The Transparency Revolution in Corporate Reporting

 
 
Professor George Serafeim looks at how standardizing the way companies report data on their social and environmental initiatives could effect revolutionary change in the stock market.
 
 
by Christian Camerota

Not long ago, only 30 companies around the world reported data about their social and sustainability (that is, nonfinancial) endeavors. Today, more than 7,000 organizations do so.

While that transparency is undoubtedly a good thing, the market has become a noisy place for investors trying to decipher what kind of company they are buying into. The Sustainability Accounting Standards Board (SASB) is an NGO established in 2011 with designs on cutting through that noise. Much the way the Financial Accounting Standards Board has systematized accounting principles in the United States over the last 40 or so years, SASB hopes to simplify and standardize how businesses report data from their environmental, social, and governance (ESG) initiatives.

George Serafeim is the Jakurski Family Associate Professor of Business Administration at Harvard Business School and an expert on sustainable and inclusive capitalism. Below, he describes how such standardized reporting could empower both companies and investors, and how it could revolutionize business practices in the future.

Christian Camerota: What prompted you to study the impact of ESG investments?

George Serafeim: Corporations can have an enormous impact on the very big problems we're facing in the world today: natural resource scarcity, social inequality, and poverty, as well as on governance issues like product safety and corruption. More and more CEOs are leading their organizations to get seriously engaged with ESG issues. At the same time, more investors are using the reported ESG data in their capital allocation decisions. Twenty years ago, there were fewer than 30 companies around the world releasing this kind of data. As of this year, there will be more than 7,000 companies doing so. It's exponential, mind-blowing growth, but we still have a very poor understanding of the value implications of these kinds of actions. So there's lots of room for improvement.

Q: Are there certain companies excelling in this area, or any industries where ESG investments are particularly valuable?

A: Economic activity around the world has become more concentrated in recent years, with most of it now controlled by just 1,000 companies. That allows economies of scale and scope and very high returns of capital, all of which give those companies tremendous power. With that power comes great responsibility. In supporting them and giving them license to grow to such an extent, people expect that these businesses will behave in a responsible way. So ESG data is important for every industry because it helps measure that behavior, though the value of different ESG investments varies by industry.

There are some good examples of companies encouraging and funding ESG innovation. Dow Chemical has enormous energy consumption in their operations, but they've managed to save more than $10 billion through efficiency programs and are moving the world toward the adoption of renewable energy sources much faster in the process. Unilever is increasing yields in their production while moving the supply chain toward more productive and just labor conditions. Novo Nordisk, a leading healthcare provider for diabetes, is making great strides in product affordability.

Most business leaders are now realizing that if you're going to be in the group of elite firms, you need to be a responsible actor.

Q: What kinds of things should investors look to leverage from this study? What are the key performance indicators (KPIs) to pay attention to?

A: KPIs are the Holy Grail. Since companies are still learning which ESG initiatives are most impactful within their given industries, and how to tackle them, there's confusion in listing all that data. As an investor, you've gone from a period of very little information in the nonfinancial domain to a state of play where there is almost too much information coming at you. The key is to understand which data is relevant.

On average, our study found that only about 20 percent of data in any given industry is material from an investment standpoint. That has huge implications in terms of the signal-to-noise ratio. For example, climate change management is very important for oil and gas firms and energy companies, whereas it's not that important for financial institutions. Affordability is important for healthcare companies, but less so for tech companies.

If you understand which 20 percent is important, you have a real advantage. SASB helps provide this kind of information via a materiality map for each industry. In our paper, we take those maps and construct scores showing how different companies are investing on material ESG issues. That allows investors to construct better risk profiles and portfolios that will perform much better. Companies that focus their efforts on key ESG issues tend to have the best future investment performance.

Q: Why is that?

A: If we have better information around ESG issues, and it is communicated and used more effectively, then that information will be incorporated into stock prices and affect the cost of capital. If that happens, capital markets will provide incentives for companies to behave responsibly and companies will exhibit those behaviors because they'll have lower costs if they do. But that will depend on organizations like SASB, and to what extent they're successful in creating a better information environment for both companies and investors.

