The Case for Corporate Social Responsibility and Sustainability (CSR) Disclosure in Financial Reporting Introduction Corporate Social Responsibility and Corporate Sustainability (CSR) are terms that are becoming more pervasive in both the business and public spheres. The presence in both realms relates to the fact that these movements are by nature a construct of the convergence between business and social landscapes. What do these terms mean and how do they relate to accounting? Investopedia defines Corporate Social Responsibility as follows: [The] corporate initiative to assess and take responsibility for the company's effects on the environment and [its] impact on social welfare. The term generally applies to company efforts that go beyond what may be required by regulators or environmental protection groupsi. Corporate sustainability, however, goes a step further by focusing on the forwardlooking nature on a company’s actions. Wikipedia defines the term as: ...a business approach that creates long-term consumer and employee value by not only creating a "green" strategy aimed towards the natural environment, but taking into consideration every dimension of how a business operates in the social, cultural, and economic environment. [It also involves] formulating strategies to build a company that fosters longevity through transparency and proper employee developmentii. From this latter definition, a parallel can be drawn with the purpose and intent behind the Management Discussion and Analysis (MD&A) section of public companies’ annual financial reporting. The question remains, “what is the true relevance of CSR from companies’ and stakeholders’ perspectives, and should there be expanded guidance and/or required key performance indicators (KPIs) for reporting in the MD&A section of annual financial reports”. This review provides a cursory review of some of the research around the convergence of CSR and financial reporting.
Written by: Lori Roter (Dec. 2012)
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Current Guidance for CSR Disclosures in Company MD&Asiii The International Financial Reporting Standards Board (IFRS) produced a management commentary in 2010, as a means of providing guidance to corporate executives with respect to the provision of information to their users, in the company’s Management Discussion and Analysis (MD&A) section of their Annual Financial Statement Reports. The IFRS commentary provides guidance only – there is no specific mandate on the level of assurance to be provided in an MD&A, nor does the commentary dictate the information that management must provide to its stakeholders. The only restrictive nature is such that financial information must not contradict the information provided in the audited financial statements. The link between Corporate Sustainability and Corporate Social Responsibility Reporting (CSR) and accounting disclosures can best be demonstrated through a broad interpretation of the following quote within the commentary: Management should identify the significant relationships that the entity has with stakeholders, how those relationships are likely to affect the performance and value of the entity, and how those relationships are managed.iv The aforementioned quote, supplemented by additional guidance on MD&A reporting, from the commentary, provide a contextual backdrop for discussion on the role of corporate sustainability, governance and social responsibility disclosures in the financial reporting context. The commentary relates that the MD&A should provide relevant information to its users through:
The provision of information that complements and supplements the financial statements; The explanation of trends that may impact operations and the entity’s financial position; The identification of key risks and associated mitigation strategies for elements that may affect the company in the future; The provision of an overview of how non-financial information has influenced the information contained in the financial statements; and The identification of significant features of the legal, regulatory and macroeconomic environments that influence the entity.
Actual disclosure requirements in the financial statements that might relate to CSR elements relate only to “... information [that] is classified as material [due to the impact it may have on]... an investor’s investment decision... when that information is omitted or misstatedv.” Discussion on these mandatory disclosures, however, is beyond the scope of this review.
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Research Statistics on Corporate Social and Sustainability Reporting Research studies undertaken jointly by the Chartered Institute of Management Accountants (CIMA), the American Institute of Certified Public Accountant (AICPA) and Canadian Institute of Chartered Accountants (CICA) on over two thousand companies in the UK and North America provide a sample overview of executives’ perspectives and application of CSR reporting in their respective ongoing operationsvi. While the researchers have commented that it is difficult to assess the quality of the information provided in the companies’ CSR reports, their findings indicate that:
79% of larger companies surveyed currently have a formal sustainability strategy; 33% of smaller companies surveyed currently have a strategy; and an additional 23% have plans to formulate a strategy within the next two years vii.
CSR has proven its importance in the corporate realm in this selected sample, however, among the survey participants, only “33% are tracking sustainability related performance measuresviii” and an even smaller proportion of respondents undertake some form of internal or external verification of their reporting metrics. While it was not clear the degree to which CSR reporting is being reflected within the sample companies’ MD&A or through other separate company reports, it is apparent that a standardized reporting approach is absent. The lack of external standards -- key performance indicators (KPIs), metrics and related benchmarks -- provide some indication that more is needed to improve the quality of information being provided to users of company informationix.
