The impact of integrated reporting in the IIRC pilot programme participants : an empirical study focused on the impact of <IR> in the firms’ cost of equity capital

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The impact of Integrated Reporting in the IIRC Pilot

Programme participants

An empirical study focused on the impact of <IR> in the firms’ cost

of equity capital

Name: Ejona Gjata

Student number: 11085800 Word Count: 16789

Thesis Supervisor: Prof. Dr. Brendan O’Dwyer

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 EJONA GJATA 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 future of corporate reporting.” This is what Integrated Reporting, as a new holistic form of disclosure promises to be. Proponents of <IR> claim that various internal and external benefits arise from the adoption of this practice. Among others, a decrease in the cost of equity capital is expected for the reporting companies. This empirical study is one of the first in this research stream that explores the role of <IR> and its claimed impact on the firms’ cost of equity. Currently there is relatively little research on <IR>, while the relationship between the disclosure of integrated reports and the cost of equity has been investigated only in one specific setting i.e. South Africa. Through this research, I aim to expand the existing literature on this and provide empirical evidence in support of the claimed benefits of <IR>.

I hypothesize that companies who disclose integrated reports are likely to experience a lower cost of equity because <IR> has the potential to mitigate information asymmetry and other factors that directly or indirectly increase the companies’ cost of capital. In addition, I hypothesize that companies with an information environment of low quality are more likely to benefit from <IR> as the effect on the cost of equity capital will be more significant for these companies. Based on a sample of 53 companies from 20 countries participating at the IIRC Pilot Programme, I construct the regression model to test the possible changes in the cost of equity capital during 2009-2014. Results seem to be mixed to some extent. While I find that indeed <IR> disclosure is negatively associated with the cost of equity, evidence is weak because the relationship is not statistically significant. However, additional analysis using an alternative measure for the quality of integrated reports indicates that the negative relationship between these variables is actually significant. Consistent with the hypothesis, I also find evidence that the impact of <IR> is stronger for companies characterized by a small size and/or low analyst coverage (both proxies for the information environment).

Overall, the study indicates some optimistic results, yet some limitations exist. Therefore further research is required to provide further evidence and draw solid conclusions.

Key Words: Integrated reporting, voluntary disclosure, cost of equity capital, information asymmetry, IIRC Pilot Programme

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1. Introduction

1.1 Background

“Integrated Reporting reflects how our Company thinks and does business. This approach allows us to discuss material issues facing our business and communities and show how we create value, for shareholders and for society as a whole.”

Dimitris Lois - Chief Executive Officer of Coca-Cola, one of the first participants in the IIRC Pilot Programme

In the modern world of 2016, with technology moving up too fast and new challenges arising every day, it is not always easy to keep up. Businesses nowadays work harder and harder and invest a lot of substantial resources to upgrade their technologies, to follow new trends and to improve their practices in order to eventually achieve their main financial and non-financial goals (such as high profits, low costs, high firm value, leadership position, competitive advantages, etc.).

What it has been made obvious during the last years is that companies need to broaden their horizons and pay more attention to the environmental, social, and governance issues affecting their businesses. Recently, investors and stakeholders are not seeking only for information regarding the financial performance of the firms, but they are also paying close attention 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 - ultimately leading to better decision making (PwC reports). In other words, investors’ interest in corporate non-financial information is increasing (ACCA, June 2013).

Research by Ocean Tomo1 showed that in 2010 only 20% of the market capitalization of S&P 500 companies consisted of physical and financial assets compared to 90% in the 1970s (Deloitte, 2015). According to the same study2, in 2015 this percentage dropped further to 16% clearly showing that intangible factors which might not always be visible in the financial reports have become the main drivers. So, focusing purely on financial metrics is no longer

1_{Ocean Tomo, LLC is a merchant banking firm that provides financial advisory and strategic consulting}

services to commercial and institutional investors. (source: Bloomberg Business)

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enough (Steve Almond, former Chairman of Deloitte Global). Instead, adopting an enhanced and more comprehensive reporting of information could be the key to address these issues. This is exactly the right moment when Integrated Reporting comes into the picture. The evolving process from financial reporting to sustainability reporting and from sustainability reporting to integrated reporting has come a long way, but it seems that firms are finally in the right track. As Serafeim (2014) states: “Integrated Reporting is a relatively new phenomenon in the world of corporate reporting that has gained significant momentum in the last ten years.” Even though it is still a novel concept, whose framework has been officially established by the International Integrated Reporting Council (IIRC) in December 2013, it has however gained some spotlight and continuous appraisal across the business world. It is still too early to have a worldwide acceptance and adoption of this new voluntary reporting – due to the challenges and limitations that firms face in the process of first time implementation – but considering the claimed positive impact on the overall performance of the firm in the short, medium and long term, it is not surprising that many consider <IR> to be “the future of corporate reporting” (White 2005, Druckman and Fries 2010, Eccles and Krzus 2010, Eccles 2012). Similarly Paul Druckman, the CEO of IIRC claims: “It is not another report, rather an evolution in corporate reporting.”

One question arises though: Why <IR> when we already have CSR or Sustainability Reporting? “Integrated thinking” is the keyword which makes the difference. Unlike CSR or Sustainability reports, this new approach isn’t just about disclosing non-financial information regarding social and environmental issues alongside financial data. “The aim of <IR> is to clearly and concisely tell the story of the company, who it is and what it does and how it creates value, […] and the performance against its strategic objectives in a way that gives stakeholders a holistic view of the company and its future” (SAICA, 2015). As Robert Eccles3 explains in one of his interviews: “…companies are increasingly making the claim that sustainability is good for business, so <IR> is an opportunity for them to provide a more coherent and specific explanation for why that’s the case.” Moreover, in the recent years CSR and Sustainability reports have become subject to criticism and increased scrutiny in that they may actually reduce the visibility of corporate social and environmental impacts (O’ Dwyer et al., 2011). According to Barth et al. (2015) and Serafeim (2015) a serious disadvantage of these reports is that they are disconnected from the strategies, business models and financial performance of the

3_{Senior Lecturer at Harvard Business School, co-writer of the book “The Integrated Reporting Movement:}

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company. Therefore, a new comprehensive form of disclosure such as <IR> might present a better alternative.

