Voluntary adoption of integrated reporting in Europe : an empirical research on the effect on cost of Equity capital and cost of debt capital

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Voluntary Adoption of Integrated Reporting in Europe

An empirical research on the effect on Cost of Equity Capital and Cost of Debt Capital

Name: Mariëlle Monique Aimé VandenKerchove Student number: 11401796

Thesis supervisor: dr. A. (Alexandros) Sikalidis

Date: June 19, 2018

Word count: 17,186

MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam

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Statement of Originality

This document is written by student Mariëlle Monique Aimé VandenKerchove who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

The International Integrated Reporting Council (IIRC) proposes Integrated Reporting (<IR>) to be the future of corporate reporting. They argue that firms issuing integrated reports will have several benefits, such as a decreased cost of capital. But if issuing an integrated report leads to a decreased cost of capital, why is not every company issuing one? Currently, not a lot of research is done on the proposed benefits of <IR>, except for some research on the cost of equity capital in the South-African setting, where <IR> is mandatory for listed firms on the Johannesburg Stock Exchange (JSE). In this research, I try to enlarge existing literature by providing empirical evidence on the claimed benefit that <IR> results in a lower cost of capital. Based on a sample of 83 companies from 13 countries, two regression models are constructed to test whether the cost of equity and the cost of debt capital changes in the sample years (2010-2016). The results are mixed to some extent. I find weak evidence that improving the quality of integrated reports leads to a lower cost of equity capital for the full sample. However, I find no evidence that companies that improve their integrated reports benefit a lower cost of debt capital. After dividing the sample into an environmentally sensitive industry sub-sample and a non-environmentally sensitive industry sub-sample, I find significant evidence for the negative relation between the quality of integrated reports and the cost of equity capital for non-environmentally sensitive industries. Furthermore, significant evidence is found for the relation between the quality of integrated reports and the cost of debt capital for non-environmentally sensitive industries, however this relation seems positive instead of negative. Additional analysis, using an alternative proxy as mesurement of the quality of integrated reports shows contradictory results with the first proxy used.

In conclusion, my research indicates some evidence on the proposed benefits of <IR>. Further research is needed to provide more evidence and to draw substantial conclusions.

Key words: Integrated Reporting, integrated report, cost of equity capital, cost of debt capital, corporate social responsibility, Europe, environmentally sensitive industries, non-environmentally sensitive industries

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1 Introduction

1.1 Background Information

Judge Professor Mervyn King (Chairman of the Council, International Integrated Reporting Council (hereafter: IIRC)) on the IIRC-website on the 12th of March 2018: “Replace the negative outrages of society against corporate wrongs with positive corporate outcomes on all three dimensions of the economy, society and the environment, then we will have a good corporate citizenry and humanity having its right to clean water, clean air and arable land – in short – the right to life”.

In his 2018 address King (2018) describes how organizations evolved in the past three centuries. From the change of human and animal labor to the use of machines during the first Industrial Revolution in the 18th century to the change from unlimited personal liability to the creation of an ‘artificial’ person carrying the capital risk and relating liabilities in the 19th

century.

After the second Industrial revolution in the late 19th century and early 20th century mass production became possible due to the constant flow of electric energy (in comparison to water and steam used before). After the Court decided in 1919 that companies were obliged to declare excessive profit as a special dividend to shareholders before considering increasing the wages of employees, the primacy of the shareholder concept was born and the idea that directors should steer the company to ensure maximization of shareholder wealth became rooted. The economist Milton Friedman reinforced this concept in the 1970’s by stating that an organization’s sole purpose is to make profit without deception or fraud. If a company makes profit without deception or fraud, it could do so at any cost to society or the environment. Governments’ solution to this problem was to tackle these adverse impacts by passing laws, such as environmental impact laws, rather than treating the source of the problem being the companies’ business model, which was driven by the outstanding primacy of shareholder wealth maximization.

After the World Wars international law required governments to operate or to disengage from acting in certain ways, but companies carried on with their business as usual. During the 20th

century society responds by asking governments to regulate against companies’ business models, again treating the symptoms instead of the cause.

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The third Industrial Revolution started close to the end of the 20th century with information technology leading to a borderless world. Economies grew as a result of the reduction of labor costs without regard to the impact it had on society and the environment. For example, the industry cities in China with their dangerous pollution levels or India where industry and motor vehicle ownership skyrocketed, resulting in pollution levels being dangerous to the citizens health in Delhi.

Towards the end of the 20th century it became apparent that earth’s resources were finite and that a growing part of organization’s market capitalization was made up of intangible assets (Eccles and Serafeim, 2015). Asset managers and owners started to realize that companies with a long term strategy of value creation in a sustainable manner would survive and thrive in the changing world of the 21st_{century. Companies only focusing on improving bottom line at any}

cost would, in contrast, fail. Furthermore, due to the globalization as a result of the information technology, society started to turn its face to organizations having a negative impact on society or the environment.

In the beginning of the 21st century companies were trying to figure out how to report on the growing part of their value not attached in their tangible assets. For this value there was no accountability in the annual reports, which then consisted only of a balance sheet, a profit and loss statement, and related notes according to financial reporting standards. This is when the Global Reporting Initiative (hereafter: GRI) was founded, providing guidance on sustainability reporting. The first version of the Guidelines was launched in 2000. Companies started issuing two types of reports, namely the annual financial reports based on accounting standards and separate sustainability reports based on the GRI Guidelines (since 2016 Global Standards for Sustainability Reporting).

In 2004 His Royal Highness The Prince of Wales established the Accounting for Sustainability Project (hereafter: A4S). He argued that the annual reports of companies in which the Royal Family had invested, did not report on how their business models impacted society and the environment. With the A4S’s three core aims A4S hopes to drive a fundamental shift towards more resilient business models and with that a more sustainable economy. The A4S claimed that there had been a lack of connection between sustainability and financial reporting resulting in sustainability reports being largely detached from the organizations’ strategic objectives (Hopwood et al., 2010) and launched a connected reporting framework in 2007 to highlight the connections between financial and sustainability information. This framework encouraged

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clear, concise, and comparable sustainability reporting to ensure that broader and longer term sustainability considerations were integrated and connected with traditional accounting measurements.

A meeting held in December 2009 in London at the A4S’s Annual Forum resulted in the idea that a committee should be formed to create an internationally accepted framework for ‘Accounting for Sustainability’ (Humphrey et al., 2017). Intentionally this committee would extend the work of the A4S-project. This is where Integrated Reporting (hereafter: <IR>) and the IIRC come into the picture.

