Authors: Athanasios Pavlopoulos, George Emmanuel Iatridis

Title: Integrated Reporting and IFRS 3: An empirical study to Cost of Equity through Firm Risk and Investor Protection.

Abstract

This study examines the relation of cost of equity associated with the disclosure quality of IFRS 3 and the Integrated Reporting (IR) compliance. Employing an IR sample composed of 498 non-financial firms that use IR either mandatorily or voluntarily from 2011 to 2019, we investigate the impact of IR and IFRS 3 disclosure quality on the cost of equity. Motivated by previous studies (i.e., El Ghoul et al., 2011; Chava, 2014; Breuer et al., 2018), we aim to highlight the informativeness effects of the disclosure quality of IFRS 3 and IR compliance on cost of equity through the two distinct channels firm risk and investor protection base.

We investigate the impact of the disclosure quality of IFRS 3 and IR compliance on the cost of equity, considering their legal, cultural, and political factors. In companies with strong legal, cultural, and political factors, our results show that the cost of equity falls when a firm invests in IR and at the same time provides high levels of IFRS 3 information. The high level of informativeness that arises from the transparent and concise disclosure quality of IR regime and IFR3 standard reduces the opportunistic behavior of managers that use IR as a tool for benefitting themselves. A contribution of our study is to show that differences in investor protection level may lead to different outcomes regarding the relation between IR and the cost of equity at the firm level.

Moreover, the risk channel (Oikonomou et al., 2012; Sassen et al., (2016; Badia et al., 2020) represents the idea that investors consider companies with low IR compliance to be riskier. Oikonomou et al, (2012) find that CSR is negatively associated with systemic risk. Sassen et al., (2016) address that higher CSR reduces overall and idiosyncratic risk. We test whether the high level of disclosure quality of IFRS 3 and IR compliance affects on firm risk. We find that higher IFRS 3 disclosure score lowers firms’ risk in companies with high IR compliance. We interpret the negative relation at higher levels of disclosure as evidence that investors consider firms with low levels of IR infromativeness to be riskier. We contribute to the wider research on the firm risk related to disclosure quality of accounting information. This study for first contributes to the IR literature by examining South African firms and voluntary adopters (non-South African firms), examining the disciplining role of a new form of disclosure, IR.

Finally, we examine the research question whether the firm risk and the high level of disclosure quality of IFRS 3 and IR compliance affects on cost of equity. We find that the negative impact of IFRS 3 disclosure quality and of IR compliance to cost of equity is more intense when firms’ risk is low, which contributes to cost of equity literature. This suggests that high IR and IFRS3 disclosure quality reduces information asymmetry between managers and external stakeholders, lowers litigation risk (Billings et al., 2015) and improves a firm’s financial transparency (Baboukardos and Rimmel, 2016; Barth et al., 2017).