The Sustainability Pendulum Is Swinging from Transparency to Performance


February 12, 2018

Happy Chinese New Year! 2018 is the Year of the Dog, a year near and dear to my heart. SASB standards will be “born” in 2018, and so were both my husband and daughter. Dogs share many wonderful characteristics: they are analytical, trustworthy, hard workers, and… popular! This will be a big year for the SASB standards as they are codified. I’d like to share some thoughts on trends and uncertainties in sustainability disclosure based on the trajectory we are on.

Since 2011, the Sustainability Accounting Standards Board (SASB) has been hard at work developing standards that are “built for purpose.” Specifically, we have designed our standards to be suitable for use in the Management’s Discussion and Analysis (MD&A) section of annual SEC filings. Why? Because a key goal of MD&A is to help investors better understand whether—and to what extent—a company’s past performance is indicative of its future performance.

This focus on performance is crucial, because it enables measurement and management, providing a host of benefits to companies and their investors. Unfortunately, most current disclosure on material sustainability factors lacks clear links to a company’s financial condition or operating performance. For example, in their SEC filings for fiscal year 2016, 73 percent of top companies reported on at least three-quarters of the sustainability topicsincluded in their industry’s SASB standard, while 42 percent provided disclosure on every SASB topic. Although these figures indicate that companies are acknowledging the materiality of these risks and have made putative attempts to inform investors, more than half of such disclosure consists of generic, boilerplate language rather than standardized performance metrics like those included in the SASB standards. In other words, existing disclosure practices are more concerned with transparency than with performance. This compliance exercise may be a step in the right direction, but it won’t unlock value unless it’s taken to the next level.

Indeed, there’s no return on investment for simply disclosing information. What drives value is managing performance. As more corporations—not to mention their investors—begin to embrace this idea, the sad state of sustainability disclosure is poised to improve dramatically in the coming years.

Today’s Trends, Tomorrow’s Impacts

In MD&A, companies are compelled to focus on the currently known trends, events, and uncertainties that are reasonably likely to have material impacts in the future, and we can use this same approach to examine the direction of sustainability disclosure as a practice. Let’s consider three categories of “known trends”: the regulatory environment, investor interest, and corporate practice.

First, in the realm of policy, we can reasonably predict that there’s little chance of near-term regulatory intervention with respect to the management of specific issues or to sustainability disclosure requirements. In fact, given the stated policy goals of the current U.S. administration, it’s likely that existing regulations related to sustainability matters—particularly those related to environmental considerations—will continue to be rolled back. However, regulation is not the primary determinant of corporate activity—nor should it be.

Supply and demand—market forces far more powerful than regulation—will play the leading role, and they’re likely to not only move the goalposts for performance but also impact the quality of disclosure. The demand for improved sustainability performance is coming from customers, employees, communities, and others, who are embracing firms that create value by treating social problems as business opportunities. Meanwhile, the demand for improved sustainability disclosure lies with shareholders, who are increasingly calling for high-quality environmental, social, and governance (ESG) information from those companies. For their part, corporations are ramping up their efforts to seize those opportunities and to supply that information in a way that’s progressively more focused—for good reason.

Investors Seek Quality Over Quantity

Among investors, the trend is clear. The world’s largest asset manager, BlackRock, recently made news headlines when its CEO wrote a letter to the world’s largest public companies demanding that “every company must not only deliver financial performance, but also show how it makes a positive contribution to society” by publicly articulating its strategy for long-term value creation. The sentiment echoed a similar letter written in August by the CEO of Vanguard, another of the world’s largest investment management firms, calling on public companies to “embrace the disclosure of sustainability risks that bear on a company’s long-term value creation prospects” using a suitable framework like the SASB standards. These investors are not motivated by social purpose or philanthropic largesse; rather, they recognize—as Bank of America Merrill Lynch recently said—that sustainability indicators are “the best signal we have found for future risk.”

Like BlackRock and Vanguard, investors are dissatisfied with existing ESG disclosure. Although more than a quarter of global assets under professional management are now invested using sustainable strategies, 71 percent of investors have expressed dissatisfaction with the quality of available sustainability data. This might seem counterintuitive given the increasing proliferation of standalone “corporate social responsibility” (CSR) reports; indeed, more than 15,000 organizations have issued more than 90,000 such reports. However, quantity does not always beget quality. Despite the fact that CSR reports often contain hundreds of data points, a study of highly rated reports revealed that 90 percent of known negative events went unreported by the company.