After this meeting another meeting took place in the beginning of 2010 between the International Federation of Accountants (hereafter: IFAC), the UN Community on Trade and Development, and other invitees such as regulators, the World Chairman of the Big Four, and asset managers. The IFAC’s view was that annual financial statements on their own were not sufficient to clear the board’s duty of being accountable. The chairman of the GRI, Mervyn King, argued that a sustainability report without numbers was insignificant, but that the current way of issuing two separate reports was also far from reality (also argued by the A4S). The standalone sustainability reports held little information used by providers of financial capital (Eccles and Krzus, 2010). Companies do not operate on a basis that different capitals are based in separate locations or buildings. These value sources are interconnected and interdependent on one another and relate to the company and its stakeholders, and their relationships have always been integrated.

These meetings led to the formal initiation of the IIRC in August 2010 with a joint press release from the GRI and the A4S announcing the creation of a new corporate reporting space around <IR> promising contribution to future economic and social well-being. The IFAC also played a role in the move towards <IR> and is a participating body in the IIRC. The IIRC pronounces itself as a global coalition of representatives from the industry, the investment community, academics, NGOs, and the accounting profession (IIRC, 2015 a). These representatives share the idea that communication from companies about how they create value should be the next step in the corporate reporting evolution with as result a future in which <IR> becomes the international corporate reporting norm (IIRC, 2013).

Since its formation in 2010 <IR> gained growing significance as can be seen by the number of organizations participating in the IIRC Pilot Program which started in 2011 for firms ready to embrace this new <IR> approach. Furthermore, the importance and visibility of the IIRC can

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be witnessed in the speed in which the International <IR> Framework (hereafter: Framework) was developed with the final approval given only three years after the formation of the IIRC (Humphrey et al., 2017).

As set out in the conceptual framework the primary audience of <IR> are the providers of financial capital (IIRC, 2013), i.e. investors and creditors. Some of the proposed benefits of applying the Framework include more efficient resource allocation, better decision-making internally as well as externally and the reduction in the cost of capital (Deloitte, 2015; IIRC, 2015 a; PWC, 2014). This last proposed benefit, the reduction in the cost of capital, will be the central subject of this thesis.

1.2 The Need for Integrated Reporting and Motivation

<IR> has been created to enhance accountability, stewardship, and trust, as well as to harness the information flow and transparency of business that technology has brought into the world. <IR> has gained attention over the past few years (De Villiers et al., 2014; Velte and Stawinoga, 2017). Through <IR> investors will be provided with the information they need to make better decisions on their capital allocations, which will result in higher long-term investment returns. The need for <IR> became apparent as market drivers were not satisfied with the complex reporting methods. The market drivers were in need of transparency, inclusiveness, and more material information. The first objective of <IR> was to communicate financial and non-financial information to a broad range of stakeholders, but current integrated reports are aimed at providers of financial capital (Humphrey et al., 2017).

One of the main goals of the IIRC with <IR> is to create a stronger dialogue between businesses and investors. Up till recently financial reports were backward looking, short term focused with a box ticking mentality, and fragmented. This resulted in reports getting too long and complex without telling the holistic story of the organization. Investors did not get the right information and capital markets suffered from short termism, an excessive focus on financial information, and a lack of trust. Information about the financial performance of an organization was not the only information required by investors and other stakeholders. Increased attention was paid to non-financial factors such as risks, opportunities, business models and strategies, environmental and social impacts in order to make better assessments of the real value of the firm with the ultimate goal of better decision-making (Eccles and Serafeim, 2015). This is

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proposed to be a direct effect of some of the huge scandals happening in the beginning of the 21st century such as Enron, Worldom, and Lehman Brothers. These scandals resulted in numerous lawsuits, job losses, reduced trust from society in organizations, and bad reputation. Furthermore, the 2007-2008 Financial Crises contributed to a further decline of public trust, lack of transparency, and a stronger call for accountability. <IR> is set out to have the potential to enhance organizations’ reputation and increase transparency by helping organizations think holistically about their strategy and plans in the context of the business impact, making better informed decisions, and managing key risks by taking advantage of key opportunities (IIRC, 2016 b). More effective capital allocation and an end to the incentive system that preserves short term thinking and decision-making will be some of the results of adopting <IR> according to the IIRC. Annual reports and the modern day business models would be more aligned and investors would understand the company and its prospects better, resulting in a better management of investment risks, validation of decisions, and assessments of companies’ future looking information (Pavlopoulos et al., 2017).

The question arising though; why do we need <IR> while we already have Corporate Social Responsibility (hereafter: CSR) and Sustainability Reporting. The difference is the term ‘integrated thinking’ which can be defined as: “the active consideration by an organization of the relationships between its various operating and functional units and the ‘multiple capitals’ that the organization uses or affects. Integrated thinking leads to integrated decision-making and actions that consider the creation of value over the short, medium, and long term” (IIRC, 2013, p. 2; IIRC, 2016 b, p. 19). This integrated thinking and the application of the guiding principles in the Framework will result in organizations no longer producing numerous, disconnected and static communications. By showing how the organization creates value in the short, medium, and long term <IR> has a combined emphasis on conciseness, strategic focus and future orientation, the connectivity of information, and the capitals and their interdependencies. <IR> also promotes a more cohesive and efficient approach to corporate reporting and aims to improve the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital (IIRC, 2016 b). According to the Framework an integrated report can be defined as a “concise communication about how an organization’s strategy, governance, performance, and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term” (IIRC, 2013, p. 7).

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The guiding principles underpinning the preparation of an integrated report are set out in the Framework and include a strategic focus and future orientation, connectivity of information, stakeholder relationships, materiality, conciseness, reliability and completeness and, consistency and comparability.

The content elements described in the Framework are fundamentally linked to one another and therefore not mutually exclusive. These content elements consist of an organizational overview and external environment, governance, business model, risks and opportunities, strategy and resource allocation, performance, outlook, and basis of presentation.

Several fundamental concepts underpin and reinforce the requirements and guidance in the Framework. Firstly, the Framework describes the value creation for the organization and for others as fundamental concept. The value the organization creates for others is linked to the value it creates for itself. If these interactions are material to the organization’s ability to create value for itself, it must be included in the integrated report. The second fundamental concept is the separation of capitals in the integrated report. These capitals are, as explained in the previous section, continuously interacting with each other. Firms applying the Framework are not required to apply the proposed categorization dividing capital in financial, manufactured, intellectual, human, social and relationship, and natural capital. This separation of capitals is included in the Framework to help organizations consider the different forms of capital they use. Lastly, the Framework states the value creation process as fundamental concept. The IIRC has issued a series of publications explaining how <IR> creates value to different stakeholders such as the companies (IIRC, 2016 b), the investors (IIRC, 2015 a; IIRC, 2015 b; IIRC, 2016 a; IIRC, 2017), and the board (IIRC, 2014; IIRC and Black Sun Plc., 2018).