Q: How do your study's findings correlate with how and what you teach at HBS?

A: When I teach, I have a few key messages. The first is that our students have agency and can make a difference in a system. Companies are moving to create more diverse workplaces and provide solutions to big global problems because certain business leaders have provided the blueprint for how to do it and remain competitive. Individuals have brought tremendous change to the system by providing leading examples, and our students can do the same.

The second lesson is that if you're strategic in your business model and your industry, your company will have a big impact. That will positively affect your future profitability through brand building, cost savings, and employee engagement, which then allows you to be a responsible actor and at the same time run a very profitable organization.

The third lesson is how those two things come together—making a difference and operating an efficient and profitable organization. It's what I refer to as the transparency revolution. In corporate reporting, we've gone from very few to very many companies reporting their ESG data. We have the internet exponentially increasing the speed and flow of that information, making the system that much more transparent. And we have social media restoring democracy with free speech. Before all of this, the information flow was much more controlled and usually one-way, from companies to consumers. Now when corporations act, whether good or bad, they can get a lot of credit or take a lot of heat, even in the same day.

About the Author

Christian Camerota is assistant director of communications at Harvard Business School.

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    • Anrhony Adekunle Owojori, FCA
    • Professor of Accounting & Business Education, Ekiti State University, Ado-Ekiti, Nigeria
    ESG issues are supposed to be key to accepting the CSR efforts of companies operating in the oil and gas industry, especially in the Niger-Delta area of Nigeria. But in the face of acute corruption, non-transparency and lack of adequate information, it becomes difficult to impact profitability and share price.
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited
    ESG issues are of great concern to one and all, whether one understands these and is aware of their implications, or even for those who take things for granted attaching little importance. Transparency in corporate reporting will help investors to prefer those companies which are duly serious of the environmental issues and are taking care of planet earth to the best of their capabilities. However, there is need to state these initiatives in simple understandable language in concise form avoiding complicated (or confusing and difficult to interpret) jargons/language. Even if detailed mention is necessary, an abstract in summary form can be enclosed.
    SASB seems to be doing a good job.
    That the economic activity across the globe is concentrated and controlled by just 1000 companies is a knowledge addition for me. This shows how much more needs to be done by others in order to increase the number.
    • Matt Ellis
    • CEO, Measurabl
    Spot on analysis by Professor Serafeim. His insights about materiality and ESG KPIs can be broadened beyond SASB to include lessons learned from other sustainability reporting frameworks and standards like GRI, CDP, GRESB and DJSI which are have been preparing industry for the sea change in transparency requirements for nearly 20 years. Bottom line is sunlight is the best disinfectant and ESG transparency is a very powerful magnifying glass!
    • Former ESG Analyst
    • xx, xx
    The United States is a laggard.
    SEC doesn't require CSR Reports for companies.

    China requires many companies to file CSR Reports.
    Why should the US be worse than China in CSR reporting.

    It doesn't make sense !!!
    • Aim
    • DSV, KOC
    "Companies are moving to create more diverse workplaces and provide solutions to big global problems because certain business leaders have provided the blueprint for how to do it and remain competitive."

    Sir, the above comments are an insult to over 800 million people around the world who go to bed hungry. I think that's a pretty big problem. The only thing that will make a change in such people's lives is a selfless, otherish giving. Corporate "responsibility" is just that, it is corporate and does nothing to include people who have become or are simply born uncompetitive. Its ultimate purpose is to further increase concentration of capital and it will be just a few years before the 1000 becomes 500, much thanks to the same flow of information you mentioned.

    It seems like, that magnitude of concentration will be perfect for people who will never even have a probability of owning an asset to revert back to stone age. Rising extremism is a perfect example.

    Please, do go to bed hungry for a few days before writing articles, although even then you may not understand the mind of a person who is truly stuck.