The significance of <IR> is continuously growing and this is easily evidenced by the increasing number of firms participating at the Pilot Programme, set by IIRC in 2011 for all those firms that were ready to challenge the traditional way of reporting and embrace a new approach. A survey (Realizing the benefits: The impact of Integrated Reporting) conducted in 2014 by the Black Sun4_{in association with IIRC, based on a sample of 66 participants from the IIRC Pilot}

Programme resulted in overall optimistic and encouraging findings with respect to the benefits of <IR>. Furthermore, according to other recent studies, advocates of <IR> claim several potential benefits of <IR>: “….internal benefits such as accelerating integrated thinking within organizations lead to better management decision-making; while external benefits of <IR> including an enhanced reputation among stakeholders and increased transparency can result in a lower cost of capital” (Zhou et al., 2015). Exactly this last part, as I will explain in the following section, will be the focal point of this research.

1.2 Prior research and motivation

In the International <IR> Framework, integrated reporting is defined as follows: “An integrated report is 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” [1A:1.1]. Even though it represents a relatively new accounting trend, still in the steps of gaining recognition and acceptance across businesses all over the world, some research has been already conducted.

Acknowledging the potential of <IR> as a future–oriented approach with a strategic focus, PwC published in 2014 a report presenting some survey findings on this matter. According to this report (Corporate performance: What do investors want to know? Powerful stories through Integrated Reporting) the survey was mainly focused on the way in which, as seen from the investment professionals’ perspective, <IR> can help management to communicate better their story. Based on the answers of 85 investment professionals from around the world, conclusions on various aspects of a company’s reporting and its management were drawn.

Among the findings of the survey, the effect of <IR> on the company’s cost of capital was discussed: 63% of the respondents agreed that disclosures based on <IR> guiding principles can have a direct impact on a company’s cost of capital, while only 11% of them disapproved.

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Figure 1 – Survey findings: <IR> and the cost of capital

Source: PwC / Powerful stories through integrated reporting

Similarly, in an earlier report of KPMG (The business case for Integrated Reporting, 2013) it is claimed: “[…] So while it is too soon for anyone to report the ‘right-sizing’ of their cost of capital through Integrated Reporting, early adopters note positive comments from their investors and they expect their cost of capital will more closely mirror their strategy, performance and prospects over time.”

Considering the overall optimistic views on the role of <IR> , these reports served as the initial motivation to conduct an empirical study focused on the extent to which <IR> adoption can bring substantive changes to companies, and more specifically, to their capital structure. In this context the cost of capital (both equity and debt) plays a primary role in determining the optimal structure of the firm’s capital and it represents a key metric for investors’ decision-making. Particularly the cost of equity, having the main influence on the overall cost of capital, is really important for companies when it comes to capital budgeting and other financial planning decisions (Larocque & Lyle, 2013; Zhou et al., 2015). Thus, the purpose of this study is to examine the relationship between the voluntary adoption of <IR> and the firm’s cost of equity capital.

Looking further into prior literature, I found stronger motivation. Actually, the relationship between voluntary disclosures and the cost of equity capital has been studied for relatively a long period in the accounting literature, with emphasis shifting from the traditional reporting (Core 2001; Healy and Palepu 2001; Leuz and Wysocki 2008) to the latter CSR information disclosures (Plumpe et al., 2008; Dhaliwal et al., 2011; Reverte, 2012; Wang et al., 2013; Dhaliwal., 2014). However, research done so far specifically about <IR> is a bit scarce and

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consists mostly of surveys and publications by the Big 4 firms and other similar organizations. Still, a few exceptions exist. For instance, Zhou et al. (2015) “Does Integrated Reporting Matter to the Capital Market?” represents one of the first empirical studies in this research stream. In this study, Zhou et al. (2015) investigate the association between <IR> and the cost of equity capital using a sample of companies listed on the Johannesburg Stock Exchange over 2009-2012, before and after <IR> was introduced as a mandatory disclosure in South Africa. The findings of this study confirm that there is indeed a significant relationship between these variables - nevertheless there are some limitations that should be addressed in the future. One problem is the generalization of results to other countries with different legal and financial environments, where unlike South Africa (considered as a unique case) the adoption of <IR> is set on a voluntary basis. The other problem is the limited sample period (2009-2012) due to the lack of data availability which can adversely affect the accuracy of results. Therefore, their call for further research in addressing these issues is a strong motivation to conduct a new complementary study.

Furthermore, in another study Simnett & Huggins (2015) discuss and analyse some new issues that arise from the establishment of the International <IR> framework, pointing out possible areas for future research. One of this issues relates to the external benefits of <IR> and in particular to the cost of capital. After summarizing existing knowledge about the impact of <IR> on the cost of capital, they raise the following question: “Do organizations that produce reports aligned with the <IR> Framework realize cost of capital reductions, or possibly a greater shareholder return over time?” Answering to this question will hopefully be possible through this research.

1.3 Research Question

As shortly mentioned earlier, there has been much discussion in prior literature about the effect that voluntary disclosures have on the cost of equity. Several studies, such as Botosan (1997) and Botosan (2000), Hail (2002), Francis et al. (2005), Dhaliwal (2011), etc., confirm the existence of a negative relationship between the adoption of voluntary disclosures and the cost of equity capital of the firms. Consequently, one can predict that the same relationship will be found in the case of <IR> since it represents a new form of voluntary disclosure. However, it is suggested that the direct generalization of the cost of capital effect is not always clearly visible (Dhaliwal et al., 2011). In addition, Zhou et al. (2015) claim that “ [….] despite the negative link between discretionary disclosures and the cost of equity capital generally concluded from the theoretical studies, the empirical evidence on the link is often less

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consistent and robust for a definitive and unambiguous conclusion to be drawn.” Even in the case in which this link has been tested (i.e. Zhou et al., 2015) the generalization of results is necessary since results based only on a specific setting (such as South Africa) can be narrow and limited. Thus, a new complementary study that focuses explicitly on the impact of <IR> using a more representative sample, can provide empirical evidence to support (or contradict?) theoretical expectations.

So, in conclusion to what it has been discussed up to this point, I would like to present the research question, based on which this empirical study will be constructed:

RQ: To what extent does the adoption of <IR> in the participant firms of the IIRC Pilot Programme reduce their cost of equity capital?

I am particularly interested in assessing the significance of the expected reduction since some skeptics claim that there are no significant benefits or that it is too early to expect empirical evidence about the effects of <IR> on the cost of capital (Michael Bray – KPMG, 2013). One example is a recent study of Barth et al. (2015)5 that could not find a significant association between them. Through this study, I examine whether this new approach offers indeed some significant benefits to the reporting firms or it’s just ‘much ado about nothing’. By using data from the participants of the Pilot Programme developed by IIRC in 2011, I expect to obtain more generalizable results due to the diversity of the sample.

