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

The International Integrated Reporting Council's Framework identifies two goals for integrated reporting: improved information for outside providers of financial capital and better internal decision making. We extend prior research that finds a positive association between integrated report quality (IRQ) and firm value by examining two channels through which this association may arise--a capital market channel and a real effects channel. To conduct these tests, we disaggregate firm value into three components: liquidity, cost of capital, and expected future cash flows. Using data from South Africa where integrated reporting is mandatory and an IRQ measure based on proprietary EY data, we find a positive association between IRQ and liquidity, which supports the capital market channel. We find no evidence of a relation between IRQ and cost of capital. We also find a positive association between IRQ and expected future cash flows. Because this association could reflect better investor cash flow forecasts--a capital market effect, better internal decisions--a real effect, or both, we attempt to distinguish these explanations. We find higher IRQ is (not) associated with higher realized future operating cash flows (greater analyst target price forecast accuracy), and is associated with less over- and under-investment. These findings support the real effects channel. Together, our findings are consistent with integrated reporting achieving its dual objective of improved external information and better internal decisions.