Do companies disclose relevant information about intangibles? Insights from business model reporting and risk reporting

For several decades, intangibles and knowledge-based resources have been a fundamental driver of value in modern economies (Porat and Rubin, 1977; OECD, 1981). In such economies, the intellectual capital (IC) – which refers to intangible factors such as know-how, relationships, expertise, and skills – has significantly contributed to competitive advantage and corporate performance (Edvinsson and Malone, 1997; Ittner et al., 1997; Stewart, 1997; Bontis, 2001). Despite the importance of intangible resources, attempts to communicate IC in the annual report have repeatedly failed (Nielsen et al., 2017). Potential reasons for this failure may include costs or potential loss of competitive advantage related to the disclosure of proprietary information about resources, know how, and process. The lack of guidance also plays a fundamental role. From a user's perspective, IC information may not be helpful if an entity does not clearly explain how IC contributes to value creation (Bukh, 2003; Beattie et al., 2013; Behn et al., 2019). However, recent regulations have offered a framework for communicating IC and integrating it into the value creation process. The EU Directive 2014/95 and the UK Companies Act have required companies to disclose information about their business model (BM) and their relevant risks in the annual report. Because IC represents a very significant source of competitive advantage – especially in high-tech industries – companies should illustrate the most critical intangible factors' contributions to value creation in the report section devoted to the BM. Furthermore, academic literature indicates that the BM is a framework for the disclosure of IC (Beattie and Smith, 2013). IC, in turn, is crucial in the mobilisation and exploitation of the other drivers of value that configure the BM, including tangible assets (Dane-Nielsen and Nielsen, 2018). In the report section devoted to risks, companies should also offer information about the most important IC elements and their effects on value creation. Thus, companies should deliver an integrated communication where BM and risk reporting address the main IC elements contributing to value creation. In this context, when an IC element is identified as a critical element of the BM and consequently recognised as a key factor that drives value, risks related to the IC element should be disclosed in a dedicated section within the annual report. Thus, IC becomes the natural link between BM and risk reporting. Such context would make it easier for recipients of IC information, such as investors, to interpret that information. The European Financial Reporting Advisory Group (EFRAG) has recently recognised the importance of this link with a project focusing on the link between non-financial risks and BM as a tool for improving corporate reporting (EFRAG, 2021b). Other professional bodies, such as the International Integrated Reporting Council (IIRC) and the World Intellectual Capital Initiative (WICI), have developed frameworks for integrated communication, where the BM acts as a framework for all other non-financial items disclosed in the annual report (Holland, 2004; IIRC, 2013; Nielsen and Roslender, 2015; WICI, 2016; European Commission, 2017; FRC, 2018). Against this backdrop, the aim of this project is twofold: • First, it examines whether and to what extent high-tech companies provide information about IC elements in the sections devoted to the BM and risks. • Second, it assesses the correspondence and level of integration between the IC elements disclosed in the BM section and those reported in the risk section. Although our choice may hamper generalisation to other industries, we have examined high-tech companies because their success largely depends on their use of IC, and we expected to find good examples of IC disclosure. We have selected the three sectors identified as 'high-tech' by Eurostat: pharmaceuticals; computers and electronics; and air and spacecraft. Because the EU Directive 2014/95 should have been implemented by the end of 2017 by all member countries, we have examined the 2018 annual reports to confirm whether all the nations under investigation implemented such regulations. This study makes three distinctive contributions by analysing: (i) IC disclosure in annual reports of high-tech companies in a mandatory context, (ii) IC disclosure in two specific sections of the annual report (i.e. business model section and risk section) to investigate the role of IC in the value creation process and the related risks, and (iii) the integration and level of correspondence of the IC information disclosed in these two sections. We have found that approximately 29% of companies do not disclose BM value drivers or risks in the narrative sections of their annual reports. Thus, there is a considerable number of non-compliant companies. The examination of companies disclosing both BMs and risks suggests that: • Companies tend to disclose IC elements in both the BM and risks sections, albeit with some industry differences. However, such disclosures are generally limited. • To disclose IC, it is more common for companies to use the section devoted to the BM rather than the risk section. This approach may be related to the fact that the BM is a concept that explains how a company generates value, and IC is mainly seen as a fundamental value driver. • Information about IC elements in the risk section rarely contains forward-looking statements that might help users assess how a company is protecting itself from future developments of principal risks. In a few cases, companies use a neutral or even positive tone when describing the potential impact of IC risks on their operations. • Only 40% of the IC elements disclosed as value drivers in the BM section are addressed in the section devoted to risks. Thus, the level of integration of non-financial information recommended by regulators has often been achieved only in part or not at all. This research provides insights into how listed companies currently report their IC and how this disclosure is integrated with mandatory BM reporting and risk reporting. These aspects may be of particular importance for all listed entities in the UK and European Economic Area (EEA) countries, which must disclose their BMs in annual reports under recent regulations. Thus, our study contributes to understanding whether companies can use mandatory BM reporting to disclose IC, as postulated by theoretical contributions in the field (Bukh, 2003; Beattie and Smith, 2013; Dane-Nielsen and Nielsen, 2018). Furthermore, the study contributes to risk reporting literature. Like BM reporting, risk reporting has become mandatory for listed companies in the UK and EEA countries. The examination of how companies address IC elements in risk reporting could provide useful information about the negative consequences of the loss of control over these elements and the incapacity to use them. Finally, we consider BM reporting and risk reporting to be strictly intertwined. According to our proposal, companies should: • offer a description of the main IC elements they rely on to create and deliver value when disclosing the BM; and • illustrate the risks associated with the main IC elements that drive their company's value in the section devoted to risks. According to the definition of 'materiality' provided by WICI (2016, p. 2), organisations should report on information representing the most significant intangibles for their value creation over time. Thus, the IC elements depicted as value drivers in the BM section should also be discussed when reporting on risk, thereby providing users with information about the potential loss of those elements' capacity to generate value. Our results suggest that the linkage between BM reporting and risk reporting is rarely satisfactory. Thus, regulators might usefully develop some guidelines to help companies effectively represent their IC within these two sections of the annual report, using the BM to provide context for other kinds of information. A crucial issue that may explain the low level of disclosure of key IC elements in the risk section is related to proprietary costs, because companies do not want to show investors the threats to IC elements. This issue could be attenuated by an effective linkage between risks and BM. In addition, the exploitation of IC elements is often associated with uncertainty that may lead to positive or negative outcomes. Although the isolated illustration of IC risks may represent a concern for some entities, a clear representation of how those items generate value if successfully exploited through BM reporting may attenuate those concerns and provide users with a more reliable view of IC. Thus, improving the integration between information on IC value drivers and the related risks may provide meaningful information on the outcomes of the value creation process.