1.4 Contributions and structure

Two main contributions result from this study. Academic contribution: As previously discussed, the current literature provides only a general knowledge on <IR> and lacks empirical evidence, which sometimes puts into question the potential that <IR> is claimed to hold. This is partly attributed to the fact that <IR> represents a new concept in corporate disclosure that is still unknown for many. Besides that, it has been suggested that empirical evidence requires some time to become visible and therefore it cannot be documented at the present time. With respect to the capital structure of companies, only two recent studies focus on the relationship between the disclosure of integrated reports and the cost of equity, and consequently they cannot provide sufficient evidence to come to definitive conclusions. From this viewpoint, this study would modestly contribute in complementing and expanding existing literature concerned about <IR> issues. Practical contribution: The “comply or explain” requirements

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of the King III Report in South Africa or the Grenelle II Act6 in France in support of <IR> are not a coincidence. In fact they can be interpreted as early signs of what might become a reality in the future: the mandating of <IR>. Particularly, if the number of voluntary adopters worldwide continues to grow at significant rates, integrated reports might become a standard form of disclosure applicable to all entities, just like the ‘normal’ annual reports. In this context exploring integrated reporting from different perspectives can be relevant to all the parties affected, including companies as well as investors, shareholders, creditors, standard-setters and other regulators. Particularly, shedding some light on the impact that integrated reporting is claimed to have on the firms’ cost of equity can be informative for internal and external decision-making.

The remainder of this study is structured as follows. Section 2 presents some theoretical explanations and literature review, followed by the hypothesis development. Section 3 provides a thorough empirical analysis that describes the research design, the selection of every variable incorporated in the regression model, the descriptive statistics and the findings of the study. Lastly, section 4 summarizes the main conclusions and identifies possible limitations.

2. Theory and Literature review

2.1 Who needs Integrated Reporting? The emergence of a new approach.

According to the official website of IIRC, <IR> has been developed in consistence with the new corporate reporting trends in the world. Since there are several market drivers, which are not matching with the existing reporting methods, <IR> is seen as an alternative solution. In this section, I explain in more detail the circumstances under which <IR> was developed. I identify three main drivers that motivated the necessity for high quality information and additionally I explain how <IR> responds to these driving forces by addressing the concerns of those affected: the businesses, the investors (and other stakeholders) and society as a whole. Having a good understanding of the role that <IR> plays in promoting transparency and accountability in corporate reporting at a time when they are needed the most, is essential in explaining why firms decide to embrace it – which will be covered theoretically in the following section.

6_{The Grenelle II Act (Article 225) is a reporting law enacted in 2012, which not only requires France-based}

companies to publicly disclose information about their environmental, social and societal impacts, but also to provide independent verification of this information.

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2.1.1 Businesses challenges

Nowadays companies operate in a multi-dimensional world: the global economy, the environment and the society on which they rely to create value (Krzus, 2011). Each dimension represents a challenge for most companies because often the impact of their activities particularly on the environmental and social dimension is not quantifiable or even visible (Mair & Marti, 2006). In addition, the business processes and transactions in the dynamic markets in which they operate have become more complex than they used to be. In light of the global financial crisis and corporate collapses in the recent years, companies are better informed about the importance of transparency and high quality information in ensuring the business viability. Managers and other internal decision-makers need high quality information not only to understand the dynamics within an organization, but also to evaluate and improve their strategies, business models, activities and performance. Financial information for this purpose is simply insufficient because although it provides a clear picture of a company’s financial situation, it fails to capture and explain the non-financial factors that contributed to this situation. Consequently, the low quality of information hinders the management’s ability to make adequate decisions - eventually hurting the company’s performance in the long run. On the other hand, according to the official Framework, <IR> provides insight about: 1) the external environment affecting the company; 2) the resources and the relationships used and affected by the company which are referred to as the “six capitals” 7; 3) the way in which the company interacts with the external environment and the capitals to create value [2A:2.3]. To cut it short, this new reporting form incorporates all the internal and external, financial and non-financial factors that influence an organization’s ability to create value over time. In this context <IR> represents a useful accounting tool that requires management to take a holistic view of its decisions and the consequences regarding financial, natural, and human resources (De Leo & Vollbracht, 2011).

However, adopting <IR> and particularly disclosing integrated reports for the very first time is also a challenge for most companies. Once that a company decides to adopt this practice, there are several technology and data challenges it has to deal with (Eccles & Armbrester, 2011). The most complex part is the integration of all relevant information into a single report that depicts the real picture of the company. In addition, the lack of regulation and of adequate standards creates difficulties in learning how to produce integrated reports. Therefore, it is

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necessary to consider both benefits and costs that arise from adopting <IR>. In general companies that have embraced this holistic form of disclosure are motivated by the conviction that the benefits (tangible and intangible) outweigh the costs of doing so (Eccles & Krzus, 2014).

2.1.2 The increasing need of investors and other stakeholders for transparency and accountability

Accounting scandals and frauds have continuously hit the headlines during the last 20 years (Enron, Worldcom, Parmalat, Tyco, Lehman Brothers, etc.) Even without referring to specific cases, one can assume all the legal, financial and moral consequences that have resulted from such scandals: bankruptcies, lawsuits, loss of jobs, diminished trust and bad reputation. As if that were not enough, the Financial Crisis of 2007-2008 contributed in further decline of public trust, lack of transparency and a strong call for accountability.

According to Healy & Palepu (2001) the efficient allocation of savings to investment opportunities is a challenge for every economy. Investors and other stakeholders have traditionally relied on the firm’s financial statements for their investment or other resource allocation decisions. However, taking into account the notorious events of the past, there have been increasing concerns over the incapability of traditional reporting in meeting the information needs of stakeholders (Cohen et al., 2012; Cheng et al., 2014). In their book on integrated reporting8 Busco et al. (2013) explain that traditional annual reports fail to deliver a “true and fair view” for three main reasons: 1) they are too long and complex; 2) they do not disclose information about the non-financial indicators that influence investors’ decisions; 3) and they do not disclose sufficient information to predict the long-term financial performance of the firm. These reasons suggest that there is a serious need for concise high quality information to enhance transparency and accountability. <IR> can play a primary role in addressing this need through the extensive disclosure of information that reflects the core of the business (Hao, 2014). Following the same line of thought, Bill McDermott9_claims:

“…(integrated reporting) enhances transparency and accountability at a time when customers, shareholders, and business partners are demanding more of each.” Similarly, Krzus (2011)

8_{Integrated Reporting: Concepts and Cases that Redefine Corporate Accountability edited by Cristiano Busco,}

Mark L. Frigo, Angelo¬ Riccaboni¬ and Paolo¬Quattrone

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argues that <IR> forms “one of the cornerstones of corporate accountability and trustworthy markets.”

