Beginning today, SASB will be providing a regular view into the sustainability issues most likely to materially impact companies across varying industries.
The corporate and investment management worlds are undergoing a seismic shift. “Sustainable” or “responsible” investing is crossing the so-called chasm into the mainstream of the investing world. The investment and management revolution that brought the “agency model” of the corporate manager (strictly focused on profit and shareholder-value maximization), and the investment portfolio manager as bound by fiduciary duty to build efficient portfolios (à la the Capital Asset Pricing Model and the Efficient Markets Hypothesis), have been superseded.
Incentives matter. What we measure matters. And how we institutionalize the outcomes matter.
Accounting innovations have driven change on historical scales—for example, the adoption of double-entry bookkeeping financed the Renaissance. Today, investors want to know how the companies they invest in are addressing the challenges not only of the coming quarter, but of ten years, or a century, hence. The Brundtland Report defined sustainable development as that which “meets the needs of the present without compromising the ability of future generations to meet their own needs.”
For the investment community today, having access to a rich set of information on corporate financial performance is a given. Prior to the 1972 Wheat Report, corporate financial disclosure was non-standardized, companies could “opinion shop” for favorable audits, and annual reports were as much marketing documents as factual reporting documents. This created enormous problems for investors trying to evaluate company performance.
Meanwhile, investment theory was taking leaps-and-bounds forward. In the years leading up to the early 70s, Harry Markowitz, Merton Miller, Bill Sharpe, Eugene Fama, Kenneth French, Jack Treynor, and others set the foundations of the Capital Asset Pricing Model and Efficient Markets Hypothesis for which several won the Nobel Prize. That work created conditions for the almost-simultaneous forming of several keystones of the modern financial system in the mid-1970’s, including 1) the 1973 founding of FASB standardizing financial reporting under GAAP, and 2) the 1975 milestones of Vanguard and BARRA bringing CAPM/EMH theory into asset-management practice via index investing at low cost, and portfolio analytics, respectively. These innovations have created the world we now inhabit, and it is easy to take them for granted.
We’ve now had public corporations reporting their financial statements (10-K, 20-F, 10-Q, etc.) under GAAP for decades, and the benefit to the corporate community and the public at large has been manifest. Since the founding of FASB, the United States has led the world in public capital formation; allocation of capital via mergers and acquisitions, spin-offs, IPOs, bankruptcies (necessary for re-allocation of the “remains”), and robust debt markets; and in corporate financial transparency.But that “agency model” in both corporate and investment management has created incentives that are misaligned for asset owners and society at large. The Sustainability Accounting Standards Board (SASB) helps address several problems: 1) the difficulty investors face in getting comparable, assured data on company performance, 2) the difficulty companies face in knowing what information investors care most about, and 3) the difficulty the capital markets face in efficiently allocating capital across companies and time horizons.
SASB creates standards for companies to use in their SEC filings. The standards help companies describe performance on issues that are material to financial outcomes in their industry, such as emissions and water use, human rights protections in supply chains, employee/workforce safety, and product safety and customer welfare. Companies that manage these issues well are often poised to capture the future. Those that manage them poorly sometimes face significant challenges in revenue growth, reputation and brand value, or, in extreme cases, social license to operate.
SASB recognizes that these issues affect companies in different industries along distinct dimensions. For example, product safety might mean preventing counterfeit drugs in the supply chain for a Pharmaceutical company, limiting component recalls for an Auto Manufacturer, or ensuring data security for an Internet Media company. Although the metrics to understand performance on these issues might be unique to each industry, the potential impact from a breech could be significant in any. The SASB metrics have been developed to help investors understand how companies are performing on those sustainability issues that are ultimately material to financial performance.
Incorporating standardized reporting on sustainability issues that affect a company’s ability to manage its future revenues, expenses, assets, (contingent) liabilities, and access to capital—and an investor’s ability to measure those things relative to other companies (and across industries)—may yield a revolution in corporate management, investor behavior, and capital allocation. Best of all, the SASB standards and metrics are designed to comply within the existing regulatory framework and support investor consideration of these issues within their existing fiduciary duty. Thus, they are a natural evolution in the capital markets, and one that requires no additional rule-making.
We are pleased to partner with Responsible Investor to bring you this article series. Over the coming months, the Sector Analysts at SASB will offer perspectives on the sustainability issues most likely to materially impact their sector, the state of disclosure on these topics, and insights on performance. We look forward to sharing the first installment, which will begin with the Financials sector.
Michael Kinstlick is the Head of Standard Setting at the Sustainability Accounting Standards Board.