Integrated reporting, financial reporting quality and cost of debt

• Published date: 26 February 2020
• Date: 26 February 2020
• DOI: https://doi.org/10.1108/IJAIM-10-2019-0124
• Pages: 517-534
• Author: Mohammad Badrul Muttakin,Dessalegn Mihret,Tesfaye Taddese Lemma,Arifur Khan

Integrated reporting, f‌inancial

reporting quality and cost of debt

Mohammad Badrul Muttakin

Department of Accounting, Deakin University, Melbourne, Australia

Dessalegn Mihret

School of Accounting, College of Business, RMIT University, Melbourne, Australia

Tesfaye Taddese Lemma

Department of Accounting, College of Business and Economics,

Towson University, Towson, Maryland, USA, and

Arifur Khan

Department of Accounting, Deakin University, Melbourne, Australia

Abstract

Purpose –Although proponents of integratedreporting (IR) advocate that this emerging practice has the

potential to transformcorporate reporting, the eventuation of this expectationwould depend on the incentive

IR provides to f‌irms. This study aims to examinewhether IR is associated with cost of debt and whether IR

moderatesthe relationship between f‌inancial reporting qualityand cost of debt.

Design/methodology/approach –Based on insights drawn from information asymmetry and agency

theories,the authors develop models that link IR and f‌inancial reporting quality with a f‌irm’s cost of debt. The

authors analyze847 f‌irm-year observations drawn from non-f‌inancialf‌irms traded on the Johannesburg Stock

Exchange,for the period between 2009 and 2015.

Findings –The authors f‌ind that f‌irms that provide integrated reports tend to have a lower cost of debt than

those do not provide IR. The authors also f‌ind an inverse association between f‌inancial reportingquality and cost

of debt, and that integrated reports accentuate this association. The f‌indings suggest that the debt market

perceives value in the information presented in integrated reports beyond what is furnished in f‌inancial reports.

Originality/value –To the best of the authors’knowledge, this study is the f‌irst to document evidence

suggesting that the debt market perceives value in the informationpresented in integrated reports, beyond

what is furnishedin f‌inancial reports.

Keywords South Africa, Cost of debt, Integrated reporting, Information asymmetry,

Financial reporting quality

Paper type Research paper

1. Introduction

Integrated reporting (IR) has received heightened public attention in recent years

particularly following the formation of the International IR Council (IIRC) and its

subsequent issuance of IR guidelines (Adams et al.,2016;Perego et al., 2016;Zhou et al.,

2017). Despite the critique that IR could be yet another tool for corporate impression

management (Melloni and Perego, 2017), the IIRC (2013, p. 3) claims that IR enables

improving “the quality of information available to providers of f‌inancial capital to enable a

more eff‌icient and productive allocationof capital.”Nevertheless, empirical evidence on the

claimed benef‌itsof IR is sparse (de Villiers et al.,2014) becauseof the emerging nature of this

Quality and

cost of debt

517

Received28 October 2019

Revised31 December 2019

Accepted22 January 2020

InternationalJournal of

Accounting& Information

Management

Vol.28 No. 3, 2020

pp. 517-534

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-10-2019-0124

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

practice. Yet, the limited available evidence showsthat the market responds to information

presented in integrated reports(Mervelskemper and Streit, 2016). For example, both Vitolla

et al. (2019) and Zhou et al. (2017) f‌ind an inverse association between alignment of

integrated reports with the IIRC’sreporting framework and analysts’forecast errors, as well

as cost of equity capital, and other studies (i.e.Baboukardos and Rimmel, 2016;Lee and Yeo,

2016) show a positive association between IR and f‌irm value. Similarly, Barth et al. (2017)

concluded that IR has economic consequences. Nevertheless, how the effect of IR relates to

the well-established channel of information to the market –i.e. f‌inancial reporting –in the

eyes of users is yet to be examined.

This study is motivated by the increasing regulatory attention paid to IR (Barth et al.,

2017;Zhou et al.,2017), the emerging assessment that corporations might be using IR as a

mechanism for impressionmanagement (Melloni and Perego, 2017) and the observed lack of

suff‌icient empiricalevidence on the benef‌its of IR (de Villiers et al.,2014). With a focus on the

debt market, we examine whether lenders incorporate information presented in integrated

reports into capital allocation decisions. While some researchers have examined how the

equity market reacts to integrated reportsthrough f‌irm valuation (Barth et al., 2017;Lee and

Yeo, 2016) and cost of equity capital (Barth et al., 2017;Zhou et al., 2017), virtually no

attention has been paid to how the debt market responds to integrated reports. This is a

signif‌icant omission because in countries such as South Africa, the debt market plays a

crucial role in f‌inancing f‌irms’activities, as it remains the primary source of external f‌inance

for publicly traded f‌irms (Barako et al.,2006;Gwatidzo and Ojah, 2014;Lemma, 2015). We

examine the association between IR and cost of debt, using the South African empirical

context, which is a pioneer in mandating the provision of IR on an “apply or explain”basis

since March 2010.

We predict that a f‌irm’s provision of integratedreports may lead to reduced cost of debt.

First, we argue that IR may improve the information environment of f‌irms by enhancing

analysts’understanding of a f‌irm’s prospects (Beyer et al., 2010) because IR blends

information on a broad range of capitals, namely, f‌inancial, human, social and natural

capital, that inf‌luence a f‌irm’s value creation (IIRC, 2013). Articulation of the f‌irm’s value

creation story in integratedreports is expected to enable readers of IR to evaluate the effects

of the f‌irm’s business model and strategicdecisions in a better way than would be possible

using disconnected corporate reports (Churet and Eccles, 2014;Dutta and Nezlobin, 2017;

Easley and O’hara, 2004;Lambert et al., 2007). This form of presenting information may

decrease external fund providers’uncertainty about a f‌irm’s future cash f‌lows and, hence,

reduce the risk premium f‌inanciers would demand to invest in the f‌irm’s securities (Dutta

and Nezlobin, 2017;Easley and O’hara, 2004;Lambert et al.,2007). Second, reduced

information asymmetry through IR disclosures may also boost demand for a f‌irm’s

securities, thereby fostering market liquidity and, hence, reducing the cost of externally

generated capital (Diamond and Verrecchia, 1991;Verrecchia, 2001). Given that f‌inancial

reporting, as a regulated practice, continues as a primary channel of communication

between the f‌irm and the market, we also predict that users’reliance on IR will have some

relationshipswith f‌inancial reporting quality.

Our f‌indings based on a sample of 847 f‌irm-year observation drawn from the

Johannesburg Stock Exchange (JSE) listed f‌irms,for the period 2009-2015, provide support

to our hypotheses. The results in all our models show that IR is associated with a lower cost

of debt. Our study also conf‌irms that f‌inancial reporting quality is associated with lower

cost of debt, and this association is more pronounced for f‌irms that provide integrated

reports. The f‌indings conf‌irm our expectation that debt market investors, especially banks,

tend to have greater incentives (and possess more effective mechanisms) to gather

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