills statistics; employee satisfaction statistics; people recruitment statistics; people retention and advocacy statistics; employee efficiency statistics; employee compensation statistics; employee benefits and retirement/legacy costs; employee training and development statistics; employee communication and service statistics; people risk management—dependence and quality of employees statistics; people risk management—social and ethical impact statistics Environmental environment; physical assets goals and objectives; condition of physical assets goals and objectives; utilization of physical assets goals and objectives; physical assets—environmental, health, and safety impact goals and objectives; physical assets risk management goals and objectives; environmental risks—identification and assessment; managing for value—physical assets; managing physical assets condition; managing physical assets utilization; managing physical assets—environmental, health, and safety aspects; managing physical assets risks; (continued)

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Table 3.1 (continued) performance—operating—physical assets; physical assets—condition statistics; physical assets—utilization statistics; physical assets risk management statistics; physical assets environmental, health, and safety impact statistics KPI category Supply chain environment; purchase price environment; supply Supply chain chain goals and objectives; supply chain—risk management goals and objectives; supply chain—cross-functional goals and objectives; supply chain—planning goals and objectives; supply chain—sourcing goals and objectives; supply chain— manufacturing/production goals and objectives; supply chain— storage goals and objectives; supply chain—delivery/distribution goals and objectives; supply chain—returns goals and objectives; supply chain—environmental, social, and ethical aspects goals and objectives; supply chain risks—identification and assessment; managing for value—supply chain; managing supply chain— cross-functional operations; managing supply chain risks; managing supply chain environmental, social and ethical aspects; managing supply chain planning; managing supply chain sourcing; managing supply chain—production/manufacturing; managing supply chain storage; managing supply chain—delivery/distribution; managing supply chain returns; performance—operating— supply chain; supply chain cross-functional operations statistics; supply chain risk management statistics; supply chain planning statistics; supply chain sourcing statistics; supply chain manufacturing/production statistics; supply chain storage statistics; supply chain delivery/distribution statistics; supply chain returns statistics; supply chain environmental, social, and ethical impact statistics ESG (Environmental, social, and governance) reporting Corporate [domain]; benchmark [domain]; energy KPI; social KPI; governance KPI; value KPI Aggregate measures— Demand management; supply management; support services common Aggregate measures—specific industries Source: Authors’ elaboration, adapted from WICI XBRL Taxonomy

✓

✓

Analyst/ investor focus

Sustainability Accounting Standards Board SASB

European Federation of Financial Analysts Societies EFFAS

✓

Fair

✓

 Useful

 Concise

✓

✓

Understandable ✓

Clear

✓

✓

Timely

 Verifiable

Reliable

[Part of comparability]

✓

✓

[Part of comparability]

✓

Consistent

Effective Standard in placement space and and timing consistent in time

Faithful ✓ representation

Reliable

Verifiable

Reliable/ verifiable

 Relevance over [Part of stanReliability quantity dardization and Transparent and consistency] responsibility

✓

Reliable Reliable/ complete

✓ Free from material error

✓

Clear and ✓ understandable

Understandable Comparable

Connected ✓

Future value creation

[Part of indicators risk assessment]

Strategic ✓ focus and future oriented

✓

Future oriented

3

Balance between privacy and disclosure

✓

✓

✓

✓

✓

✓

✓

✓

✓

✓

Accurate Neutral

Free ✓ and [Part of relevant materiality from error and relevance]

International Integrated Reporting Council IIRC

International Accounting Standards Board IASB

Global Reporting Initiative GRI

Climate Disclosure Standards Board CDSB

Stakeholder inclusive Material Complete

Table 3.2 Overlap of reporting principles recommended in different frameworks

92 Voluntary Corporate Disclosure

✓

✓ Concise

✓

✓

✓

The mission of each organization cited is as follows: CDSB: Climate change and natural capital information to be integrated into mainstream reporting GRI: Empower decisions that create social, environmental and economic benefits for everyone IASB: Transparency, accountability, and efficiency to financial markets to foster trust, growth, and long-term financial stability in the global economy IIRC: Alignment of capital allocation and corporate behaviour to wider goals of financial stability and sustainable development SASB: Investors’ decision-making to sustain value creation EFFAS: Measurement and disclosure of intellectual capital, promoting standardization of the format to contain costs and facilitate inter-company benchmarking, and fostering the valuation of the information on intangibles WICI: Structure for the reporting of intangibles material for an organization’s value creation process and their communication to stakeholders Source: Authors’ elaboration

World Intellectual Capital/Assets Initiative WICI

Appendix 93

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Kasznik R, Lev B (1995) To warn or not to warn: management disclosures in the face of an earnings surprise. Account Rev 70(1):113–134 Kelly GJ (1994) Unregulated segment reporting: Australian evidence. Br Account Rev 26 (3):217–234 Kianto A (2008) Assessing organisational renewal capability. Int J Innov Reg Dev 1(2):115–129 Kimbrough MD (2005) The effect of conference calls on analyst and market underreaction to earnings announcements. Account Rev 80(1):189–219 KPMG (2019) Insights on corporate reporting KPMG, GRI, United Nations Environment Programme, Centre for Corporate Governance in Africa (2016) Carrots & Sticks. Global trends in sustainability reporting regulation and policy Kristandl G, Bontis N (2007) Constructing a definition for intangibles using the resource based view of the firm. Manag Decis 45(9):1510–1524 Kyle AS (1985) Continuous auctions and insider trading. Econometrica 53(6):1315–1335 Lajili K, Zéghal D (2005) Labour cost voluntary disclosures and firm equity values: is human capital information value-relevant? J Int Account Audit Tax 14(2):121–138 Laksmana I (2008) Corporate board governance and voluntary disclosure of executive compensation practices. Contemp Account Res 25(4):1147–1182 Lambert R, Leuz C, Verrecchia RE (2007) Accounting information, disclosure, and the cost of capital. J Account Res 45(2):385–420 Leftwich RW, Watts RL, Zimmerman JL (1981) Voluntary corporate disclosure: the case of interim reporting. J Account Res 19:50–77 Leung S, Horwitz B (2004) Director ownership and voluntary segment disclosure: Hong Kong evidence. J Int Financ Manag Acc 15(3):235–260 Leuz C (2004) Proprietary versus non-proprietary disclosures: evidence from Germany. Econ Politics Account 13(4):164–199 Lev B, Penman SH (1990) Voluntary forecast disclosure, nondisclosure, and stock prices. J Account Res 28(1):49–76 Li X (2010) The impacts of product market competition on the quantity and quality of voluntary disclosures. Rev Acc Stud 15(3):663–711 Lim S, Matolcsy Z, Chow D (2007) The association between board composition and different types of voluntary disclosure. Eur Account Rev 16(3):555–583 Marr B (2005) Perspectives on intellectual capital. Elsevier, Burlington Martín-de-Castro G, Delgado-Verde M, López-Sáez P, Navas-López JE (2010) Towards ‘an intellectual capital-based view of the firm’: origins and nature. J Bus Ethics 98(4):649–662 Matsumoto D, Pronk M, Roelofsen E (2011) What makes conference calls useful? The information content of Managers’ presentations and Analysts' discussion sessions. Account Rev 86 (4):1383–1414 Matsumura EM, Prakash R, Vera-Muñoz SC (2014) Firm-value effects of carbon emissions and carbon disclosures. Account Rev 89(2):695–724 Mercer M (2004) How do investors assess the credibility of management disclosures? Account Horiz 18(3):185–196 Mercer M (2005) The fleeting effects of disclosure forthcomingness on management’s reporting credibility. Account Rev 80(2):723–744 Meritum (2002) Guidelines for managing and reporting on intangibles (Intellectual capital report) Miller GS, Skinner DJ (2015) The evolving disclosure landscape: how changes in technology, the media, and capital markets are affecting disclosure. J Account Res 53(2):221–239 Milne MJ (2002) Positive accounting theory, political costs and social disclosure analyses: a critical look. Crit Perspect Account 13(3):369–395 Morris RD (1987) Signalling, agency theory and accounting policy choice. Account Bus Res 18 (69):47–56 Mouritsen J (2003) Overview: intellectual capital and the capital market: the circulability of intellectual capital. Account Audit Account J 16(1):18–30

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Mouritsen J, Larsen HT, Bukh PN (2001) Valuing the future: intellectual capital supplements at Skandia. Account Audit Account J 14(4):399–422 Mouritsen J, Bukh PN, Larsen HT, Johansen MR (2002) Developing and managing knowledge through intellectual capital statements. J Intellect Cap 3(1):10–29 Mouritsen J, Bukh PN, Marr B (2005) A reporting perspective on intellectual capital. In: Marr B (ed) Perspectives on intellectual capital. Pergamon Press, Oxford, pp 69–81 Myers SC, Majluf NS (1984) Corporate financing and investment decisions when firms have information that investors do not have. J Financ Econ 13(2):187–221 Nagar V, Nanda D, Wysocki P (2003) Discretionary disclosure and stock-based incentives. J Account Econ 34(1–3):283–309 Nielsen C, Madsen MT (2009) Discourses of transparency in the intellectual capital reporting debate: moving from generic reporting models to management defined information. Crit Perspect Account 20(7):847–854 Orens R, Aerts W, Lybaert N (2009) Intellectual capital disclosure, cost of finance and firm value. Manag Decis 47(10):1536–1554 Pantzalis C, Park JC (2009) Equity market valuation of human capital and stock returns. J Bank Financ 33(9):1610–1623 Patelli L, Prencipe A (2007) The relationship between voluntary disclosure and independent directors in the presence of a dominant shareholder. Eur Account Rev 16(1):5–33 Patten DM (2002) The relation between environmental performance and environmental disclosure: a research note. Acc Organ Soc 27(8):763–764 Penman SH (1980) An empirical investigation of the voluntary disclosure of corporate earnings forecasts. J Account Res 18(1):132–160 Petty R, Guthrie J (2000) Intellectual capital literature review. J Intellect Cap 1(2):155–176 Piotroski JD, Wong TJ, Zhang T (2015) Political incentives to suppress negative information: evidence from Chinese listed firms. J Account Res 53(2):405–459 Plumlee M, Brown D, Hayes RM, Marshall RS (2015) Voluntary environmental disclosure quality and firm value: further evidence. J Account Public Policy 34(4):336–361 Prencipe A (2004) Proprietary costs and determinants of voluntary segment disclosure: evidence from Italian listed companies. Eur Account Rev 13(2):319–340 PricewaterhouseCoopers (2019) Mind the gap: the continued divide between investors and corporates on ESG Raffournier B (2006) The determinants of voluntary financial disclosure by Swiss listed companies. Eur Account Rev 4(2):261–280 Rahman S (2012) Impression management motivations, strategies and disclosure credibility of corporate narratives. J Manag Res 4(3). https://doi.org/10.5296/jmr.v4i3.1576 Ricardis (2006) Reporting intellectual caital to augment research, development and innovation in SMEs. European Commission, Brussels Rogers J, Stocken P (2005) Credibility of management forecasts. Account Rev 80(4):1233–1260 Rogers JL, Van Buskirk A (2009) Shareholder litigation and changes in disclosure behaviour. J Account Econ 47(1–2):136–156 Roos G, Roos J (1997) Measuring your company’s intellectual performance. Long Range Plan 30 (3):413–426 Saint-Onge H (1996) Tacit knowledge the key to the strategic alignment of intellectual capital. Plan Rev 24(2):10–16 Samaha K, Khlif H, Hussainey K (2015) The impact of board and audit committee characteristics on voluntary disclosure: a meta-analysis. J Int Account Audit Tax 24:13–28 Schipper K (1981) Discussion of voluntary corporate disclosure: the case of interim reporting. J Account Res 19:85–88 Schoenfeld J (2017) The effect of voluntary disclosure on stock liquidity: new evidence from index funds. J Account Econ 63(1):51–74 Shleifer A, Vishny RW (1989) Management entrenchment: the case of manager-specific investments. J Financ Econ 25(1):123–139

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Skinner DJ (1994) Why firms voluntarily disclose bad news. J Account Res 32(1):38–60 Skinner DJ (1997) Earnings disclosures and stockholder lawsuits. J Account Econ 23(3):249–282 Spence M (1974) Competitive and optimal responses to signals: an analysis of efficiency and distribution. J Econ Theory 7(3):296–332 Spence M (1976) Competition in salaries, credentials, and signaling prerequisites for jobs. Q J Econ 90(1):51–74 Spence M (1978) Job market signaling. In: Uncertainty in economics. Academic Press, New York, pp 281–306 Striukova L, Unerman J, Guthrie J (2008) Corporate reporting of intellectual capital: evidence from UK companies. Br Account Rev 40(4):297–313 Sun N, Salama A, Hussainey K, Habbash M (2010) Corporate environmental disclosure, corporate governance and earnings management. Manag Audit J 25(7):679–700 Tasker SC (1998) Bridging the information gap: quarterly conference calls as a medium for voluntary disclosure. Rev Acc Stud 3(1–2):137–167 Toms JS (2002) Firm resources, quality signals and the determinants of corporate environmental reputation: some UK evidence. Br Account Rev 34(3):257–282 Trueman B (1986) Why do managers voluntarily release earnings forecasts? J Account Econ 8 (1):53–71 Trueman B (1997) Managerial disclosures and shareholder litigation. Rev Acc Stud 2(2):181–199 Vergauwen PGMC, van Alem FJC (2005) Annual report IC disclosures in The Netherlands, France and Germany. J Intellect Cap 6(1):89–104 Verrecchia RE (1983) Discretionary disclosure. J Account Econ 5:179–194 Verrecchia RE (1990a) Information quality and discretionary disclosure. J Account Econ 12 (4):365–380 Verrecchia RE (1990b) Endogenous proprietary costs through firm interdependence. J Account Econ 12(1–3):245–250 Verrecchia RE (2001) Essays on disclosure. J Account Econ 32(1–3):97–180 Wagenhofer A (1990) Voluntary disclosure with a strategic opponent. J Account Econ 12 (4):341–363 Wang WY, Chang C (2005) Intellectual capital and performance in causal models. J Intellect Cap 6 (2):222–236 Wang M, Hussainey K (2013) Voluntary forward-looking statements driven by corporate governance and their value relevance. J Account Public Policy 32(3):26–49 Wang K, Sewon O, Claiborne MC (2008) Determinants and consequences of voluntary disclosure in an emerging market: evidence from China. J Int Account Audit Tax 17(1):14–30 Watson A, Shrives P, Marston C (2002) Voluntary disclosure of accounting ratios in the UK. Br Account Rev 34(4):289–313 Watts RL (1977) Corporate financial statements, a product of the market and political processes. Aust J Manag 2(1):53–75 Watts RL, Zimmerman JL (1978) Towards a positive theory of the determination of accounting standards. Account Rev 53(1):112–134 Watts RL, Zimmerman JL (1986) Positive accounting theory. Contemporary topics in accounting series. Prentice-Hall, Upper Saddle River Waymire G (1985) Earnings volatility and voluntary management forecast disclosure. J Account Res 23(1):268–295 Welker M (1995) Disclosure policy, information asymmetry, and liquidity in equity markets. Contemp Account Res 11(2):801–827 Whiting RH, Miller JC (2008) Voluntary disclosure of intellectual capital in New Zealand annual reports and the “hidden value”. J Hum Resour Cost Account 12(1):26–50 Wong J (1988) Economic incentives for the voluntary disclosure of current cost financial statements. J Account Econ 10(2):151–167 World Intellectual Capital/Assets Initiative (2016) WICI intangibles reporting framework Xiao JZ, Yang H, Chow CW (2004) The determinants and characteristics of voluntary internetbased disclosures by listed Chinese companies. J Account Public Policy 23(3):191–225

Chapter 4

Social and Environmental Reporting

Abstract This chapter reviews the literature on social and environmental reporting and it empirically analyzes three case studies on reporting practices. To date, it appears increasingly relevant to examine the social and environmental disclosure and manner of presentation that companies with diverse sizes select. Indeed, disclosures not only improves firms’ transparency and visibility but also enables firms to evaluate their wide range of social and environmental issues’ impacts, resulting in more accurate predictions about the risks and opportunities they face. To this end, the chapter first introduces the movements towards increased social and environmental disclosure, especially at the European level with Directive 2014/95/EU. It then shows the choices concerning social and environmental reporting of three Italian companies in the food and beverage industry. The scope is to understand whether there are significant burdens that impede small/medium companies—compared to the larger counterparts—to prepare such disclosures or whether, regardless of their smaller size, these types of firms can successfully respond to the growing stakeholders’ expectations of corporate disclosure with regard to social and environmental impact.

4.1

Introduction

Whilst the previous chapters illustrate the theory underpinning mandatory and voluntary corporate disclosure, this chapter empirically investigates social and environmental reporting with multiple case studies and the following one examines the new frontiers of voluntary reporting through social media with quantitative analysis. Over the past 20 years, social and environmental reporting has moved from exception to expectation and, finally, to enforcement of the rules. Formal inclusion of environmental, social, and governance (ESG) considerations, therefore, became the rule. The matters related to social and environmental reporting are various, including climate change, community, consumer, employees, energy, health and safety, social responsibility, sustainability, water management, and so on. Gray et al. (2010: 6) © Springer Nature Switzerland AG 2020 A. Ghio, R. Verona, The Evolution of Corporate Disclosure, Contributions to Management Science, https://doi.org/10.1007/978-3-030-42299-8_4

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deliberately suggest that social accounting in terms of practice, policy, and possibilities is almost infinite.1 Reviewing the literature on the factors influencing the extent and nature of social and environmental reporting, Adams (2002) breaks the factors down into three groups: (1) corporate characteristics (e.g. size, industry group, and financial/economic performance), (2) general contextual factors (e.g. country of origin, media pressure, stakeholders and social, political, cultural, and economic context), and (3) the internal context (e.g. identity of company chair and existence of a social reporting committee). From a regulatory perspective, in Europe, the last decade has been fundamental to define the borders of non-financial information, giving rise to the revolutionary European Union (EU) directive on the disclosure of non-financial and diversity information (Directive 2014/95/EU). This directive traced a path for deeper transparency and accountability on social and environmental matters (CSR Europe and GRI 2017). However, member states have a little flexibility when translating the directive into national-level laws in terms of reporting framework, disclosure format, auditor’s involvement, and diversity information. Table 4.5 in Appendix 1 summarily maps a few of the main choices that member states adopted in the non-financial information directive’s transposition process. For instance, certain countries refer explicitly to specific disclosure frameworks, such as the Eco-Management and Audit Scheme (EMAS), the United Nations Global Compact (UNGC) together with the Organisation for Economic Co-operation and Development (OCDE), ISO 26000, the International Labour Organization (ILO) Declaration or Global Reporting Initiative (GRI) frameworks (e.g. Denmark and Spain), whilst others allow preparers’ mixed reporting methodology comprising one or more reporting standards (e.g. Italy and Poland). With regard to the disclosure format, member states mostly allow preparers diverse alternatives, including management reports, annual reports, business reports, or separate reports (e.g. Austria, Croatia, and Slovenia), whilst others allow preparers the only-one-report option including a strategic report (United Kingdom), management report (Estonia, Netherlands, and Norway), annual report (France, Greece, and Slovakia) or an attachment to the summary report by the board (Iceland). Certain member states enforce the auditor’s involvement, expanding it from merely checking whether the consolidated non-financial statement has been

Gray (2010: 5) argues that: “(. . .) social accounting can embrace any possible way in which we can imagine that individuals/groups/organisations might choose to request, give and receive accounts from one another. . . Even if we draw our boundaries a little tighter, we will still find that social accounting is a complex, diverse, amorphous and constantly changing craft... Social accounting is not precise or definable, and this imprecision is very likely to remain the case until such time as social accounting is subject to demanding international regulation—and even then evolution may still produce the new and the unexpected. To a considerable extent, it is the voluntary—one might even say willful—nature of much of social accounting practice that produces the diversity and the lack of any systematic or organised development”. 1

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provided to the consistency check of disclosures as part of reviewing the management report (e.g. Belgium and United Kingdom) or identifying material misstatements (i.e. Netherlands). Lastly, regarding the diversity information, a number of European countries enlarged the scope including not only information on age, gender, professional, and educational background but also religious affiliation (Bulgaria). Other countries require diversity information reports from all large public interest entities (Austria) or all listed public interest entities with 250 or more employees (Croatia) or all large listed public interest entities with 500 or more employees (Cyprus). Furthermore, a number of countries require that the preparers present the diversity information in the same format as non-financial information (Denmark) or in the management report (Estonia) or in the annual report (Lithuania and Slovenia). It is interesting to understand how the expansion of social and environmental reporting is also often associated with the increasing triple bottom line reporting over the years.2 Firms of all sizes are now expected to report more than just financial information to their stakeholders. However, smaller firms often have limited financial and human resources, limiting their ability to process and disclose a larger range of information. To this end, Ghio and Verona explored the GRI sustainability disclosure database3 containing 56,692 reports published by 13,962 organizations, which can be either GRI consistent or not.4 The companies and organizations releasing the above-mentioned reports are of all types, sizes, and sectors, worldwide.

