Leading and Lagging Countries in Contributing to a Sustainable Society

Editor's note: Please see related story, Corporate Sustainability Reporting: It's Effective.

To what extent companies contribute to a sustainable society is a question increasingly important, not only to the companies themselves, but also to investors, the countries they do business in, and civil society in general. But it is a difficult question to answer, with standards just now emerging in the form of "integrated reports" that help companies disclose corporate sustainability efforts just as they do financial data.

Are these efforts yielding results? We wanted to determine the extent to which corporate and investor behavior is changing. We did so by analyzing data from more than 2,000 companies in 23 countries, and then ranked those countries based on the degree of integration of corporate environmental and social performance with financial performance. On the investor side we looked at the number of times investors accessed environmental and social data on Bloomberg terminals and ranked countries based on the number of "hits," accounting for the size of each country's capital market. We also developed a call to action to spur greater global sustainability practices.

Integrated Reporting Advances

Integrated reporting is an emerging management practice that involves the integration of a company's required financial report with its voluntary (except for a few countries) corporate social responsibility or sustainability report. Sometimes referred to as One Report, integrated reporting is the combination in a single document of the material measures of financial and nonfinancial—environmental, social, and governance (ESG)—performance and the relationships between them. Sustainable strategies for a company that contribute to a sustainable society for all of us increasingly depend on a mutually reinforcing relationship between financial and nonfinancial performance.

Integrated reporting is about more than a document. It is also about a more integrated company website that leverages the Internet to provide detailed information, along with analytical tools, that is of interest to shareholders and other stakeholders. The Internet can also be used to increase the degree of dialogue and engagement with all stakeholders. Integrated reporting is as much about "listening" as it is about "talking."

Since integrated reporting is still in its early stages, just what it means to issue an integrated report is not yet well defined. At least five US companies—AEP, KKR, Southwest Airlines, Pfizer, and United Technologies Corporation—declare that they practice integrated reporting. Natura, Novo Nordisk, and Philips are acknowledged leaders in integrated reporting and have been doing so for at least three years. Approximately 270 companies using the Global Reporting Initiative's G3 Guidelines are self-declared integrated reporters. As of March 1, 2010, approximately 450 companies listed on the Johannesburg Stock Exchange must file an integrated report or explain why they are not doing so.

These numbers, while small relative to the total number of publicly listed companies in the world, show that interest in integrated reporting by companies is rising. This suggests that efforts to develop a framework for integrated reporting, such as the current initiative of the International Integrated Reporting Committee (IIRC), will be welcomed by the corporate community, since such a framework will give useful guidance to a management practice that is already happening.

Integrated reporting represents a significant change in corporate behavior, since it requires a more holistic view regarding financial, natural, and human resource allocation decisions, and the interdependencies between them. It also means taking a longer-term view, since improved financial performance from better use of natural and human resources usually isn't reflected in the next quarter's earnings. Thus integrated reporting requires a change in the behavior of investors: They must take a longer-term view and more explicitly incorporate ESG metrics into their financial models, thereby transforming them into business models.

The State Of Integrated Reporting

In order to determine the extent to which corporate and investor behavior is changing to contribute to a more sustainable society, we analyzed the state of integrated reporting in 23 countries. In collaboration with Sustainable Asset Management (SAM), we used its proprietary database of 2,255 companies and reports by SAM analysts, who evaluated whether key performance indicators and narrative information regarding environmental and social performance were integrated with the presentation of financial information.

We then created an index ranking each country in terms of the degree of integrated reporting for each of environmental and social performance, dividing the countries at the median between High and Low. (We created this index by taking for each country the difference between the percentage of companies that integrate both narrative information and key performance indicators and the percentage of companies that integrate neither one.)

In order to determine the extent to which investor behavior is changing, we used data made available to us from Bloomberg showing the number of times in two quarterly periods that investors accessed a long list of environmental and social performance metrics. Although six months is a short period, the total number of hits was approximately 34 million, so we believe it is a robust measure of investor interest. Of course, we don't know whether investors who actually looked at these data make investment decisions based on them, but we believe it is a reasonable assumption that investors who take an interest in ESG data are more likely to integrate that data in their investment decisions. We created an index ranking based on the number of hits controlled for the total stock market capitalization of all listed companies in each country, dividing countries at the median between High and Low.

Sustainable Or Unsustainable?

Based on this analysis we were able to classify countries, for each of environmental and social performance metrics, into the following categories:

• In Sustainable countries—such as Germany and the United Kingdom—there was a high degree of integrated reporting by companies and a high level of investor interest in the respective nonfinancial performance metric. Companies and investors in these countries are on the vanguard of integrated reporting and should continue to exercise leadership in order to help create a more sustainable global society.
• In Unsustainable countries—including China, Hong Kong, and South Korea—there was very little integrated reporting by companies and very little interest by investors in nonfinancial performance metrics. These countries need a regulatory shock in order to break out of the equilibrium they are in. Because neither investors nor companies are paying much attention to ESG issues, it is unlikely that market forces will be sufficient to generate a change in behavior.
• In Sustainable Companies countries—such as Brazil, South Africa, and Sweden—there is a high degree of integrated reporting by companies but very little interest by investors in nonfinancial performance metrics. Companies in these countries need to educate investors on the importance of nonfinancial metrics in evaluating company performance and making investment decisions. Investors can leverage experiences from investors in other countries and learn emerging practices on ESG integration and engagement.
• In Sustainable Investors countries—such as India, Japan, and the United States—there is very little integrated reporting by companies but a high level of interest by investors in nonfinancial performance metrics. Investors in these countries need to demand more integrated reporting by the companies they invest in. Companies need to actively engage with various stakeholders and identify and report in an integrated way the material ESG topics for their business.

An important point to note about these rankings is that they are a relative comparison of countries. They do not measure the degree to which different countries contribute to a sustainable society in an absolute sense. Even the countries that rank high on the indices might still have a lot of work to do to effectively engage and address the environmental and social problems they are grappling with.

Table 1
Company Integration and Investor Interest in Environmental Performance

Table 2
Company Integration and Investor Interest in Social Performance

Call To Action

When Table 1 (environmental performance) is compared with Table 2 (social performance), most countries are in the same category for each of these metrics. This includes the United States, which ranks lowest in the degree of integrated reporting by companies but ranks ninth out of the 23 countries in terms of degree of investor interest. This contradicts the assertion of many US executives that investors don't care about nonfinancial performance.

The result for South Africa, classified as Sustainable Companies, is also notable since it is the first country to mandate integrated reporting starting this year. It will be interesting to see if investor behavior will change in response. The same is true for France, where companies with more than 5,000 employees are required to produce integrated reports after 2012, under the Grenelle II Act.

Executives, investors, public officials, NGOs, and members of civil society in each of these countries need to challenge and consider these results. If they believe they have been classified incorrectly, they need to generate data of their own making the case. But if they agree with our classification, they need to take the necessary actions according to their classification.

No country stands alone, and we cannot have a sustainable society without the active commitment of every single country on our one planet Earth.