To save the world, some say to start with reporting requirements.
This past summer, 181 CEOs who are part of the executives’ group the Business Roundtable drafted a new statement of purpose for corporations and, with a few words, made a radical shift. For more than two decades, the group of top executives had held that companies’ managers and directors had a primary duty to serve stockholders, but the updated statement included also customers, employees, suppliers, and supporting communities.
The executives are responding to a mounting sense that a company needs to do good while doing business, whether that means keeping carbon emissions low, waterways clear, or workers healthy and well paid. In 2016, nearly $23 trillion—or 26 percent—of assets managed in the United States, Europe, Asia, Australia, Canada, and New Zealand were branded as sustainable investments. This represented an increase of 25 percent in just two years.
In more evidence that the corporate world has taken note, data collected by Chicago Booth’s Rustandy Center for Social Sector Innovation finds that more than half of S&P 500 companies released corporate-social-responsibility reports with metrics specific to their 2017 performance, and that the majority of the remaining companies published websites with general commitments to sustainability. Further, according to data from the Sustainability Accounting Standards Board (SASB), 85 percent of companies registered with the US Securities and Exchange Commission now disclose some sort of sustainability information in regulatory filings, which include annual reports.
But CSR reporting is almost entirely voluntary in the US. If a company reports a decline in its carbon footprint, it generally does so because it behooves the company to make that disclosure. Meanwhile, there are no standards for reporting. When it comes to public companies, half are including in their regulatory filings fairly generic or boilerplate CSR information that isn’t particularly useful to investors or other users.
Several groups are trying to improve the state of CSR reporting. In the US, the SASB develops and distributes CSR (or sustainability) reporting standards for use in SEC filings. The European Union has moved to strengthen the transparency of sustainability reporting by making larger companies include annual statements on sustainability and diversity. The Global Reporting Initiative strives to help companies develop meaningful sustainability reports.
Ultimately, if informative CSR reporting is to become widespread, it might be necessary to mandate such reporting and to impose a set of standards. We have collected and synthesized arguments for and against this in an independent report commissioned by the SASB and a related research paper. We outline a few of the arguments here. As is so often true, the success or failure of a reporting effort could be in the details.
While the consequences of any mandate can be difficult to predict, we have some sense of the possible pros and cons of more-extensive and better CSR reporting. Let’s start with some pros. Better CSR disclosures could improve companies’ reputations and customers’ satisfaction. As consumers become more aware of what socially responsible steps a company is taking, especially steps that align with their own values, they may develop more trust in the company’s brands and products and become more devoted customers.
For investors, CSR disclosures could provide useful and additional information. First, investments in CSR, like other investments, are associated with future cash flows and risks. Standardized CSR disclosures could help the market gain a clearer picture of a company’s risks and value, making it possible to compare one company’s CSR activities with another’s, and helping investors monitor such activities (or lack thereof). Such disclosures, if they are informative, could increase the liquidity of secondary securities markets, just as the usual financial information does. Less uncertainty about firm value can also lower the cost of capital.
Broad rules leave more room for managers to hide or bury bad news. . . . But specificity can backfire by providing companies with an excuse to only disclose what is required by the letter of the law.
Second, a manager can have goals other than maximizing shareholder value. Say a CEO uses corporate dollars to support a favorite charity even though there is no real benefit to the company for doing so. Managers are unlikely to be forthcoming about such pet projects and any negative impacts unless required, and standardized CSR reporting could bring the activity into the open. Investors who are more informed would have more power to hold managers and companies accountable, and managers would have more incentive to keep shareholder priorities top of mind.
At the same time, CSR reporting could help shareholders and other stakeholders drive a company to act in more responsible and sustainable ways. CSR disclosures could make a company more inclined to, say, stop polluting, or to put its investments and purchasing power toward backing companies that use renewable energy or purchase ethically sourced materials. Seeing positive payoffs, companies could even vie to impress stakeholders by proving they are more socially responsible and sustainable than their competitors.
We could go on, but let’s also touch on potential drawbacks, some of which have to do with how CSR reporting rules are implemented. There’s a good chance that CSR disclosures would make it easier to compare companies’ do-gooding activities, but there’s no guarantee of that outcome.
Consider the challenge of heterogeneity. Even within a single industry, business activities vary. Company cultures aren’t standardized, and that will remain true even if accounting mandates and standards are put in place. Couple this with the fact that any reporting standard provides a certain amount of discretion to managers and leaves room for interpretations of what should be reported.
With this in mind, how broadly or specifically should rules be written? Broadly drafted rules leave leeway for heterogeneity but can also make accurate reporting impossible as managers struggle to fully provide what’s required. Consider Section 1502 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires more than 1,300 companies to declare whether any of their products contain “conflict minerals,” mined in the war-torn Democratic Republic of the Congo, where detractors claim that proceeds from mineral extraction fuel human-rights abuses. Around 80 percent of companies can’t say for sure if this is true of their products, and only 1 percent are certain their products do not contain such materials, according to research by Hong Kong University of Science and Technology’s Yong H. Kim and University of Michigan’s Gerald F. Davis.