That <IR> also gained attention from the Big4 firms over the past few years becomes apparent when looking at brochures and guidelines published on their websites. EY issued an article on <IR> in which is stated that the needs from investors and other stakeholders for information have changed from short-term results and traditional reporting to the view that the value of a company reaches beyond financial aspects (EY, 2014; EY, 2016). <IR> is the solution to a better understanding of the organization and a basis for decision-making. Paul Fitzsimon, PwC Head of Reporting and Chief Accountant, states: “A fundamental change in reporting requires much more than a focus on the end report. It requires a deeper understanding of all the building blocks of the business’ value creation process” (PwC, 2014). PwC issued a practical implementing guide for anyone looking to implement a more holistic business management

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system of <IR> (PwC, 2015). The guide is helpful for firms that want to start their first integrated report as well as for firms willing to improve their current reporting process. Deloitte published “A Directors’ Guide to <IR>” in which is explained that <IR> ironically is not about reporting at all, but about integrated thinking, responsible business behaviors, and innovation (Deloitte, 2015). The drivers of <IR> are rebuilding trust in business and long-term value creation. KPMG proposed <IR> as a way of closing the gap between current reporting and investor needs in a report from March 2013. The conclusion from this report is that readers need a more complete picture of the value of the business. <IR> is built around components of content and by linking these components, an integrated report builds a story of the business (KMPG, 2013 a). Another article about <IR> published by Michael Bray, KPMG Australia, states that: “Fundamentally, Integrated Reporting is about improving the basis of capital allocation” (KMPG, 2013 b). <IR> is proposed as a solution for capital markets to understand firm’s strategies, align their models with the performance of the business, and help them to make more efficient and forward-looking investments. In this report Bray proposes that <IR> should be of specific interest to CEOs, CFOs and directors, as they are challenged with telling their firm’s ‘story’ to the markets to obtain external financing at a reasonable cost.

The question arises, with all of these proposed benefits for organizations (IIRC and Black Sun Plc., 2018), investors, and other stakeholders, why not every organization worldwide has adopted the <IR> approach and issued an integrated report? This question forms the motivation for this research which will focus on the proposed benefit for organizations voluntarily adopting <IR> and the outcome this has on their cost of capital.

1.3 Research Question

The purpose of this thesis is to examine the relationship between the voluntary adoption of <IR> and the firm’s cost of capital. More specifically, this thesis will investigate the relation between the voluntary adoption of <IR> and the cost of equity capital and the voluntary adoption of <IR> and the cost of debt capital. Therefore, the following research question will be answered in this thesis:

RQ: Does the voluntary adoption of <IR> affect the cost of equity capital and the cost of debt capital for firms in Europe and does this effect differ between environmentally sensitivity industries and non-environmentally sensitive industries?

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Providing an answer to this research question is important since it can provide empirical evidence on one of the claimed benefits of adopting <IR> (IIRC, 2015 a). Specifically, this thesis will show whether providers of financial capital value the information they extract from integrated reports and subsequently require a lower rate of return on their investment due to, for example, the reduction in information search costs. If I find evidence that the voluntary adoption of <IR> affects the cost of capital, the results should be of interest to organizations, investors and creditors. This lower rate of return requirement can result in an increased willingness from companies to adopt these reporting guidelines. For investors, the results could be of relevance in making better resource allocation decisions as the integrated report provides information about the creation of value in the short, medium, and long run. Moreover, the results could also be of interest to creditors as an integrated report provides them with information about how the firm is going to create value over time and therefore creditors can make better decisions about issuing debt to these companies and make better credit risk assessments (Sengupta, 1998).

Furthermore, I will examine whether firms that operate in an environmentally sensitive industry (hereafter: ESI), such as mining, oil or electricity, benefit more from telling a narrative story about how they create value in the short, medium, and long run than firms that operate in non-environmentally sensitive industries (hereafter: NESI) (Reverte, 2009). If investors and other creditors value the story that these firms tell about their environmental impact and what they do to mitigate these risks, it is possible that they require a lower rate of return from these companies when more information is available to them via the annual integrated report. <IR> could be an opportunity for these ESIs to discuss their operations and the actions they take to make sure that the environment, one of the main pillars of <IR>, is impacted only minimal by their business. The results should be of interest to firms operating in ESIs, but as well to providers of financial capital, i.e. investors and other creditors. If I find that the reduction in the cost of capital for ESIs is larger than the reduction in the cost of capital for NESI firms, firms that operate in these sensitive industries can decide to issue an integrated report to tell their story and as a result also benefit from a lower cost of capital. For investors and other creditors these result might also be of interest to help them better allocate their resources and assess which investment option is best for them, not only money-wise but also consciousness-wise.

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1.4 Contributions and Structure

The main contribution resulting from this study is that it complements the scarce, but increasing stream of literature on <IR>. Over the years this subject has gained more interest, but empirical evidence is lacking. Some research is done on the relationship between <IR> and the cost of equity capital (Barth et al., 2017; Zhou et al., 2017). These studies document a negative relation between the quality of <IR> and the cost of equity capital in the mandatory South-African setting. As these results are not generalizable to other jurisdictions with different legal systems and to other financial environments, the current study complements this literature by investigating this relation in a voluntary setting for firms in Europe. The number of firms voluntarily adopting <IR> worldwide grows, which could ultimately lead to mandating <IR> in other jurisdictions than South-Africa, Brazil and Kenya. To see whether voluntary adopting <IR> has an influence on one of the proposed benefits of <IR> can be relevant for all parties affected, such as investors (present or potential), firms, regulators, but also creditors and standard-setters. By investigating the impact <IR> has on the benefit of reduced cost of capital, can be helpful and informational for decision-making internally as well as externally.

The remainder of this paper proceeds as follows. Section 2 provides a literature review with prior research on the subject of voluntary disclosure and cost of capital, discusses the underlying theoretical background and the cost of capital concepts. The hypotheses will be developed in section 3. Section 4 describes the research design and the variables used. The results of voluntary adopting <IR> on the cost of debt and cost of equity capital will be described in section 5 together with the additional analysis part. Section 6 concludes.