Based on the these arguments, it is reasonable to conclude that the increasing needs of investors and other stakeholders for information that goes beyond the financial metrics of the company represent an important driver to produce integrated reports. As for the outcome, integrated reports will help these stakeholders make better resource allocation decisions by providing them with high quality information about the firm’s ability to create value over time (Eccles & Saltzman, 2011; Eccles & Krzus, 2014).

2.1.3 Society

Since integrated reports disclose a lot of information about the impacts of business activities on the environment and people’s lives, <IR> is of great value to the entire society. In the recent years, the mass-media, along with NGOs and environmental organizations, pays a particular attention to the companies’ policies and practices on the social and natural environment in which they operate (Solomon, 2007). In the past some of these practices have been very abusive and disruptive by destroying many resources or even causing serious disasters (think of OK Tedi, Chernobyl and various oil spills). In light of such events, society has become more sensitive and demands greater accountability from businesses. CSR and Sustainability reports issued for this purpose have been of limited effectiveness. Through the years they have been continuously accused for serving for greenwashing purposes instead of reporting on the real practices of companies (Adam, 2004; Clarkson et al. 2008; Cho et al., 2010; Lyon and Maxwell, 2011; Mahoney et al., 2013) which has significantly diminished their credibility.

Unlike these disclosures, <IR> provides a single report with a holistic view of the company’s environment and activities by linking in an integrated way the company’s strategy, business models, risk, opportunities and performance (Ioannou & Serafeim, 2011). From this viewpoint it offers a better alternative than CSR or Sustainability disclosures because it overcomes their weaknesses and can serve as an instrument to monitor and keep under control the company’s bad practices. In consistence with this viewpoint, Eccles and Saltzman (2001) state: “A sustainable society requires that all of its companies practice integrated reporting, so that resources used today do not jeopardize access to resources for future generations.” It is the responsibility for the well-being of the planet and of future generations that drives the demand of society for enhanced disclosures through <IR>.

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Although in the International <IR> Framework it is clearly stated that providers of financial capital represent the targeted audience of <IR>, it is however suggested that an integrated report can benefit all the stakeholders who are interested in an organization’s ability to create value over time. Since it takes in consideration and satisfies not only the information needs of primary shareholders but also those of the wider society, the role of <IR> in corporate reporting will probably grow in the future.

2.2 Why are companies embracing Integrated Reporting? Theoretical perspectives As discussed in the prior section <IR> is a new trend that promises to bring positive changes in corporate reporting. However, at the present it is still at an early stage of development. Many companies struggle to select and collect the non-financial information, to measure and integrate it in the overall performance (Deloitte, 2015). The lack of experience along with the little guidance and the substantial costs arising from the necessary customization of accounting systems make the adoption of this approach a burdensome. Taking these obstacles into account, why are (some) firms choosing integrated reports and disclosing more than they are required to? In this section I explain from a theoretical viewpoint the decision of a company to voluntarily disclose reports aligned with the guiding principles of <IR>. Various theories have been employed to interpret thoroughly the reasons for these changes in reporting.

2.2.1 Information asymmetry and the agency theory

As the literature suggests, information asymmetry is present when where one party (the agent) has more or better information than the other (the principal). In the context of business companies, managers are usually more knowledgeable than shareholders about the company’s performance and often they have incentives to overstate its value (Healy & Palepu, 2001). Shareholders and potential investors, on the other side, have only limited information which is made available by these managers. Due to this asymmetry, investors find it hard to distinguish between good firms and bad firms so this leads them to evaluate all firms at an average level regardless of their quality (Healy & Palepu, 2001). This is consistent with Akerlof’s (1970) “Market for lemons” which argues that uncertainty and lack of information will motivate sellers to market poor quality goods (lemons) as there is no incentive for selling high quality goods, considering that they will be under-priced. So, while more lemons will be offered in the market, less willing buyers will be to pay for them. As a consequence the average quality of goods and the size of market are likely to be reduced (Akerlof, 1970). This is known as adverse selection and according to Akerlof it might eventually lead to market failure. The same situation happens

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when investors or other capital providers (the uninformed party) need to evaluate investment opportunities for certain companies because they don’t have access to the private information. This is a main issue, particularly for high quality companies which get undervalued and lose many potential investors.

A second issue arises after investors or other capital providers have allocated their funds to a company: the agency problem. Once they invest in a company, these shareholders delegate decision making to management, so they don’t get actively involved (Healy & Palepu, 2001). Due to the misalignment of interests between them, managers might have incentives to expropriate and misuse the shareholders’ funds, resulting in increased costs for both parties (monitoring and bonding costs).

2.2.2 Signaling as a response to the information asymmetry

According to Spence’s (1973) “Job Market Signaling” model, a high quality firm can distinguish itself from the other low-quality parties by sending signals i.e. providing voluntary information about its quality. Although this signaling theory was originally introduced to explain the information asymmetry in the labour market, it has been used as a potential explanation for voluntary disclosures as well (Campbell et al., 2001; Watson et al., 2002; Bin & Ying, 2009; Lan et al. 2013; Shehata, 2014). Since the existence of asymmetric information makes it difficult to distinguish between low quality and high quality companies, the later ones can disclose private information to investors and shareholders to convince them that they are superior (Campbell et al. 2001) and they are acting optimally (Watson et al. 2002).

By nature <IR> represents an increased level of disclosure so it might serve as a way to communicate these ‘signals’ and lower information asymmetry. According to Eccles et al. (2010) <IR> provides insights into the quality of management, while Eccles et al. (2013) mention the case of the Brazilian cosmetics company, Natura which considers <IR> as “the best way to signal its focus on environmental and social stewardship and to convince the public regarding its commitment to these goals.” Similarly Zhou et al. (2015) asserts that companies adopt <IR> to show to investors that they integrate sustainability in the business daily activities and know how to manage the main risks and opportunities.

2.2.3 An alternative explanation: The legitimacy theory

For a long time the legitimacy theory has been used in literature as a potential explanation for the voluntary disclosure of social and environmental accounting issues (Lindblom, 1994; O’Donovan, 2002; Campbell et al., 2003; Tilling 2004; Deegan & Blomquist, 2006; Cho, 2009;

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Omran, 2015) and according to Tilling (2004) it is one of the most cited theories within this stream of research. This theory is based on what it is known as the “social contract” between a company and the society in which it operates and suggests that companies are constrained to comply with the terms of this contract if they want to continue operating (Deegan, 2002; Deegan & Blomquist, 2006). To be more specific, the “social contract”10_{represents the}

expectations and demands that society has related to the company’s behaviour based on what it perceives as a socially acceptable (legitimate) behaviour. In order to ensure their existence and to keep operating, companies will attempt to gain social legitimacy by acting in accordance with the society’s expectations. As prior literature suggests, voluntary disclosure is seen as a key mechanism for firms to legitimise their operations.

