The Economic Consequences Associated with Integrated Report Quality: Capital Market and Real Effects

Abstract

We examine whether integrated report quality (IRQ) is associated with stock liquidity, firm value, expected future cash flows, and cost of capital. Our study is motivated by the recent focus on sustainable capitalism and the global interest shown by firms, investors, and regulators in integrated reporting. We use data from South Africa because it is the only country where integrated reporting is mandatory. We use a measure of IRQ based on proprietary data from EY, which rates these reports as part of its Excellence in Integrated Reporting Awards. We find that IRQ is positively associated with stock liquidity, measured using bid-ask spreads, and firm value, measured using Tobin’s Q. Our results are consistent whether we analyze levels or changes. When we decompose the firm value into an expected future cash flows effect and a cost of capital effect, we find that the positive association between IRQ and firm value is attributable mainly to the cash flows effect, which is consistent with investors revising estimates of future cash flows upward as a result of better understanding the firm’s capitals and strategy or future cash flows increasing because of improved internal decision making. We provide evidence on these two explanations and find it is more likely that our results are attributable to improved decision making by managers than to analysts forecasting future cash flows more accurately.