2 The authors acknowledge that sustainability reporting can be used as a synonym of other terms related to non-financial information, such as corporate social responsibility (CSR) reporting, environmental, social, and governance (ESG) disclosure, and more. Generally, social and environmental reporting is also an innate component of integrated reporting, which combines the disclosure of financial and non-financial performance. To this end, triple bottom line reporting can well include all these terms, more generally recalling the idea that a firm should not only consider its financial performance but also consider people’s lives and the planet. In 1994, John Elkington coined the term “triple bottom line” to underline that firms should handle these three bottom lines simultaneously:

1. Profit, which is the traditional measure of corporate financial performance and derived from the profit and loss (P&L) account. 2. People, measuring how socially responsible an organization has been throughout its actions and operations. 3. Planet, measuring how environmentally responsible the firms’ activities are. 3 The database is available at: https://database.globalreporting.org/search/. Last accessed 1 October 2019. 4 Note that there are several major providers of sustainability reporting guidance including, amongst others:

– The GRI (GRI’s Sustainability Reporting Standards); – The Organisation for Economic Co-operation and Development (OECD Guidelines for Multinational Enterprises) – The United Nations Global Compact (the Communication on Progress) – The International Organization for Standardization (ISO 26000, International Standard for social responsibility)

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Fig. 4.1 Number of organizations by size releasing a triple bottom report in Europe over the period 2007–2016 (Source: Authors’ elaboration)

Ghio and Verona contained the investigation at the European level and focused on the latest available 10 years from 2007 to 2016. Figure 4.1 points out how in the analyzed 10 years’ period the European organizations issuing a triple bottom line report increases regardless of their size, regardless of whether the enterprise is small/medium, large or multinational, the graph definitely shows a growing trend. Specifically, in 2007 there were only 66 small enterprises, 382 large enterprises, and 89 multinational enterprises releasing triple bottom reports. In 2016, the number increased to 296 for small entities, 1328 for large entities and 620 for multinational entities that prove to have the greatest expansion with an increase of seven times greater than the number of 2006. However, also the small and large groups increased such that they are about four times bigger than the first year analyzed.5 This result was expectable, given that European large enterprises, which are public interest entities, were expected to comply with the new disclosure requirements of the laws that were transposed from the non-financial information directive by 2018. Accordingly, the new EU requirements for non-financial information can help firms move from merely complying with legal requirements to actively developing their responsible business behaviour and contributing towards building a more sustainable future. The Directive 2014/95/EU itself states that “(. . .) disclosure of

5 Table 4.6 in Appendix 2 reports a detailed analysis of the trend of organizations releasing triple bottom line reports over the period 2007–2016 divided amongst the three categories of small/ medium (Panel A), large (Panel B), multinational (Panel C) enterprises and amongst all the European countries.

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non-financial information is vital for managing change towards a sustainable global economy by combining long-term profitability with social justice and environmental protection. In this context, disclosure of non-financial information helps the measuring, monitoring and managing of undertakings’ performance and their impact on society”. The differences in reporting landscapes across the EU companies also suggest that small/medium enterprises still lack experience on how successful reporting can function as a critical tool to improve responsible business practices and incorporate sustainability into business models. Moreover, for small/medium enterprises the costs associated with the preparation and dissemination of such disclosure may be more onerous than for large and multinational entities with more developed communication functions. In the following, Ghio and Verona discuss the theoretical reasons for social and environmental reporting (Sect. 4.2). Section 4.3 sets the methodology used in this chapter and analyzes multiple cases of social and environmental reporting. Section 4.4 draws conclusions of the challenges and opportunities for social and environmental disclosure.

4.2

Theoretical Reasons for Social and Environmental Reporting

The social and environmental reporting literature dates back to the early 1970s and it has proliferated over the last decades (Parker 2005). Gray et al. (1987: ix) define social and environmental accounting as “the process of communicating the social and environmental effects of organisations’ economic actions to particular interest groups within society and to society at large. As such, it involves extending the accountability of organisations (particularly companies), beyond the traditional role of providing a financial account to the owners of capital, in particular, shareholders. Such an extension is predicated upon the assumption that companies do have wider responsibilities than simply to make money for their shareholders”. Accordingly, social and environmental reporting is more likely to take a qualitative/narrative form (Cormier and Gordon 2001); however, it can also take a quantitative form and in this case, the quantitative information may be either in financial or non-financial terms (Mathews 1997). As illustrated in the introduction, Adams (2002) shows that multiple influences can affect the decision and the manner in which to report social and environmental disclosure, including corporate characteristics (e.g. size, industry group, corporate age, and financial–economic performance), general contextual factors (e.g. country of origin, political context, economic context, and pressure groups) and internal context (e.g. corporate governance, extent and nature of stakeholder involvement, and corporate culture). The reader can easily derive that there is no consensus around the underpinnings for social and environmental accounting. Indeed, prior literature on social and

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environmental accounting bases on a multitude of theoretical frameworks, given that “social accounting is a complex, diverse, amorphous and constantly changing craft” (Gray et al. 2010: 5). However, one can connect the large body of research on social and environmental accounting and the perspectives underlying it to two main streams of literature (Murray et al. 2006; Gray et al. 1995). The first stream of literature draws on a sociopolitical approach where the disclosure of social and environmental information assumes an accountability function and acts as a democracy mechanism (Lehman 2001; Cooper et al. 2005). In this fashion, the corporate engagement into non-traditional (i.e. non-financial) disclosure becomes a mechanism to empower not only shareholders but all the potential interested parties, thereby ultimately reducing inequalities and injustices (Bebbington 1997). The dominant theories around social and environmental reporting derived from the sociopolitical approach are the stakeholder theory, the legitimacy theory and the political economy theory (Gray et al. 1995). Therefore, enterprises report social and environmental disclosure, because it legitimizes corporate behaviour (e.g. Killian and O’Regan 2016), helps to respond to stakeholders’ pressure (Roberts 1992) and since the economic domain cannot be detached from the political, social, and institutional domains (Cooper and Sherer 1984). The second stream of literature analyzes the function of disclosure, i.e. the decision-usefulness approach (Dierkes and Antal 1985; Eccles et al. 2014). Under this perspective, there are a plethora of studies exploring the external stock market reactions to social and environmental disclosure (Cormier et al. 2011; Murray et al. 2006; Dhaliwal et al. 2011, 2012; Cheng et al. 2014; Plumlee et al. 2015). Ultimately, the decision-usefulness perspective also relates to the internal managerial actions implemented in order to improve social and environmental performance. As a matter of fact, the improvement of such disclosures may also be an important stimulus to solve problems of social and environmental impact reducing, for instance, operating costs related to energy consumption (Jasch 2003), waste disposal and the improvement of relations with human resources, local communities, and other stakeholders critical to the running of the firm and the improvement of the corporate image across the entire value chain (Tate et al. 2010). The debate around social and environmental disclosure also recognizes more critical perspectives. In this context, Cho and Patten (2007) provide evidence that environmental disclosure is used as a means of legitimization. In fact, the authors show that poorer environmental performance leads to higher levels of disclosure and the nature of such disclosures appears to vary depending on the type of information: monetary and non-monetary. In a similar vein, companies may engage in hypocrite disclosure to construe façades and satisfy the institutional pressures (Cho et al. 2015a). Similarly, Rodrigue et al. (2012) provide consistent findings that environmental mechanisms are part of a symbolic strategy to manage stakeholder perceptions of environmental management, thus confirming the part of the literature conferring a symbolic role to social and environmental governance. In this sense, although companies today use more extensive corporate social responsibility (CSR) disclosure than a few decades ago, their disclosure habits are majorly pushed by their

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concerns around corporate image and legitimacy, which unavoidably fail to be value relevant (Cho et al. 2015b). To conclude, a strand of the literature draws on contemporary political theory to democratize accounting technologies and move from monologic to dialogic accounting (Brown 2009). Dialogic accounting recognizes heterogeneity and, therefore, social and environmental disclosure is a tool to expose the perspective of interested parties (Dillard and Ruchala 2005). However, the accounting system limits what is disclosed and related accountability. To this end, Dillard and Vinnari (2019) propose to design accounting systems such that they address specific needs of alternative accountability systems. From this standpoint, accounting should help prevent an abuse of power by problematizing the reality and its representation, thereby listening to a plurality of voices. A path may be to resort to shadow reports, which, through a counter account and counter perspective, can respond to the corporate’s account and address the inequalities (Tregidga 2017). In the ensuing part of this chapter, Ghio and Verona take a back seat from the underlying reasons that motivate companies to provide social and environmental disclosure whilst using a comparative perspective to understand how and what the analyzed companies decide to disclose.

4.3

Multiple Case Study: The Food and Beverage Industry in Italy

Italy is one of the major advanced economies (G7) together with Canada, France, Germany, Japan, the United Kingdom, and the United States. It is the third largest national economy in the Eurozone and on the basis of the International Monetary Fund estimates for the gross domestic product of 2019, Italy ranks eighth after the United States, China, Japan, Germany, India, the United Kingdom, and France.6 Furthermore, Italy is the ninth largest exporter in the world with $496 billion exported in 2017 after China, the United States, Germany, Japan, South Korea, Netherlands, France, and Hong Kong.7 The Italian economy is mostly driven by the manufacture of excellent consumer goods in large part manufactured by small- and medium-sized companies. Starting with the largest by the value of annual output, the main Italian industries are tourism, machinery, iron and steel, chemicals, food processing, textiles, motor vehicles, clothing, footwear, and ceramics.8

6 See https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx. Last accessed October 2019. 7 See https://www.cia.gov/library/publications/resources/the-world-factbook/fields/239rank. html#IT. Last accessed October 2019. 8 See https://www.cia.gov/library/publications/resources/the-world-factbook/geos/it.html. Last accessed October 2019.

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Within this context, Ghio and Verona explore social and environmental disclosure in practice in a key industry for Italy: the food and beverage industry. Specifically, they analyze social and environmental reports published by a small/medium (i.e. Centrale del latte di Firenze, Pistoia, Livorno S.p.a, see Sect. 4.3.1), a large (i.e. Lavazza, see Sect. 4.3.2) and a multinational company (i.e. Gruppo Campari, see Sect. 4.3.3) in this industry.9 The reason behind the investigation of the practice in this industry is because, together with the arts and fashion, the food and beverage industry is intimately related to Italy’s cultural heritage. Based on the data from the Italian National Statistics Institute’s statistical archive of active enterprises for 2018, the companies in the food and beverage industry accounted for about 55,600 firms and 445,600 employees, i.e. 14.54% and 12.10% of the whole manufacturing sector.10 Besides, behind the food and beverage industry’s success and sustainability, there are numberless social and environmental issues, such as people’s knowledge and skills, their vision, the level of innovation and prospects to draw people, cultures, and traditions together. Moreover, it is also noteworthy that the food, beverage, and tobacco industries together constitute 11.3% of all the innovative manufacturing firms.11 Companies operating in the food and beverage industry have to manage risk, safeguard their customers by warranting correct storage, shipping, packing and distribution, and ensuring quality and care throughout the whole supply chain. To this end, these firms also have to comply with increasingly more complex regulations and standards relating to food and agriculture. It is, therefore, of the utmost relevance for these firms to transform a mere compliance to regulation into userfriendly information and to build consumer and stakeholder confidence in their activities.12 Lastly, on the basis of a synthetic structural indicator (premised on profitability, performance on foreign markets, cost competitiveness and innovation) measured by the Italian National Statistics Institute (2019), the pharmaceutical, electrical equipment, machinery, and beverage industries are at the top of the list in 2016. In the details, beverages and leather goods show progress in competitiveness compared to the manufacturing average in all the indicator components.

9

The classification of enterprises as small/medium, large, and multinational is based on the GRI Sustainability Disclosure Database Data Legend, which follows the EU definitions. Therefore, the European Commission defines small/medium enterprises as having less than 250 employees and an annual turnover of up to 50 million euros or a balance sheet total of no more than 43 million euros. Large enterprises have more than 250 employees and an annual turnover higher than 50 million euros or a balance sheet total of more than 43 million euros. A multinational enterprise is a large enterprise that, furthermore, produces goods or deliver services in more than one country. 10 See http://dati.istat.it/. Last accessed October 2019. 11 Data retrieved from http://dati.istat.it/. Last accessed October 2019. 12 The analysis and monitoring of all suppliers and ingredients ensuring their origins and compliance are necessary to build consumer trust, prevent food fraud, and manage legal complexity across different countries.

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Considering the complex world of social and environmental disclosure, Ghio and Verona adopt a multiple case study approach. This approach, in fact, allows the researchers to disentangle the wide set of information contained in the company reports (Yin 1981). By pursuing an interpretive orientation, the authors attempt to capture the views of different companies and concentrate on how their different understandings illuminate the corporate disclosure issues (Yin 2018). Ghio and Verona deliberately raise the research question: What are the complexities associated with the production of sustainable and environmental reporting depending on firm size? The authors gathered the most recent reports available from the company websites and the GRI sustainability disclosure database.13 For the case study analyses, Ghio and Verona focus on five main points: 1. The source of the social and environmental reporting, i.e. where the company reports the social and environmental information. 2. Any alternative sources of information. 3. The age of reporting, i.e. since when the company reports social and environmental information. 4. The structure of the reports analyzed. 5. The content of the social and environmental information and the GRI indicators the companies referred to. Of course, the fourth and fifth points comprise the greatest part of the discussion, given that they can, strictly speaking, help answer the research question.

4.3.1

Social and Environmental Reporting by Small/Medium Entities: The Case of Centrale del Latte della Toscana S.p.a (Mukki)

Centrale del Latte della Toscana is a company established in Florence, in the centre of Italy, in 1954. Since its foundation, the core business has been to select, pasteurize, bottle, and distribute milk.14 In 1966, the company developed the Mukki brand. From the Florence centre, it began to progressively merge with the milk plants of Pistoia and Livorno, extending all the distribution to the whole Tuscany. From 2016, the company started a new phase in order to strengthen and develop, whilst maintaining its strong identity and values.15

13 The database is available at https://database.globalreporting.org/search/. Last accessed 11 October 2019. 14 Their commitment was and still is to “ensure a glass of healthy milk every day to all children”. These were the words of the Mayor of Florence, Giorgio La Pira. 15 The company history has been retrieved from the company website https://www.mukki.it/storia/. Last accessed on 11 October 2019.

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The latest report included in the GRI sustainability disclosure database that the company Centrale del Latte della Toscana Spa—later indicated as Mukki for simplicity—published, refers to the year 2015. In this case, all the information is contained in the company’s annual report, which is published in Italian and made up of 189 pages in total. The decision to analyze Mukki as the small company in order to answer the research question, is justified in that this company has more than 10 years of experience with sustainability reporting. As a matter of fact, already in 2004 Mukki received a certificate of compliance with the GRI guidelines, providing reports that, as explained on the company’s website, have both an internal and external value regarding the company’s economic, social, and environmental performance and regarding the company activities connected to these areas.16 It is relevant to highlight that Mukki draws up reports in compliance with the second version (G2) of the GRI guidelines from the 2004 financial year, because the first edition allowed the company to reach a particularly remarkable goal, i.e. being the first Italian company in the food and beverage industry to have achieved the status of “in accordance reporter”. For the preparation of the 2015 edition of the sustainability report, as for the previous editions, the company is committed to achieve level A for quality and compliance with the G3.1 guidelines.17 Even though the company has long experience with sustainability reporting, this is not a stand-alone report, because it forms part of the annual report. The latter report is the only document the authors could obtain from the GRI disclosure database, since it is not available—or at least the authors failed to find it—on the company website.18 Table 4.1 briefly represents the structure of Mukki’s annual report and the company’s commitment towards non-financial voluntary information covering around 45% of the whole report, is instantly palpable at first glance. Specifically, the annual report comprises a total of 189 pages of which the sustainability report covers 82 pages, whilst the remaining pages report the mandatory financial information. In this analysis, Ghio and Verona focus on the sustainability reporting to understand and discuss the social and environmental information that Mukki disclosed. As explained in the sustainability report’s text, the company discloses sustainability information with a yearly frequency. The company does not use reporting assurance services for the sustainability report. Nevertheless, financial statements were subjected to external accounting control. Consequently, external auditors verified the economic and financial data contained in the sustainability report. In order to represent the global sustainability 16

See https://www.mukki.it/certificazioni/bilancio-di-sostenibilita/. Last accessed on 11 October 2019. 17 The A level of compliance with the G3.1 requires that the company reports all the numbered elements envisaged in the guidelines, that the company gives a particularly transparent disclosure on the methods of economic, social, and environmental management and that there is a full answer—motivating all omissions—to all key indicators. 18 Last accessed on 11 October 2019.

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Table 4.1 The structure of Mukki’s annual report Main sections Highlights Summary The firm’s identity The history and values The ownership and governance structure The 231 Model and the social sustainability protocol The integrated certification system Supply chain, territory, and environment Social responsibility policies. The stakeholders The firm and its products The performances Performance measurement under the triple bottom line view Economic performance Social performance Environmental performance Appendix Methodological note Table of contents Performance indicators Financial statements Annual report total

Pages 2 2 35 4 5 3 1 12 2 7 33 1 8 11 12 12 3 2 6 105 189

% 1.1 1.1 18.5 2.1 2.6 1.6 0.5 6.3 1.1 3.7 17.5 0.5 4.2 5.8 6.3 6.3 1.6 1.1 3.2 55.6 100.0

Source: Authors’ elaboration

performance, Mukki makes reference to the GRI sustainability reporting guidelines in the G3.1 version, with a number of updates in view of the adoption of the fourthgeneration GRI guidelines. In the discussion of Mukki’s social and environmental information, Ghio and Verona follow the indications contained in the annual report in compliance with the GRI guidelines. Firstly, with reference to the strategy, Mukki extensively presents all the projects they have undertaken in order to reach its main strategies. For instance, it shows the self-styled Patto di Filiera (translated as supply chain agreement), which Mukki signed together with several organizations, an agricultural cooperative and Tuscan farms. The annual report expresses the principles of this supply chain agreement as follows: “(1) To develop a greater sensitivity and awareness in the Tuscan consumer towards the Tuscan cow’s milk supply chain and its products; (2) To strengthen the bovine milk supply chain in Tuscany in quantitative and qualitative terms, also identifying criteria for the correct remuneration of each component of the supply chain; (3) To strengthen the relationship between the bovine milk supply chain and the institutional, economic, and social levels of the Tuscany region; (4) To raise the level of safety and quality of regional dairy products, spreading food and scientific information among consumers, identifying new and additional qualitative and

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nutritional elements useful for enhancing regional agricultural production; (5) To set up projects that are consistent with what is indicated in the previous points in order to raise the quality and safety of each phase of the production and transformation process; projects that can also affect the organization of farms, aimed at increasing the level of well-being and safety of workers, animals, and improving the quality and decorum of the rural landscape”.19 It is relevant to note the great weight Mukki attributes to the supply chain, which is recalled in all five points of the analysis. Furthermore, the GRI Supply Chain related Standard Disclosures appear in different sections of the Guidelines (GRI 2015). Nevertheless, for Mukki the supply chain has such a prominent role for its activities that they need to deal with it in their general strategies. In this context, the authors underline that the section related to supply chain, territory and environment covers more than 6% of the entire annual report (see Table 4.1). Mukki conclusively summarizes its general strategy, explaining that “all the contracts, pacts and agreements on which the livestock supply chain of dairy cattle in Tuscany base and of which the plant is an essential part, aim at developing the production’s quality and quantity, together with a process based on maximum respect for environmental and social regulations as well as respect for the best employment policies”.20 Regarding the organizational profile, Mukki provides, at the beginning of the report, an overview of the ownership structures (page 6) and the board of directors consisting of five directors without executive power elected by the shareholders. Amongst the corporate bodies, in compliance with the law, the Board of Statutory Auditors consists of three effective members and two alternates. For the financial and accounting audit, the company ultimately elected, with a 3-year mandate, a Big Four accounting firm. In the section regarding corporate governance, in line with the recent trends, Mukki provides information regarding gender diversity. Specifically, one out of the five directors of the board is a woman, one of the three statutory auditors is a woman, and one of the five executives is a woman. A large part, about 3.7%, of the annual report, deals with the firm and its products. The firm’s activities are concentrated in the production plant located in Florence and a number of warehouses located in various cities (e.g. Arezzo, San Vincenzo, Grosseto, Collesalvetti, Portoferraio, Massa, and Pistoia) to ensure that the products arrive on a widespread basis in the entire Tuscan territory. In the report, the users can find a detailed list of the firm’s products. Commencing January 2013, the company adopts a Code of Ethics and an Organisation, Management, and Control Model (231 Model) prepared in accordance with Legislative Decree no. 231/2001. Specifically, there is a list of areas that fall under continuous monitoring, such as workers’ safety, waste disposal surveillance, relations with the public administration, management of entertainment expenses, donations and sponsorships, receipts, control and discharge of raw materials, and finished products and final activities of the finished product packaging. 19 20

The authors’ free translation of page 16 of Mukki’s Annual Report 2015. The authors’ free translation of page 18 of Mukki’s Annual Report 2015.