In this context, the legitimacy theory can also be used to explain why companies decide to disclose integrated reports. As mentioned in the prior section, various events such as financial scandals, frauds, corruption and abusive practices in the past years have significantly damaged the reputation of many firms and have called into question the credibility of corporate reporting. Deegan & Blomquist (2006) argue that there is a lot of pressure put on companies when accidents like Ok Tedi11 take place, which forces these companies to make some changes in order to restore trust and credibility. Integrated reports can be an example of such changes. Accountability and transparency are two of the major pillars of <IR> (Mervyn King- IFC 2012) through which credibility can be build/restored. At a time when society has become more demanding and less tolerant towards firms’ activities, it makes sense to presume that firms might adopt this form of disclosure as a way to communicate their compliance with the “social contract” and obtain acceptance from the broad community. There exist some academic papers such as Jensen & Berg (2011), Ditlevsen et al. (2013) and Magnaghi & Aprile (2014) that take in consideration the legitimacy theory as a possible explanation for disclosing integrated reports, however there are mixed. While Ditlevsen et al. (2013) conclude that integrated corporate reporting can help businesses obtain social legitimacy, Jensen & Berg (2011) and Magnaghi & Aprile (2014) disagree. According to them <IR> is too new and lacks regulation

10_{Also known as “social licence to operate”}

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and enforcement so legitimacy, which is gained through isomorphic processes12, cannot explain the decision of companies to adopt this form of disclosure (Jensen & Berg, 2011).

2.3 The cost of equity capital

According to ACCA13, the cost of equity is defined as “the relationship between the amount of equity capital that can be raised and the rewards expected by shareholders in exchange for their capital.” In other words, it refers to the minimal rate of return that equity investors/shareholders expect to gain as a compensation for contributing in the firm’s capital. Literature suggests that the cost of equity is of main interest to companies for at least two reasons:

1) for capital budgeting decisions i.e. to evaluate investments projects or acquisitions by estimating the future expected cash flows discounted at the appropriate rate/ cost of equity (Estrada, 2000; Easley & O’Hara, 2004; Zhou et al., 2015).

2) to compose and adjust the capital structure of the company in order to minimize the overall cost of capital and maximize the company’s value (Easley & O’Hara, 2004, Shrestha & Mishra, 2012).

Based on these arguments, it can be concluded that the role of the cost of equity in a company is fundamental because it affects a variety of corporate decisions (Easley & O’Hara, 2004; Dhaliwal et al., 2011). Therefore it is likely that companies are interested in lowering it in order to optimize their performance. Additionally, a lower cost of capital will attract more investors and lead to greater investment, therefore it benefits the entire economy (Shrestha & Mishra, 2012).

2.3.1 Voluntary disclosures and the cost of equity capital.

“The effect of disclosure level on the cost of equity capital is a matter of considerable interest and importance to the financial reporting community.” (Botosan, 1997)

As discussed in the prior section information asymmetry, when present, can have negative impacts and increase costs for a company through adverse selection (Leuz & Verrechia, 2000). An example is the undesirable effect on the cost of equity capital. Literature indicates that a positive relationship exists between asymmetric information and the cost of equity, which means that the presence of information asymmetry in a company will increase its cost of equity

12_{The isomorphic processes consist of coercive processes, mimetic processes and normative pressures}

(DiMaggio and Powell, 1983). Jensen & Berg (2011) explain that the impact of these processes on <IR> is negligible therefore legitimacy cannot be considered as an explanation for disclosing integrated reports.

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capital (Easley and O'Hara, 2004; Berger et al., 2006; Armstrong et al., 2010; Barron et al., 2012; He et al., 2013). In this context, voluntary disclosure plays a principal role in mitigating such effect. In one of the earliest studies, Diamond & Verrechia (1991) conclude that based on a model of illiquid market, disclosing public information will reduce information asymmetry among investors and increase liquidity of the firm’s securities, resulting in the decrease of the cost of capital. Similarly Leuz & Verrechia (2000) hypothesize that commitment to increased levels14_{of disclosure will reduce information asymmetry, considered as a component of the}

cost of capital. By using a sample of German companies voluntarily reporting under IAS or US GAAP, they show that the presence of increased disclosure will significantly lower the bid-ask price and increase the trading volume, both proxies for information asymmetry. Botosan (1997) tests the association between voluntary disclosures and cost of equity in a sample of 122 manufacturing firms and finds that for firms with greater disclosure, the cost of equity will be reduced about 9.7%. However, this is true only for the sub-sample of firms with low analyst coverage, while for firms with high coverage, Botosan (1997) explains that no evidence is found due to the limitations of the proxy used for the disclosure level. Additional evidence is provided by Lopes & Alencar (2008) that examine the same relationship for listed firms in Brazil, which is characterized by a poor quality disclosure environment. They evaluate the quality of firm disclosures based on a new index – the Brazilian Corporate Disclosure Index (BCDI) and conclude that disclosure is significantly associated with the cost of equity, particularly for Brazilian firms with low analyst following and ownership concentration. Later studies such as Dhaliwal et al. (2011), Reverte (2012) and Wang et al. (2013) focus on a more specific form of voluntary disclosure – CSR reporting. Dhaliwal et al. (2001) predict that CSR disclosures will affect the cost of equity for firms who initiate this reporting form compared to the firms who don’t. In consistence with their prediction, Dhaliwal et al. (2011) find that firms with a higher cost of equity are more likely to adopt CSR reporting in the following year. They confirm the existence of a negative relationship between CSR disclosure and the cost of equity capital and in addition conclude that firms initiating CSR disclosures can collect a greater amount of equity capital compared to the non-initiating firms. On the other hand Wang et al. (2013) provide mixed results. While in one hand it is shown that the cost of equity is reduced through CSR disclosure for companies in Europe and North America, on the other hand this doesn’t hold for Asian companies. According to the study this discrepancy in the results arises

14_{According to Leuz & Verrechia the term “increased level of disclosure” can refer either to an increase in}

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from the different perceptions of managers and investors towards CSR disclosures in different regional and cultural environments. Finally, Reverte (2012) conducts a study with Spanish listed companies and comes to the conclusion that consistent with Plumpe et al. (2008) the negative association between CSR reporting and the cost of equity is stronger for environmentally sensitive companies.

