Valuing Corporate Responsibility

How Do Investors Really Use Corporate Responsibility Information?

Rory Sullivan

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9781906093600
• eBook ISBN: 9781351278225
• Topic: Negocios y empresa
• Subtopic: Negocios en general

Investors have taken a long time to pay attention to corporate responsibility. Despite the growing number of companies that were taking action to manage the social and environmental impacts of their activities and operations and that were reporting on their corporate responsibility performance, mainstream investors' interest in governance issues was, on the whole, piqued only in those situations where a major accident or scandal hit the headlines.

This has changed dramatically. With over 600 large investment institutions, including asset managers, insurance companies and pension funds having signed the UN-backed Principles for Responsible Investment, it can now be plausibly argued that "responsible investment" has become mainstream. This change is potentially of huge significance, and the investment community is now widely seen as one of the key audiences for the thousands of corporate responsibility reports produced each year.

Yet the reality is that there is a striking lack of understanding among companies of investors' interests. The consequence has been that, despite many companies identifying investors as one of the critical audiences for their corporate responsibility reports, most investors – even those that have made commitments to responsible investment – see these reports as irrelevant to their investment decision-making. The problem is compounded by the singularly poor job that investors do of explaining to companies what sort of information they are really interested in, and where corporate responsibility performance fits into their overall assessments of companies. This has led to frustrations on both sides. Investors have been accused of not paying sufficient attention to companies' corporate responsibility performance, and companies have been accused of producing information that not only has no immediate relevance to investors but, worse, seems to have no relevance to the key business challenges that these companies face. Valuing Corporate Responsibility aims to address the "dialogue of the deaf" that characterizes too many of the discussions between companies and their investors on corporate responsibility issues, through:

1. Explaining to companies what responsible investment looks like in practice and, from this analysis, explaining what sort of corporate responsibility information investors are interested in and how this information is used in practice.

2. Explaining to investors some of the practical difficulties faced by companies when preparing corporate responsibility reports and the implications for the quality and utility of the data provided in these reports.

Valuing Corporate Responsibility also analyses how issues such as investors' views on materiality and investment time-frames influence the dialogue that investors have with companies on corporate responsibility matters. It concludes that there is a need for a major rethink of current approaches to responsible investment, as the manner in which most investors are implementing their responsible investment commitments is unlikely to see them making a substantial contribution to improving corporate responsibility performance or to the wider goals of sustainable development.

Written by one of the world's leading experts on responsible investment, Valuing Corporate Responsibility is one of the most important books to be written on corporate responsibility over the past decade. It is of relevance not only to companies and to responsible investment professionals but to all those interested in really understanding how companies and their investors relate to each other and the implications of this relationship for sustainable development.

1
Introduction

Setting the scene

The past 20 years have seen a major change in the debate around the social and environmental responsibilities of companies. Companies are now expected to manage issues as diverse as climate change, environmental pollution, employee relations, human rights, and bribery and corruption. Furthermore, companies’ responsibilities are seen as extending far beyond the factory gate to encompass questions such as health and safety in suppliers’ factories, environmental management in the supply chain and the use and disposal of the company’s products. Companies have responded by establishing management systems, conducting environmental and social audits, creating board committees and appointing senior managers, and committing capital and resources to efforts to improve their social and environmental performance.

In order to demonstrate their commitment to action, and as part of the process of building their brands, strengthening their reputations and improving their relationships with key stakeholders, many large companies now publish annual reports on their social and environmental performance. In total, some 3,500 corporate responsibility reports were issued in 2009 alone (CorporateRegister.com 2010: 4). These reports cover topics as diverse as emissions to air and water, waste generation, resource consumption, human rights, health and safety, community engagement and philanthropy.

These reports have been hugely valuable; they have placed a wealth of information into the public domain, they have allowed companies to explain their social and environmental impacts in the context of their wider impacts on and contributions to society, and they have helped nongovernmental organisations hold companies to account for the delivery of their social and environmental commitments.

For a long time, with the exception of the socially responsible investment community, investors paid relatively little attention to corporate responsibility. While mainstream investors, in the round, understood why companies were investing time and resources in managing their social and environmental impacts, it is probably fair to say that their active interest was confined to situations where a major accident or scandal hit the headlines. This situation has changed dramatically. With over six hundred large investment institutions (asset managers and pension funds) having signed the UN-backed Principles for Responsible Investment¹ and similar numbers supporting the Carbon Disclosure Project (CDP),² it can plausibly be argued that ‘responsible investment’—which is generally a shorthand for the view that investors should take account of environmental, social and governance issues in their investment processes, and should encourage companies to improve their reporting and performance on these issues—has now become mainstream investment practice.

