The growing power of non financial reports

Ioannis Ioannou and George Serafeim are exploring the value of forcing corporations to issue sustainability reports, which provide information about corporate performance in terms of social, environmental and governance issues.

In a breakthrough study, they asked: what is the effect of mandatory sustainability reporting on management practices across the world?

Tate & Lyle, the global supplier of food and beverage ingredients, was founded in the UK in 1921 and is headquartered there today. It operates more than 45 production facilities globally and employs more than 5,600 people, and its products are used by millions of consumers daily. Check its online annual report for 2010, and you’ll find an interesting change in how they summarise their operations:

This year, we have changed how we report corporate social responsibility (CSR). We have incorporated those areas in which we measure performance — safety, environment, community — into this ‘Business review: Performance’ section, emphasising their importance to the long-term success of the business. The other two parts of our traditional CSR report, namely how we manage our relationships with commercial partners and suppliers, and our approach to employee health and wellbeing, are covered in the ‘Business review: What we do’ section, since they are an integral part of how we do business.

We believe that changing the way we report CSR more accurately reflects the central role it plays in the way we do business – which, for Tate & Lyle, means operating to high social, ethical and environmental standards in all circumstances. (Source)

Such changes in how companies disclose their sustainability activities to their stakeholders (and, via online presentations, to the rest of the world as well) are part of a trend that many have noted and in which we have taken a strong interest. In many countries around the world, for instance, non-financial reports on environmental, social or governance activities now occur because of mandates imposed by government legislation. . The question then, that demands more attention, is whether such sustainability reporting laws and regulations change how companies actually behave and the way they engage with their key stakeholders and the broader society.

Making a difference

We have analysed the impact of mandatory sustainability reporting on a number of measures reflecting socially responsible management practices in 58 countries around the world. Our research shows that mandatory sustainability reporting does make a significant difference. It leads to a multitude of benefits both for firms as well as for the country as a whole, namely:

• Business leaders embrace a greater sense of social responsibility. CSR Europe for example, noted that at Ethical Corporation’s 10th Annual Responsible Business Summit 2011, held in London last May, the CEOs of PepsiCo, Panasonic, Innocent Drinks, Alliance Boots, Johnson Matthey, Seventh Generation and Kraft Foods shared best practices. More leaders are now paying attention to this important subject, especially in companies that report on it.
  
• Firms have elevated sustainable development to a priority goal. One example: Air Liquide in France, in April of this year, announced that it was dedicated to sustainable development in three ways: limiting CO2 emissions, boosting human resource diversity and placing sustainable development at the heart of R&D. Its report on this subject is public and available at http://www.airliquide.com/en/air-liquide-committed-to-sustainable-development.html.
  
• Companies are investing more and taking a higher interest in their employees. Consider Agility for example, which was once a small warehousing company in Kuwait and is now a top 10 logistics operations firm, provided its first CSR Report last March. Impressively, five of its 19 bullet points deal with employees. (www.eyefortransport.com/content/agility-releases-2011-corporate-social-responsibility-report)
  
• Boards of directors are providing more effective managerial oversight. Last April, EUbusiness commented, “One of the lessons of the [recent financial] crisis was that corporate governance, mostly based on self-regulation, was not as effective as it could have been. Directors failed in their supervisory functions, as there was no effective challenge to the management in boardroom due to the phenomenon of group think.” Directors today, especially in companies committed to filing non-financial performance reports, seem to be exerting much more oversight in this regard. (www.eubusiness.com/topics/finance/governance-11)
  
• Firms are increasingly operating with ethical standards in mind. In 2009, Sustainable Life Media reported the results of a UK survey. The headline read ‘One in Four Consumers Boycott Ethically Challenged Companies’;  Also, in a recent Edelman survey of 5,000 members of the informed public, nearly two-thirds of those interviewed cited “transparent and honest business practices” as the most important factor for a company’s reputation. (Source and source)
  
• Incidents of corrupt practices, and bribery and corruption in particular, drop. It is no accident that the webpage on this topic by the Portal for Responsible Supply Chain Management states flatly: “Seamless and transparent business can do without corruption.” It goes on to note: “Many companies operating in weak rule of law countries and competing against companies with weak governance standards are still faced with the dilemma of paying bribes to win business or withdrawing from high-risk markets. Even if corruption is easy and seems a faster way to make business, on the long-term, transparency in finance and practices seems to be more efficient.” (www.csr-supplychain.org/key-topic/bribery)
  
• Society shows a higher regard for managers in countries where sustainability reporting is mandated by law and thus, countries in which companies disclose their adherence to non-financial goals and standards  The Edelman Trust Barometer is a survey that has been conducted for 11 years that ‘gauges attitudes about the state of trust in business, government, NGOs and media across 23 countries’. One of the questions the survey asks is the extent to which an industry and its managers can be trusted ‘to do what is right’. In their ranking of 16 industries for 2011, technology firms came out on top, financial services firms on the bottom. The key, of course, is what those surveyed are most looking for in terms of their regard for companies. In this case, the survey found that the top four factors were providing high-quality products or services, having transparent and honest business practices, being a company ‘I can trust’ and treating employees well. Importantly, as one summary of the 2011 survey indicated, “The vast majority [more than 80 per cent] of UK citizens believe that companies should align their business objectives with those of society and that government should play an active role in making sure that businesses operate in society’s interests.” (Source)
  

The real key

In our own research  we found that while reporting on non-financial matters is important, reporting alone is not enough. We found that countries with stronger enforcement mechanisms see a higher level of social responsibility in its business leaders, the elevation of sustainable development in its corporate goals and more substantial investments in employee training. Then, too, third-party validation of sustainability reporting provided additional insurance that the reports were not simply public relations ploys.

Our research is important because socially responsible managerial practices can enhance the competitiveness of a country by generating higher levels of trust in business. Regulators and policymakers should take this into account when considering mandating integrated or sustainability reporting. We found it noteworthy that the European Union has consistently emphasised the importance of sustainable development and building trust between business and society to increase Europe’s competitiveness.

Moreover, the results suggest that managers can use reporting as a tool for building better and more effective communication channels between the firm and its stakeholders, making the firm more transparent and more accessible. Developing a reputation for responsible corporate behaviour also could result in a competitive advantage in labour, product and capital markets and consequently, higher economic value. The message is clear: ensuring that companies take a good look at and report on how they are doing in non-financial areas makes a real difference to how they behave.