In the following section a summary of the conclusions reached by these studies is provided, emphasizing the main direct and indirect ways in which the cost of equity is reduced through voluntary non-financial disclosure.

2.3.2 Reducing the cost of equity capital through voluntary disclosure

According to Botosan (2006) there exist two principal streams of research explaining the way in which the cost of equity capital is reduced through information disclosure: 1) by reducing information asymmetry and/or transaction costs; 2) by reducing the estimation risk. Extending Botosan’s work and summarizing existing literature that offers different explanations about the impact of disclosure on the cost of equity, Dhaliwal et al. (2014) identifies 4 mechanisms15 through which disclosure can help lower the cost of equity capital:

1) Voluntary disclosure reduces information asymmetry and by doing so it leads to higher market liquidity. (Diamond & Verrechia, 1991; Welker 1995; Botosan 1997; Leuz & Verrechia, 2000; Hail 2002).

Interpretation: Information asymmetry creates adverse selection and as a consequence illiquidity of the stock market because: 1) investors will be less willing to trade and 2) they will ask for a “liquidity premium” to protect themselves by the uncertainty in the market. As Welker (1995) and Botosan (1997) suggest, the disclosure of private information will reduce information asymmetry and consequently will enhance market liquidity because more investors will be willing to trade and at a lower price. Eventually this will lead to a lower cost of equity capital.

2) Voluntary disclosure reduces the estimation risk (Coles et al., 1995; Clarkson et al., 1996; Botosan 2006; Lambert et al., 2007).

Interpretation: According to Botosan (2006) estimation risk is that part of risk that originates from the uncertainty of investors about the parameters of a security's return or payoff. In the

15_{Following the same line of thought, Zhou et al. (2015) assorts these mechanisms in two groups: direct}

determinants (risk sharing and estimation risk) and indirect determinants (market liquidity and information asymmetry).

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presence of information asymmetry, the estimation risk is higher since investors are uncertain whether they are making the right estimations due to the lack of available data. As a consequence, a higher rate of return (cost of equity) will be required to bear this risk. However, when more transparent information is disclosed, there is less uncertainty in estimating future returns so the estimation risk will be reduced. The same will happen to the cost of equity.

3) Voluntary disclosure reduces the monitoring costs of investors. (Lombardo & Pagano, 2002) Interpretation: Monitoring costs arise because of the misalignment of interest between investors and management. Since investors are aware of the fact that their funds can be misused by the company to achieve certain objectives, they need to monitor its performance (employing lawyers, auditors, financial analysts). As a result they will require a higher rate of return to compensate for these costs (higher cost of equity). However, if the company decides to become more transparent towards its investors by voluntarily disclosing private information, investors will reduce the monitoring costs and accept a lower rate of return for their investments, which is translated into a lower cost of equity capital.

4) Voluntary disclosure enhances risk sharing (Merton 1987, Cheynel, 2013)

Interpretation: Voluntary disclosure can help less known companies to be noticed by investors and attract them to allocate their resources in the company. Consequently this improves their risk sharing amongst investors and leads to a lower cost of equity.

A clear understanding of the ways in which these mechanisms directly or indirectly affect the cost of equity capital is necessary for purposes of this study. <IR> represents an innovative form of voluntary disclosure, therefore it can be reasonably predicted that it will affect the cost of equity through the same or similar mechanisms.

2.3.3 The association between <IR> and the cost of equity capital

The International Integrated Reporting Council (IIRC) claims in various publications that amongst the benefits of <IR> is the positive impact on a firm’s cost of capital. According to the IIRC, <IR> provides a holistic understanding of the risks to which a company is exposed and of the company’s strategy and business model in response to such risks. As a result it leads to a lower cost of capital.

As discussed in the beginning of this paper, the popularity of <IR> has been growing during the past years. This is also reflected in the academic literature: several studies focused precisely on this topic have been conducted during this time (Eccles & Krzus, 2010; Adams & Simnett, 2011; Eccles & Saltzman, 2011; Krzus, 2011; Ditlevsen et al., 2013; Ioana & Adriana, 2013

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Owen, 2013; Cheng et al., 2014; Churet & Eccles, 2014; Adams, 2015). However, with respect to the relationship between this form of voluntary disclosure and the cost of equity capital, the existing literature is scarce - mainly because research is limited to the opinions or expectations of professionals of the field and to the results of some surveys16 by the Big 4 companies. However, there exist two recent studies who provide some empirical evidence. For instance Zhou et al. (2015) explore this relationship by focusing on a unique national setting such as South Africa, where starting from 2010 <IR> was made mandatory following the requirements of King III17_{. Based on a sample of 130 listed companies operating in South Africa during 2009}

– 2012, a negative association is found between <IR> and the cost of equity capital, particularly for companies with a limited information environment. Similarly, in another study Barth et al. (2015) empirically tests the economic consequences associated with Integrated Report Quality (IRQ). Their study also focuses on South Africa and comprises the top 100 companies listed on the Johannesburg Stock Exchange. While they show that IRQ is positively associated with both firm value and market liquidity, they cannot provide sufficient evidence18 on the relationship between IRQ and the cost of capital. These studies provide a good starting point for further research, which is necessary to reach a solid conclusion regarding this matter.

2.4 Hypothesis Development

In the literature review various aspects of <IR> and the cost of equity capital were covered from different viewpoints. Two of the most relevant studies, Zhou et al. (2015) and Barth et al. (2015) assert that <IR> has the potential to reduce the information asymmetry and affect the cost of equity. This potential stems from a number of attributes that <IR> possesses such as the holistic nature of information, the interconnectedness of the capitals, the ability to identify and manage the important risks, the future orientation and the strategic focus of this disclosure (Barth et al., 2015) All these characteristics contribute to a complete picture of the company’s performance, which links in an integrated way both financial and non-financial factors that

affect the value creation process of the company in the short, medium and long term. In addition Barth et al. (2015), consistent with Dhaliwal et al. (2011)19_{, explains that <IR> can}

16_{See for example the “Corporate performance: What do investors want to know? Powerful stories through}

Integrated Reporting”( PwC, 2014) or “The Business Case for Integrated Reporting” (KPMG, 2013)

17_{It refers to the King Code of Governance Principles for South Africa (King III report) issued in 2009 by the}

King Committee of South Africa.