4.3 Multiple Case Study: The Food and Beverage Industry in Italy Fig. 4.2 Mukki’s stakeholder’s map (Source: Authors’ elaboration adapted from Mukki’s Annual Report 2015)

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Environment & Community Shareholders & Creditors Retailers & Suppliers

Consumers & Human Resources Mukki

Commencing 2015, a Protocol for Social Responsibility and a Charter of Commitments further support the company’s commitment towards social responsibility. Both these documents are based on the principles of the standard UNI EN ISO 26000—the guide to social responsibility and on the integrated certification system as well as the internally adopted code of ethics adopted. According to the annual report, the indicators used to serve “to concretely measure the commitments towards the community in relation to the following main stakeholders: ethics, environmental, local community, consumers”.21 In this context, it is important to note that, with reference to the effective application of the principles set forth in the Protocol and the adequacy of the commitments assumed under the Charter of Commitments, the company is subjected to voluntary verification by a third party. This latter is responsible for verifying the effective implementation of the system. The user, therefore, is somewhat ensured that all the sustainability reporting is not only boilerplate to impress and embellish the firm’s circumstances, but is effectively put into practice. A four-level picture represents the main stakeholders that the company identified, where the company is at the ground level and the first groups of stakeholders rounding it are the consumers and the human resources. The retailers and suppliers are at the second level, the shareholders and creditors at the third level and, lastly, the more external groups are the environment and the community (see Fig. 4.2). The company explicitly declares that “it is impossible to separate the economic effects of a decision concerning the business activity from the social and environmental issues. In fact, economic decisions often present a trade-off with the two other dimensions, environmental and social”.22 To this end, Mukki relies on the 21 22

The authors’ free translation of page 13 of Mukki’s Annual Report 2015. The authors’ free translation of page 38 of Mukki’s Annual Report 2015.

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Table 4.2 Mukki’s requirements of Social Accountability 8000 Requirements Child labour Forced labour Health and safety Freedom of association and right to collective bargaining Discrimination Disciplinary practices Working hours Remuneration Management system

Pages 1 3 2 3 3 1 2 2 2

Source: Authors’ elaboration

triple bottom line approach presenting not only the economic but also the social and environmental performance. Given the interests of this chapter on social and environmental disclosure, Ghio and Verona focus on the content of the social and environmental information that the company provides. The inspiration for Mukki’s social performance information is the international certification standard Social Accountability Certification SA 8000 (SA 8000), which specifies the requirements for social accountability (SAI 2001). SA 8000 concerns nine social accountability requirements. The authors examine the space in terms of the number of pages the company reserves for each requirement (see Table 4.2). Starting with child labour, the company declares that it never recruited underage staff or personnel who had not completed the compulsory study path; furthermore, Mukki verifies the presence of minor personnel also within the reference supply chain. Relatedly, the user can infer that the company neither engages nor supports the use of forced labour. Mukki explains that overtime is required and that they pay the utmost attention to the personnel needs of the interested parties, in line with regulatory provisions and with what is established in the agreements with the trade unions. With reference to health and safety, Mukki proactively fulfils the legal requirements and carries out systematic training activities of employees on prevention issues. The employees belonging to trade unions are about 60%, proving the company’s freedom of association. Investigating the gender policies, Mukki highlights the limited presence of female personnel, but it also points out that the relative average annual percentage has increased from 14% in 2004 to 19% in 2015. The presence of women is, however, still low, but one can also find the reason in the company’s specific characteristics. Mukki is a manufacturing firm with disadvantaged production schedules and particular operating conditions. In fact, women exceed 40% of employees in administrative and commercial functions, whilst there is an almost total absence of females in other functions. To conclude, it is relevant that Mukki is interested in the management of gender policies, including the examination of pay levels for men

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and women, confirming full equivalence between genders, the protection of maternity and the acceptance of any requests for transformation from full-time to part-time contracts and an agreement on the flexibility of working hours. Very briefly and as stated, for the sake of consistency with the SA 8000 indicators, Mukki indicates that, in the year reported, they conducted only two disciplinary procedures that concluded with a formal warning. Concerning the remuneration and working hours, the user of the sustainability report finds an extensive explanation of the type of contracts and working hours. Overall, it emerges that working hours, for all the personnel, “follow planned shifts and, where possible, allow adequate flexibility in terms of entry, use of the second weekly rest, recoveries of different nature”.23 In conclusion, considering the management system, the annual report includes a commitment to comply with national and other applicable legislation.24 The social dimension of Mukki’s report bases on the GRI guidelines and internationally recognized reporting practices.25 The social dimension, therefore, contains four main subcategories: (1) labour practices and decent work; (2) human rights; (3) society; and (4) product responsibility. Box 4.1 reports all the indicators disclosed by the company. Overall, the authors note profound compliance with the G4 Guidelines and the GRI Sustainability Reporting Standards (GRI Standards) with few exceptions resulting in partially different wording or a lack of certain indicators in all four subcategories.

23

Authors’ free translation of page 54 of Mukki’s Annual Report 2015. Mukki adheres to the following laws and standards: UNI EN ISO 9001:2008 for the quality management system; UNI EN ISO 22000:2005 for the food safety management system; Food Safety System Certification—FSSC; Global Standard for Food Safety—BRC; International Food Standard; UNI CEI EN ISO/IEC 17025:2005 for analysis laboratory management systems; BS OH SAS 18001:2007 for the Occupational Health and Safety Management System; UNI EN ISO 14001:2004 for the environmental management system; and SA 8000:2008 for corporate social responsibility management. 25 Amongst the laws and standards within the international framework, the following are worth mentioning: the United Nations (UN) Declaration (1948), “Universal Declaration of Human Rights”—the United Nations (UN) Convention (1966), “International Covenant on Civil and Political Rights”—the United Nations (UN) Convention (1966), “International Covenant on Economic, Social, and Cultural Rights”, 1966—the United Nations (UN) Declaration (1986), “Declaration on the Right to Development”—the United Nations (UN) Declaration (2007), “United Nations Declaration of the Rights of Indigenous Peoples”—the International Labour Organization (ILO) (1977), “Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy”—the United Nations (UN) Convention (1979), “Convention on the Elimination of all Forms of Discrimination against Women (CEDAW)”—the International Labour Organization (ILO) Declaration (1998), “Declaration on Fundamental Principles and Rights at Work”—the Organisation for Economic Co-operation and Development (OECD) (2011), OECD Guidelines for Multinational Enterprises. 24

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Box 4.1 Mukki’s Social Performance Indicators Labour practices and decent work – Total number of employees by typologies, type of contract, and region – Total number and turnover rate of employees by age, gender, and region – Benefits provided to full-time employees that are not provided to temporary or part-time employees, by significant locations of operation – Percentage of total workforce covered by collective bargaining agreements – Minimum notice periods regarding operational changes, including whether these are specified in collective agreements – Percentage of total workforce represented in formal joint management– worker health and safety committees that help monitor and advise on occupational health and safety programmes – Types of injury and rates of injury, occupational diseases, lost days, and absenteeism and total number of work-related fatalities, by region and by gender – Education, training, counselling, prevention and risk control programmes implemented to support workers, their families or the community in relation to serious illnesses or diseases – Formal agreements with trade unions on health and safety – Average hours of training per year per employee by gender and by employee category – Composition of governance bodies and breakdown of employees per employee category according to gender, age group, minority group membership, and other indicators of diversity – Ratio of basic salary and remuneration of women to men by employee category – Return to work and retention rates after parental leave, by gender Human rights – Total number and percentage of significant investment agreements and contracts that include human rights clauses or that underwent human rights screening – Percentage of main suppliers and contractors that were screened using human rights criteria and related actions taken – Total hours of employee training on human rights policies or procedures concerning aspects of human rights that are relevant to operations, including the percentage of employees trained – Total number of incidents of discrimination and corrective actions taken – Operations and suppliers identified in which the right to exercise freedom of association and collective bargaining may be violated or at significant risk and measures taken to support these rights (continued)

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Box 4.1 (continued) – Operations and suppliers identified as having significant risk for incidents of child labour and measures taken to contribute to the effective abolition of child labour – Operations and suppliers identified as having significant risk for incidents of forced or compulsory labour and measures to contribute to the elimination of all forms of forced or compulsory labour – Percentage of security personnel trained in the organization’s human rights policies or procedures that are relevant to operations Society – Percentage of operations with implemented local community engagement, impact assessments, and development programmes – Total number and percentage of operations assessed for risks related to corruption and the significant risks identified – Percentage of employees who received training on the organization’s anticorruption policies and procedures – Confirmed incidents of corruption and actions taken – Positions on public policy, participation in the development of public policies and pressures exercised – Total value of political contributions by country and recipient/beneficiary – Monetary value of significant fines and total number of non-monetary sanctions for non-compliance with laws and regulations – Operations with significant actual and potential negative impacts on local communities Product responsibility – Percentage of significant product and service categories for which health and safety impacts are assessed for improvement – Type of product and service information required by the organization’s procedures for product and service information and labelling and percentage of significant product and service categories subject to such information requirements – Total number of incidents of non-compliance with regulations and voluntary codes concerning marketing communications, including advertising, promotion, and sponsorship, by type of outcomes – Monetary value of significant fines for non-compliance with laws and regulations concerning the provision and use of products and services Source: Authors’ elaboration based on Mukki’s Annual Report (2015) and G4 Guidelines

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It appears that Mukki examines the social dimension deeply; the company reports most of the indicators—33 indicators out of total of 48—suggested in the G4 Guidelines. The company excludes only a few topics outside of the company’s interest or those that are not applicable. For instance, there is no indication of the number of labour practice grievances, or the number of human rights impact grievances or the number of grievances about impacts on society filed, addressed and resolved through formal grievance mechanisms. Another example of an excluded indicator is the one related to the results of surveys measuring customer satisfaction, which is probably too costly for a small company like Mukki.26 The environmental category, as explained, contains information related to the firm’s “impact on living and non-living natural systems, including land, air, water and ecosystems” (GRI 2015). Mukki articulates the analysis in three areas of interest: (1) consumption; (2) emissions and waste; and (3) other relevant information. In line with the social disclosure discussion, Box 4.2 summarizes all the environmental indicators that Mukki discloses.

26 For the sake of completeness, the authors list all the social indicators that are listed in the G4 Guidelines outside the scope of Mukki’s sustainability report by category:

– Labour practices and decent work: Workers with high incidence or high risk of diseases related to their occupation; health and safety topics covered in formal agreements with trade unions; percentage of employees receiving regular performance and career development reviews, by gender and by employee category; percentage of new suppliers that were screened using labour practice criteria; significant actual and potential negative impacts for labour practices in the supply chain and actions taken; number of grievances about labour practices filed, addressed, and resolved through formal grievance mechanisms. – Human rights: Total number of incidents of violations involving rights of indigenous peoples and actions taken; total number and percentage of operations that have been subjected to human rights reviews or impact assessments; significant actual and potential negative human rights impacts in the supply chain and actions taken; number of grievances about human rights impacts filed, addressed, and resolved through formal grievance mechanisms. – Society: Communication and training on anti-corruption policies and procedures; total number of legal actions for anti-competitive behaviour, anti-trust, and monopoly practices and their outcomes; percentage of new suppliers that were screened using criteria for impacts on society; significant actual and potential negative impacts on society in the supply chain and actions taken; number of grievances about impacts on society filed, addressed, and resolved through formal grievance mechanisms – Product responsibility: Total number of incidents of non-compliance with regulations and voluntary codes concerning the health and safety impacts of products and services during their life cycle, by type of outcomes; total number of incidents of non-compliance with regulations and voluntary codes concerning product and service information and labelling, by type of outcomes; results of surveys measuring customer satisfaction; sale of banned or disputed products; total number of substantiated complaints regarding breaches of customer privacy, and losses of customer data

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Box 4.2 Mukki’s Environmental Performance Indicators Materials – Materials used by weight or volume – Percentage of materials used that are recycled input materials Energy – Energy consumption within the organization by the primary source of energy – Energy consumption outside of the organization by the primary source of energy – Reduction of energy consumption due to conservation and efficiency improvements – Initiatives to supply energy-efficient products or services based on renewable energy and consequent reductions in energy requirements as a result of these initiatives Water – Total water withdrawal by source – Percentage and total volume of water recycled and reused Biodiversity – Operational sites owned, leased, managed in or adjacent to protected areas, and areas of high biodiversity value outside of protected areas – Description of significant impacts of activities, products, and services on biodiversity in protected areas and areas of high biodiversity value outside of protected areas – Habitats protected or restored – Strategies, implemented actions, future plans to manage the impacts on biodiversity Emissions – – – –

Direct greenhouse gas (GHG) emissions Energy indirect greenhouse gas (GHG) emissions Emissions of ozone-depleting substances (ODS) Nitrogen oxides (NOx), sulphur oxides (SOx), and other significant air emissions Effluents and waste

– Total water discharge by quality and destination – Total weight of waste by type and disposal method – Total number and volume of significant spills (continued)

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Box 4.2 (continued) – Weight of transported, imported, exported, or treated waste deemed hazardous under the terms of the Basel Convention and percentage of transported waste shipped internationally Products and services – Extent of impact mitigation of products’ and services’ environmental impacts – Percentage of products sold and their packaging materials that are reclaimed by category Compliance – Monetary value of significant fines and total number of non-monetary sanctions for non-compliance with environmental laws and regulations Transport – Significant environmental impacts of transporting products and other goods and materials for the organization’s operations and transporting members of the workforce Overall – Total environmental protection expenditures and investments by type Source: Authors’ elaboration based on Mukki’s Annual Report (2015) and G4 Guidelines As for the social dimension, the authors emphasize the high degree and comprehensiveness of detailed information. As a matter of fact, of the 34 environmental indicators listed in the G4 Guidelines (GRI 2015), Mukki discusses up to 25 indicators, overall implying the company’s intense commitment to the environmental issues.27

27

For the sake of completeness, the authors list all the environmental indicators that are listed in the G4 Guidelines outside of the scope of Mukki’s sustainability report by category: – Materials: Energy intensity; reductions in energy requirements of products and services – Water: Water sources significantly affected by the withdrawal of water – Biodiversity: Total number of IUCN Red List species and national conservation list species with habitats in areas affected by operations, by level of extinction risk – Emissions: Other indirect greenhouse gas (GHG) emissions; GHG emissions intensity; reduction of GHG emissions; identity, size, protected status, and biodiversity value of water bodies and related habitats significantly affected by the organisation’s discharges of water and runoff – Supplier environmental assessment: Percentage of new suppliers that were screened using environmental criteria; significant actual and potential negative environmental impacts in the supply chain and actions taken

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Lastly, Mukki also provides information about industry supplementary indicators for food processing, such as the percentage of goods purchased from suppliers that comply with the company’s procurement policies, the percentage of volume purchased from suppliers that comply with internationally recognized responsible production standards the nature, scope, and effectiveness of any programme and practice (contributions in kind, voluntary initiatives, knowledge transfer, partnership initiatives, and product development) that promote access to healthy lifestyles, the prevention of chronic diseases and the availability of healthy, nutritious and accessible foods that improve the well-being of disadvantaged communities, etc.

4.3.2

Social and Environmental Reporting by Large Entities: The Case of Lavazza

Lavazza S.p.A. is an Italian, family-owned company founded in Turin in 1895 and have been manufacturing roasted coffee from the outset. The success of the company’s product roots in a proficient use of mixing, an art still unknown to competitors who limit themselves to selling coffee in a single variety.28 After the Great War, Lavazza experienced an unstoppable growth, moving to new plants and introducing a successful advertising campaign based on figurines not only depicting the most varied events linked to coffee but also to Italian and international historical facts. At present, collectors collect these figurines like stamps and coins. Lavazza has always been an innovative company. In 1950, to preserve the coffee fragrance, it used for vacuum packaging for the first time, making conservation possible for a long time and therefore allowing a much wider distribution. Even today, the coffee we buy is vacuum packed. In 2016, Lavazza acquired the French company, Carte Noire, and the Danish company, Merrild. In 2017, continuing its growth strategy in all the coffee segments, it took over Kicking Horse Coffee in Canada, ESP (Espresso Service Proximité) in France and the Italian Nims. In 2018, it acquired Blue Pod Coffee in Australia and the American Mars Drinks.29

– Environmental grievance mechanisms: Number of grievances about environmental impacts filed, addressed, and resolved through formal grievance mechanisms. The first advertising slogan of the Lavazza mixture stating “Lavazza Paradise in a mug” appeared in newspapers and was broadcast on the radio already in 1950. This slogan still inspires Lavazza’s television advertising campaign. 29 The authors retrieved company history from the company website https://www.lavazza.com/en/ about-us/history.html. Last accessed on 23 October 2019. 28

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To date, Lavazza ranks 8th amongst the most reputable companies in Italy and 38th according to the 2019 Italy RepTrak Awards and the 2019 Global RepTrack 100.30 Since 2004, Lavazza launched social responsibility projects founding the Giuseppe and Pericle Lavazza Foundation, a non-profit organization aimed at improving the living conditions of people in coffee-producing countries. In the same year, Lavazza also launched ¡Tierra!, an initiative with which Lavazza has steadily improved the living conditions of more than 3000 farmers involved in eight countries, encouraging economic growth, improving their lifestyle and introducing new, more sustainable, and profitable agricultural techniques. In 2012, Lavazza issued their first sustainability report and the company, furthermore, provided social and environmental information on the corporate website. Hence, different from Mukki, in this case the social and environmental information is contained in the sustainability report, separate from the annual report. The sustainability report issued in 2018 extends over 178 pages. The Italian and English versions of the report have an identical length and structure.31 Table 4.3 briefly represents the structure of Lavazza’s sustainability report and at first glance the importance of people and the environment, which represent 29.2% and 16.9% of the whole report, is tangible. An external audit firm carried out a limited assurance engagement of the sustainability report as on 31 December 2018 of the company. Lavazza applies the GRI’s Sustainability Reporting Standards, selecting the indicators considered significant with reference to the topics considered relevant for the company. Furthermore, the company endorsed the United Nations Global Compact including in its sustainability report’s Communication on Progress (COP) in order to inform all internal and external stakeholders about the activities undertaken and results achieved in implementing the Global Compact’s principles. Each of the report’s three chapters ultimately comprises references to the UN’s Sustainable Development Goals (SDGs) that are appropriate for the company. In line with the previous case, Ghio and Verona discuss the report’s content in the order in which it is presented within the reports, followed by focussing the attention on the social and environmental information (i.e. on Chapters 2 and 3 of the sustainability report). Figure 4.3 represents the main stakeholders that the company identified, together with the major communication tools used. The sustainability report’s first chapter deals with the Lavazza Group in general and at its heart there are three sustainable development goals (SDGs), namely goal 8 regarding decent work and economic growth; goal 9 on industry, innovation, and infrastructure; and goal 17 regarding partnerships for the goals.

30

Available at https://insights.reputationinstitute.com/reptrak-reports/italy-reptrak-awards-2019 and https://insights.reputationinstitute.com/reptrak-reports/global-reptrak-2019. Last accessed on 20 October 2019. 31 In this discussion, the authors refer to the English version of the 2018 sustainability report.

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Table 4.3 The structure of Lavazza’s sustainability report Main sections Contents Letter from the Chairman and from the CEO Methodological note Structure of the group: Parent company and foreign subsidiaries Stakeholder engagement and materiality analysis Chapter 1: The Lavazza Group Key figures Lavazza in 2018: A year of recognition Group governance and financial performance Goal Zero Chapter 2: People at the Core Key figures Coffee-growing communities and the commitment of the Lavazza Foundation Suppliers and customers: Valuable partnerships The people of the Lavazza group Chapter 3: Environmental Commitment Key figures Lavazza’s environmental performance Continuous improvement Appendix Lavazza and the Global Compact GRI Indicators Independent auditor’s report on the consolidated non-financial disclosure Good news Sustainability report total

Pages 3 4 2 2 4 24 2 10 8 4 52 2 16 12 22 30 4 18 8 57 14 4 6 33 178

% 1.7 2.2 1.1 1.1 2.2 13.5 1.1 5.6 4.5 2.2 29.2 1.1 9.0 6.7 12.4 16.9 2.2 10.1 4.5 32.0 7.9 2.2 3.4 18.5 100.0

Source: Authors’ elaboration

The year 2018 signalled a number of awards and successes for the company, including the greatest increase in its brand asset value, as well as winning the Superbrand of the Year and Superbrands Passion for Branding 2018 awards.32 Investigating Lavazza’s corporate governance structures, the firm’s familiness is detectable not only from the ownership in the hands of the Lavazza family but also from their presence in the board of directors. Six of the 11 board members are from the Lavazza family. Of these six, one is the chairman and two are vice-chair. In terms of gender equality, only three directors are women—all of them from the Lavazza family.

These awards celebrate “the brand’s excellence and the commitment of those who continue to invest in brand values, making respect and sustainability the focus of its growth strategies” (Lavazza Sustainability Report 2018).