This change is potentially of huge significance; investors’ views on topics such as climate change are an important influence on the actions that companies take (Sullivan and Mackenzie 2006). Companies have seen investor interest in corporate responsibility as providing them with the opportunity to demonstrate the effectiveness of their risk management processes and to highlight the potential business opportunities presented by, for example, climate change and changing demographic patterns (GRI 2009). The investment community is now widely seen as one of the key audiences for the annual corporate responsibility reports produced by companies.

Given the many thousands of corporate responsibility reports produced each year, there should, in theory, be a substantial amount of useful data and information available to investors. Yet, despite the volume of reports produced and the very significant progress that has been made in developing standardised indicators (e.g. the work of the Global Reporting Initiative³) and reporting tools (e.g. the AccountAbility AA1000 series on assurance⁴), corporate responsibility reporting remains unsatisfactory in the eyes of many investors. Common critiques are that:

• Corporate responsibility reports are inconsistent in scope and content.
• Companies have a ‘pick and mix’ approach to the indicators on which they report. Reporting tends to focus primarily on good news rather than providing a properly balanced assessment of performance.
• The business implications of social and environmental issues are not discussed in the context of the company’s strategy and key value drivers.
• It is frequently difficult to assess how companies are performing against their own corporate responsibility policies and commitments.
• It is not clear what resources (human, financial, etc.) have been allocated for the achievement of the company’s corporate responsibility objectives.
• The processes for assessing materiality (or financial significance) are rarely transparent.
• Companies do not explain what has been excluded from the scope of reporting.

The consequence has been that the theoretical potential of corporate responsibility reporting remains unrealised. Investors are reluctant to rely on the data presented for financial modelling, it is difficult if not impossible to make meaningful comparisons between companies, and the credibility benefits that should accrue to companies that have a proactive approach to corporate responsibility have proved elusive. The limits and inconsistencies in corporate responsibility reporting affect all companies, both those that produce excellent reports and data, and those that do not.

The answer is not as simple as saying that companies should report using a standard reporting protocol or report against a standard list of indicators. Companies, in fact, face a number of quite fundamental challenges. First, they need to communicate with a range of parties, not just investors; employees, customers, civil society organisations and governments are all important audiences for information and companies need to balance the needs and interests of these different parties in their reporting. Second, companies are not homogeneous and standard reporting protocols such as those produced by the Global Reporting Initiative (GRI) may not be directly applicable to their operations. This problem is compounded by the fact that at least some companies wish to differentiate themselves on the basis of their corporate responsibility activities, and standard reporting protocols may not allow them to do this effectively. Third, companies face resource constraints and, inevitably, need to make trade-offs between the information that is requested and that which they can actually provide. Fourth, and with good cause, companies frequently complain that the information that they do provide is ignored (e.g. see Brooksbank 2010) or, worse, taken out of context to present a misleading picture of the company and its activities. That is, there may be limited incentive for companies to improve their reporting.

The final challenge faced by companies, and the most significant in the context of this book, is that, while the investment community has criticised corporate responsibility reporting, it is often not clear what information investors are looking for or how they might use this information. Even though the investment community has highlighted its commitment to responsible investment, individual investors have not been explicit about the scale of this commitment (i.e. how mainstream is responsible investment), what it means in practice (i.e. how investors actually give effect to this commitment) or how corporate responsibility information might be used in investment decisions. The consequence is that companies struggle to know how to most effectively communicate with investors on corporate responsibility matters (GRI 2009: 4).

About this book

This book seeks to bridge the ‘lack of understanding’ chasm between companies and investors. It is not a cookbook presenting an idealised model for corporate responsibility reporting, nor does it present simplistic recommendations for companies about what information should be included in their corporate responsibility reports; reporting is such a dynamic area that such a book would have a shelf life of a few months at most. Moreover, the unfortunate reality is that corporate responsibility reporting will, for some time to come, remain a messy and imperfect discipline,⁵ and so investors will simply have to make the best of the information that is provided.

Therefore, the overarching aims of this book are (1) to provide investors with the basic skills that they need to make sense of the information they receive (and will continue to receive) on companies’ corporate responsibility performance, and (2) to provide companies with some practical suggestions on how they can make their reporting more useful for investors. More specifically, the book has four objectives:

• To explain what responsible investment looks like in practice and, from this analysis, to explain what sort of corporate responsibility information investors are interested in and how this information might be used.
• To provide some practical proposals on how companies can make their corporate responsibility reporting more useful to investors.
• To describe to investors some of the practical difficulties faced by companies when preparing corporate responsibility reports and the implications for the quality and utility of the data provided in these reports.
• To explain how issues such as materiality and investment time-frames impact on the dialogue that investors have with companies on corporate responsibility matters.