18_{According to Barth et al. (2015) even though a negative association is found between IRQ and the cost of}

capital, evidence is weak and inconsistent

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enhance market liquidity and investor base, while decreasing the estimation risk and monitoring costs. To sum it up, both studies predict a reduced cost of equity. So, the higher is the quality of the report, the more it is likely to lower the cost of equity. These predictions, along with all the literature discussed so far lead to the first hypothesis of this study:

H1: There is a significant negative relationship between the <IR> disclosure and the cost of equity capital.

The information environment

As discussed in the literature review, the information asymmetry is one of the most widely-known mechanisms affecting the link between these two variables. Literature suggests that the presence of asymmetric information determines the quality of the information environment in which a company operates (Armstrong et al., 2010). Companies who are characterized by a low information environment quality have more asymmetric information than those operating in a high quality environment. Reasonably, it is expected that integrated reports will be more useful and effective for the first type of companies and as a consequence the effect on the cost of equity capital will be stronger in the case of a poor information environment. Hence, the second hypothesis is formally hypothesized as follows:

H2: The effect of <IR> disclosure on the cost of equity capital is stronger for firms that have a lower information environment quality.

Two of the most widely used proxies for the quality of the information environment are the firm size and analyst coverage. Regarding the firm size, Chae (2005) shows that information asymmetry is higher in smaller firms compared to larger firms, while Drobetz (2010) states that “large firms are likely to have less information asymmetry because they are likely to be more mature, have well-established disclosure strategies, and get more attention from the market.” While regarding analyst following, Brennan & Subrahmanyam, 1995 evidence a negative association between the number of forecast analysts and the adverse selection costs, implying that firms with more analyst coverage have less information asymmetry (and hence a better information environment). This is also supported by Lopes & Alencar (2008) who found that the link between disclosure and the cost of equity is more pronounced in Brazilian firms with low analyst coverage. So, in conclusion I expect that the effect of <IR> will differ based on the quality of the information environment, i.e. firm size and the analyst coverage. Therefore, H2 can be specifically formulated in two parts:

H2(a): The effect of <IR> disclosure on the cost of equity capital is more significant for smaller firms relative to larger firms.

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H2(b): The effect of <IR> disclosure on the cost of equity capital is more significant for firms with less analyst coverage relative to those with more analyst coverage.

3. Empirical analysis

3.1 Sample description and data sources

For purposes of this empirical study, a quantitative research method is employed. The target sample consists of the companies participating at the IIRC Pilot Programme20 during 2011-2013.The participants of the Pilot Programme were amongst the first businesses willing to apply the International Framework and to produce reports aligned with the guiding principles of <IR>, therefore I regard this sample as suitable for the study. In addition, the diversity which characterizes the sample21 makes it appropriate to generalize results, particularly when compared to the samples used by Zhou et al. (2015) and Barth et al. (2015) which comprise only listed companies in South Africa. The full published list of the 99 participants from 23 countries is provided in Appendix A. To collect data about the quality of <IR> in these pilot companies, I use the Thomson Reuters ASSET4, as suggested by Serafeim (2015) and Serafeim & Ioannou (2014). ASSET4 is an ESG Database which provides accurate, reliable and comparable information regarding the financial, environmental, social, and governance issues for more than 4600 global companies based on 250+ KPIs and 750+ individual data points (Thomson Reuters, 2013). According to Serafeim (2015) ASSET4 measures the capacity and commitment of companies to integrate the financial and extra-financial aspects in their daily decision making and activities, by scoring them between 0 and 100.22 . I get access to ASSET4 through Datastream and collect the necessary data to measure the quality of <IR> in two ways, which are explained in the next section. Unfortunately, I am not able to find data for 38 companies, which consequently restricts the sample to 61 companies.

To measure the cost of equity capital I collect data from I/B/E/S through Wharton Research Data Services (WRDS). I/B/E/S is a well-known database with high reputation for historical

20_{The IIRC Pilot Programme officially started in October 2011 and consisted of 3 phases: the dry run, pilot}

cycle 1 and pilot cycle 2.It served as a platforms for companies who were ready to challenge the traditional way of reporting and contributed to the further development of the International <IR> Framework.

21_{The sample consists of companies from different countries/regions, of different industries, sizes and}

characteristics.

22_{“The raw scores are normalized and adjusted for skewness and the differential between the mean and the}

median, then fitted to a bell curve to derive ratings between 0 and 100 for each company” (Thomson Reuters, 2013).

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estimates, therefore I consider it to be a suitable source to retrieve data for both the cost of equity and analyst coverage. In section 3.3 a detailed description of these variables is provided. At the end of the data collection process in I/B/E/S, the sample is further reduced to 53 companies due to missing/incomplete data items for 8 companies.

Finally, to obtain accounting information for the control variables such as firm size, beta, leverage and book-to-market ratio I use Datastream. All the necessary financial data is available for the remaining companies. The final sample consists of 53 companies from 20 countries, including Coca-Cola, Novo Nordisk, Unilever and Microsoft. This final sample is provided in Appendix A along with the initial list of all the participants of the IIRC Pilot Programme.

Regarding the sample period, I focus on the reports disclosed during a 6-years period, from 2009 to 2014. This includes the pre-adoption period (2009-2011) and the adoption period (2012-2014). At the initial stage of the study 2015 was included as well, but due to missing data in ASSET4 for the majority of companies, I was constrained to remove it in order to avoid reducing the sample size.

3.2 Research Design

To examine the effect of <IR> on the cost of equity capital I follow the work of Dhaliwal et al. (2011) and Zhou et al. (2015) and test H1 by running the following OLS regression model:

ΔCOEC i, t+1 = β0 + β1 ΔIR_TOTAL i, t + β2 ΔSIZE i, t + β3 ΔBM i, t + β4 ΔBETA i, t

+ β5 ΔLEV i, t + β6 CSR i, t + ε i, t

As both studies suggest, I use the yearly change in the values of the cost of equity (COEC) and of the quality of <IR> (IR_TOTAL) instead of the values itself in order to address potential endogeneity arising from unobserved firm characteristics also known as firm-specific heterogeneity (Nikolaev & van Lent, 2005; Zhou et al., 2015). Following Dhaliwal et al. (2011) and Zhou et al. (2005), the same approach is used for the control variables.

I split the sample in two subsamples to test the role of the information environment for H2: the sample firms are sorted into large firms and small firms based on the median firm size for H2(a); into firms with low analyst following and firms with high analyst following based on the median number of analysts for H2(b). Then they are tested separately by using the same regression model as in H1. The regression analysis is executed using Stata. Detailed descriptive statistics is provided in section 3.4.