Broad rules also leave more room for managers to hide or bury bad news. A key reason to require CSR disclosures would be to allow the public to see how companies and their activities compare with each other, even if this means some companies will have to release unfavorable information. But if managers think disclosing something is risky or not in a company’s best interest, they will have more freedom to avoid disclosing it, whether that means making selective disclosures or burying unfavorable information in a boilerplate statement.
One could respond to these obstacles by making disclosure rules very specific—but this has its own challenges. It is difficult for any standard setter to predict and articulate the specific CSR information that will be relevant in the future. Plus, specificity can backfire by providing companies with an excuse to only disclose what is required by the letter of the law, even if other, less favorable disclosures would be more relevant to their stakeholders.
Let’s assume standards are implemented effectively, with the ideal balance of specificity and flexibility. It will still be costly to compile relevant data, vet information, create reports, and hire auditors to verify these reports. This could be especially burdensome for smaller companies.
And at companies of all sizes, there are risks involved in sharing information. Consumer groups and activists could gain power to set standards for an industry, and their priorities might not align with those of investors. Information disclosed could conceivably be used in regulatory actions, as evidence in litigation, or in the media. An unforeseen and unavoidable issue such as a natural disaster could lead to bad publicity, even when it is outside the control of management. Imagine that companies are made to report the types of energy they use, and a hurricane damages one company’s renewable infrastructure, forcing it to use coal-powered energy while a competitor several states away uses renewable power without disruption. The point is that a mandatory CSR reporting regime could expose the company to reputation risk and increase the likelihood of bad publicity, even when it is not at fault or despite good systems and CSR policies.
Moreover, there are limits to what a CSR-reporting mandate can achieve. If disclosures prove too costly, unfavorable, or risky, a company could also make changes to its business to avoid the disclosure. Thus, while the objective of a reporting mandate would likely be to make companies more socially responsible, and ideally companies would respond to required CSR disclosures by embracing more sustainable activities, they could avoid this by moving business elsewhere, perhaps to less-transparent overseas subsidiaries. If a goal is to reduce pollution or CO2 emissions, shifting polluting activities to an overseas spin-off doesn’t reduce pollution or emissions so much as keep them from public view.
Conversely, even when companies respond, it might not lead to the intended outcome. In 2014, a garment factory collapsed in Bangladesh, killing more than 1,100 people. Nike was one of the companies sourcing products from Bangladesh at the time, and rather than work toward improving labor-safety conditions, it pulled out of the country. This decision essentially left the workers’ fates to competitors that were perhaps less concerned about their CSR reputations and unlikely to provide safer work environments.
With these pros and cons in mind, we recognize that as imperfect as CSR-disclosure regulation and reporting standards may be, it could still be worth creating them. But the details of the requirements and their implementation would matter greatly.
The details include who would make and oversee these rules. In the US, the SEC already oversees financial disclosures and seems a best fit for this. The rules could potentially roll into the existing structure for auditors, even though CSR auditing would require a substantially different set of knowledge. Financial auditors don’t necessarily know about carbon footprints, energy usage, or materials sourcing—and it could be far more complex and less straightforward to audit carbon footprints than revenues and expenses.
In terms of reporting specificity, metrics-based rules could help fend off meaningless disclosures. Meanwhile, it could make sense to give companies input into establishing the metrics and standards, so that the rules reflect and respect the diversity of industries. But then one would have to guard against regulatory capture and, of course, independent enforcement would be key.
Medicine teaches us it will take time, effort, and investment.
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Demand for corporate social responsibility is forcing companies to value more than money.
Are Profits Passé?There’s more to study and discuss before reporting requirements can become a reality. But there are good reasons to start this debate, or prepare for the possibility of a CSR-reporting mandate. There are costs associated with pollution, greenhouse-gas emissions, and the like, and those can be recorded. Moreover, as the Business Roundtable recognizes, companies have stakeholders beyond investors, and a large number of these stakeholders—including consumers, employees, and society more broadly—have a legitimate interest in companies’ CSR activities and could benefit from improved reporting. Because these stakeholders typically have a more arm’s length, passive relationship with companies, it is harder for them to ask for this information, and hence standards could be particularly useful for them.
As interest in sustainable investment grows, so too will demand for reliable, comparable information on CSR activities. And although it is challenging to create a framework for CSR disclosures, it could be important to do so. Investors are increasingly focused on sustainable investments, and CEOs are acknowledging the importance of various stakeholders. But without a reliable reporting framework, and without the accountability that one would create, it’s unlikely that the good intentions expressed by CEOs and investors, and the ensuing benefits to society, will actually materialize.
Hans B. Christensen is professor of accounting and the David G. Booth Faculty Fellow at Chicago Booth.
Christian Leuz is the Joseph Sondheimer Professor of International Economics, Finance, and Accounting at Booth.
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Too much detail can overload investors, to the detriment of their decision making.
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