Primary Stakeholder Viewpoints Institutional Investors’ Perspectives In 2011, the United Nations Environment Program (UNEP) Finance Initiative undertook a study, in collaboration with Principles for Responsible Investment (PRI), to help ascertain the importance of environmental externalities to institutional investors. Externalities caused by a company can impact hard costs for a company in view of:
Revocation of licences from regulatory authorities for non-compliance with environmental and other statutes such as exceeding waste discharge limits in excess of stipulated thresholds; Increased contingent liabilities (mitigation/remediation costs and lawsuits by third parties) and resultant increased insurance costs; and, Potential impact on future growth through the increased cost of capital.
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Publicity around poor environmental practices can also yield to:
Goodwill impairment through damage to a company’s brand and reputation, exacerbated by reduced revenues due to decreased product demand.
Poor environmental planning, measurement and reporting may result in companies’ failure to plan for, and consider, the potential large financial impact from more stringent environmental regulations and more international restrictions on imports of products whose production practices do not adhere to environmental or social standardsx. On a broader level, in addition to the Environment, Social and Governance (ESG) issues are also disclosures desired by investors. In 2009/10, a study of fifteen mainstream institutional investors and two service providers was undertaken by Toby Heaps, the editor-in-chief and chief executive of Corporate Knights Magazine, to develop a better understanding of the use and importance of ESG to these user groups. Most of the interviewees use ESG information to one degree or another. External interest group and regulators’ pressures have resulted in a degree of standardization of some environmental indicators such as those relevant to carbon emissions and climate change. Governance information is also readily available. Investors often do, however, develop their own metrics to assess companies and to integrate ESG into financial analysesxi. Where industry-specific and relevant performance indicators exist, they are incorporated into the investment company’s model; otherwise, companies create their own measuresxii. Interviewed investors relayed that metrics pertaining to social determinants such as employee turnover, are also becoming increasing relevant to their decision-making. Many companies are now voluntarily disclosing these indicators. Employee satisfaction, for example, is a relevant metric for helping to predict the risk of employee departure from a given entity. It is a “critical cost factor for companiesxiii”. The loss of institutional knowledge along with the sunk cost expended on departed employees; and the added training costs associated with imparting the required level of knowledge and skill to new employees can be substantial in certain industries. Certain key institutional investors such as Goldman Sachs make it clear that “...the indicators [they] use to assess performance with respect to environmental, social and corporate governance issues are essential to analyze a company’s ability to sustain competitive advantage over the long termxiv.”
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A Question of Fiduciary Responsibility – The Pension Plan Trustee Pension Plan trustees are responsible for the overall stewardship of their portfolios, on behalf of fund participants. These trustees, particularly those who work on behalf of public sector organizations, are also under the microscope of public opinion – to do the “right thing”, given that the majority of the plans relate to public service employees who are funded by taxpayer dollars. Historically, pension plan trustees have conveyed that it was their firm belief that, “it was beyond their fiduciary responsibilities to consider ESG matters in an investment decision”. More recent legal opinions regarding the principle of fiduciary responsibility of investment trustees, however, have imparted that, “it may [now] be considered a breach of fiduciary duty not to consider such matters”xv. Pension plan consultants such as Mercer have developed ESG ratings which are brought down to the asset class level as they firmly believe that ESG issues will “undoubtedly influence future returnsxvi”. Some interviewees in the study of institutional investors discussed in the previous section felt that they could obtain some insight into a company’s ESG practices through their regulatory filings. Information such as whether executive pay was tied to ESG metrics; whether the company had ESG committees and/or the degree to which site remediation requirements were addressed, could be gleaned from careful review of companies’ annual financial reports. Many interviewees, however, noted that ESG information provided from other external sources were more useful from an investors’ perspectivexvii. Companies’ Perspectives on Sustainability Reporting Most companies interviewed in the ESG study, did not dispute that ESG factors can and