2 Literature Review

2.1 Prior Research

To understand where my study fits in with prior literature, I briefly examine earlier research on the general relationship between voluntary disclosures and cost of capital and what limited research has been done on the relationship between the adoption of <IR> and the effect on the cost of capital.

The relationship between voluntary disclosures and the effect on the cost of equity capital has been studied for a long period in the accounting literature. These studies vary from the effect of voluntary disclosure of traditional reporting on the cost of equity capital (Botosan, 1997;

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Botosan and Plumlee, 2002; Leuz and Verrechia, 2000; Petrova et al., 2012) to the effect of voluntary disclosure of CSR information on the cost of equity capital (Dhaliwal et al., 2011; El Ghoul et al., 2011; Plumlee et al., 2015; Sharfman and Fernando, 2008). These studies generally find a negative relationship between CSR performance and cost of equity capital. Moreover, the relationship between voluntary disclosures and the effect on cost of debt capital has been studied in different settings. Sengupta (1998) finds a negative relation between financial costs and disclosure quality in a sample of US listed firms. In addition, Dadashi et al. (2013) studied the association between voluntary disclosure and cost of debt in Iran. No evidence for a negative relation is documented in this study. Wang et al. (2008) find a relation between extensive voluntary disclosure and as a result lower cost of debt in China, just like Guidara and Acheck (2015) in Hong Kong. Orens et al. (2010) document a negative relation between non-financial disclosure and the cost of debt on a sample of North American and Continental European companies.

Furthermore, up to now a few studies have been done on the effect <IR> has on the cost of equity capital (Barth et al., 2017; Zhou et al., 2017). Zhou et al. (2017) utilize the discretionary disclosures made by listed companies on the Johannesburg Stock Exchange (hereafter: JSE). South-Africa is the forerunner in the adoption of <IR> by being the first country to incorporate <IR> in its listing requirements under the King Code on Corporate Governance in 2010. The King III report highlights the importance of integrated thinking, integrated reporting and value creation, and uses the definitions from the IIRC. This mandatory adoption makes South-Africa an unique case to study the proposed benefits of <IR>. What is worth noting though is that the <IR> concept is mandated on an ‘apply or explain’ base. This results in discretion for firms as to what they disclose and how they disclose it. Subsequently this results in variations in the quality of integrated reports issued and in the level of alignment with the Framework. The ultimate goal of mandating <IR> was to make South-Africa a more appealing country to invest in, as the annual reports are more transparent through <IR>. Zhou et al. (2017) document a negative relation between the level of alignment of an integrated report with the Framework and analyst earnings forecast errors. This first part of their research suggests that the information subtracted from the integrated reports is useful to sophisticated capital market participants, such as analysts, in assessing future financial performance of organizations. Furthermore, a negative relation between the level of alignment of integrated reports with the Framework and the cost of equity capital is documented in the overall sample. Further analysis

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indicates that the reduction is mainly contributed to the sub-group of companies with lower information environments. This result suggests that investors are willing to accept a lower rate of return as a result of reduced information risk, which is a result of the improved information environment for these organizations. The last part of this research comes close to my research, although this research has some limitations as the results are not generalizable as they are based on the unique characteristics of South-Africa and the limited sample period (2009-2012). In addition, Barth et al. (2017) researched the positive association documented in prior research between Integrated Report Quality (hereafter: IRQ) and firm value by examining two channels via which this association may arise – a capital market effects channel and a real effects channel. These effects are linked to the two aims the IIRC has for <IR>, being the improved quality of information available to outside providers of financial capital to enable more efficient capital allocation and supporting integrated internal thinking, decision-making, and actions that focus on value creation for the firm. Firm value is therefore disaggregated in three components of which stock liquidity and cost of capital are the capital market effects. The expected future cash flow could be either a capital market effect – as participants are better able to make more accurate future cash flow estimations because they have better information – or a real effect – managers making better decisions generating higher future cash flows – or both. Barth et al. (2017) conduct analyses on both levels- and changes-specifications. No evidence of a relation, levels or changes, between IRQ and the cost of capital is documented in this research, indicating that IRQ is associated with firm value through the components of liquidity and expected future cash flows and not through the cost of capital. The proposed benefit from the IIRC, that firms adopting <IR> benefit a lower cost of equity capital, does not seem to hold in this case.

Not only South-Africa exhibits these unique characteristics as <IR> became mandatory in Brazil in the Sao Paulo Stock Exchange as well. Listed companies are required to report non-financial key performance indicators on a ‘comply or explain’ basis (EY, 2014). As of January 2018 Kenya also added <IR> in the code of corporate governance for state corporations. The emphasis shifted from the quantity of information included in integrated reports to the quality of integrated reports for both practitioners and academics (Pistoni et al., 2018). By looking at literature on the quality of voluntary disclosures, Pistoni et al. (2018) developed a scoring model, the <IR> Scoreboard, divided into four areas. The main finding of this study is that the overall quality of the integrated reports analyzed is low. The Framework is followed

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in the integrated reports, but the information disclosed on relevant aspects, such as capital, the business model, strategic priorities and the value creation process is limited. There is an absence of connectivity between strategy, the business model, performance and future outlook; an information gap between areas of governance, stakeholder engagement and, materiality process; inadequate descriptions of business models and internal auditing, completeness of information, and limited third-party verification (Eccles and Serafeim, 2015). More attention is paid to the form than to the content of the reports. An explanation for this observation could be that if an organization decides to issue an integrated report, they start with focusing and implementing the easy tasks and in a later stage (or after a couple of years) implement the required internal processes and IT systems, which require significant resources (Pistoni et al., 2018). Another explanation could be that disclosing information could be detrimental to an organization as competitors can use this information to enter the market (Graham et al., 2005). Pistoni et al. (2018) document a significant improvement in the quality of the content and form in the years of research (2013-2014), which suggests that firms are improving what they disclose in the integrated reports, but that it takes time to implement. An alternative explanation could be that companies issue integrated reports for legitimacy purposes only (Beck et al., 2017; Lai et al., 2016).

Eccles and Krzus (2018) conducted an interesting experiment upon the question ‘is it possible and, if so, how difficult would it be to construct an integrated report for a company based on information from documents the company has already placed in the public domain?’ The results suggest that companies exaggerate in the concerns they express about issuing an integrated report. The main concerns include that constructing an integrated report would be too complex for companies that have worldwide operations and cause a burden for small- and medium-sized organizations. Furthermore, these problems are exacerbated by the absence of reporting standards. Related to this complexity is the cost issue. According to these firms the costs of making an integrated report outweigh the benefits. Moreover, disclosure generates litigation risk by disclosing long-term strategy and execution plans due to the forward-looking nature of integrated reports. Eccles and Krzus (2018) show that within 40 hours they construct an integrated report over the year 2016 with information ExxonMobil placed on their website, which suggests that information is already available to intended users of the integrated reports contradicting the litigation risk concern and that constructing an integrated report is not as complex, or costly, as organizations pretend it to be.