32

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Table 4.4 The structure of Campari’s sustainability report Main sections Contents Letter from the Chairman: Building more value together Note on methodology Campari Group’s identity The identity and values The history Campari Group worldwide and growth strategy The brands The master blenders The governance model Sustainability for the group Sustainability policies and governance The stakeholders The value chain Materiality analysis The people Responsible practices Environment Community involvement Appendix Correlation table to the L.D. 254/16 GRI content index Sustainability report total Independent auditor’s report on the consolidated non-financial disclosure

Pages 3 2 4 40 4 10 4 8 2 12 72 4 2 1 3 28 12 12 10 34 10 24 155 4

% 1.9 1.3 2.6 25.8 2.6 6.5 2.6 5.2 1.3 7.7 46.5 2.6 1.3 0.6 1.9 18.1 7.7 7.7 6.5 21.9 6.5 15.5 100.0

Source: Authors’ elaboration

In only three pages, the report discloses matters concerning the internal control and risk management system.33 The second chapter of the report concerns social disclosures, therefore involving the following SDGs: goal 1 regarding no poverty; goal 2 regarding zero hunger; goal 3 regarding good health and well-being; goal 4 regarding quality education; goal 5 regarding gender equality; goal 6 regarding clean water and sanitation; goal 8 regarding decent work and economic growth; goal 9 regarding industry, innovation, and infrastructure; goal 13 regarding climate action; goal 15 regarding life on land; and goal 17 regarding partnerships for the goals. It is relevant to highlight that Lavazza discloses its commitment by reporting several launched projects totalling 24 projects divided between 17 countries with

33 The authors highlight that this part related to the internal controls is not extensively dealt with, which is also noted in the independent auditor’s report suggesting “to strengthen the reporting and control system, also in view of a future extension of the reporting perimeter to other Group companies, in order to facilitate the availability and verifiability of quantitative data”.

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Shareholders and top management

• Interviews, monthly management meetings, specific meetings with shareholders with reference to sustainability topics

Customers and consumers

• Customer service, social networks, sales network as a listening, mediation and communication tool

Local communities

Coffe-growing communities

Suppliers

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• Community engagement initiatives

• Regular visits to communities of coffee growers benefiting from Lavazza Foundation's projects

• Regular meetings with suppliers and on-site visits, shared plans for improvement, sharing of the supplier's code of conduct ad the code of ethics

International, National and Local institutions NGOs

• Participation in national/international organizations, initiatives with the participation of NGOs like Save the Children and Oxfam, etc.

Governance bodies

• Organisation of regular meetings, ethics committee

Press and digital media

• Relations with local and international press, social networks

Human resources

• Training and performance management programmes, focus groups and group coaching, welfare programme, sharing of the employee code of conduct and the code of ethics, etc.

Trade unions and trade associations

• Regular briefings on the group's situation, negotiation meetings about corporate and production plant issues, relationships and participation in the activities of trade associations

Fig. 4.3 Lavazza’s stakeholders and major communication tools (Source: Authors’ elaboration adapted from Lavazza’s Sustainability Report 2018)

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three main scopes of activity, i.e. ¡Tierra!, social focus and nature preservation. 94,000 people benefit directly from the social activity that the company carries out. With reference to the supply chain, Lavazza shows, in a narrative style, the relationship with the suppliers and integrates it with quantitative data, such as the volume of purchases from national and international suppliers. The company also depicts its attention to the customers, ensuring the quality management system’s efficacy and efficiency as well as the company’s continuous will to improve supporting customer satisfaction programmes. Finally, the report devotes ample space to the disclosure concerning Lavazza’s commitment to its employees (22 pages). The focus on its employees’ well-being and their engagement are truly the cornerstones of the company’s policies, including initiatives intended to engage employees on sustainability issues. A few examples of how the company put its commitment towards people into practice are the implementation of smart working programmes or the company carpooling system and promoting sustainable mobility for homework journeys by encouraging the efficient sharing of vehicles in order to contain the environmental impact. The report further quantitatively shows the breakdown of men and women with fixed and indefinite term contracts, the type of employee by age, the ratio of women’s versus men’s average salary, hiring, and termination by gender and other information. All in all, the report deals extensively with Lavazza’s attention to gender equality. Box 4.3 summarizes all the GRI social topics touched in Lavazza’s sustainability report. Box 4.3 Lavazza’s Social Performance Indicators Employment – New employee hires and employee turnover Occupational health and safety – Types of injury and rates of injury, occupational diseases, lost days and absenteeism, and number of work-related fatalities Training and education – Average hours of training per year per employee – Percentage of employees receiving regular performance and career development reviews Diversity and equal opportunity – Diversity of governance bodies and employees – Ratio of basic salary and remuneration of women to men Human rights assessment – Employee training on human rights policies or procedures (continued)

4.3 Multiple Case Study: The Food and Beverage Industry in Italy

127

Box 4.3 (continued) Local communities – Operations with local community engagement, impact assessments, and development programmes Source: Authors’ elaboration The sustainability report’s third chapter concerns Lavazza’s environmental commitment. The main SDGs referred to in this last chapter are goal 8 regarding decent work and economic growth; goal 9 regarding industry, innovation, and infrastructure; goal 12 regarding responsible consumption and production; and goal 13 regarding climate action. Apart from the quantitative breakdown of direct and indirect emissions, the materials used for packaging and electricity and water consumption, Lavazza reports about the project to set guidelines for calculating espresso’s environmental impacts and the continuous improvement process involving a large number of personnel. Ultimately, in compliance with the ISO 14001, ISO 50001, and OHSAS 18001 standards, Lavazza is developing and implementing its health, safety, energy, and environment management system (SG-SSEA). Box 4.4 briefly details all the GRI environmental topics touched in Lavazza’s sustainability report. Box 4.4 Lavazza’s Environmental Performance Indicators Materials – Materials used by weight or volume Energy – Energy consumption within the organization – Energy intensity Water – Water withdrawal by source Emissions – Direct GHG emissions – Energy indirect GHG emissions (continued)

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Box 4.4 (continued) – Other indirect GHG emissions Effluents and waste – Water discharge by quality and destination Source: Authors’ elaboration Ghio and Verona emphasize that Lavazza, even though engaged in multiple environmental projects and actions, is able to contain the environmental indicators, identifying 8 out of the 32 indicators specified in the 300 series of the GRI Standards. To conclude, the authors note that Lavazza specifically indicates adherence to the ten principles of the United Nations Global Compact (GC) to promote the integration of business sustainability by promoting a sustainable global economy that respects human and labour rights, safeguards the environment, and fights corruption. For each goal, the company reports the actions implemented and the monitoring and assessment mechanisms.

4.3.3

Social and Environmental Reporting by Multinational Entities: The Case of Gruppo Campari

The history of Campari Group dates back to 1860 when spirits maker Gaspare Campari’s experiments resulted in the creation of a new drink with a unique bitter flavour whose recipe is still a top secret to date. Currently, Campari is the sixth largest player worldwide in the premium spirits sector with global distribution and trading in more than 190 countries.34 The latest report uploaded on the company website is the report for 2018. Similar to Lavazza, in this case the sustainability report contains the social and environmental information separate from the annual report. The sustainability report is published in both English and Italian. Both versions of the report consist of 155 pages35 (Table 4.4). Campari uses assurance services providing, at the end of the sustainability report, the independent auditor’s report on the consolidated non-financial disclosure consistent with Article 3, paragraph 10 of L.D. 254/2016 and Article 5 of CONSOB36 Regulation 20267/2018.

34

For further information on Campari Group’s history, refer to the corporate website. In this discussion, the authors always refer to the English version of Campari’s sustainability report. 36 CONSOB stands for Commissione Nazionale per le Società e la Borsa translated in English to the Italian Companies and Exchange Commission, which is an Italian government authority responsible for regulating the Italian securities market. 35

4.3 Multiple Case Study: The Food and Beverage Industry in Italy

129

Campari started reporting social and environmental disclosure voluntarily in 2013. Thus, with the issuance of mandatory non-financial information as required by Legislative Decree 254/16, the company carried out a gap analysis to identify the areas of improvement.37 The report is drawn up according to the GRI Standards for sustainability reporting and other advanced sustainability reporting frameworks and it confirms that at least one indicator for each material matter is disclosed. Needless to say, the company also provides additional information, which is considered uniquely relevant to a multinational company in the spirits industry. The authors highlight that the group’s sustainability covers more than 46% of the whole report, with more extensive coverage for information on the following: people (about 18%), responsible practices (about 8%), environment (about 8%), and community involvement (about 7%). Also significant is the space reserved for the Campari’s identity, covering almost 26% of the whole report and including extensive information on the firm’s long history (about 7%), its brands (about 5%), and its governance model (about 8%). Ghio and Verona, however, acknowledge that this part is apparently shorter than the sustainability part. On closer inspection, there is a reference to other separate reports providing more detailed information, such as the report on corporate governance and ownership structure and specific parts of the company’s website. Similar to the previous case analyses, in this discussion Ghio and Verona shortly analyze the sustainability report following the order of the GRI content index: organizational profile, strategy, ethics and integrity, governance, and stakeholder engagement. The authors afterwards focus on the environmental and social performance disclosure. Starting with the strategy, since 1995 the group combines organic growth with external growth by making acquisitions of brands in the core business of spirits leading to a portfolio of over 50 premium and super premium brands divided into global, regional, and local priorities. The company is listed on the Italian stock market and has a traditional administration and control model, consisting of a management body (the board of directors) and a control body (the board of statutory auditors). Its corporate governance system bases on the principles of the code of conduct for listed companies. The board of directors has 11 members. Four are women and six independent directors. Two of the board of statutory auditors’ six members are women. The report discloses, in six pages, the risk management listing all the main risks including risks related to potential instability in the countries in which the group

In the sustainability report we read as follows: “Although it started reporting socio-environmental information in 2013 on a voluntary basis, Campari Group has verified that the information produced so far complies with the recent regulatory provisions. For this reason, with the support of external advisers, a gap analysis was performed in 2017 with the involvement of the management of six corporate departments, which led to an action plan being drawn up indicating areas for improvement, in order to adapt the reporting system and the existing documentation to the provisions of Legislative Decree 254”.

37

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operates, risks relating to the company’s dependence on consumer preference and propensity to spend, risks relating to the company’s dependence on key customers, risks relating to market competition, risks relating to the company’s dependence on licences for the use of third-party brands and licences granted to third parties for use of the group’s brands, risk of failure to comply with laws and regulations, risks relating to legislation in the beverage industry, risks relating to product compliance and safety, environmental risk, risks relating to environmental policy, tax risks, risks relating to employees, cybersecurity risks and exchange rate, and other financial risks. Campari reports that its behaviour contributes to the achievement of 11 of the 17 Sustainable Development Goals (SDGs). This is relevant, as in 2016 the company established the sustainability committee in order to “define an approach to sustainability that is shared across the entire Group” (page 53). This point suggests that the group assigns a great role to sustainability issues and it is moving step-by-step not only through words but also through action towards sustainable business. Figure 4.4 represents the main stakeholders that the company identified, together with the company engagement towards them. The company identifies several internal and external stakeholders and lists, for each of them, the engagement and channels of dialogue. The authors derive that, amongst the key topics considered for stakeholders’ value creation, there are product quality and safety for customers, investments, job creation and aid for the community, business climate, and career development for the camparistas, etc. To measure its social performance, Campari takes 14 aspects into account, including employment, labour/management relations, occupational health and safety, training and education, diversity and equal opportunity, freedom of association and collective bargaining, child labour, forced or compulsory labour, human rights assessment, local communities, supplier social assessment, customer health and safety, marketing and labelling, and customer privacy. Each aspect contains all the indicators and narrative information on management’s approach of topics considered material to enable the company to explain how it manages its social impacts (GRI 103, 2016). Box 4.5 lists all the material social topics dealt with in the sustainability report.

4.3 Multiple Case Study: The Food and Beverage Industry in Italy

Consumers

• Market research and customer satisfaction; Tests and focus groups; social media; company websites; events

Bartenders

• Campari Academy courses; Campari Academy Truck; Campari Barman Competition; events; sustainability questionnaire

Local communities

• Corporate volunteering; Negroni Week; charity activities for NGOs; Visits to Galleria Campari; contributions to external shows

Press

• Press releases and PR material; websites; Preparation and coordination of interviews with senior management; events

(i.e. Campari's employees)

• Two-yearly survey on inetrnal morale; internal and external training courses; performance appraisal; Yammer internal social network, etc.

Suppliers, distributors and commercial partners

• Supplier code; Sedex; co-product development; Innovation projects; business meetings; third-party verification

Camparistas

Competitors Shareholders, investors and analysts Trade associations

Trade unions

131

• Participation in sector association conferences • Shareholders' meeting; press releases and investor presentations; analyst calls, investor meetings, roadshows and investor conferences, etc. • Periodic meetings; preparation and sharing of projects and best practices; participation in meetings and activities of associations • Collective and supplemental bargaining; meetings with company union representatives; conferences

Institutions

• Participation in national and international conferences on issues facing the industry

Schools and universities

• Development of projects in partnership; graduate programs; company testimonials at educational institutions, etc.

Fig. 4.4 Campari’s stakeholders and engagement (Source: Authors’ elaboration adapted from the company Sustainability Report 2018)

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Box 4.5 Campari’s Social Performance Indicators Employment – New employee hires and employee turnover by age group, gender, and region – Parental leave and return to work rate Labour/management relations – Minimum notice periods regarding operational changes and whether collective agreements specify the notice period and provisions for consultation and negotiation Occupational health and safety – Workers representation in formal joint management–worker health and safety committees – Types of injury and rates of injury, occupational diseases, lost days, and absenteeism – and number of work-related fatalities, by region and gender Training and education – Average hours of training per year per employee, by gender and employee category – Programmes for upgrading employee skills and transition assistance programmes – Percentage of employees receiving regular performance and career development reviews Diversity and equal opportunity – Diversity of governance bodies and employees by gender, age group, and other indicators of diversity where relevant – Ratio of the basic salary and remuneration of women to men for each employee category, by significant locations of operation Freedom of association and collective bargaining – Operations and suppliers in which the right to freedom of association and collective bargaining may be at risk and measures taken with the intention to support these rights Child labour – Operations and suppliers at significant risk for incidents of child labour and measures taken to contribute to the effective abolition of child labour (continued)

4.3 Multiple Case Study: The Food and Beverage Industry in Italy

133

Box 4.5 (continued) Forced or compulsory labour – Operations and suppliers at significant risk of incidents of forced or compulsory labour and measures taken to contribute to the elimination of all forms of forced or compulsory labour Human rights assessment – Operations that have been subjected to human rights reviews or impact assessments Local communities – Operations with local community engagement, impact assessments, and development programmes Supplier social assessment – New suppliers that were screened using social criteria Customer health and safety – Incidents of non-compliance concerning the health and safety impacts of products and services Marketing and labelling – Requirements for product and service information and labelling and percentage of significant product or service categories covered by and assessed for compliance with such procedures – Incidents of non-compliance concerning product and service information and labelling – Incidents of non-compliance concerning marketing communications, including advertising, promotion, and sponsorship Customer privacy – Substantiated complaints concerning breaches of customer privacy and losses of customer data Source: Authors’ elaboration It is interesting to observe that in relation to Mukki, Campari, a large and public company, is able to report 21 social performance indicators compared to the 33 reported by Mukki. The authors derive that the materiality analysis carried out by Campari allows it to report and focus on specific topics that are material, providing a more accessible report on selected issues.38 38 Campari, in the process of identifying material topics, carried out a benchmarking comparison with competitors and distributed a sustainability questionnaire to the Group’s entire management.

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Environmental performance is explained via six main aspects: energy, water, emissions, effluents and waste, environmental compliance, and supplier environmental assessment. Box 4.6 lists all the specific material environmental topics considered in the report. Box 4.6 Campari’s Environmental Performance Indicators Energy – Energy consumption within the organization – Energy intensity Water – Water withdrawal by source – Water recycled and reused Emissions – Direct GHG emissions – Energy indirect GHG emissions Effluents and waste – Water discharge by quality and destination – Waste by type and disposal method – Total number, total volume, and impacts of recorded significant spills by location and material Environmental compliance – Significant fines and non-monetary sanctions for non-compliance with environmental laws and/or regulations Supplier environmental assessment – Percentage of new suppliers that were screened using environmental criteria Source: Authors’ elaboration Ghio and Verona again underline how Campari is able to contain the environmental indicators identifying 13 out of the 32 indicators specified in the 300 series of the GRI Standards.

4.4 Challenges and Opportunities for Social and Environmental Reporting

4.4

135

Challenges and Opportunities for Social and Environmental Reporting

Social and environmental disclosure contributes to the firm’s long-term sustainability, considering not only the firm’s economic impacts but also all the positive and negative environmental and social effects. The three case studies analyzed enable the reader to understand how social and environmental disclosure reflects the company culture and identity regardless of the firm size. In fact, Ghio and Verona find that Mukki, although a small company, has developed a profound sensitivity to stakeholders’ expectations over the years. This sensitivity manifests through a variety of actions, including, for instance, measures aimed at involving the consumers, sharing lots of up-to-date and in-depth information on the website, Mukki’s employees making themselves available to attend to any request for clarification and further information as well as every possible complaint, enriching their packaging with lots of useful suggestions that integrate the mandatory information, opening their gates every year to around 25,000 visitors, and carrying out important recreational and educational initiatives throughout the region. Therefore, Mukki’s social principles are not only documented in the code of ethics but they are also effectively put into practice. Another example relates to the measures aimed at involving the personnel’s freedom to join trade unions and in pursuing a constant enhancement of relations with trade unions. Mukki updates the union on its strategies and perspectives, management trends, the market and, in any case, on all the events that may influence the internal context. Another aspect to underline is Mukki’s commitment, despite its small size, to certify its activities to such an extent that it has, over time, accrued ten certifications, including, for example UNI EN ISO 9001:2008 (Quality management system), UNI EN ISO 22000:2005 (Food safety management system), Global Standard for Food Safety—BRC, International Food Standard—IFS, SA 8000:2008 (Corporate social responsibility management), and UNI EN ISO 14001:2004 (Environmental responsibility management system). The presence of multiple certifications creates the impression that even if there is a cultural orientation towards social and environmental issues, Mukki also assigns a prominent role to the procedural forms, which are, however, in line with the food and beverage industry customs (Unioncamere 2003). Of the three social and environmental reports, Lavazza’s and Campari’s reports are, predictably, more comparable amongst themselves, whilst Mukki’s disclosure, in a certain sense, is less standardized. Hence, the production of a less standardized disclosure may require more effort by the reporting function. The authors also recall how it may be more difficult for small-/medium-sized entities to find comparables that can help at fostering reporting and comparability. Therefore, one of the first takeaways of the analysis is that large and multinational entities’ reports are usually easier to compare, whilst small-/medium-sized companies’ reports require increased efforts and often may result in very specific disclosures. Overall, these arguments lead to the consequence that small-/medium-sized

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entities also need greater flexibility than their large and multinational counterparts. The latter, in fact, should unavoidably sum up their multitude of actions, programmes, projects, and performances, which altogether lead to schemas and the selection of only the material topics. In this context, the authors underline how in Mukki’s report, in contrast to Lavazza and Campari, the materiality analysis is not described. For large and multinational companies, the materiality analysis is, instead, an essential part of the report, because it provides the users with a quick understanding of the most relevant topics within the jungle of disclosures. The second takeaway is that the social and environmental disclosure is truly a catalyst to establish the virtuous cycle the authors meant in the previous chapters. The issuance of reports containing social and environmental disclosures appears to be an applicable incentive mechanism to make companies think not only about the economic loss or profit but also their negative or positive impact on the environment and the society. Therefore, the inclusion of this kind of information enlarges the stakeholders involved. Companies pay attention to their shareholders, but now also those who have other interests than economic profit or loss, such as employees, other workers who are not employees, trade unions, suppliers, customers, vulnerable groups, local communities, and non-governmental organizations (NGOs) or other civil society organizations, amongst others, draw great attention (GRI 101, 2016). The third takeaway is that companies, regardless of their size, search for principles, standards, and recommendations that guide in the representation of social and environmental disclosures. Specifically, in all three cases the companies prepare a report in accordance with the GRI Standards using part of selected GRI Standards and indicators to report specific information. The adoption of the GRI Standards also allows European companies to directly comply with the European Directive (GRI 2017). More generally, the use of the GRI Standards can also serve as a basis to further disclose the organisation’s engagement in achieving the UN SDGs (GRI et al. 2017). Whilst analyzing the cases, Ghio and Verona noticed certain limitations, which should be acknowledged. Firstly, despite efforts to standardize social and environmental reporting as stated, it still appears that social and environmental corporate reporting by companies is hardly comparable, even with regard to companies operating in the same industry and having the same cultural origins. Secondly, in all three cases, if the provision of social and environmental disclosures can help at thinking about certain matters, it actually does not always, by default, translate into good practice. Therefore, the disclosure may not relate to the social and environmental outcomes that are achieved. For instance, in the analyzed cases all the companies deal with gender equality information, but the men still dominate the corporate governance bodies. Finally, and more worryingly, little reference is made to the level and type of assurance, especially in small-/medium-sized companies. The external assurance, also in the case of a multinational company—in the specific case analyzed—is performed in a limited assurance engagement and therefore it cannot provide the users “with a sufficient level of assurance to become aware of all significant facts and circumstances that might be identified in a reasonable assurance engagement”.