often do have an inherent value on their business’ worth and further, can have a material influence on how they are viewed and valued in the investment landscapexviii. Where the debate remains is on the “type” of relevance ESG has on companies. Given that there is no clear reporting standardization, many investors continue to view ESG as being limited to a company’s marketing play – to enhance brand image – rather than on providing any additional relevant financial data.xix, xx In contrast, “Some companies do not view ESG impacts as sufficiently material to company performance to warrant quantification and public disclosure and therefore do not publish performance indicators.”xxi And still yet other companies, such as those interviewed in the joint 2010 accounting bodies’ study, see the business case for enhanced sustainability analysis and reporting in so far as it assists in modeling future energy consumption requirements, for example. Energy savings translate into hard input cost reduction potential for certain manufacturing and resource development enterprises and helps to identify projects which may prove to be controversial in the sphere of public opinionxxii. Written by: Lori Roter (Dec. 2012)
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Non-manufacturing/development companies can also make a business case for employing CSR into their business operations. For example, ASDA, Britain’s second largest supermarket has profited from at least a million pounds in savings from implementing sustainable practices such as recycling, composting and reduced packagingxxiii. Over eighty-seven percent of the German DAX-30-companies disclosed non-financial sustainability KPIs in their financial reports as early as 2005. The majority of these disclosures, over eighty-five percent were reflected in the MD&A xxiv. These findings clearly support the importance of CSR information disclosure to improve investors’ ability to gauge a company’s future performance, at least in Germany, if not beyond. Thoughts on the Future Evolution of CSR in International Accounting Standards Since the 1980s and increasingly in the current day, citizens of the industrialized countries are putting a greater emphasis on “green business” as demonstrated by their purchasing choices. It is clear from the enhanced marketing focus on “green products” that companies are already responding to individuals’ desire for more environmentally and socially responsible products and services. The push for greater disclosure arises from regulators and investors, as described earlier, however, the root of this insurgence may well result from companies’ need to ensure that they maintain and enhance profits. The mainstay of these profits is derived from customers – customers who are becoming increasingly savvy on the products and services they purchase, and on the relevance of these products and services on the global environmental and social landscapes. With the advent and progressive ease with which social media can be used to proliferate a “message,” customers can have a far greater impact on an individual company’s bottom-line if adverse communications regarding a company’s CSR practices is ensued. As a result of persistent pressure from investors of U.S. companies, the SEC issued interpretive guidance in 2010 that clarified the climate-related “material” effects on businesses that publicly listed companies should disclose to investorsxxv. While this regulatory clarification only applies to companies listed on U.S. stock exchanges, the impact of the investors’ lobby in the U.S. may well lend to greater pressure on the International Accounting Standards’ Board to provide similar guidance to public companies following IFRS. There has been a great deal of argument supporting the need for the inclusion of both quantitative and qualitative factors (such as KPIs) in the determination of materiality with respect to ESG issuesxxvi. Investors in German companies emphasize the importance of the development of industry-specific “Best Practices Guides” to enable them to compare individual company results with other companies within a given sector. It is felt that KPIs on their own, in the absence of standardized metrics do not provide the required link between sustainability performance and business performance.xxvii As outlined in this review, other investors and companies alike, in various countries, support the push for CSR standard setting.
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There may still be some debate as to where these standards should reside. The IASB is already trusted for its independence – accordingly, it can be argued that standard setting and independent third-party verification should be undertaken by the accounting professionxxviii. Arguments could also be made for sustainability reporting agencies such as the Global Reporting Initiative, whose expertise lies in the development of CSR metrics and who already developed a model for CSR reporting, to take the leadxxix. Resultantly, it may be warranted for the IASB to collaborate with other environmental and social science experts to coalesce CSR reporting metrics or guidance for companies under the IFRS umbrella.