Based on what we know today—the increasing interest in ESG information, and the growing dissatisfaction with the quality of existing data—we can reasonably surmise that investors are likely to shift the narrative from more disclosure to better disclosure. They appreciate transparency, but only insofar as it illuminates their understanding of performance. Investors will be satisfied when they have access to decision-useful, industry-specific performance metrics with clear links to material financial and operational impacts.

The Corporate Perspective 

As investors continue to beat the drum for improved disclosure quality, it should be music to the ears of corporations. Companies have long complained of disclosure overload, which has arguably worsened in the era of the CSR report. Not only are such reports expensive to produce, their value to a company’s internal decision-makers is as dubious as it is to investors. Meanwhile, due to that shortcoming, companies also field requests for sustainability information in the form of dozens or even hundreds of questionnaires from investors and ratings agencies, creating an additional significant burden on the company with limited benefit to its shareholders. For companies, less is definitely more.

This is why corporations are likely to push for a “quid pro quo” approach to improving sustainability disclosure. Some will reduce their CSR reporting while others push back on questionnaires and shareholder resolutions (and still others will do both) to offset the investment required—in things like controls and assurance—to deliver more reliable, higher-quality ESG data. Although some investors may wish companies would invest their tax windfall in sustainability reporting, it’s more likely—and more valuable over the long run—that they will focus on driving performance on the small handful of ESG issues that are material to their business.

Indeed, many corporations appear to be committed to effectively managing their most crucial sustainability impacts—not because of regulatory oversight or investor demand, but because it’s good for business. A growing recognition that sustainability performance and financial performance are intertwined has inspired firms to pursue “shared value”: projects that are mutually beneficial to addressing societal challenges and enhancing the organization’s bottom line. This is why more than 1,300 companies representing $25 trillion in market capitalization have voluntarily adopted targets for reducing greenhouse gas (GHG) emissions. It’s why automakers are embracing electric vehicles and phasing out conventional engines, with one eye to the future and the other on 63 percent year-over-year sales growth. It’s why food companies are pouring resources into the organic market, where growth is outpacing conventional foods by 300 percent. And it’s why 80 percent of CEOs think their company is approaching sustainability as a route to competitive advantage: They’re cutting costs, they’re disrupting markets with innovative inputs, processes, and products, they’re attracting top talent, and they’re strengthening their brands.

Materiality Is Key

Again, by considering what we know today, an otherwise fuzzy future becomes clear. The pendulum that once led to ESG disclosure overload is swinging back toward a more streamlined, materiality-focused approach. By continuing to narrow their sights on the sustainability factors that are most vital to their business, companies will not only improve their performance, they will usher in a new era of more effective disclosure and more efficient markets.

The SASB standards were designed to provide a roadmap to this next wave of business and investment management. Our standards zero in on the subset of sustainability-related disclosure topics and associated metrics (five topics and 14 metrics, on average) that are most important to companies in each of 79 industries. Independent research from Harvard Business School using historical data supports the validity of the SASB’s approach, determining that the application of the SASB “lens” to sustainability has yielded outperformance for both companies and their investors—including sales, sales growth, return on assets, and return on equity in addition to improved risk-adjusted shareholder returns. This is, in part, why companies like JetBlue have begun to eschew CSR reports in favor of the SASB’s more streamlined, investor-focused approach—not just because it satisfies investor demand, but because it helps firms direct their attention and resources toward the sustainability efforts most likely to drive value.

Just as companies benefit from selling off business segments that aren’t well-aligned with their core competencies, they can benefit from sharpening their sustainability focus to emphasize those factors that are essential to their business. Materiality—“measuring what matters”—is the key. So, maybe we can’t predict the future, but we don’t need a crystal ball to see the reality that has already begun to unfold. The future of ESG disclosure will be more focused, because performance has always been the name of the game.

Happy Chinese New Year. May Peace, Prosperity, and Performance be yours in 2018, the Year of the Dog.


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