4.4 Challenges and Opportunities for Social and Environmental Reporting

137

To conclude, in this empirical case analyses Ghio and Verona focus on a single industry to avoid complications deriving from different industries including, for instance, diverse value chains and diverse environmental and social leading indicators. The next challenge for standard setters would be to develop industry-specific standards for non-financial disclosures with the ultimate goal to create an “economy based on true value, true profits and true costs: ensuring more sustainable companies are more successful”, and improving “decision-making and external disclosure, eventually transforming the financial system to reward the most sustainable companies”.39 The focus on people and the environment creates opportunities to track a path for achieving sustainability in a tangible manner, cultivating the dialogue with all the interested parties and effective engagement with the communities and territory. Therefore, even if the preparation and dissemination of such disclosures create burdens for small/medium enterprises, it can help them respond dynamically to the risks and opportunities via programmes that can meet the evolving needs and goals of the society and focus on their mission. A number of open challenges still remain. Firstly, what are the boundaries of social and environmental disclosures? Secondly, is there an overlap between financial and non-financial disclosures? Or, what is the missing link between mandatory and voluntary disclosure? Ultimately, what has emerged in practice is that social and environmental disclosures only make sense if they are effectively prepared and if they reliably represent the company’s engagement and impact. The question, therefore, is: What kind of assurance can build trust amongst parties and ensure reliability?

39

See https://www.wbcsd.org/Overview/Our-approach

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Appendix 1 Table 4.5 Transposition summary of Directive 2014/95/EU on non-financial and diversity information

Country Directive 2014/95/EU

Reporting framework • International; • EU based; or • National framework

Austria

//

Belgium

//

Bulgaria

A reporting framework to be specified on instruction of the minister of finance

Disclosure format • Management report; or • Separate report published alongside the management report or within 6 months of the balance sheet date, made available on the undertaking’s website and referenced in the management report

• Management report; or • Separate non-financial report published later, but to be filed together with the management report • Management report; or • Separate report with reference made to management report • Management report; or • Separate report published with the management report; or • Separate report published on the

Auditor’s involvement Member states shall ensure that the statutory auditor or audit firm checks whether the consolidated non-financial statement has been provided. Member states may require that the information in the consolidated non-financial statement be verified by an independent assurance services provider //

Presence of statement and consistency check of disclosures as part of the review of the management report Presence of statement and consistency check of disclosures as part of the review of the management report

Diversity reporting required • Age; • Gender; • Professional and educational background

Applies to all large public interest entities

//

Needs to include religious affiliation

(continued)

Appendix 1

139

Table 4.5 (continued)

Country

Reporting framework

Croatia

//

Cyprus

//

Czech Republic

//

Denmark

• International, national or EU-based reporting framework—with reference to UNGC COP, PRI, or GRI frameworks for auto-compliance

Disclosure format website by 30 June of the following year with a statement in the management report • Consolidated annual report; or • Separate report in conjunction with the management report; or • Separate report published within 6 months of the balance sheet date on the website of the enterprise for at least 5 years //

• Annual report; or • Separate report published with the annual report or consolidated report; or • Separate report on the website published within 6 months from the balance sheet date with reference in the annual or consolidated report • Annual or management report; • Separate report published on the website of the enterprise for a period of 5 years with a reference in the management report;

Auditor’s involvement

Diversity reporting required

//

Applies to all listed public interest entities with 250 or more employees

//

Applies to all large listed public interest entities with over 500 employees //

//

Presence of statement and consistency check of disclosures as part of the review of the management report

To be presented in the same format as non-financial information

(continued)

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Table 4.5 (continued)

Country

Reporting framework

Disclosure format • Annual or management report that has to be published within 4 months for public interest companies and 5 months for other companies • Management report

Estonia

//

Finland France

// //

// • Annual report within 8 months of the end of the financial year and made available on website for 5 years

Germany

//

Greece Hungary

// //

Iceland

//

• Management report; or • Separate non-financial report within 4 months after the balance sheet date • Annual report • Annual report; • Consolidated annual report • Attachment to the summary report by the board

Auditor’s involvement

//

// Presence of statement and content is required if a company has 500 + employees and a turnover of over 100 million euros or balance sheet of over 100 million euros //

Diversity reporting required

Must be presented in the management report // //

//

// //

// //

Presence of statement and consistency check of disclosures as part of the review of the management report

Applies to all large, public interest entities

(continued)

Appendix 1

141

Table 4.5 (continued)

Country Ireland

Reporting framework //

Italy

• International, national or EU-based reporting framework; or • Mixed reporting methodology constituted by one or more reporting standards

Latvia

//

Lithuania

//

Disclosure format //

• Management report; or • Separate report approved by the administrative body and at disposal of the supervisory body and the auditor within the deadline for the financial statements, published on the company register and alongside the management report • Management report; or • Separate report published alongside the management report; • Consolidated management report • Annual or management report; • Separate report published within 3 months of the last day of the financial year and made available on the undertaking’s website and referenced in the annual report

Auditor’s involvement //

Presence and content of statement

Diversity reporting required Except large traded companies that issue securities other than shares, admitted to trading on a regulated market //

Presence of statement and consistency check of disclosures as part of the review of the management report

//

//

Must be presented in the annual report Applies to large listed companies

(continued)

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Table 4.5 (continued)

Country Luxembourg Malta

Reporting framework // //

Netherlands

//

Norway

//

Poland

• International, national, or EU-based reporting framework; or • Mixed reporting methodology constituted by one or more reporting standards // //

Portugal Romania

Slovakia

Slovenia

• International or EU-based reporting framework //

Disclosure format // • Director’s report; or • Consolidated director’s report • Annual management report

• Management report //

// //

• Annual report

• Business report, or • Consolidated business report, • Separate report published alongside the business report or within

Auditor’s involvement // //

Diversity reporting required // //

Presence of statement and consistency check of disclosures and identification of material misstatements are part of the review of the management report //

//

//

//

// Presence of statement and consistency check of disclosures as part of the review of the management report //

// //

//

Applies to large and medium listed companies. Must be published in the annual report

//

//

(continued)

Appendix 1

143

Table 4.5 (continued)

Country

Spain

Sweden

United Kingdom

Reporting framework

• International, EU-based or national reporting framework, explicitly mentioned the following: EMAS, UNGC, UNGP, OCDE, ISO 26000, ILO Declaration or GRI //

//

Disclosure format 6 months of the balance sheet date, made available on the undertaking’s website and referenced in the business report • Management report, or • Separate report published alongside the management report, or • Consolidated management report

• Annual report, or • Separate sustainability report published alongside the annual report • The strategic report

Auditor’s involvement

Diversity reporting required

//

//

//

//

Presence of statement and consistency check of disclosures as part of the review of the management report

//

Source: Authors’ elaboration // means that requirements are the same as in the Directive 2014/95/EU

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Appendix 2 Table 4.6 Number of organizations releasing a triple bottom report in Europe over the period 2007–2016 Year 2007 2008 Country Panel (A): Small/medium entities Austria 6 4 Belgium 0 2 Bulgaria 0 0 Croatia 0 0 Cyprus 0 0 Czech Republic 0 0 Denmark 0 0 Estonia 0 0 Finland 1 0 France 0 1 Germany 4 4 Greece 0 1 Hungary 0 1 Iceland 0 0 Ireland 0 0 Italy 3 5 Latvia 0 0 Lithuania 0 0 Luxembourg 0 0 Malta 0 0 Netherlands 4 5 Norway 0 2 Poland 0 0 Portugal 3 3 Romania 0 0 Slovakia 0 0 Slovenia 0 0 Spain 44 36 Sweden 0 2 United Kingdom 1 2 Total 66 68 Panel (B): Large entities Austria 12 13 Belgium 7 10 Bulgaria 0 0

2009

2010

2011

2012

2013

2014

2015

2016

6 3 0 0 0 0 0 0 1 1 5 3 7 0 0 4 0 0 0 0 7 2 0 5 1 0 0 70 19 1 135

25 4 0 0 0 0 0 0 0 2 8 4 7 0 0 5 0 0 0 0 10 2 0 4 0 0 0 100 20 5 196

20 6 0 0 0 0 2 0 2 2 19 7 12 0 0 9 0 0 0 0 14 3 0 11 1 0 0 122 26 5 261

22 7 1 1 0 0 2 1 8 2 24 9 12 0 0 14 0 0 1 0 14 4 1 11 1 0 0 158 26 7 326

42 5 0 1 0 1 2 1 10 3 20 6 5 1 0 22 0 0 0 0 20 1 4 9 0 1 1 122 28 7 312

33 37 0 0 0 0 3 1 6 6 24 12 6 1 2 17 3 0 3 0 20 4 3 8 0 0 0 110 28 9 336

27 28 0 0 0 1 4 2 8 8 26 6 4 1 1 19 1 0 1 0 21 6 7 5 1 1 0 86 25 6 295

21 16 0 0 0 4 4 2 11 17 27 10 8 2 3 22 1 0 1 0 20 7 2 3 0 1 0 82 26 6 296

12 17 2

17 20 1

38 24 2

38 30 2

42 33 2

41 48 4

54 44 3

42 42 3

(continued)

Appendix 2

145

Table 4.6 (continued) Year 2007 2008 Country Croatia 2 2 Cyprus 0 0 Czech Republic 2 2 Denmark 4 5 Estonia 0 0 Finland 8 13 France 11 17 Germany 23 30 Greece 6 11 Hungary 4 6 Iceland 0 0 Ireland 1 2 Italy 26 37 Latvia 0 0 Lithuania 0 0 Luxembourg 1 0 Malta 0 0 Netherlands 24 29 Norway 10 9 Poland 4 6 Portugal 15 26 Romania 3 2 Slovakia 1 3 Slovenia 0 0 Spain 182 212 Sweden 10 20 United Kingdom 26 42 Total 382 497 Panel (C): Multinational entities Austria 2 2 Belgium 1 2 Bulgaria 0 0 Croatia 0 0 Cyprus 0 0 Czech Republic 1 1 Denmark 2 3 Estonia 0 0 Finland 2 5 France 10 13 Germany 15 14 Greece 2 3

2009 4 1 2 8 0 21 19 33 20 15 0 3 46 0 0 2 0 39 12 10 31 8 5 0 236 46 49 641 3 1 0 1 0 1 3 0 8 15 21 4

2010 6 1 2 16 1 27 23 52 22 16 0 5 57 2 0 3 0 53 16 14 36 4 6 0 248 57 65 770

2011 8 1 2 19 3 27 30 73 26 12 0 7 53 1 0 4 0 70 19 21 39 8 6 0 260 87 74 914

2012 7 3 4 19 2 70 33 87 31 13 1 10 59 2 0 5 0 69 19 26 45 7 5 1 234 88 105 1015

2013 8 3 8 23 2 77 46 105 27 12 2 5 58 4 0 8 0 83 21 37 41 11 6 3 230 91 140 1128

2014 9 4 8 25 5 75 54 124 32 12 1 7 68 5 0 9 0 88 45 31 37 11 5 2 242 98 186 1276

2015 7 3 11 28 6 76 62 111 26 11 1 7 71 2 0 8 0 83 61 33 35 8 6 1 244 108 186 1296

2016 11 3 13 26 5 79 67 120 31 11 1 5 81 2 1 8 1 83 67 35 35 6 6 4 222 122 196 1328

4 1 0 0 0 2 15 0 13 18 18 6

4 5 0 1 0 4 22 1 15 22 31 12

8 7 0 2 0 3 24 2 47 31 46 11

10 7 0 2 0 5 25 1 44 35 52 13

13 10 0 3 0 8 31 1 44 84 50 15

10 11 0 4 0 8 30 1 48 99 58 14

14 11 1 4 0 11 32 1 45 122 59 14

(continued)

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Table 4.6 (continued) Year 2007 2008 2009 2010 2011 2012 Country Hungary 4 4 9 10 16 15 Iceland 0 0 0 0 0 1 Ireland 0 0 0 1 1 2 Italy 6 6 8 9 12 11 Latvia 0 0 0 0 0 0 Lithuania 1 1 1 1 1 1 Luxembourg 0 2 1 2 3 2 Malta 0 0 0 0 0 0 Netherlands 5 9 8 14 23 29 Norway 2 2 1 1 4 5 Poland 0 0 0 0 2 2 Portugal 0 1 2 4 3 4 Romania 0 0 0 0 0 1 Slovakia 0 0 0 1 1 1 Slovenia 0 0 0 1 2 4 Spain 14 18 20 24 46 44 Sweden 2 6 10 11 25 27 United Kingdom 20 25 27 31 42 56 Total 89 117 144 187 298 386 Panel (D): Entities (small/medium, large and multinational) Austria 20 19 21 46 62 68 Belgium 8 14 21 25 35 44 Bulgaria 0 0 2 1 2 3 Croatia 2 2 5 6 9 10 Cyprus 0 0 1 1 1 3 Czech Republic 3 3 3 4 6 7 Denmark 6 8 11 31 43 45 Estonia 0 0 0 1 4 5 Finland 11 18 30 40 44 125 France 21 31 35 43 54 66 Germany 42 48 59 78 123 157 Greece 8 15 27 32 45 51 Hungary 8 11 31 33 40 40 Iceland 0 0 0 0 0 2 Ireland 1 2 3 6 8 12 Italy 35 48 58 71 74 84 Latvia 0 0 0 2 1 2 Lithuania 1 1 1 1 1 1 Luxembourg 1 2 3 5 7 8 Malta 0 0 0 0 0 0 Netherlands 33 43 54 77 107 112

2013 14 1 3 16 0 1 3 0 30 5 3 3 1 1 5 36 30 68 414

2014 13 1 6 18 0 1 3 0 40 10 2 6 1 0 6 40 34 75 515

2015 12 0 4 21 0 1 7 0 41 18 5 3 2 2 6 46 36 89 576

2016 10 0 4 18 0 1 9 0 37 23 6 6 2 3 8 46 38 95 620

94 45 2 11 3 14 50 4 131 84 177 46 31 4 8 96 4 1 11 0 133

87 95 4 12 4 16 59 7 125 144 198 59 31 3 15 103 8 1 15 0 148

91 83 3 11 3 20 62 9 132 169 195 46 27 2 12 111 3 1 16 0 145

77 69 4 15 3 28 62 8 135 206 206 55 29 3 12 121 3 2 18 1 140

(continued)

References

147

Table 4.6 (continued) Country Norway Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom Total

Year 2007 12 4 18 3 1 0 240 12 47 537

2008 13 6 30 2 3 0 266 28 69 682

2009 15 10 38 9 5 0 326 75 77 920

2010 19 14 44 4 7 1 372 88 101 1153

2011 26 23 53 9 7 2 428 138 121 1473

2012 28 29 60 9 6 5 436 141 168 1727

2013 27 44 53 12 8 9 388 149 215 1854

2014 59 36 51 12 5 8 392 160 270 2127

2015 85 45 43 11 9 7 376 169 281 2167

2016 97 43 44 8 10 12 350 186 297 2244

Source: Authors’ elaboration. Data source https://database.globalreporting.org/search/

References Adams CA (2002) Internal organisational factors influencing corporate social and ethical reporting beyond current theorising. Account Audit Account J 15(2):223–250 Bebbington J (1997) Engagement, education and sustainability: a review essay on environmental accounting. Account Audit Account J 10(3):365–381 Brown J (2009) Democracy, sustainability and dialogic accounting technologies: taking pluralism seriously. Crit Perspect Account 20(3):313–342 Cheng B, Ioannou I, Serafeim G (2014) Corporate social responsibility and access to finance. Strateg Manag J 35(1):1–23 Cho CH, Patten DM (2007) The role of environmental disclosures as tools of legitimacy: a research note. Acc Organ Soc 32(7-8):639–647 Cho CH, Michelon G, Patten DM, Roberts RW (2015a) CSR disclosure: the more things change. . .? Account Audit Account J 28(1):14–35 Cho CH, Laine M, Roberts RW, Rodrigue M (2015b) Organized hypocrisy, organizational façades, and sustainability reporting. Acc Organ Soc 40:78–94 Cooper DJ, Sherer MJ (1984) The value of corporate accounting reports: arguments for a political economy of accounting. Acc Organ Soc 9(3–4):207–232 Cooper C, Taylor P, Smith N, Catchpowle L (2005) A discussion of the political potential of Social Accounting. Crit Perspect Account 16(7):951–974 Cormier D, Gordon IM (2001) An examination of social and environmental reporting strategies. Account Audit Account J 14(5):587–616 Cormier D, Ledoux MJ, Magnan M (2011) The informational contribution of social and environmental disclosures for investors. Manag Decis 49(8):1276–1304 CSR Europe, GRI (2017) Member State Implementation of Directive 2014/95/EU. A comprehensive overview of how Member States are implementing the EU Directive on Non-Financial and Diversity Information Dhaliwal DS, Li OZ, Tsang A, Yang YG (2011) Voluntary nonfinancial disclosure and the cost of equity capital: the initiation of corporate social responsibility reporting. Account Rev 86 (1):59–100 Dhaliwal DS, Radhakrishnan S, Tsang A, Yang YG (2012) Nonfinancial disclosure and analyst forecast accuracy: international evidence on corporate social responsibility disclosure. Account Rev 87(3):723–759

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Dierkes M, Antal AB (1985) The usefulness and use of social reporting information. Acc Organ Soc 10(1):29–34 Dillard JF, Ruchala L (2005) The rules are no game: from instrumental rationality to administrative evil. Account Audit Account J 18(5):608–630 Dillard J, Vinnari E (2019) Critical dialogical accountability: from accounting-based accountability to accountability-based accounting. Crit Perspect Account 62:16–38 Eccles RG, Ioannou I, Serafeim G (2014) The impact of corporate sustainability on organizational processes and performance. Manag Sci 60(11):2835–2857 Elkington J (1994) Towards the sustainable corporation: win-win-win business strategies for Sustainable Development. Calif Manag Rev 36(2):90–100 Global Reporting Initiative (2015) G4 Sustainability Reporting Guidelines Global Reporting Initiative (2016) GRI 101: Foundation Global Reporting Initiative (2017) Linking the GRI Standards and the European Directive on non-financial and diversity disclosure Global Reporting Initiative, United Nations Global Compact, World Business Council for Sustainable Development (2017) SDG compass. Linking the SDGs and GRI Gray R, Owen D, Maunders K (1987) Corporate social reporting: accounting and accountability. Prentice-Hall International, London Gray R, Kouhy R, Lavers S (1995) Corporate social and environmental reporting: a review of the literature and a longitudinal study of UK disclosure. Account Audit Account J 8(2):47–77 Gray R, Owen D, Adams C (2010) Some theories for social accounting? A review essay and a tentative pedagogic categorisation of theorisations around social accounting. Adv Environ Account Manag 4:1–54 ISTAT (2019) Rapporto sulla competitività dei settori produttivi. Istituto nazionale di statistica, Roma Jasch C (2003) The use of Environmental Management Accounting (EMA) for identifying environmental costs. J Clean Prod 11(6):667–676 Killian S, O’Regan P (2016) Social accounting and the co-creation of corporate legitimacy. Acc Organ Soc 50:1–12 Lavazza (2018) Sustainability Report 2018. Turin Lehman G (2001) Reclaiming the public sphere: problems and prospects for corporate social and environmental accounting. Crit Perspect Account 12(6):713–733 Mathews MR (1997) Twenty-five years of social and environmental accounting research. Is there a silver jubilee to celebrate? Account Audit Account J 10(4):481–531 Mukki (2015) Annual Report 2015. Florence Murray A, Sinclair D, Power D, Gray R (2006) Do financial markets care about social and environmental disclosure? Account Audit Account J 19(2):228–255 Parker LD (2005) Social and environmental accountability research. Account Audit Account J 18 (6):842–860 Plumlee M, Brown D, Hayes RM, Marshall RS (2015) Voluntary environmental disclosure quality and firm value: further evidence. J Account Public Policy 34(4):336–361 Roberts RW (1992) Determinants of corporate social responsibility disclosure: an application of stakeholder theory. Acc Organ Soc 17(6):595–612 Rodrigue M, Magnan M, Cho CH (2012) Is environmental governance substantive or symbolic? An empirical investigation. J Bus Ethics 114(1):107–129 Social Accountability International (2001) Social Accountability 8000 Tate WL, Ellram LM, Kirchoff JF (2010) Corporate social responsibility reports: a thematic analysis related to supply chain management. J Supply Chain Manag 46(1):19–44 Tregidga H (2017) “Speaking truth to power”: analysing shadow reporting as a form of shadow accounting. Account Audit Account J 30(3):510–533 Unioncamere (2003) I modelli di responsabilità sociale nelle imprese italiane. In collaboration with ISVI. In: Molteni M, Lucchini M (eds) I modelli di responsabilità sociale nelle imprese italiane. Franco Angeli, Milano Yin RK (1981) The case study as a serious research strategy. Knowledge 3(1):97–114 Yin RK (2018) Case study research and applications. Design and methods, 6th edn. Sage, Los Angeles

Chapter 5

New Communication Channels

Abstract This chapter examines the Web’s and social media’s role as new corporate communication channels. Ghio and Verona document that the low costs associated with the Web and social media provide free and immediate as well as large amounts of information to stakeholders, overcoming the media’s monopoly in reporting corporate information. Ghio and Verona provide empirical evidence of the determinants for social media presence and activity around earnings announcements for a sample of firms listed on the Alternative Investment Market (AIM), London, over the period 2007–2015. The authors also show the association between presence and activity on social media before earnings announcements and press coverage in the aftermath of earnings announcements.