Concluding Notes It is apparent that the environment, corporate governance and social impacts resulting from business practices will continue to become increasingly important factors in the financial world. Standardization of CSR indicators and metrics would provide a superior means of measuring threats and opportunities for a given public entity and for comparing results across sectors. Regardless of whether standards do come into force in the future, it would be prudent for companies to adopt KPIs and report out on associated CSR metrics in their MD&As: to increase transparency; mitigate future potential legal liabilities; and, to improve the bottom line by being seen as a good corporate citizen. Any decision regarding standard setting for CSR metrics in financial reporting will undoubtedly negatively impact certain companies’ cost of capital by increasing the disclosure of their risk profile. While there is much research abound, a great deal of time may still be required to develop reportable trends, performance measures and other metrics. Extensive consultations brought through IASB exposure drafts would be required, and consideration given to the idea of prospective treatments of these policy changes, should these changes become mandatory disclosures in the financial statements proper. i
Investopedia (2012). Definition of Corporate Social Responsibility. URL: http://www.investopedia.com/terms/c/corp-social-responsibility.asp <accessed on December 14, 2012>. ii Wikipedia (2012). Corporate Sustainability. URL: http://en.wikipedia.org/wiki/Corporate_sustainability <accessed on December 14, 2012>. iii IFRS (2010). IFRS Practice Statement - Management Commentary A framework for presentation, (31pp). URL: http://www.ifrs.org/News/PressReleases/Documents/New%20Transfers/Managementcommentarypracticestatement8December.pdf iv Ibid (p.14) v Girdharry, K., E. Simonova, and R. Lefebvre (2011: 13). MD&A – Counterpart to or Distraction from Financial Reporting, CGA-Issue in Focus. URL: http://www.cga-canada.org/en-ca/ResearchReports/ca_rep_201101_MDA.pdf vi AICPA, CICA and CIMA (2010: 1). Evolution of corporate sustainability practices Perspectives from the UK, US and Canada, joint research study, (19pp) URL: http://www.cica.ca/publications/list-ofpublications/manual/item45663.pdf. vii Ibid (p. 1). viii Ibid (p.1).
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ix
Ibid (p.12). PRI Association and UNEP Finance Initiative (2011: 23). Universal Ownership - Why environmental externalities matter to institutional investors URL: http://www.unpri.org/files/uop_long_report.pdf xi Chartered Accountants of Canada (2010: 5). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making, (p.5). URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xii Ibid (p.6) xiii Thomson Reuters ASSET4 (2010). The Next Phase of Integrating Environmental, Social and Governance (ESG) Information into Mainstream Investing in Chartered Accountants of Canada (2010). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making, (p.6). URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xiv Goldman Sachs (2008: 52). GS Sustain, June 30 in Chartered Accountants of Canada (2010). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making, (p.5). URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xv Chartered Accountants of Canada (2010: 6). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making. URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xvi Ibid (p.8). xvii Ibid (p.9) xviii Chartered Accountants of Canada (2010: 8). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making, (41 pp.). URL: http://www.cica.ca/publications/list-ofpublications/manual/item41881.pdf xix Girdharry, K., E. Simonova, and R. Lefebvre (2011: 13). MD&A – Counterpart to or Distraction from Financial Reporting, CGA- Issue in Focus. URL: http://www.cga-canada.org/en-ca/ResearchReports/ca_rep_201101_MDA.pdf xx Ibid (p.8) xxi Goldman Sachs (2008: 52). GS Sustain, June 30 in Chartered Accountants of Canada (2010). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making, (p.5). URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xxii AICPA, CICA and CIMA (2010: 16). Evolution of corporate sustainability practices Perspectives from the UK, US and Canada, joint research study, (19 pp.) URL: http://www.cica.ca/publications/list-ofpublications/manual/item45663.pdf. xxiii Ibid (p.17). xxiv Hesse, A (2006 :2). Letter to the IASB on the Discussion Paper – Management Commentary. Sustainable Development Management Consultants. URL: http://www.ifrs.org/Current-Projects/IASB-Projects/ManagementCommentary/DP05/Comment-Letters/Documents/16_230_MCCL80.pdf xxv PRI Association and UNEP Finance Initiative (2011: 40). Universal Ownership - Why environmental externalities matter to institutional investors URL: http://www.unpri.org/files/uop_long_report.pdf xxvi Chartered Accountants of Canada (2010: 17). Environmental, Social and Governance (ESG) Issues in Institutional Investor Decision Making. URL: http://www.cica.ca/publications/list-of-publications/manual/item41881.pdf xxvii AICPA, CICA and CIMA (2010: 2). Evolution of corporate sustainability practices Perspectives from the UK, US and Canada, joint research study, (19 pp.) URL: http://www.cica.ca/publications/list-ofpublications/manual/item45663.pdf. xxviii AICPA, CICA and CIMA (2010). Evolution of corporate sustainability practices Perspectives from the UK, US and Canada, joint research study, (19 pp.) URL: http://www.cica.ca/publications/list-ofpublications/manual/item45663.pdf. xxix Global Reporting Initiative (2011). Sustainability Reporting Guidelines and Indicator Protocols Set (51pp & 110pp). URL: https://www.globalreporting.org/resourcelibrary/G3.1-Guidelines-Incl-Technical-Protocol.pdf. x
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