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2.2 The Agency Theory and Information Asymmetry: a Theoretical Perspective The hardest challenge for an economy is the optimal allocation of savings to investment opportunities (Healy and Palepu, 2001). Entrepreneurs and firms want to attract household savings to fund their business ideas. The savers and the entrepreneurs want to do business with one another, but optimally matching savings with ideas is difficult for two reasons. The first one is known as the information problem or information asymmetry. Information asymmetry occurs when one party has more or better information than the other party. Management has more information about their firms’ investments opportunities than the investors have. Furthermore, management has an incentive to overstate the value of these investment opportunities. There are three asymmetric information models, the first one being moral hazard, which occurs when the informed party does not enter the transaction in good faith or provides misleading information to the uninformed party, for example executive compensation contracts. The second model is on adverse selection or screening, which is the asymmetry of information between the agent and the principal on the characteristics of a transaction, for example health insurance. The third and last model is signaling, in which the idea is that the agent credibly gives information about a certain characteristic to the principal, for example an university degree (Spence, 1973).

The information problem can ultimately lead to the breakdown of the capital market (Akerlof, 1970). In the article of Akerlof (1970), the example of buying a car is used. There are four types of cars; new and second-hand cars. Both can either be good cars or bad cars (also referred to as ‘lemons’). If someone buys a new car, they know that there is a chance that it is a good car and one minus that chance that it is a bad car or a ‘lemon’. Driving the car for a certain amount of time helps the individual form an idea about the quality of the car. If hereafter he decides to sell it, the individual has better information than the buyer of the second-hand car. Both the good and the bad cars will sell at the same price, because the buyer cannot tell the difference between them as he does not have this type of information. This has implications for investment opportunities as well (Healy and Palepu, 2001). If half the business ideas are ‘good’ and the other half are ‘bad’, the investors cannot distinguish between them. The entrepreneurs of the ‘bad’ ideas will try to sell their ideas as ‘good’. Investors realize this possibility and will value both the ideas average. The capital market therefore undervalues some ‘good’ ideas and overvalues some of the ‘bad’ ones in comparison to the information the entrepreneurs have on

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their ideas. This can result in high-quality firms loosing potential investors if the investors undervalue these firms (Spence, 1973).

To mitigate this problem and for capital markets to function efficiently, several solutions can be suggested, such as optimal contracts between the entrepreneurs and the investors, so that private information will be fully disclosed. By doing so there will be no misevaluation and this problem is mitigated. Another solution can be provided through regulated disclosures in financial reports, such as the financial statements and the footnotes. Additionally, firms can voluntary disclose information, such as management forecasts or press releases. Furthermore, analysts and the financial press give disclosures about firms. Various economic and institutional factors determine whether the information asymmetry is eliminated by contracting, regulation, and intermediaries, such as financial analysts, or that some residual information problem remains. Factors can, for example, be the ability to monitor optimal contracts or regulatory imperfections.

The second problem in matching savings with ideas occurs after the investor allocates money to the organization and is known as the incentive problem. This refers to the misalignment of incentives between management and investors/shareholders, due to the separation of ownership and control. This phenomenon is also known as the agency problem. Investors delegate their decision-making rights to the entrepreneur as they do not want to play an active role in the firms’ management themselves (Healy and Palepu, 2001). As entrepreneurs act in a self-interested way, they can make decisions that expropriate the investors’ funds such as making investments that can be harmful to the investor, as their interests are not aligned, which could lead to increased costs (Jensen and Meckling, 1976). This is the case when savers acquire an equity stake in the firm. The investors can limit divergence from their interest by establishing incentives for the entrepreneur and by incurring monitoring costs to limit the activities of the entrepreneur that are harmful to the investor. However, it is impossible to mitigate that the entrepreneur makes decisions that are always at zero cost aligned with the viewpoint of the investor. The agency costs are defined as the sum of the monitoring expenditures by the principal (the investor), the bonding expenditures by the agent (the entrepreneur or the firm) and the residual loss. When the investor does not acquire an equity stake in the firm, but a debt stake, the situation differs from the above mentioned. The entrepreneur can still expropriate the investments value by taking part in high risk capital projects or using the money to pay out the cash received from the investors as dividend to equity stakeholders (Smith and Warner, 1979).

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By entering these high risk capital projects or paying out dividend, the chances of the firm being able to fully repay the debt becomes uncertain. There are two outcomes from participating in high risk capital projects. The first one is that the project has a high-payout, in which case the entrepreneur benefits, but the project can also fail, in which case the debtholder does not get his loan repayment.

Optimal contracts between the entrepreneurs and their investors can be a solution to the agency problem. In these contracts entrepreneurs can be required to frequently disclose information that is relevant to the investors. This gives the investors the opportunity to monitor the entrepreneurs and confirm that they use the firm’s resources in the best interest of the external owners. Another proposed solution is the set-up of corporate governance mechanisms, such as a board of directors. These can monitor and discipline the management on behalf of the external investors. Financial analysts or other intermediaries can help mitigate management misuse of the firms’ resources as well (Healy and Palepu, 2001).

2.3 Legitimacy Theory: an Alternative Interpretation

“Legitimacy is a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions” (Suchman, 1995, p. 574). The legitimacy theory is one of the most cited theories within the social and environmental accounting area, especially in understanding voluntary disclosures made by organizations (van der Laan, 2009). This theory is concerned with the relationship between the organization and society at large. According to this theory, organizations should seek to ensure that their operations fall within the bounds and norms of their respective communities to be perceived as ‘legitimate’ by various stakeholder groups in society, also known as a ‘social contract’ between society and organizations (Deegan, 2006; 2014; Deegan and Blomquist, 2006; O’Donovan, 2002). The central premise within this theory is that organizations can maintain their operations as long as they have the support of the community. Support can be earned if the organization is perceived by society as complying with the expectations of the community with which they interact. Voluntary disclosure can be seen as a key mechanism for organizations to legitimize their existence and their operations. As a result, the legitimacy theory can also be used to explain why organizations decide to issue integrated reports (Beck et al., 2017; Lai et al., 2016).