5.1

Introduction

“Congrats to Ted Sarandos, and his amazing content licensing team. Netflix monthly viewing exceeded 1 billion hours for the first time ever in June [. . .]”1 During July 2012, Netflix CEO Reed Hastings was the first top executive to disclose material information on social media. A few months later, eBay and Dell used Twitter to announce their financial results and other key information to investors. In spite of initial concerns about violating rules of disclosure, the U.S. Securities and Exchange Commission (SEC) announced during April 2013 that companies could use social media to disclose sensitive information. Goldman Sachs reacted positively to this announcement with a Tweet, “Thanks to @Sec_News for today’s announcement on social media from those of us @GoldmanSachs”.2 Today, companies all over the world use social media to communicate with their investors. For example, Independent Resources PLC, a UK-listed small- and medium-sized enterprise (SME) operating in the oil and gas

1 2

3 July 2012—Reed Hastings’ Facebook account. @GoldmanSachs, 2 April 2013.

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industry, mentions both the stock market on which it is listed and its ticker symbol in its Twitter account description.3 The Web and, more recently, social media have revolutionized the dissemination of corporate communication substantially. Until a few years ago, companies were disclosing their information through traditional communication channels to a limited number of people. For a long time, the press has monopolized the use of media through its discretionary power to decide on which pieces of information to report (Cahan et al. 2015; Tetlock 2007; Tetlock et al. 2008; Kothari et al. 2009). These days, the communication function is no longer a privilege of a small elite mainly represented by journalists. Through the Web and social media, companies can now directly convey information to externals without using intermediaries (Kaplan and Haenlein 2010; Bushee et al. 2010). This possibility is most important for firms facing difficulties in attracting investor attention, for example SMEs and young firms. In a traditional business environment, press and financial analysts influence the information environment surrounding firms (McNichols and O’Brien 1997; Miller 2006). Information providers, such as media and analysts, tend to focus on larger-sized firms, due to the larger audience. Considering that the business press has a limited amount of pages/ space and human resources, articles mostly cover large listed companies, which are of interest to a large audience of readers. Similarly, analysts provide reports and suggestions on the companies their investors mostly demand. As a result, SMEs and young firms suffer from low visibility. These types of firms particularly need additional investor attention in order to attract external capital to finance their growth. Past research documents that firms with low visibility benefit from hiring an investor relations firm to attract more investor attention. Following the hiring of an investor relations firm, firms with low visibility report that their analysts following and market valuation increase (Bushee and Miller 2012). However, this type of communication strategy is often too costly for SMEs and young firms. They do not always have the resources to hire a sufficient number of people in their investor relations department and develop new communication activities (Boulland et al. 2019). The low costs associated with the Web and especially with corporate social media communication and the possibility to independently provide a rich and constant flow of information, have facilitated the wide reach of platforms, such as Twitter and Facebook, amongst all types of companies. Blankespoor et al. (2013) document that information disclosed via social media is particularly effective for firms with low visibility. Therefore, SMEs and young firms can use social media to convey information to their investors, reducing the dearth of information surrounding their activities. Anecdotal evidence shows that SMEs use Twitter to disseminate information relevant to investors. For instance, Metal Tiger Plc, a medium-sized listed

3 “Independent Resources—AIM quoted company (AIM:IRG) with expertise in the geology of and operations in the Mediterranean basin.”—Information retrieved on 27 April 2016.

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151

company, describes itself on its Twitter account as “London AIM listed (LON:MTR) resource investor with high impact projects in Botswana, Spain & Thailand. Focused on precious & strategic metals. #MetalTiger”. Similarly, Brady Plc’s account description reports “Brady plc (BRY.L) is a leading global provider of trading and risk management software to the worldwide #commodity and #energy markets. #CTRM #ETRM”. Abzena, another medium-sized company listed on AIM London, tweets “#Abzena expects revenue flows as humanised antibodies enter clinical development—@AbzenaGroup tinyurl.com/l42eo2b via @proactive_uk”. Despite large use of social media and the potential implications of different communication strategies, there are still few insights into the use and effects of corporate social media, especially for firms with low visibility (Blankespoor et al. 2013; Miller and Skinner 2015; Lee et al. 2015; Jung et al. 2017). On the one hand, corporate social media disclosure may expand knowledge about the firms’ activities and future performance. On the other hand, corporate social media disclosure may lead to information overload or information being considered not relevant. Moreover, given the limited presence of competing sources of information, managers may be tempted to exploit investors’ limited attention by disclosing information strategically on social media (Jung et al. 2017). With an interest in understanding the relationship between new communication channels and corporate communication, in this chapter Ghio and Verona examined prior literature and provide empirical evidence on web and social media corporate communication. Consistent with previous studies, Ghio and Verona consider investor attention as a scarce resource (DellaVigna and Pollet 2009; Hirshleifer et al. 2009; Hirshleifer and Teoh 2003). As such, firms may opportunistically disclose information and potentially gild the pill of bad news. Thus, the channel used to disseminate corporate information plays a fundamental role in defining the level of attention that investors allocate to stocks, particularly in complex and uncertain situations (Boulland and Dessaint 2017; Kahneman 1973). The authors organized the remainder of this chapter as follows. Section 5.2 briefly explores the Web’s role in disseminating corporate information. Section 5.3 discusses social media’s impact on corporate communication by reviewing the burgeoning literature on social media in accounting and finance. Section 5.4 provides empirical evidence on the determinants of corporate social media presence and activity for a sample of firms listed on the AIM London, and the associated consequences in terms of press coverage. Ghio and Verona use a unique proprietary database collecting firms’ communication on Twitter and Facebook. To conclude, Sect. 5.5 discusses the challenges and opportunities of new communication channels, paving the way to multiple future research in this domain.

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5.2

5 New Communication Channels

Web Communication

The possibility to establish a web presence, most often with a website, represented the beginning of substantial changes in corporate communication (Drake et al. 2012). Whereas, in the past, companies would have had access to a larger audience than their investors and analysts mostly through press articles or press reports, today the Web allows them to decide the content of their website and the timing for updates, and it gives them the ability to include forums in their websites to interact with their users. In fact, externals can pull information via web search engines or by directly typing the web address of the company’s website. Companies can also push information to externals via their email newsletters, provided that externals sign up for the corporate newsletters. Furthermore, popular websites that are dedicated to financial information, such as Yahoo Finance and Google Finance, and specialized accounting and finance forums, such as SeekingAlpha, provide timely and almost unlimited information about firms’ fundamentals and news. Regulators also use the Web to disseminate financial information. In the United States, the SEC relies on the Edgar database as the primary system for submissions by companies and others who are required by law to file information with the SEC. The Edgar database contains millions of companies and individual filings and is beneficial to investors and corporations, increasing the efficiency, transparency, and fairness of the securities markets. The system processes about 3000 filings per day, serves up 3000 terabytes of data to the public annually and accommodates 40,000 new filers per year on average.4 In the European Union, the Transparency Directive of 2004 compelled firms to use English language wire services to disseminate their news. This change in news dissemination strengthens the disclosure requirements of firms that are listed on European stock markets (Boulland et al. 2014). Past research shows that investors and customers consume the information that firms place on the Web. Choi and Varian (2012) estimate monthly retail sales of automobiles, homes, and the turnover associated with tourism by examining the Google Search Volume Index (SVI). Da et al. (2011) document that product search frequency is positively associated with firm performance. Drake et al. (2012) show that the Internet’s search option is changing the demand for news and, therefore, weeks before the earnings announcement, investors search for corporate information on Google. The authors document that Google searches increase about 2 weeks prior to the earnings announcement, reach their peak at the earnings announcement and persist at a high level for a period after the announcement. Moreover, the authors find that earnings announcements preceded by a high volume of Google searches are partially pre-empted. Investors have also created forums to discuss firms’ activities. An interesting and significant example is SeekingAlpha.com, an online platform providing stock market insights and financial analyses, including earnings call transcripts, investment ideas, and research on exchange-traded funds (ETFs) and stocks written by finance 4

For further information, refer to https://www.sec.gov/edgar/aboutedgar.htm

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153

experts. Users discuss corporate news and provide a forecast of firms’ performance. Chen et al. (2014) document that SeekingAlpha.com articles and commentaries predict stock prices on a 3-month horizon. The authors show that a fraction of negative words predicts negative earnings surprises and that users can differentiate between good and unreliable SeekingAlpha.com articles. Lastly, these articles prove that the tone of the commentaries is more relevant than the tone of the articles. Professional accounting bodies also use web communication to communicate externally. However, how they communicate has substantially changed over time. Brivot et al. (2015) show that even the language adopted by the American Institute of Certified Public Accountants (AICPA) has changed over time to address different needs. They examine the language that the AICPA used in web communications with their members and outsiders to describe the accounting association. As such, the authors identify three periods, such as: – 1997–2001: The language of marketing. The AICPA logic aligns with the prevalent logic in the economic context, such as globalized consumerist capitalism. – 2002–2004: The language of classic professionalism, a celebration of parrhesia. The objective is to relegitimize the accounting profession’s activities in the aftermath of the Enron Scandal. – 2005–2010: The language of marketing—development of the Vision Project. The AICPA’s language on the Web reflects the tension between professionalism and commercialism in the accounting profession. Moreover, the marketing language is the language used in the environment in which the AICPA operates. It is possible to observe a transformation in how professionals produce and sell expertise. Overall, it appears that accountants aim to legitimize specific concepts that are related to professionalism within their commercialism approach to business. Generally, the Web has represented a major change in corporate communication. On the one hand, organizations started becoming more independent in deciding the content and timing of the information provided externally. By overcoming the need to use the business press to communicate externally, firms have more freedom in deciding their news focus, with the potential for opportunistic use. On the other hand, people external to the organizations have the potential to start discussing corporate news. Firms have thus partially lost part of their ability to shape the external narrative about their activities, increasing the risk of potential reputational risk. The main limitations associated with the use of corporate websites are the frequent lack of update information, the difficulties to directly interact with the firm other than by email or a standard pre-filled form, and the need to pull information rather than having information pushed. In the next section, the authors discuss and explore how social media overcame most of these limitations.

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5 New Communication Channels 1800

Facebook

Instagram

Twier

1600 1400 1200 1000 800 600 400 200 0 2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Fig. 5.1 Number (in millions) of users for Facebook, Instagram, and Twitter (Source: Authors’ elaboration, data gathered from Statista.com)

5.3

Social Media

To fill the information gap amongst the different actors, social media can play a key role, since it provides free and immediate as well as massive information to a large number of stakeholders.5 The widespread use of social media has revolutionized the communication process, as information is created outside of professional routines and practices (Miller and Skinner 2015). Kaplan and Haenlein (2010) define social media as platforms that publish either on a public website or a social networking site and which are accessible to a selected group of people. Users can share messages (e.g. Twitter), pictures (e.g. Instagram), videos (e.g. YouTube), professional information (e.g. LinkedIn), or all of the above (e.g. Facebook). A few of the globally most popular social media platforms are Facebook (1.620 billion users in December 2018), Instagram (1 billion users in December 2018), and Twitter (330 million users in December 2018).6 Figure 5.1 provides additional information about the trend of social media adoption. All three social media platforms analyzed, i.e. Facebook, Instagram, and Twitter, have increased their number of users, with a recent significant increase in Instagram’s popularity over the last 4 years. From an international perspective, the low costs associated with the use of social media platforms facilitate their widespread use across developed and developing countries. Figure 5.2 shows that the United States and India are the countries with the highest number of social media users. The United Kingdom is one of the top countries at the global level for the number of Twitter users (14 million Twitter

5 6

See Saxton (2012) for a literature review on the users of social media information. Source: Statista.com. Accessed on 2 September 2019.

5.3 Social Media

155

Mexico United Kingdom Brazil China Indonesia India United States 0

50

100

150

200

250

300

Number of Twitter Users (July 2019) Number of Instagram Users (July 2019) Number of Facebook Users (July 2019)

Fig. 5.2 Number (in millions) of users for Facebook, Instagram, and Twitter per country (Source: Authors’ elaboration, data gathered from Statista.com)

users in July 2019). With 23% of the national population using Twitter, the United Kingdom is the country with the highest number of people relative to the country population using Twitter. Companies can convey information to market participants through social media without using intermediaries. Companies officially say that they release the information they consider relevant on social media. For instance, Procter & Gamble, an American consumer goods company, displays the following on the description of its Twitter account: “Your official home for all the latest news & info about P&G and our family of trusted brands [. . .]”.7 Users and potential investors have immediate and easy access to information in almost any country and time zone. The decision by Bloomberg Terminal’s database, a major source of information for investors and analysts, to include tweets in its newsfeeds since 2013 confirms that investors demand corporate social media information. From the regulatory perspective, there is still intense debate in light of these new communication channels’ recent wide reach. Regulators face difficulties in defining appropriate regulations for social media communication that maintains an equilibrium between investor protection and disclosure costs for firms. In the United States, the SEC allows firms to use social media in order to disclose relevant information. The oversight body motivated its decision allowing companies to announce their 7

Information retrieved on 20 April 2016 at 4.35 pm.

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earnings firstly on social media instead of solely on corporate websites as follows, “An increasing number of public companies are using social media to communicate with their shareholders and the investing public. We appreciate the value and prevalence of social media channels in contemporary market communications, and the commission supports companies seeking new ways to communicate”.8 However, the SEC has recently alerted investors to pay attention to the risk of fraud, due to misleading information disclosed on social media and immediately disseminated all over the world with the intent of manipulating share prices.9 In Europe, hardly any specific regulations exist for corporate social media use. Companies mostly refer to rules on voluntary disclosure. An exception is the December 2016 Social Media Guidance Protocols for firms listed on the AIM, stating that “Social media and other forms of electronic communication are powerful tools which can be of significant value to AIM companies when communicating with a broad range of investors and stakeholders. Such communications may include ‘twitter’, non-regulatory news feeds, an AIM company’s website etc. Whatever the form of public communication, these are subject to the same rules regarding disclosure of regulatory information”.10 The authorities enforced this rule during August 2018 (Section C2.2. Notice) by fining a company £75,000 for breaching AIM Rules 10 and 31, specifically finding that “The AIM company breached AIM Rule 10 by making public relevant information via social media before it was disclosed in a regulatory notification. By failing to have sufficient procedures, resources and controls in place to monitor its disclosures made through social media, the AIM company also breached AIM Rule 31”.11 The analysis of social media data allows researchers to obtain information about firms’ decisions and users’ comments about companies. Accounting and finance research still lags behind other disciplines, for example marketing and computer science, on the issue of gathering evidence about the role of social media as a communication channel. Thus far, a relatively small number of accounting and finance studies provide evidence about social media disclosure’s impact on market participants’ decisions. Miller and Skinner (2015) in their editorial for a special issue in the Journal of Accounting Research entitled “The Evolving Disclosure Landscape: How Changes in Technology, The Media, and Capital Markets are Affecting Disclosure”, argue that “new forces (such as social media and increased mobility) are emerging, and these forces are likely to change disclosure in important ways”. Miller and Skinner (2015) emphasize that companies can, on the one hand, use social media to disseminate new or existing information; on the other hand, firms may have partially lost

8

https://www.sec.gov/litigation/investreport/34-69279.htm. Accessed on 20 April 2018. https://www.sec.gov/oiea/investor-alerts-bulletins/ia_rumors.html. Accessed on 21 April 2018. 10 For further information, https://www.londonstockexchange.com/companies-and-advisors/aim/ advisers/inside-aim-newsletter/inside-aim-newsletter. Accessed on 12 September 2019. 11 https://www.londonstockexchange.com/companies-and-advisors/aim/advisers/aim-notices/ad19. pdf. Accessed on 20 September 2019. 9

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157

control of the information environment. Users can access widespread unverified and non-verifiable information about companies. The possibility of interaction amongst users may foster negative reactions to firms’ news. By investigating how and why companies communicate with investors on social media, Blankespoor et al. (2013) show that high-tech firms issuing tweets containing hyperlinks to press releases about earnings announcements receive higher investor attention. Yet, they do not find evidence that firms use social media opportunistically. Lee et al. (2015) document that firms engaging on social media during a product recall, experience less backlash from their investors than firms who are not active on social media. In an experimental study, Elliott et al. (2018) show that CEOs’ activity on social media can mitigate investors’ negative reactions to firms’ bad news. Both Lee et al. (2015) and Elliott et al. (2018) support the idea that social media is a more superior communication channel than traditional websites in establishing bonds with investors. Jung et al. (2017) provide evidence of the costs associated with corporate social media activity. They find that a company tweeting bad news concurrent with a user’s retweet leads to more negative articles about a firm than in traditional media. Interestingly, Manetti and Bellucci (2016), as well as Bellucci and Manetti (2017), show that social media may represent a useful platform to foster dialogic accounting. However, firms exhibit limited engagement with their stakeholders via social media and mostly from an agonistic perspective. By examining users’ opinions, Bartov et al. (2017) show that opinions on Twitter before earnings announcements predict forthcoming quarterly earnings and announcement returns. Their results are stronger for firms operating in poor information environments. Kadous et al. (2017) provide experimental evidence that social media influences investors’ decisions even when it has little predictive power. These findings raise concerns about the potential side effects on the market efficiency of the widespread use of social media. Twitter activity can also influence firms’ actions. Gao et al. (2017) show that executives who are more active on social media receive higher compensation, because boards are subject to limited visibility. Lastly, Cade (2018) document that criticisms from Twitter users influence managerial decisions only if the managers receive a large number of retweets. The authors also show that users would appreciate more firms responding to criticisms considered valid or firms highlighting at least a few positive aspects of their activities instead of firms not responding. Overall, it emerges that social media influences investors’ decisions. Moreover, information on social media, either from the company or about a company, appears relevant to predict firms’ future performance. Top managers’ social media accounts also provide an accurate description of firms’ future decisions. However, despite social media’s substantial relevance in daily decisions, the accounting literature, and finance literature on this topic are still in their infancy.

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5 New Communication Channels

Empirical Analysis of Corporate Social Media Adoption

This section examines the determinants to communicate and to be active on social media around earnings announcements. Ghio and Verona investigate the association between corporate social media communication and firm visibility, with a particular focus on press coverage around earnings announcements. Ghio and Verona examined corporate social media communication for AIM-listed firms over the period 2007–2015. The AIM London, created in the United Kingdom in 1995, has less rigorous and less expensive listing requirements than traditional stock exchanges. In 2017, approximately 1000 companies had already listed on AIM with an average capitalization of 80 million euros each. It is the largest stock exchange in the world for SMEs, as its market capitalization is almost 12 times larger than Alternext, a Pan-European stock exchange for firms of smaller size.12 AIM strictly regulates firms’ website content (Rule 26 of the Disclosure and Transparency Rules). AIM is a stock market dedicated to smaller growing companies and has a regulatory environment designed for this type of firm (Gerakos et al. 2013).13 Moreover, differently from other stock exchanges, AIM represents an ideal setting, since it requires all listed companies to have a website and also regulates their content.14 Social media, therefore, represents a more flexible manner for firms to communicate externally than traditional websites. Overall, Ghio and Verona justify the decision to focus on AIM-listed firms by the need to have a comparable set of firms and by the need to mitigate the concern that unobserved firm characteristics drive our results. Metal Tiger Plc, which describes itself on Twitter as “London AIM listed (LON: MTR) resource investor with high impact projects in Botswana, Spain & Thailand. Focused on precious & strategic metals. #MetalTiger” tries to keep its investors engaged by sending Tweets like “Thanks to all the shareholders & investors supporting the company. It is greatly appreciated. Have a gr8 weekend. All the way from Bangkok!”15 Through social media, it is possible to convey a wide range of information that investors could incorporate in their decision-making. Nevertheless, there are still a few insights into the use of social media from a company perspective (Blankespoor et al. 2013; Jung et al. 2017; Lee et al. 2015). Figure 5.3 shows social media presence, i.e. Twitter and/or Facebook accounts, of AIM-listed firms over the period 2007–2015. The presence on social media,

12 http://www.londonstockexchange.com/statistics/historic/aim-country-of-operation-and-incorpora tion/aim-companies-country-of-operation.htm 13 The London Stock Exchange describes AIM as follows: “AIM is the most successful growth market in the world. Since its launch in 1995, over 3,600 companies from across the globe have chosen to join AIM. Powering the companies of tomorrow, AIM continues to help smaller and growing companies raise the capital they need for expansion”. Further information at http://www. londonstockexchange.com/companies-and-advisors/aim/. Accessed on 5 April 2018. 14 Rule 26, AIM Rules for Companies, London Stock Exchange, January 2016. 15 Information retrieved on 26 April 2016.