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3.3 Variable description

In this section I provide a description of the main variables incorporated in the regression model. First I describe the measurement of the implied cost of equity capital as the dependent variable. Secondly, I describe the scoring methodology for <IR> as the main independent variable and finally I provide an explanation for the control variables. The definition of all variables is provided in Appendix B.

3.3.1 Measurement of the cost of equity capital

According to Botosan (20016) the cost of equity capital (COEC) is a forward looking concept. Therefore it is difficult to be measured because it is not directly observable. Although literature suggests that several models can be employed to calculate the cost of equity capital (see e.g. Claus and Thomas, 2001; Gebhardt, Lee, and Swaminathan, 2001; Easton, 2004; Ohlson & Juettner‐Nauroth, 2005) there still exists an academic debate trying to determine which model is the best (e.g. Botosan & Plumlee, 2005; Botosan, Plumlee and Wen, 2011). For purpose of this study, I employ the price-earnings growth (PEG) ratio of Easton (2004) since it is considered to be one of the most widely used and appropriate measures for firm-specific estimates of the cost of equity (Easton, 2004; Barron et al. 2012). For instance, it has been used in various studies including Francis et al. (2008), Lopes and Alencar (2008), Dhaliwal et al (2011), Barron et al. (2012), Zhou et al (2015). The modified PEG model that I use, in consistence with these studies, calculates the cost of equity (r) based on the following formula:

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

dps1 = expected dividends per share (t = 1)

I collect all the required analyst data for the expected one and two-years ahead earnings per share (eps1, eps2), the expected dividends (dsp1) and the current stock price (P0) in I/B/E/S.

Since this database provides monthly estimates, I first calculate the monthly cost of equity capital (for each year) and then estimate the average value of the cost of equity during the 12 month period following the fiscal year-end. I follow this approach because as Zhou et al. (2015) suggests, the quality of the disclosed reports is estimated on a yearly basis, so it necessary to provide comparable values to match these variables.

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3.3.2 Measurement of the quality of <IR>

The disclosure quality of integrated reports is the independent variable of interest. As there are no established rules and standards to follow, it is not easy to set a benchmark and determine the quality of an integrated report. Therefore different studies use different proxies to measure the quality of <IR> in companies. For instance, Zhou et al. (2015) measures the quality of disclosures based on a self -constructed coding framework aligned with the <IR> Prototype Framework (2012) issued by the IIRC. This coding framework includes 31 components against which the integrated reports are scored: the higher the total score, the more the report reflects the principles of the <IR> Framework. However, Zhou et al. (2015) admit that this scoring method is subjective primary because the Prototype Framework from which the constructed coding frameworks derives, is principle-based and requires judgment. Barth et al. (2015) adopts a similar approach by developing a measure for the quality of <IR> based on the EY Excellence in Integrated Reporting Awards. However, the subjective nature of these measures limits their accuracy. While they can be more suitable in a specific setting such as South Africa where the listed companies are more easily comparable and follow the same rules regarding <IR>, this might not be the case across other jurisdictions with different political and legal environments in which the adoption of <IR> and the form of integrated reports is simply a matter of free choices.

Therefore, I follow another approach. I construct two proxies to represent the quality of <IR> based on publicly available data from ASSET4. For the first measure I rely on the study of Serafeim (2015) and choose the same score category in ASSET4. More specifically, my first proxy for <IR> (IR_TOTAL) is the score of the integration/vision and strategy category which “measures a company's management commitment and effectiveness towards the creation of an overarching vision and strategy integrating financial and extra-financial aspects. It reflects a company's capacity to convincingly show and communicate that it integrates the financial, social and environmental dimensions into its day-to-day decision-making processes” (as defined in ASSET4). This description matches the philosophy and characteristics of <IR> therefore, consistent with Serafeim (2015) I regard it as a suitable measure for the disclosure quality of integrated reports. The integration/vision strategy category is found under the governance pillar in ASSET4 where scores are available for each year.

To construct the second proxy, I follow the work of Bernardi & Stark (2015) on <IR>. They theorize that the level of ESG disclosures will influence the effectiveness of <IR> and that “…linking ESG performance with financial performance through an integrated report will give

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stakeholders a more holistic understanding of the company and its future…” (Bernardi & Stark, 2015). The same idea is supported by prof. Christian Strenger, IIRC board member, who argues that between the <IR> approach and ESG disclosures exist overlaps and synergies that “strive for the same aim and from which both can benefit.

”

Consistent with these arguments, I employ the Integrated Rating (A4IR) score from ASSET4 as an alternative measure. This score measures the company’s overall performance by incorporating the individual subs-scores of the four main pillars: economic, environmental, social and governance performance. As its definition in ASSET4 suggests, the EESG (Integrated Rating) score reflects “a balanced view of a company's performance in these four areas. “Although it is a general and indirect proxy, it still can work since it incorporates data items directly linked with <IR>. Based on the scoring methodology of ASSET4, scores for each measure range from 0 to 100, with 100 being the maximum possible score for the disclosure of highest quality. Since I predict a negative association between the disclosure quality of <IR> and the cost of equity, then I expect that IR_TOTAL (for both measures) to have a negative coefficient.

3.3.3 The control variables

The control variables added in the regression analysis include firm size (SIZE), leverage (LEV), beta (BETA) and book-to-market ratio (BM). Additionally, a dummy variable has been added in the regression: the disclosure of CSR reports. I control for the size, beta, and book-to-market ratio – also known as the Fama-French three-risk factors, since they are appropriate and widely used by most studies in this research stream (Francis et al., 2008; Barron et al., 2012; Reverte, 2012; Wang et al. 2013; Dhaliwal et al. 2011; Zhou et al., 2015). Consistent with the Fama-French model a negative coefficient is expected for the SIZE variable because it is negatively associated with the cost of equity, while a positive coefficient is expected for BETA and BM. In addition, I control for leverage (LEV i, t) as well since Fama & French (1992) and

Dhaliwal et al. (2005) suggests that the cost of equity (COEC) increases as the level of leverage (LEV) also increases. Therefore a positive coefficient is expected for this variable. All the necessary data to calculate LEV, BETA and BM are extracted from DataStream and a detailed description of each variable is provided in Appendix B.

Finally I add a dummy variable in the analysis. This dummy variable is the disclosure of CSR reports. It is coded 1 if standalone CSR reports are issued by the company along with integrated reports and 0 otherwise. According to Zhou et al. (2015) recent research has shown that issuing standalone CSR reports can help to further reduce the cost of equity by improving the

The impact of integrated reporting in the IIRC pilot programme participants : an empirical study focused on the impact of <IR> in the firms’ cost of equity capital