Investors – in particular those that have made commitments to responsible investment – are increasingly interested in the relationship between companies’ strategic objectives and their financial and sustainability performance. There is growing momentum behind the idea that companies should produce ‘integrated reports’ that explain how factors such as climate change, resource use or human rights will affect their current and future performance. The idea is that a more holistic approach to reporting that includes financial and non-financial, qualitative and quantitative information should help embed sustainability into companies’ decision-making by moving performance metrics and incentives away from an undue focus on short-term financial performance. While the proposition that companies should provide a more holistic and longer-term account of their sustainability impacts and performance is, clearly, sensible, it is important to be realistic about the actual contribution that integrated reporting will make to the creation of more sustainable businesses.
There are four aspects to highlight. First, the reality is that no matter how high quality the information provided by companies, investors are likely to continue to pay little or no attention to this data. This is illustrated by a recent report from the Association of Chartered Certified Accountants (ACCA): Link to report which concluded that analysts pay little attention to any form of narrative reporting and are particularly sceptical about the investment value of any reporting on social and environmental performance, seeing much of theinformation in narrative reports as ‘irrelevant, “useless” or worse’. Second, the vast majority of investors are incentivised to focus on short-term performance. Many, therefore, remain sceptical that additional data on long-term strategy or sustainability performance will enhance their ability to make investment decisions over the time-frames that are of interest to them. Third, there is a risk that a focus on integrated reporting will divert companies from providing information that is relevant to wider stakeholders, not just investors. In fact, there have been criticisms of a number of companies producing integrated reports on exactly these grounds, i.e. that they do not provide sufficiently granular or detailed information for stakeholders other than investors. Fourth, it is not clear that integrated reporting is actually the right answer to the question of how can investors best integrate consideration of environmental, social and governance (ESG) issues into their investment decisions. The problem is that investment integration remains very much in its infancy. It is therefore unsurprising that investors have started with relatively simple measures of corporate responsibility performance (e.g. does the company produce a corporate responsibility report or not) and with an almost obsessive focus on those aspects of performance that are most obviously financial material (e.g. the implications of emissions trading for European electricity utilities). We have, to date, seen relatively little attention being paid to many important aspects of corporate responsibility performance,. This is either because indicators have yet to be developed because the precise relationship to company
performance has not been established, or, and this is probably the most pressing issue, the quality and consistency of corporate reporting on environmental and social issues varies a great deal from sector to sector and company to company. A case in point is human rights where there is broad agreement that this is an important issue for companies but where, other than in ethical funds, we have seen relatively little progress on integrating these issues into investment decisions. This is starting to change. Investors are starting to use corporate responsibility information in a variety of ways, e.g. to assess companies’ quality of management, to benchmark companies on the basis of their management systems and processes, and to compare companies on the basis of their environmental or social performance (e.g. greenhouse gas emissions per unit of turnover). In conclusion, integrated reporting should help address one of the central limitations of current approaches to reporting, namely the disconnect between corporate responsibility-related issues and other aspects of corporate strategy and performance.However, integrated reporting is not a panacea. It is not clear that integrated reporting will have any influence on the dialogue that investors have with companies or the investment decisions that are made. Perhaps more importantly, there is a risk that the focus on integrated reporting will divert valuable time and attention away from the more pressing matter of ensuring that companies provide data that are consistent, comparable, robust and useful.
We run two risks. The first is that investors may – perhaps paradoxically – become less interested in environmental, social and governance issues because the potential for investment outperformance is limited as a consequence of the inevitably limited data sets that will be provided in integrated reports. The second is that we limit the potential for engagement to drive improvements in corporate responsibility performance; without high quality data it is difficult to make meaningful comparisons between companies or to hold companies to account for their performance.
Dr Rory Sullivan is the author of Valuing Corporate Responsibility: How Do Investors Really Use Corporate Responsibility Information? (Greenleaf, 2011) which was released this week.
RI readers can receive a 30% discount on the book list price by entering the special code VCR360 at the checkout on the following site: www.greenleaf-publishing.com/valuing