5.4 Empirical Analysis of Corporate Social Media Adoption

159

70% 60% 50% 40% 30% 20% 10% 0% 2007

2008

2009

2010

2011

2012

2013

2014

2015

Fig. 5.3 AIM-listed firms’ social media (Twitter and/or Facebook) adoption date (Source: Authors’ elaboration)

i.e. Twitter and/or Facebook, increased substantially over time, reaching almost 60% of the AIM-listed firms in 2015. For both Twitter and Facebook, the number of observations has increased comparatively even if a larger number of firms adopted Twitter. Similar to previous studies (Lee et al. 2015; Jung et al. 2017), Ghio and Verona focus on Twitter and Facebook to measure corporate social media presence, as these two social media platforms are considered the most widespread and the most used social media.16 Nonetheless, the authors highlight that these two social media platforms are complementary, as they are often used for different purposes. On Twitter, it is usually well-accepted that people receive information from the profile that they follow, in addition to the activity of broadcasting a tweet. On Facebook, companies usually have pages instead of profiles and to be in contact with them, it is, therefore, necessary to like their pages. Thereby, Facebook users automatically subscribe to news that will appear on their Facebook wall, which is a sort of home page on Facebook. Miller and Tucker (2013) state that “when a user likes a page, this means that he or she signs up for the news feed so he or she receives posted communications from the organization” (p. 56). However, consistent with Blankespoor et al. (2013), Ghio and Verona analysis of corporate social media communication focuses on Twitter, as it is the channel that investor relations departments predominantly use to communicate to externals. The authors obtain financial information and data about analysts from EIKON, earnings announcement dates from Institutional Brokers’ Estimate System (IBES)

16

Consistent with Jung et al. (2017), the authors examine corporate presence on Twitter and Facebook, since other social media like LinkedIn, Instagram, Pinterest, Youtube, and Google+ are not broadly used to release financial news.

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and business press articles from RavenPack. Data on headquarters’ location have been hand-collected from the companies’ websites. For social media data, the authors partially hand-collected data about firms’ presence on Twitter and developed an ad hoc Python script to retrieve tweets around earnings announcements. The analysis of social media communication around earnings announcements provides the opportunity to focus on a period that is topical to financial news. Moreover, considering that earnings announcements are seasonal events and investors have to process competing information to make their investment decisions (Boulland and Dessaint 2017), an understanding of social media use in the period around earnings announcement is particularly relevant to firms in order to increase their visibility. Building on prior research, the authors model the firm’s decisions to have a social media account and communicate on Twitter based on a number of potential determinants, as specified in Eq. (5.1): SOCIALMEDIAi,t ¼α0 þα1 SIZE ,t þα2 GROWTH i,t þα3 MTB,t þα4 ROAi,t þ α5 LEV i,t þα6 INTANGi,t þα7 ANALYSTSi,t þα8 INTERNET i,t þ α9 POPULATION i,t þIndustry Fixed Effects þ Year Fixed EffectsþΩi,t

ð5:1Þ

where SOCIALMEDIA is: SOCIAL_MEDIA_ACCOUNT equal to one if a firm has a Twitter account or/and a Facebook page at least 2 weeks before the earnings announcement, and zero otherwise; TWITTER_ACTIVITY equal to the number of tweets that a firm issued during the 2 weeks before the earnings announcement. We measure SIZE as the natural logarithm of total assets. We measure GROWTH as the change in revenues from t1 to t. MTB is the Market to Book ratio. ROA indicates profitability and we measure it as net income divided by lagged total assets. LEV indicates leverage measured as total liabilities divided by lagged total assets. INTANG indicates intangible assets and we measure it as intangible assets divided by lagged total assets. We measure ANALYSTS as the number of analysts following the firm during the year. We measure INTERNET as the percentage of the population using Internet in the country of the company’s headquarters. Lastly, we measure POPULATION as the population of the city in which the company is headquartered divided by 1000. The authors include year and industry fixed effects to mitigate the potential concerns that time and industry-specific factors drive the results. We winsorize all continuous variables at the top and bottom 1% to reduce the influence of outliers, and we cluster standard errors at year and firm level to account for withinfirm and within-time correlations. This analysis identifies the determinants of the presence on social media (SOCIAL_MEDIA_ACCOUNT) and the presence of communication on Twitter around earnings announcements (TWITTER_ACTIVITY). We examine several factors that could influence social media presence and communication. Firms of larger size (SIZE) may have more resources to establish a presence on social media via their

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communication and investor relations department. Nonetheless, small firms may also have strong incentives to be active on social media, due to social media’s low cost and the need to increase the firms’ visibility. Growing firms (GROWTH) and firms with potential for growth (MTB) may have high incentives to be active and communicate on social media to attract investors’ attention. In this manner, firms can ensure sufficient financing for their expansion and overcome potential financing limitations associated with low investors’ attention. Firms reporting positive financial results (ROA) will have strong incentives to emphasize their performance on social media, especially around earnings announcements. Firms with more intangibles (INTANG) are usually considered part of the new economy firms (Barth et al. 2018; Srivastava 2014) and their shareholders may have a greater demand for information on social media. As firms with more intangibles want to fill the gap between book value and firm value, social media communications may assist them in delivering information on their market value. Firms with a higher level of liabilities (LEV) and with more analysts’ following (ANALYSTS) may be pressured by creditors and analysts to provide a constant and timely flow of information. As such, firms may consider using corporate social media to satisfy the external appetite for information. Companies located in countries with high Internet users (INTERNET) incur fewer costs to use social media as communication tools and they will have higher access to people with knowledge about the use of social media. Moreover, firms located in highly populated areas (POPULATION) may be more likely to be solicited by their local stakeholders to use social media to communicate with them. The authors investigate the consequences with regard to the external visibility of social media presence and communication on Twitter around earnings announcements. To examine external visibility, Ghio and Verona study the number of press articles about firms (PRESS_COVERAGE) in the aftermath of the earnings announcement (Chapman et al. 2019; Drake et al. 2014). Their conjecture is that the press would pick up information on social media, further fostering firms’ visibility. The authors estimate how social media presence and communication affect firms’ press coverage by estimating the following model: PRESS COVERAGE i,t ¼ α0 þ α1 SOCIALMEDIA,t þ α2 SIZE ,t þ α3 GROWTH i,t þ α4 MTB,t þ α5 ROAi,t þ α6 LEV i,t þ α7 INTANGi,t þ α8 ANALYSTSi,t þ Industry Fixed Effects þ Year Fixed Effects þ Ωi,t ð5:2Þ where PRESS_COVERAGE is the number of press articles about a firm in the 3-day period after the earnings announcement. SOCIALMEDIA is: SOCIAL_MEDIA_ACCOUNT equal to one if the firm has a Twitter account or/and a Facebook page at least 2 weeks before the earnings announcement and zero otherwise; TWITTER_ACTIVITY equal to the number of tweets a firm issued during the 2 weeks before the earnings announcement. We measure SIZE as the natural logarithm of total assets. We measure GROWTH as the change in revenues

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Table 5.1 Sample composition Firm-year observations reported on the AIM market from 2007 to 2015 – Firm-year observations in utility and financial industry – Firm-year observations with negative equity – Firm-year observations with unavailable data Total number of firm-year observations Number of unique firms

8794 1411 469 3721 3373 637

Table 5.2 Descriptive statistics

SOCIAL_MEDIA_ACCOUNT TWITTER_ACTIVITY PRESS_COVERAGE SIZE GROWTH MTB ROA LEV INTANG ANALYSTS INTERNET POPULATION

(1) N 3373 3373 3373 3373 3373 3373 3373 3373 3373 3373 3373 3373

(2) Mean 0.310 0.139 0.097 8.459 0.036 2.725 0.114 0.356 0.487 1.237 82.06 3125

(3) P25 0 0 0 7.685 0.019 0.318 0.162 0.172 0.029 0 78.39 52

(4) P50 0 0 0 9.649 0.016 0.810 0.003 0.342 0.216 1 85.38 412

(5) P75 1 0 0 10.870 0.145 2.237 0.057 0.508 0.532 2 89.84 8700

(6) StDev 0.463 0.527 0.561 3.740 0.297 6.541 0.363 0.225 3.495 1.538 12.57 3990

from t1 to t. MTB is the Market to Book ratio. ROA indicates profitability and we measure it as net income divided by lagged total assets. LEV indicates leverage and we measure it as total liabilities divided by lagged total assets. INTANG indicates intangible assets and we measure it as intangible assets divided by lagged total assets. ANALYSTS is the number of analysts following the firm during the year. The authors include year and industry fixed effects to mitigate the potential concerns that time and industry-specific factors drive the results. We winsorize all continuous variables at the top and bottom 1% to reduce the influence of outliers and we cluster standard errors at year and firm level to account for within-firm and within-time correlations. Table 5.1 describes the sampling and data collection process. Following the Fama-French 12 industries classification, the authors exclude firms operating in industry with FF code 11 (i.e. the financial and insurance industry), because they adopt specific disclosure rules (DuCharme et al. 2001; Burgstahler et al. 2006; Ball and Shivakumar 2008). The authors also delete observations with negative equity. Next, they exclude observations with unavailable data. The final sample is composed of 3373 firm-year observations (637 unique firms). Table 5.2 reports the descriptive statistics for the variables used in the analyses. The mean value of SOCIAL_MEDIA_ACCOUNT is 31%. The mean value of TWITTER_ACTIVITY is 13.9%. The mean value of PRESS_COVERAGE is

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163

Table 5.3 Multivariate analysis of the determinants of social media presence and Twitter activity

SIZE GROWTH MTB ROA LEV INTANG ANALYSTS INTERNET POPULATION Constant Industry FE Year FE Observations Adj. R-squared

(1) SOCIAL_MEDIA_ACCOUNT 0.013 (0.004) 0.072 (0.028) 0.035 (0.013) 0.025 (0.034) 0.005 (0.067) 0.001 (0.002) 0.007 (0.008) 0.001 (0.001) 0.000 (0.000) 0.658 (0.130) Yes Yes 3373 0.192

(2) TWITTER_ACTIVITY 0.014 (0.006) 0.058 (0.033) 0.024 (0.013) 0.038 (0.020) 0.065 (0.066) 0.002 (0.002) 0.006 (0.008) 0.003 (0.002) 0.000 (0.000) 0.494 (0.219) Yes Yes 3373 0.087

***, **, and * indicate significance level at the 1%, 5%, and 10% level, respectively

9 articles. The sample firms have a median (mean) size (SIZE) of 9.649 (8.459), a median (mean) growth (GROWTH) of 1.6% (3.6%) and a Market to Book ratio 0.810 (2.725). The return on assets (ROA) exhibits a median (mean) value of 0.3% (11.4%), the median (mean) leverage (LEV) is 34.2% (35.6%) of lagged total assets, the median (mean) intangibles is 21.6% (35.6%) of lagged total assets, and the median (median) analysts’ following (ANALYSTS) is 2 (1.237). Turning to the local characteristics, the median (mean) Internet penetration (INTERNET) is 85.38% (82.05%) and the median (mean) population (POPULATION) is 412,000 (3,125,000) people. Table 5.3 presents the results of Eq. (5.1), estimating the determinants of social media presence and communication on Twitter before earnings announcements. Column (1) reports the analysis of the determinants of social media presence. The coefficients on SIZE (coeff ¼ 0.013) and MTB (coeff ¼ 0.035) are positive and significant at less than a 1% level (two-tailed). The coefficient on GROWTH

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Table 5.4 Multivariate analysis of the relationship between social media presence and activity and press coverage

SOCIAL_MEDIA_ACCOUNT

(1) PRESS_COVERAGE 0.061 (0.023)

TWITTER_ACTIVITY SIZE GROWTH MTB ROA LEV INTANG ANALYSTS Constant Industry FE Year FE Observations Adj. R-squared

0.006 (0.005) 0.056 (0.045) 0.021 (0.007) 0.007 (0.022) 0.049 (0.056) 0.001 (0.000) 0.004 (0.005) 0.042 (0.095) Yes Yes 3373 0.017

(2) PRESS_COVERAGE

0.005 (0.013) 0.007 (0.005) 0.051 (0.044) 0.019 (0.008) 0.006 (0.022) 0.049 (0.057) 0.001 (0.000) 0.004 (0.006) 0.043 (0.095) Yes Yes 3373 0.015

***, **, and * indicate significance level at the 1%, 5%, and 10% level, respectively

(coeff ¼ 0.072) is positive and significant at less than a 5% level (two-tailed). Column (2) reports the determinant analysis of Twitter activity. The coefficient on SIZE (coeff ¼ 0.014) is positive and significant at less than a 5% level (two-tailed). The coefficients on GROWTH (coeff ¼ 0.058) and MTB (coeff ¼ 0.024) are positive and significant at less than a 10% level (two-tailed). Taken together, larger and growing firms, as well as firms with growth opportunities, appear to have a stronger presence on social media and to be more active around earnings announcements. Table 5.4 presents the results of Eq. (5.2), estimating the association between social media presence and communication on Twitter and press coverage around the earnings announcement. Column (1) reports the analysis of the association between social media presence and press coverage in the aftermath of an earnings announcement. The coefficient on SOCIAL_MEDIA_ACCOUNT (coeff ¼ 0.061) is positive and significant at less than a 1% level (two-tailed). Column (2) reports the analysis of the association between

5.5 Challenges and Opportunities for New Communication Channels

165

Twitter activity pre-earnings announcement and press coverage in the aftermath of an earnings announcement. The coefficient on TWITTER_ACTIVITY (coeff ¼ 0.005) is positive, though not significant. These results indicate that social media presence contributes toward increasing firms’ visibility on traditional media post-earnings announcement. These findings contribute to the growing stream of research on corporate social media (Blankespoor et al. 2013; Blankespoor 2018; Lee et al. 2015; Jung et al. 2017). By showing the determinants of the presence and activity on social media, these results provide further evidence for the factors affecting firms to be active on social media, specifically size, growth, and growth opportunity. By showing a positive association between social media presence and press coverage, these results also help explain the relationship between traditional and new communication channels. Ultimately, the evidence provided is informative to regulators to further understand the factors driving firms to be present and active on social media.

5.5

Challenges and Opportunities for New Communication Channels

A central question in the study of corporate social media is whether market participants find relevant information that firms release on social media. For instance, every second approximately 6000 tweets are issued on Twitter, which equals more or less 500 million tweets per day.17 Firms with low visibility represent a testing ground for social media. The limited presence of other media coverage reduces the potential effects of other information sources when assessing how corporate social media activity affects firms’ stakeholders. Researchers could also explore the Twitter policy change, moving the character limit from 140 to 280 characters, which took place on 07 November 2017. Future research could explore the characteristics of people consuming social media information. Whereas current research assumes that unsophisticated investors are the primary users of corporate social media information, it would be interesting to further investigate whether analysts and institutional investors also consider social media information in their investment decision process. In a similar fashion, auditors could use information retrieved from social media to detect potential red flags in their clients’ business activities. Glassdoor.com, a popular social media reporting employees’ opinions on their employers, may provide information similar to whistle-blowers. Auditors and regulators could use such information in their monitoring activities, potentially deterring firms from misbehaving. Past research mostly investigates corporate social media communication on Twitter. Considering the evolving disclosure landscape (Miller and Skinner 2015), changes in technology and media are likely to affect the type of disclosure and the 17

Source: http://www.internetlivestats.com/twitter-statistics/. Accessed on 3 April 2018.

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associated impact on capital markets. The Web and social media allow firms a complete new range of communication types other than text. The fastest growing social media platform, i.e. Instagram, mostly relies on pictures coupled with short texts. YouTube is another very popular social media platform and users generate and consume a large amount of video content. Firms will need to adapt their communication to the new channels, with implications regarding timeliness and the confidentiality of information. Whereas large companies have often released information on a quarterly basis and small companies on a yearly basis, they are now expected to communicate more frequently on social media. Researchers still have to determine the implications of these expectations in terms of data producing and processing time, as well as the reliability and relevance of corporate communication (McGuigan and Ghio 2019). Another open question concerns the professional figure in charge of managing corporate social media accounts. Given the importance of releasing financial and non-financial information, people with deep social awareness and a good understanding of the firms’ fundamentals, values, and strategies need to manage social media accounts. Interview and survey-based papers could shed light on the current corporate practice and different people’s approaches to corporate social media communication. Furthermore, social media platforms, such as LinkedIn, may provide useful information to corporate governance studies. Information on people’s studies and careers tends to be accurate and up to date. LinkedIn provides information on the background of people other than managers. It is, therefore, possible to expand corporate governance analyses at the micro-level and gain a better understanding of the role of organisational social capital. Analytical and empirical work on the contagion effect amongst users and the number of messages would be relevant for understanding the speed and type of corporate messages that become viral. Prior studies social media’s impact on capital markets mostly adopt a firm perspective (Jung et al. 2017; Blankespoor et al. 2013) or study users’ talks on specialized blogs, for example Seeking Alpha (Chen et al. 2014). Research into this area would also help firms better understand which type of information investors demand and how firms, especially ones with low visibility, can be more effective in decreasing information asymmetry and increasing their value as a consequence.

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Chapter 6

Conclusions

Abstract This manuscript explored the evolution of corporate disclosure. In this chapter, the authors retrace the theoretical and empirical approaches used in this book. It comprehensively shows the research questions investigated and the related results. Furthermore, it discusses the implications for a large audience including academics, managers, preparers, users, and standard setters. This chapter further illustrates a number of limitations encountered in the study and provides numerous avenues for future research. The authors encourage the advancement of the research in this domain by adopting multiple research methods for which a multidisciplinary approach is highly recommended.

6.1

Introduction

This concluding chapter provides an overview and discussion of the book’s structure, its theoretical contributions, the empirical findings, and the practical implications. Furthermore, it acknowledges the limitations and suggests a number of future research avenues. This study is a journey through the huge body of literature on corporate mandatory and voluntary disclosure. To this end, Ghio and Verona triangulate critical literature reviews with empirical analyses, using both qualitative and quantitative methods. In Chaps. 2 and 3, the authors employed a mostly narrative approach with the primary scope of identifying, integrating, and synthesizing the most relevant studies and takeaways from previous research on either mandatory or voluntary corporate disclosure. In the second part of the book, Ghio and Verona used a multi-strategy design, mixing a comparative case study, and quantitative analyses. Through the case study analyses, in Chap. 4 the authors interpreted the corporate behaviour in terms of social and environmental reporting, identifying the main differences across reportings of different-sized firms. In Chap. 5, instead, through a multivariate analysis, the authors modelled the firm’s decisions on the assumption, based on a

© Springer Nature Switzerland AG 2020 A. Ghio, R. Verona, The Evolution of Corporate Disclosure, Contributions to Management Science, https://doi.org/10.1007/978-3-030-42299-8_6

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Conclusions

number of potential determinants, that the firms have a social media account and communicate on Twitter. Furthermore, the authors investigated the consequences, in terms of external visibility, of social media presence and Twitter communication around earnings announcements on traditional press. As the dense domain of corporate disclosure unceasingly creates new horizons, Ghio and Verona highlight challenges for future research, including novel or partially unexplored theoretical perspectives, different methods, data sources, research designs, and data analyses. The rest of this chapter is organized as follows: Sect. 6.2 provides a brief overview of the research carried out in this manuscript, Sect. 6.3 discusses the theoretical contributions of the study and it presents the implications for academics, managers, users, and standard setters. Lastly, Sect. 6.4 assesses the limitations of the study and identifies a number of avenues for future research.