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2.4 Cost of Capital

The cost of capital is based on the external financing a firm uses. If a firm is solely financed through equity, the cost of capital is referred to as cost of equity capital. If a firm is solely financed through debt, the cost of capital is referred to as cost of debt capital. These definitions will be explained in the next paragraphs. Most firms do not use one or the other, but are financed by both equity and debt. The cost of capital is then calculated from a weighted average of the capital sources, also known as the weighted average cost of capital (hereafter: WACC). Cost of capital is a critical factor for firms in deciding which sort of financing they want to attract. Firms strive to get the most optimal financing mix where the cost of capital is the lowest. The WACC is calculated with the following equation (Frank and Shen, 2016):

WACC = E/V * Re + D/V * Rd * (1-Tc)

Where E is the market value of the firm’s equity, V is the total market value of the firm’s financing (E+D), Re refers to the cost of equity, D is the market value of the firm’s debt, Rd refers to the cost of debt and Tc is the corporate tax rate.

2.4.1 Cost of Equity Capital

As mentioned before, the cost of equity capital refers to the required rate of return on an investment in equity from investors and it refers to the required rate of return on a particular project/investment for the firm. There are several models that are used to calculate the cost of equity capital. The two most used models are the dividend growth model (DGM) and the capital asset pricing model (CAPM) (Ashton, 1995) of which the first one is calculated as:

DGM = (Dividends per Share (for next year) / Current Market Value of Stock) + Growth Rate of Dividends

The second model, CAPM, is calculated as:

CAPM = rf + βa (rm – rf)

Where rf refers to the risk free rate, βa is the beta of the security and rm is the expected market

return.

In this research I follow the approach as suggested by Easton (2004) and use the Price Earnings Growth (hereafter: PEG) model, which is developed from the DGM model as mentioned before. Further information on this model can be found in paragraph 4.3.1.

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2.4.2 Cost of Debt Capital

As explained above the cost of debt capital refers to the effective rate a firm pays on its debt. Commonly, it refers to after-tax cost of debt, but it could also refer to the firm’s cost of debt before taking taxes into account. Taxes, or interest expenses, are deductible, therefore firms can calculate the cost of debt capital after taxes. The cost of debt capital in this research is calculated as (Gray et al., 2009):

Cost of Debt Capital (CoDC) = interest expense / average total debt

3 Hypotheses Development

3.1 Integrated Reporting and Cost of Equity Capital

As outlined in the literature review in the previous section, the cost of equity capital can be affected by reducing the information asymmetry between the firm and its investors (Barth et al., 2017; Botosan, 1997; Botosan and Plumlee, 2002; He et al., 2013; Healy and Palepu, 2001; Zhou et al., 2017). <IR> can help reduce the information asymmetry in at least three ways (Zhou et al., 2017). First, by producing an integrated report the firm signals the quality of the firm. Some of the requirements of <IR> include the clear commitment to value-creation and the identification of risks and opportunities. By issuing an integrated report the company signals that environmental, social, and other factors are part of their daily operation and that risks and opportunities are well-managed. Second, by providing an integrated report the information set of the firm’s disclosure is expanding and includes more value drivers than solely financial information into one report. Moreover, the interconnection between these value drivers is shown. For investors, the information in these reports reduces the information search costs as the integrated report contains all the relevant information, which also increases liquidity. Third, issuing an integrated report reduces the uncertainty about a firm’s prospects. The <IR> principles place emphasis on organizations’ strategy, on the business model, and on forward-looking information. These emphases are aimed at reducing uncertainty about the firm’s long-term performance. If the principles are followed, the information risk of the company can be reduced by lowering the uncertainty relating to the long-term performance, which can result in a lower cost of equity capital.

One of the main goals of <IR> is to help firms be more transparent about how they create value in the short, medium, and long term. Investors and other stakeholders require more

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transparency after some scandals that took place in the beginning of this century and after the Financial Crises hit. Some research is done on the relation between the cost of capital and transparency (Barth et al., 2013). This study focuses on the relationship between earnings transparency and the cost of capital and finds evidence that firms with more transparent earnings enjoy a lower cost of capital. Firms in which the earnings reflect the changes in the economic value of the firm better are seen as more transparent. Another paper reviews the literature that has been written on the role of financial reporting transparency and the reduction of governance-related agency conflicts among managers, directors, and shareholders as well as in reducing agency conflicts between shareholders and creditors (Armstrong et al., 2010). More research is done on the relation between multiple measures of disclosures and the cost of capital (Berger, 2011; Beyer et al., 2010; Botosan, 1997; Dhaliwal et al., 2011).

Collectively, these arguments support the proposition that <IR> could help reduce the cost of equity capital if the principles of <IR> are adequately followed, which leads to the following hypothesis:

H1: Companies producing higher quality integrated reports have a lower cost of equity capital

3.2 Integrated Reporting and Cost of Debt Capital

It is recognized that information asymmetry is reduced by voluntary disclosing more information (Jensen and Meckling, 1976). The availability of more information increases the opportunity to get external finance with lower costs (Armitage and Marston, 2007; Guidara and Achek, 2015). If creditors value the extra information companies provide about their business in the integrated report, there is a possibility that they require a lower rate of return (interest). One of the main characteristics of an integrated report is the holistic story telling about value-creation in the short, medium, and long term. For creditors, this holds the benefit that credit risk can be easier assessed and determined, which results in a lower cost of debt capital (Sengupta, 1998). The disclosures affect the firm’s non-diversifiable risk. By giving more information, the cost of capital is directly influenced by the market’s assessment of the riskiness of future cash flows (Barth et al., 2017). The cost of equity capital influences the total cost of capital most, but the separation of the total cost of capital in the equity part and the debt part is interesting if the results happen to be in the opposite direction, or to see whether creditors and investors value the information in the reports differently. Although, based on literature on

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the effect voluntary disclosure of information has on the information environment and subsequently on the valuation of this information by stakeholders, I expect that when the principles of <IR> are adequately followed the cost of debt capital will be lower, which leads to the following hypothesis:

H2: Companies producing higher quality integrated reports have a lower cost of debt capital

3.3 Integrated Reporting and Cost of Capital for Environmentally Sensitive Industries versus Non-Environmentally Sensitive Industries