To deliver on these objectives, the book is divided into four parts, as follows:

• Chapters 2, 3 and 4 describe the major responsible investment strategies that may be adopted by investors and the implications for corporate responsibility reporting. Chapter 2 provides a broad overview of the responsible investment field, with the subsequent chapters providing a series of case studies and examples of how investors use corporate responsibility information in practice.
• Chapter 5 examines the key technical issues—uncertainty in emissions estimation, the scope of reporting, assurance—that impact on the quality and utility of the data provided in corporate responsibility reports.
• Chapter 6 critically assesses investment practice and the implications for companies’ reporting and performance.
• Chapter 7 draws together the key themes of the book, offering some practical proposals on how corporate responsibility reporting can be made more useful for investors and on how investors can have a more constructive dialogue with companies on corporate responsibility and sustainable development issues.

Some qualifications

There are a number of important limits to this book. The first is that the focus is, in the main, confined to the information presented in formal corporate responsibility reports, the information provided on companies’ websites, the material contained in annual reports and accounts, and the information provided in response to investor-supported disclosure initiatives such as the Carbon Disclosure Project. Clearly, companies provide additional reports to other stakeholders, including to government (e.g. as part of licence conditions, as part of wider community right-to-know initiatives such as publicly available pollutant inventories), to customers (e.g. product labelling) and to academics and researchers. In practice, however,investors tend to rely heavily on the information provided directly by companies for their analysis of corporate responsibility performance.

Second, the majority of the examples presented relate to environmental rather than social performance. There are three reasons for this: environmental issues are frequently easier to quantify, environmental reporting is much more developed (in terms of agreed indicators and benchmarks) and investors now have significant experience in analysing and valuing climate-change-related risks for their investment portfolios. It is therefore easier to explain both how investors use corporate responsibility information and the limits in corporate responsibility reporting using environmental examples. However, this is not intended to imply that company performance in areas such as human rights or labour standards is of any less importance. Social issues, in particular the question of whether and how these can be integrated into investment practice, are discussed in Chapter 6.

Third, the objectives that companies should be setting for themselves are not prescribed. While corporate objectives are clearly a central question for any discussion of sustainable development, they fall somewhat outside the primary focus of this book, which is on how companies report on their performance and how this data can be used by investors. That said, one of the critical questions for investors (and a topic that is canvassed in Chapters 3 and 4) is how do the objectives being set by companies compare to the policy targets set by government and the expectations of key stakeholders? Chapter 6 offers some wider reflections on the relationship between corporate responsibility and sustainable development.

Fourth, the perspective presented is that of an equity investor (i.e. an investor in the shares of companies), with a relatively long-term (i.e. 1–2 years) view on a company. Clearly, investors can invest in other asset classes (e.g. fixed income, private equity, hedge funds) with a range of investment time-horizons (from very short term to a number of years). While the characteristics of the specific asset class and the time-frame of interest determine the importance of environmental and social issues in the investment process and the influence that can be exerted by the investor, the broad principles underpinning investment research and decision-making remain the same. Therefore, the recommendations and proposals made here have general applicability across all asset classes, not just equities, and across the range of time-horizons likely to be encountered.

Fifth, large companies are the main subject of this book, in part because they are more likely to produce corporate responsibility reports and in part because they have the most significant social, environmental and economic impacts (and so are most likely to face pressure to report on their corporate responsibility performance). From an investment perspective, these are also the companies that investors are more likely to invest in (i.e. that are likely to attract the greatest amount of capital).

Notes

1 www.unpri.org, accessed 2 November 2010.

2 www.cdproject.net, accessed 2 November 2010.

3 www.globalreporting.org, accessed 2 November 2010.

4 The AA1000 series comprises three distinct standards: AA1000APS (Principles Standard), AA1000AS (Assurance Standard) and AA1000SES (the Stakeholder Engagement Standard). See www.accountability.org/standards/index.html, accessed 2 November 2010.

5 For example, while the GRI provides what is probably the most widely cited voluntary reporting framework (see, for example, ICAEW 2008: 11), just over 1,400 of corporate responsibility reports issued in 2009 followed the GRI reporting guidelines (www.globalreporting.org/GRIReports/GRIReportslist/reportslist.htm, accessed 2 November 2010), representing slightly less than 40% of the 3,500 such reports issued in that year (CorporateRegister.com 2010). A similar picture emerges when the reporting practices of larger companies are analysed. A 2008 survey by KPMG found that, while over three-quarters (77%) of the Global 250 that produced a corporate responsibility report stated that their report was based on GRI reporting guidelines, only 37% declared an Application Level (a measure of the extent to which they actually applied the guidelines), with just under half of these reporting against all 50 of the GRI’s core indicators (KPMG 2008: 35-37).

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• Preface: a book with three narratives
• Abbreviations
• 1 Introduction
• 2 Investors and their interests
• 3 Case studies on investment research and engagement
• 4 Analysing and interpreting corporate responsibility reports
• 5 Key issues in corporate responsibility reporting
• 6 Investment practice and its implications for corporate responsibility
• 7 Wider recommendations and proposals
• 8 Conclusions
• References
• About the author
• Index