6.2

Research Overview

This book explored the evolution of corporate disclosure, which advanced not only in terms of matters disclosed but also how the information is externally published. Moving from the mandatory level of disclosure, Chap. 2 showed how prior theoretical and empirical research considers mandatory reporting partially effective at alleviating the information asymmetries between insiders (usually managers) and outsiders (usually owners). Ghio and Verona presented the mandatory corporate disclosure’s excessive shareholding orientation, which pursues two main possibilities: (1) an information role (i.e. value relevance) and (2) a contracting role (i.e. monitoring and evaluating managers’ functions). Accordingly, there are contractual incentives (e.g. compensation plans) and market incentives (e.g. reduced cost of capital) for producing financial reporting information. Nonetheless, the authors highlighted how regulatory enforcement in the form of accounting standards is expected to mitigate market frictions resulting from moral hazard and adverse selection (Dechow et al. 2010). By now, it is more than certain that “Accounting is valuable to the extent that it is credible, comprehensive, and subject to careful and professional judgement” (Liang 2000: 473). In this context, Chap. 2 also discussed the main patterns for opportunistic reporting, the role of external auditors and the decreasing value relevance of corporate information, especially for the New Economy firms. However, over-regulation has shortcomings too. The provision of information implies direct and indirect costs, including assurance costs and the cost of processing information (Whittington 1993: 313). Therefore, it is impossible to know ex ante the optimal degree of regulation. The delegation of power to standard setters, such as the International Accounting Standards Board (IASB), and the related legitimacy, present substantial limitations in terms of representation and understanding of the economic reality (Danjou and Walton 2012). Furthermore, often external auditors, at least the Big Four audit firms, are involved in the development and interpretation

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171

of accounting standards that actually threaten their neutrality and integrity and potentially generate conflicts of interest (Baudot et al. 2018). All in all, the analysis of the accounting standards regulatory process and the assurance process showed the limits of the ongoing one-size-fits-all approach (Ghio and Verona 2018). The authors, after having considered the complexities arising in the research on the regulatory process, separated the research streams in the following three groups and questions: 1. Source of demand: What is the primary explanatory variable for accounting regulation adopted in this type of research? 2. Role of standards: What roles do accounting standards play? 3. Role of accounting theory: What role does accounting theory play in this type of research? Once the literature on mandatory disclosure was theoretically and critically discussed, this book continued reviewing the literature on voluntary disclosure. Chapter 3 extended the view of corporate information, providing a theoretical picture of corporate disclosure, dealing with the information that firms provide beyond the minimum mandatory requirements (Boesso and Kumar 2007). Ronen and Yaari (2008) explain: “Given that voluntary disclosure is made by self-serving management, its credibility is suspect. There thus is demand for interpreters with financial acumen, such as analysts, to digest the information content of these disclosures”. In this light, Ghio and Verona discussed the costs of voluntary disclosure and lingered over not only the proprietary, preparation/dissemination, political, and litigation costs but also the costs related to the disclosure credibility. To this end, Chap. 3 also analyzed the standard setters’ and practitioners’ perspectives. It emerged that the key factors for the credibility of voluntary reporting include a sound reporting framework, strong governance, consistent wider information and external professional services. To build credible reports, firms also need to ensure consistency across time and between entities, to have competent and accountable preparers and appropriate and reliable information systems. Moreover, they should mandate external specialists to certify the reliability and comprehensiveness of reports. Finally, giving the users access to all reports and regulatory involvement for instance in standards oversight can also contribute to attaining an all-around perspective over the firm and developing the desired credibility (IAASB 2019). Chapter 3 then focused on corporate governance’s role in shaping corporate voluntary disclosure; the authors specifically reviewed the literature on the relationships between corporate voluntary disclosure and (1) corporate board characteristics, (2) firm and control environment characteristics, and (3) ownership structures. Ferramosca (2018) argues that better corporate governance strengthens the company’s social consent by affirming the company’s sustainability. Furthermore, better corporate governance ensures or at least strengthens the quality of the disclosure, which, in turn, favours the stakeholders’ consent and still favourably influences the company’s sustainability. In essence, she (2018: 83) suggests that a higher quality of information can positively influence the firm’s sustainability and this

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positive effect is even intensified by the force of a sound corporate governance system. Next, Chap. 3 opened the discussion on two specific types of voluntary disclosure, i.e. management forecasts and conference calls and the unique disclosure issued with reference to the firm’s intellectual capital. The authors actually recognize the increasing demand for timely and relevant information in the hands of the insiders who have a deeper knowledge of the firm and its future perspective. In this context, management forecasts supply investors with an advanced appraisal of the managers’ future plans and projects that can turn into increased firm value (Trueman 1986; Wang and Hussainey 2013). Conference calls further represent another relevant channel of voluntary disclosure to affect investors’ and financial analysts’ estimates (Frankel et al. 1999; Matsumoto et al. 2011). Ultimately, the intellectual capital report can also provide investors and other stakeholders with relevant forward-looking information (Abhayawansa 2014). This book intersects the theoretical discourse around the evolution of corporate reporting with empirical analyses to verify how corporate reports and related channels have changed over the last few decades. Since prior research usually argues that “social and environmental reporting has been criticised as being ad hoc and incomplete; as an ‘implicit’ element of an organisation’s performance, such observations should be expected as management develops a deeper understanding of performance expectations” (Frost and Jones 2015: 532), Chap. 4, after having reviewed prior literature, dealt with social and environmental reporting through a comparative case study analysis. To date, firms are actually compelled to participate in social and environmental activities and demonstrate their engagement to the stakeholders and the wider society more generally. The UN Sustainable Development Goals (SDGs) are the most evident case in point of the challenge any organization is facing to achieve a better and more sustainable future for all. The targets addressed include those related to poverty, inequality, climate, environmental degradation, prosperity, and peace and justice (Adams 2017; Rosati and Faria 2019).1 Furthermore, the efforts towards standardizing social and environmental information by advancing the Global Reporting Initiative (GRI) and integrated reporting have doubtlessly elevated the expectations around corporate reporting. Within this background, the research question Ghio and Verona tried to respond to was: What are the complexities associated with the production of sustainable and environmental reporting depending on firm size? The discussion of the three case studies took into consideration both the challenges and opportunities for social and environmental disclosure across different firm sizes. In Chap. 5, the authors focused on new communication channels, specifically Internet and social media. As in the previous chapter, the authors, after having reviewed the related literature, approached the subject with an empirical analysis, but in this case they used quantitative methods. The explosion of the Internet and,

1

See https://www.un.org/sustainabledevelopment/sustainable-development-goals/

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more recently, corporate social media completely turned the dissemination costs of corporate disclosure. The publication of news and corporate information has never been as cheap as nowadays, potentially opening the doors to smaller and younger firms, as well as firms with lower visibility (Blankespoor et al. 2014). Overall, past research shows that social media affects investors’ decisions. Moreover, disclosure on social media, either from the firm or about a firm, is relevant in order to predict firms’ future performance (Bartov et al. 2017; Jung et al. 2018). The social media accounts of top managers also offer an accurate description of firms’ future plans (Kaplan and Haenlein 2010). However, despite social media’s substantial relevance in daily decisions, financial accounting, and finance research on these matters are not yet sufficiently explored (Blankespoor 2018). Therefore, with the objective of understanding the relationship between new communication channels and corporate communication, Ghio and Verona provided empirical evidence of the determinants for social media presence and activity around earnings announcements for a sample of firms listed on the AIM over the period 2007–2015. Furthermore, the findings showed the association between presence and activity on social media before earnings announcements and press coverage in the aftermath of earnings announcements.

6.3 6.3.1

Contributions of the Manuscript Theoretical Contributions

This book provided multiple contributions to prior accounting and accountability literature and related studies in finance, corporate governance, and organization. Firstly, the authors intended to contribute to the financial accounting literature in several manners: • Ghio and Verona showed how starting from a basic mandatory financial information system, companies have, over time, moved towards increased voluntary information. Therefore, this study contributes to the body of knowledge exploring the corporate information systems and their evolution (Bushman et al. 2004; Perrini and Tencati 2006). • By showing the determinants for social media presence and activity, the authors provided further evidence on the factors affecting firms to be active on social media, specifically size, growth, and growth opportunity. The results also explained the relationship between traditional and new communication channels by showing a positive association between social media presence and press coverage. These findings provided an original contribution to the growing stream of research on corporate social media (Blankespoor et al. 2014; Blankespoor 2018; Lee et al. 2015; Jung et al. 2018). • The authors, conclusively, wrapped up a set of theories that are preponderantly used within the disclosure studies in the financial accounting domain: agency theory, capital need theory, legitimacy theory, and signalling theory. It is time to

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consider new horizons to explain from different perspectives the current disclosure–explosion phenomenon and the processes of change in corporate disclosure in practice (von Alberti-Alhtaybat et al. 2012). Secondly, Ghio and Verona extended the social and environmental accounting and accountability literature in many respects: • The discussion was receptive to multiple approaches and perspectives in social and environmental accounting (Mathews 2004; Brown and Fraser 2006; Gray et al. 2010), including: (1) the prevailing stream of literature drawing on a sociopolitical approach that encourages the triple bottom line as an accountability and democracy tool (Lehman 2001; Bebbington 1997) and (2) the other mainstream body of research falling under the decision usefulness approach (Eccles et al. 2014) exploring the markets’ external reactions to social and environmental disclosure (Cormier et al. 2011) and the internal managerial actions to improve social and environmental performance (Tate et al. 2010). Moreover, the authors discussed how the search for legitimacy may lead companies to symbolically issue social and environmental information (Cho and Patten 2007; Rodrigue et al. 2013). To conclude, this book introduced the critical—or radical—theory stream of literature, which is not satisfied with the shareholder orientation or the stakeholder orientation of corporate disclosure, both failing to embrace the pluralistic construal of society (Brown 2009). Critical dialogic accounting recognizes the paramount role of dialogue that, taking into account the counter narratives, can finally transform the passive audience of reports into a proactive push towards social and environmental engagement (Brown and Fraser 2006; Bebbington et al. 2007). • Ghio and Verona also documented, through a comparative case study of a small, large, and multinational company, how companies practically disclose and to what degree they apply the standards on social and environmental disclosure. This approach allowed the authors to reflect on the theoretical underpinnings of social and environmental disclosure, working backwards from practice to theory. Thirdly, Ghio and Verona contributed to finance, corporate governance, and organization along the following lines of research: • The critical review of Chaps. 2 and 3 clearly confirmed that the quantity and quality of disclosure, either mandatory or voluntary, have a direct effect on the cost of capital by reducing asymmetric information and, consequently, the risk as perceived by outsiders. Ghio and Verona, in this vein, contribute to the body of finance literature on the relationship between disclosure, its characteristics and the cost of capital, as well as the cost of debt (e.g. Botosan 1997; Lambert et al. 2007; Cheynel 2013). • The authors also recollected the finance literature on the relationship between corporate disclosure and market liquidity (Schoenfeld 2017), as well as the literature on how corporate disclosure affects firm value (Balakrishnan et al. 2014; Al-Akra and Ali 2012; Matsumura et al. 2014).

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• Prior literature mostly focused corporate governance drivers or brakes with regard to increased corporate disclosure. Overall, it is argued that better corporate governance increases the amount and fosters the quality of corporate disclosures. Ghio and Verona extensively discuss the literature on the relationship between corporate disclosure and board characteristics, such as firm characteristics, monitoring environment, and ownership composition. • In conclusion, the authors contributed to the organization literature, as the evolution in corporate reporting unavoidably reflects in the new organizational charts. In detail, the disclosure expansion leads to restructuring the administration function where the data processing, preparation, and dissemination become increasingly complex and influential. This setting is intensified for innovative firms, high-growth firms, and small- and medium-sized entities. These types of firms often have to also measure the immeasurable and disclose their intellectual capital (Dumay 2016).

6.3.2

Practical Implications for Academic Literature

Considering the overload of disclosure frameworks, related standards, guidelines, and growing regulation, the academic discourse is enlarging and experiencing numerous challenges and opportunities. The foregoing discussion also suggested that corporate disclosure is a continuously evolving field and it may even experience a new paradigm shift. The understanding of corporate disclosure moved from the early and dominant economic/ rationalist perspective to the political/sociological. In the future, scholars may explain it through the new lens of the critical/radical perspective. Therefore, we witnessed an evolution from the economic/rationalism metaphor, which substantiates the neoclassical economics, finance, and areas like scientific management, towards the political/sociological metaphor, which encompasses more explicitly issues related to power and justice and which is greatly derived from the social contract and socialist perspectives (Gray et al. 2010). However, both these perspectives consider accounting as a monologic practice whereby the company discloses its reality, even to any interested or potentially interested stakeholder—but the company discloses remains solely its own representativeness. A more recent debate hopes for a shift towards a more dialogic accounting practice; simply put, the company discloses its reality, a stakeholder then responds with its reality, another with its own, and so forth, hereby establishing an authentic dialogue. This approach allows recognizing the radical difference that opens accounting to critical scrutiny where social and environmental reporting is no longer concerned only about the company’s impact on society; however, it also becomes imperative to assess how society perceives the company’s actions (Brown and Dillard 2015). The authors wish to further expand the accounting and accountability literature regarding this academic debate and, therefore, this study showed in each chapter a

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number of avenues for future research. However, the corporate disclosure domain cuts across so many matters that Ghio and Verona encourage the foundation of multidisciplinary groups exploring the effects of corporate disclosure on investor behaviour (intersecting accounting and behavioural finance), of managerial choices on corporate disclosures (intersecting accounting, management, and neuroscience) and of the new forms of communication on the comprehensiveness and usefulness of corporate disclosure. To conclude, Ghio and Verona highlight the accountants’, auditors’, and stakeholders’ changing role. The accountant’s role is evolving from a mere bookkeeper before the new millennium to the wider financial accounting information preparer of the last two decades, to the extended reporting preparer of both financial and non-financial information. There is room to investigate how the accountant’s skills and competencies have evolved, whether the companies are seeking new competencies and how the old-style accountants are familiarizing themselves with the recent technological evolution. Similar thoughts arise for the external auditors who, in future, will be involved in assurances services that are far removed from the more objective or at least the more acquainted financial assessments. Ultimately, following the recent arguments about dialogic accounting, we are also witnessing a transformation in the stakeholders’ role—from passive information receivers to active carriers of information.

6.3.3

Practical Implications for Managers, Preparers, Users, and Standard Setters

In the last decade, the EU member states have signed the financial information borders enlargement, giving rise to the revolutionary EU directive on the disclosure of non-financial and diversity information (Directive 2014/95/EU). This directive traced a path for deeper transparency and accountability of corporate social and environmental reporting (CSR Europe and GRI, 2017). Furthermore, Ghio and Verona empirically showed how companies are increasingly exploiting unconventional channels of communication, including social media. Managers will need to absorb not only the increased non-financial information requirements but will also need to keep up with the use of the new channels, with implications in terms of the timeliness and trust of information (Kaplan and Haenlein 2010; Elliott et al. 2018). Whereas large companies have often released information on a quarterly base and small companies on a yearly base, the external expectations are now growing. A more frequent and quick communication is becoming a market rule. These expectations have consequences for both users and preparers in terms of data producing and processing time, reliability, and relevance of corporate communication. A mass of information, often hardly understandable, overwhelms the users. Overall, it is becoming increasingly complex to connect all the information in a system, especially for a non-expert user. The systematic interpretation of the

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disclosure is even more complex considering the speed with which information is published. As emphasized in the previous chapters, the comparability of small- and mediumsized companies’ reports require increased efforts, as they may often need to disclose entity-specific information. A corollary to this argument is that small- and mediumsized entities also need greater flexibility than their large and multinational counterparts. A relevant takeaway of this book is that the social and environmental disclosures appear to act as a catalyst of a virtuous cycle with regard to holistic and integrated thinking. The issuance of reports containing social and environmental disclosures appear to be an applicable incentive mechanism to make companies think not only about economic performance but also a negative or positive impact on the environment and society. Lastly, and especially relevant for standard setters, Ghio and Verona noticed that companies, regardless of their size, search for principles, standards, and recommendations that guide in the representation of the disclosure. Specifically, in the comparative case study, it emerged that companies prepare a report in accordance with the GRI Standards. Companies use parts of selected GRI Standards and indicators to report specific information. The adoption of the GRI Standards also allows European companies to comply with the EU directive (GRI 2017). More generally, using the GRI Standards can also serve as a basis to further disclose the organization’s engagement in achieving the UN SDGs (GRI et al. 2017). The awareness of multiple disclosure frameworks, standards, and best practices is key for a disclosure that is financially and non-financially fair.

6.4

Limitations and Future Challenges

Ghio and Verona conclude this book by acknowledging a few limitations and suggesting numerous future avenues for research, particularly in terms of empirical questions and research design. The first part of this book critically reviewed the literature on mandatory (Chap. 2) and voluntary (Chap. 3) disclosure. As such, it suffers from a number of literature reviews’ methodology limitations. It is, in fact, restricted to the selected sources used by the authors who mostly referred to textbooks and academic journal articles published in English, whilst several other relevant sources like theses, conference papers, government publications, and legal and professional publications, to cite just a few of the possibilities, are considered with minor attention. The corporate disclosure topic is actually so wide that the inclusion of all the sources is almost impossible. The analysis is, therefore, mostly limited to the academic discourse. It is a great opportunity and challenge for future research to develop a historical literature review of corporate disclosure to map the evolution also from the practitioners’ viewpoint, for instance, sourcing amongst the purported grey

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literature: practitioners’ reports, material produced by business and trade journals, legal and professional publications, newspapers, and magazine articles. Moreover, as the debate around corporate disclosure can be traced back in history, there are at least two possible alternative paths that have not been explored in this book. One is related to the historical origin of corporate disclosure, analyzing the precursors’ thoughts; and a second one is related to understanding which historical events might have prompted the changes in corporate disclosure. Another limitation, and as the flipside of the coin a challenge for future research, is to appreciate the role of standard setters and their reciprocal relationships and power. In this book, the authors have widely discussed the need for the formulation of common principles for corporate disclosure. At the same time, Ghio and Verona also emphasized the growing number of recent frameworks from several organizations even if they share a number of commonalities in terms of fundamental principles. Overall, in the disclosure-framework jungle, an agreed-upon synthesis of useful principles and standards for practitioners when developing disclosure becomes most relevant to support the corporate dialogue and establish a common language. This book focused on the theories commonly used in the studies on corporate disclosure involving agency theory, capital needs theory, legitimacy theory, and signalling theory; however, future studies may mobilize diverse theoretical backgrounds to unravel corporate disclosure. An idea may be to extend the agendasetting theory, searching the differences in the employment of social and non-social media and how they affect investors, analysts, auditors, and other stakeholders’ reaction (McCombs 2005; Russell et al. 2014). Another avenue is to investigate, under a knowledge-based theory, the diverse effects that good and bad news have on firm performance, risk appetite, innovation strategies, and involvement with communities, to name but a few (Nickerson and Zenger 2004; Nikolaou 2017). The authors suggested several research questions in the first part of the manuscript; the most compelling may be: – To what extent does the type of adoption and enforcement influence earnings quality and generate spillover effects on reporting transparency, thereby reducing the transaction costs? – Are there unintended consequences of the IAS/IFRS adoption? The new accounting standards may have caused unintended consequences at the micro level and at the macro level. – What is the role of the different organizations (e.g. IASB, EFRAG, the Big Four, and governments) in the implementation and enforcement process? – What is the relationship between auditing and corporate governance? Do they complement or substitute each other in the processing and dissemination of corporate disclosure of quality? – What is the impact of diversity (e.g. gender, ethnic background, sexual orientation) and technology (e.g. blockchain) on the level of professional scepticism? – What type of accounting information, i.e. earnings versus cash flows, is relevant to the investors of the New Economy firms?

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– Does the market participants’ awareness of financial reporting information, other than earnings, reduce the incentives for New Economy firms to manage earnings and focus to maximize other financial reporting items, such as cash flows? – Which communication channels do the more successful firms prefer? Or how do more successful organizations share knowledge? – In a society overwhelmed by information, has the impact of good and bad news changed compared to the pre-Internet era? – Is the relevance of intellectual capital disclosures dependent on the quality of mandatory financial reporting? – How do stakeholders, other than investors and analysts, influence corporate disclosure? – How are diverse types of voluntary disclosure strategically integrated by firms and for what possibilities? – What role does voluntary disclosure play in the distribution of power amongst insiders and outsiders? – What kind of new communication channels do firms currently use or are expected to use in the future and what are their predictable effects? In the second part of this book, the authors discuss two empirical studies, specifically in Chap. 4 through a comparative case study analysis to derive the differences in small, large, and multinational firms’ reporting of social and environmental information, whilst, in Chap. 5, through a multivariate analysis, the authors tested the role of the Internet and social media as new corporate communication channels. The selection of the above-mentioned methods unavoidably ruled out the implementation of other useful methods to explain how, what and why firms disclose. For instance, it may be interesting to survey interviewing or organizing focus groups with preparers of non-financial information after the implementation of the EU directive (Directive 2014/95/EU). Examining the current financial and non-financial harmonization process, it would be useful to better understand whether certain limits emerge in the standardization process and what the relationship between political and technical bodies within the EU is. Future studies, therefore, may respond to a research question that aims at inferring whether the EU plays a legitimization role or whether it only tries to respond to the external prevailing pressures (Radaelli 2000). Likewise, it would be interesting to explain the impact of external pressures on the final corporate disclosure decisions, especially when flexibility is allowed, for instance in terms of the adoption, amendment or rejection of certain standards in the implementation process of the EU financial and non-financial directives (e.g. Directive 2013/34/EU and Directive 2014/95/EU). If the three case studies analyzed (Chap. 4) help the reader understand how social and environmental disclosures mirror the company culture and identity regardless of the firm’s size, however, they are limited to the effects deriving from only one firm characteristic, i.e. size. Through other comparative case studies, future research may verify the impacts of other firm characteristics, for instance, the ownership structures, corporate governance systems, and external environment. Moreover, in this

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empirical case analysis, Ghio and Verona focused on a single industry to avoid co-founding effects deriving from the comparison of different industries, including diverse value chains and environmental and social leading indicators. The next challenge would be to identify infra-industry preferences in corporate disclosure. Considering Chap. 5, the authors focused on firms with low visibility representing a testing ground for social media. In fact, the limited presence of other media coverage constrains the potential effects of other sources of information when assessing how corporate social media activity impacts on firms’ stakeholders. Future studies may verify the impact of a Twitter policy change moving the character limit from 140 to 280 characters, which took place on 7 November 2017. Moreover, the social media field provides opportunities to identify who are the users of corporate information, exploring the characteristics of people consuming social media. Although recent research assumes that unsophisticated investors are the primary users of corporate social media information, it would be remarkable to further scrutinize whether analysts and institutional investors also consider social media information in their decision-making. Overall, also in the second part of the book, which is mostly empirical, a number of open challenges still remained: – What are the boundaries of social and environmental disclosures? – Is there an overlap between financial and non-financial disclosures? Or are there missing links between mandatory and voluntary disclosure? – What emerged in practice is that social and environmental disclosures make sense only if they are effectively prepared and if they reliably represent the engagement and impact of the company. Therefore, what kind of assurance can build trust amongst parties and ensure reliability? – What characteristics and conditions enable effective and successful corporate dialogue amongst a firm, its employees, analysts, auditors, and all other stakeholders? – Do auditors and regulators use social media information to detect red flags and carry out their monitoring activities? If yes, how do they use it? – How are changes in technology and media likely to affect the type of disclosure and the associated impact on capital markets? – Which are the implications deriving from the use of new platforms (e.g. Instagram and YouTube) in terms of the timeliness and trust of information? – Is there any contagion/viral effect amongst users around corporate disclosures that have been published on social media? – Finally, what are the skills and competencies required by the new professional figure in charge of managing corporate social media accounts?

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