If an ESI firm, such as an oil company, spills oil in the ocean because one of their boats sinks, whether due to an accident or human failure, this has an effect on the company. The news discusses this terrible disaster, help is being send to save birds covered in oil and investors, creditors, and other stakeholders of the firm ask for an explanation on how this could have happened. For these firms the results of such an environmental disaster can be huge as regulators may demand change or set out new rules and requirements for companies in this industry, investors might require a higher rate of return, and the firm’s reputation is damaged. The main goal of <IR> is that firms tell a concise, holistic narrative story about their organization and the business in which they operate, how they create value in the short, medium, and long term, and how they use different forms of capital to accomplish this in the annual integrated report. Furthermore, information is given about governance, the environment, risks they face, and how they mitigate these risks. An integrated report can therefore have a positive effect for firms that operate in ESIs as environmental disclosures result in trust from a broad range of stakeholders (Peters and Romi, 2013; Rupley et al., 2012; Stacchezzini et al., 2016). Clarkson et al. (2013) examine the relation between environmental voluntary disclosure and firm value for ESIs. They find a positive association between disclosure quality and overall firm value. However, when they examine whether this relation is through the cost of equity capital, no significant association is found. Clarkson et al. (2013) document a positive relation between voluntary environmental disclosure and firm value due to the cash flow component of firm value. Plumlee et al. (2015) considers both ESIs and NESIs in their research and document an association between disclosure quality and firm value through the association with cost of equity capital. This evidence suggests that the results on the previously mentioned hypotheses could differ across industries, which leads to the following hypotheses:

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H3: The effect of voluntarily adopting <IR> on the cost of equity capital is stronger for firms operating in environmentally sensitive industries than for firms operating in non-environmentally sensitive industries

H4: The effect of voluntarily adopting <IR> on the cost of debt capital is stronger for firms operating in environmentally sensitive industries than for firms operating in non-environmentally sensitive industries

4 Research Methods and Design

4.1 Sample Selection

To answer the research questions a quantitative method is employed. The sample selection process starts with all the European firms voluntary adopting <IR> according to the IIRC’s website. Some of the annual reports, classified as integrated, do not contain words like ‘integrated report’, ‘integrated thinking’ or ‘IIRC’s framework’. To understand how the IIRC determines whether firms issue integrated reports when the abovementioned words are not in these reports, I contact the IIRC via their website and receive a response about the main criteria they use to determine whether an annual report is an integrated annual report. If the report is structured around the six capitals, it is determined an integrated report by the IIRC.

Appendix C provides the full published list of <IR> issuers according to the IIRC. I exclude the companies that are unlisted and I obtain data about the quality of the integrated reports from Thomson Reuters ASSET4 (Serafeim, 2015). This database provides in-depth, objective and comparable environmental, social, and governance (ESG) data on more than 4,000 companies regarding financial, environmental, social, and governance issues (Thomson Reuters, 2012). ASSET4 measures the capacity and commitment of firms integrating financial with non-financial data on a scale from 0 to 100. I use two types of variables to measure the quality of integrated reports which will be explained later on in paragraph 4.3.2. The Thomson Reuters Database is accessible via Datastream and the companies with missing data on integrated report quality are eliminated from the sample.

Data to measure the first dependent variable of this research, the cost of equity capital, is collected from I/B/E/S. This database shows historical estimates which are necessary to calculate the implied cost of capital.

To calculate the cost of debt capital, the second dependent variable, I obtain data via Datastream. More information on the two dependent variables can be found in paragraph 4.3.1.

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The control variables for both regression models are obtained from Datastream as well. Some of these control variables are for example leverage, total assets and beta. I will elaborate more on these control variables in paragraph 4.3.3.

Three companies are founded after the beginning of the sample period. To improve consistency these companies are excluded from the final sample.

My final sample to test Hypotheses 1 and 2 comprises 505 company-year observations over seven years (83 unique companies). To test Hypotheses 3 and 4 I divide the sample in firms that operate in ESIs and firms that operate in NESIs (Reverte, 2009). This leads to two sub-samples consisting of 195 company-year observations for the ESI firms over a 7 year period (31 unique companies) and 310 company-year observations (52 unique companies) for the NESI firms.

In appendix D the final list of European companies adopting <IR> is presented. The companies in the final sample are located in 13 different countries. Of these companies 30 are located in the United Kingdom and 8 in Italy, Spain and the Netherlands, the other countries in the sample locate up to five companies voluntarily issuing integrated reports. As the companies are located in different countries in Europe, the results of this research will be more generalizable than the results of Zhou et al. (2017) and Barth et al. (2017), whose samples only comprise JSE-listed companies in South-Africa. The focus regarding the sample period is on reports during a 7 year period from 2010 to 2016. Thus including the pre-adoption period of <IR> and the post-adoption period. Initially, I include fiscal year 2017 in the sample period but due to a lot of missing data for the majority of the companies, this year is removed to circumvent further reduction of the sample.

4.2 Variable Description 4.2.1 Dependent Variables

Cost of Equity Capital (COEC) There is a lot of debate on which measure of cost of equity capital is the best (Zhou et al., 2017). The PEG-model from Easton (2004) is the most popular measure in prior research. The implied cost of equity capital (r) is calculated as the square root of expected two-years ahead earnings per share plus the expected one-year ahead dividends per share minus the expected one-year ahead earnings per share divided by the current stock price per share.

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Where:

P0 = current stock price per share (t=0)

eps1 = expected one-year ahead earnings per share

eps2 = expected two-years ahead earning per share

rdps1 = expected dividends per share (t = 1)

Botosan and Plumlee (2005) find that this measure tends to outperform the other measures. The other measures include the GLS model as developed by Gebhardt et al. (2001), the CT model from Claus and Thomas (2001) and the estimation method developed from Easton et al. (2002). In this research I follow Zhou et al. (2017) and use the PEG-model to calculate the implied cost of equity capital. Barth et al. (2017) use a different method to calculate the implied cost of equity capital. As proposed by Daske et al. (2008) Barth et al. (2017) use an average of four models as main proxy to calculate the cost of equity capital. The four models are developed in earlier research (Claus and Thomas, 2001; Easton, 2004; Gebhardt et al., 2001; Ohlson and Juettner-Nauroth, 2005). The data to calculate the cost of equity capital is, as mentioned earlier, obtained from I/B/E/S. As this database provides monthly estimations, these are used to estimate the average value of the cost of equity capital for every company-year as suggested by Zhou et al. (2017). The integrated report quality values are on a yearly-basis which makes it necessary to provide values on the cost of equity capital also per year to be consistent.

Cost of Debt Capital (CODC) To proxy for the cost of debt I follow Gray et al. (2009) by dividing the interest expense by the average total debt. This proxy is commonly used in the literature (Dadashi et al., 2013; Guidara and Achek, 2015; La Rosa et al., 2017; Sengupta, 1998).

4.2.2 Independent Variable of Interest

The Quality of the Integrated Reports (IR_TOTAL) The independent variable of interest in

this research is the quality of integrated reports. <IR> is currently not mandatory and therefore lacks specific guidelines and rules. This makes it difficult to assess the quality of the integrated reports issued. Several measures have been employed in prior research such as in Zhou et al.

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(2017) who use a coding framework constructed in accordance with the <IR> prototype Framework. Moreover, Barth et al. (2017) use the EY excellence in integrated reporting awards scores in South-Africa to measure the quality of integrated reports. Both these measures have the limitation that they are subjective and only suitable in the specific South-African setting. As suggested by Bernardi and Stark (2018) and Serafeim (2015) I collect data from Thomson Reuters ASSET4 via Datastream as mentioned in the previous section.

The first proxy to measure the quality of <IR> (IR_TOTAL1) is constructed through the work of Bernardi and Stark (2018). According to them, ESG disclosure levels influence <IR> effectiveness. They suggest that by linking the ESG performance with financial performance in an integrated report, the holistic understanding of the company by its stakeholders will improve. Therefore, my first proxy is the Integrated Rating score from Thomson Reuters ASSET4. This number, between 0 and 100, measures the company’s overall performance by incorporating the individual subs-scores of the four pillars, being the economic, the environmental, the social, and the governance performance. The definition ASSET4 gives of this measure suggests that the EESG (Integrated Rating) score reflects “a balanced view of a company’s performance in these four areas.” However, this measure is general and indirect, it incorporates data that is directly linked to <IR>. Therefore, I consider this proxy to be suitable for this research.

As an alternative proxy to measure the quality of integrated reports I use the integration/vision and strategy score as suggested by Serafeim (2015). Data for this score is obtained from Thomson Reuters ASSET4 via Datastream. This score, also between 0 and 100, measures “the company’s management commitment and effectiveness towards the creation of an overarching vision and strategy integrated financial and extra-financial aspects. It reflects a company’s capacity to convincingly show and communicate that it integrated the economic (financial), social and environmental dimensions into its day-to-day decision-making processes” (as defined in ASSET4). As this definition matches the view of <IR>, I consider this proxy as a suitable alternative measure for valuing the quality of integrated reports (IR_TOTAL2). To support hypotheses 1 and 2 IR_TOTAL (both proxies) need to have a negative coefficient.

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4.2.3 Control Variables

Control Variables for H1 and H3 The control variables for hypotheses 1 and 3 also adopt the levels-form just as the dependent variables and the independent variable. These control variables are derived from prior research. Fama and French (1992) find a negative association with expected returns and firm size, and a positive association with the book-to-market ratio. Therefore, I include firm size (SIZE) as a control variable in my research. This variable is calculated as the natural logarithm of a company’s total assets as suggested by Zhou et al. (2017). Moreover, I use the market-to-book ratio (MB) in contradiction to Fama and French (1992), who use the book-to-market ratio. This changes the expectation on the direction of this variable from positive in Fama and French (1992) to negative in my research. Furthermore, I control for the market model (BETA) as suggested by Fama and French (1992). Consistent with them a positive coefficient is expected for BETA. Size, book-to-market ratio and beta are also known as the Fama-French three-risk factors and are widely used by most studies in this research stream (Dhaliwal et al., 2005; Dhaliwal et al., 2011; Francis et al., 2008; Zhou et al., 2017). I also include leverage (LEV), because Fama and French (1992) and Dhaliwal et al. (2006; 2011) suggest that the cost of equity capital increases as the degree of leverage increases. Thus, a positive coefficient is expected for this variable. Finally, as suggested by Zhou et al. (2017) a dummy variable is added for the disclosure of CSR reports. The variable is coded 1 if a standalone CSR report is issued by the company along with the integrated report and 0 otherwise. Issuing standalone CSR reports can influence the cost of equity capital as the information environment for the company improves as suggested by prior literature.

Control Variables for H2 and H4 The control variables for the cost of debt capital regression are firm size (SIZE), leverage (LEV), return on assets (ROA) and interest coverage (IntCov) as proposed by Gray et al. (2009). Leverage is the ratio of total debt to total assets and interest coverage is the ratio of operating income to interest expense. The corporate size is expected to have a negative effect on the cost of debt as more voluntary disclosure implies less creditors’ perceived risk and risk of default (Guidara and Achek, 2015; Sengupta, 1998). The predicted sign of leverage is positive as suggested by Gray et al. (2009), whereas the predicted coefficients for return on assets and interest coverage are negative. All variables are used in their levels-form as proposed by Gray et al. (2009). As suggested by Guidara and Achek (2015) and Orens et al. (2010) I also include a dummy variable for loss (LOSS). This variable takes the value of 1 if the net income before extraordinary items is negative in the current year and

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0 otherwise. If a loss occurs in the current year, an organization might report more information during the year to provide an explanation to its stakeholders.

Furthermore, to both regressions two additional dummy variables are added (DINDUSTRY and DYEAR). The control variable industry (DINDUSTRY) takes the value of 1 if the company belongs to an ESI and 0 otherwise. The activities of these companies involve a higher risk of environmental impact (Reverte, 2009). Mining, oil and gas, chemical, forestry and paper, steel and other metals, electricity, gas distribution, and water are considered to be sensitive industries (Reverte, 2009; Fernández-Gago et al., 2016). To test hypotheses 3 and 4 this dummy variable is removed as the partitioning is made based on this variable.

As the companies in the sample started issuing integrated reports in different years the dummy (DYEAR) takes the value of 1 in the year the company first issued an integrated report and the value of 0 otherwise.

All data is trimmed at the 1st_{and 99}th_{percentile to deal with potential outliers and missing data}

on the variables.

4.3 Research Models

Hypothesis 1 predicts a negative relation between the quality of integrated reports and the cost of equity capital. This hypothesis is tested by estimating the following OLS regression model:

COEC i, t+1 = β0 + β1 IR_TOTAL i, t + β2 SIZE i, t + β3 MB i, t (1) + β4 BETA i, t + β5 LEV i, t + β6 CSR i, t + ∑ DINDUSTRY + ∑ DYEAR+ ε i, t

Equation (1) is developed from Dhaliwal et al. (2011) and Zhou et al. (2017). All the variables are used in their levels-form. To support hypothesis 1 the coefficient on IR_TOTAL must be negative.

Voluntary adoption of integrated reporting in Europe : an empirical research on the effect on cost of Equity capital and cost of debt capital

Voluntary Adoption of Integrated Reporting in Europe

Table of Contents

1 Introduction

2

Literature Review

3

Hypotheses Development

4

Research Methods and Design