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The Evolution of Business Reporting: Make Room for Sustainability Disclosure Financial reporting and sustainability reporting1 are often

Integrating financial, environmental, and social

assumed to be distant cousins without much in common. The latter has only recently been formalized with the advent of the Global Reporting Initiative’s (GRI’s) Sustainability Reporting Guidelines, whereas the former has been evolving steadily over the past 100 years. Hundreds of companies worldwide produce sustainability reports, but very few combine these disclosures with their financial data. As a

Why Sustainability Disclosure Matters for Investors

Sustainable development directly drives (or limits) value creation. It is an integral part of good process control, product/process innovation, avoidance of liability, and enhancement of an organization’s intangible assets. Put simply, the quality of sustainability management can

performance reports

help investors distinguish between companies that are efficient and well positioned to protect their market competitiveness and those that are

result, investors are making decisions based on incomplete information because they lack disclosures on how sustainability enhances value

headed for a bumpy ride. Certain specific factors can help drive a company’s value; therefore, their disclosure should be

creation. What is needed is a new approach to business reporting that maintains traditional finan-

of interest to investors. These factors include a range of different competencies, actions, and liabilities. Some of the most commonly cited are

cial information (driven by accounting standards) and supplements it with information from sustainability reporting.

outlined below.

© 2004 Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/tqem.20024

Alyson Slater and Sean Gilbert

Environmental Quality Management / Autumn 2004 / 41

Environmentally Driven Innovation Environmentally driven innovation can create shareholder value by lowering costs, improving production processes and service delivery, and helping to find new markets. Increased process efficiency is an example of a proven sustainability strategy for decreasing costs and adding revenue, thereby improving profitability. Additional opportunities to cut costs and create revenues through increased yield and the sale of waste streams (e.g., scrap metal and agricultural by-products) exist throughout the business value chain, in areas such as product design, manufacturing processes, and use and disposal of materials. Many companies fail Over the longer term, process to explore these opinnovations can also lead to the tions, however. creation of new products to meet Particularly for emerging customer needs. sectors with low margins, environmentally driven innovation can offer significant benefits and enhance overall competitiveness. Over the longer term, process innovations can also lead to the creation of new products to meet emerging customer needs. For the investor, these numbers should matter. Environmental performance indicators related to resource use and waste generation can support assessments of the cost savings and revenues that are available to, or already realized by, a company that is being scrutinized by potential investors. The trend in performance should also give some indication of the overall ability of the company to manage these issues and capitalize on the opportunities they present.

industry sectors, sustainability issues can have a direct impact on market access and cost structure, and therefore represent a key risk and uncertainty for investors. The growing number of companies that have suffered business setbacks due to mishandling of key environmental and social issues over the last decade has spurred the measurement and management of these issues in an attempt to effectively anticipate new risks and opportunities in the marketplace. Such liabilities and risks can rapidly and unexpectedly depress shareholder value. Consider, for instance, the impact of the Exxon Valdez oil spill (Liptak, 2004). Investors face the threat of unexpected drops in earnings due to fines and penalties, increased costs from changes in regulation, and greater than expected expenses resulting from understated or undisclosed liabilities. To this list could also be added risks such as loss of customer loyalty, reduced market share, and higher insurance premiums. Access to information about the realities that some companies face would allow shareholders to better protect themselves before they are forced to bear the burden for sustainabilityrelated losses.

Assessment of Future Competitive Advantage Assessment of future competitive advantage is one of the key areas where sustainability reporting can support investor decision making. Two studies in recent years by the World Resources Institute (WRI) applied a methodology that investors and analysts could use to evaluate how uncertainties associated with future environmen-

Exposure to Risks and Contingent Liabilities

tal issues could be translated into financial terms and integrated into established investment decision-making frameworks. Overall findings in-

Exposure to risk and liability represents a second integral part of valuing a company. In some

cluded the following (Austin & Sauer, 2002; Repetto & Austin, 2000):

42 / Autumn 2004 / Environmental Quality Management


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Companies assume that all organizations in their sector would be affected similarly if changes occur in environmental issues or regulations. In fact, however, the WRI work shows that individual companies have very different risk and exposure levels. Analysts would do well to capitalize on these differ-

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ences in order to make strong investments. Of 29 companies studied by the WRI, six mentioned relevant pending environmental issues or legislation in their environmental reports, but discussed these only in a qualitative way and did not attempt to translate them into impacts on their assets. None of the 29 companies included data on relevant environmental issues in their financial/annual reports.

The risk that poor or incomplete disclosure poses for investors is twofold: First, investors are hampered in their ability to choose companies with the best future earnings growth and potential for shareholder value creation. Second, when liabilities eventually come to light, corporate value is suppressed. With this yawning gap in disclosure, sustainability reporting has become increasingly rele-

dition to significantly stronger five-year mean operating profit margins (1.52 percent) versus their nonreporting counterparts (1.25 percent). When the sample was trimmed down to 35 companies that produced the most comprehensive GRI-based reports, the five-year operating profit margin gap increased dramatically to 3.41 percent for the GRI reporters versus 1.25 percent for the 748 nonreporting companies (Lintstock & Imagination, 2004). These early findings may indeed indicate that previous assertions about the importance of material sustainability disclosure are well founded. Public disclosure of sustainability information indicates that a company has the ability to monitor, measure, and manage the Sustainability reporting has become risks and opportunities increasingly relevant for investors associated with comas a source of information on plex issues. Strong perenvironmental and social formance in these areas performance. allows cost-saving measures in the short term and enhances the organization’s ability to avoid risk and capitalize on opportunities associated with environmental issues in the longer term.

vant for investors as a source of information on environmental and social performance. Indeed, smart companies recognize that sustainability

Current Practices: Why Investors Are Not Getting the Disclosures They Need

performance matters, and that even simply the degree of disclosure by companies may offer some indication of potential outperformers.

tinue to be better understood in terms of their material impacts on the financial bottom line, companies and shareholders alike are finding that they

A recent study by Lintstock and Imagination looked at the general market performance of 798 companies listed on the S&P 1200 that did not

need access to comparable, credible, and comprehensive data in order to make better decisions. In the paragraphs that follow, we provide a

issue a sustainability or environmental report, comparing them with 193 listed companies that did issue a report based on the GRI’s Sustainabil-

quick overview of the forms of disclosure currently used in key world markets and assess their efficacy.

ity Reporting Guidelines. The study found that the GRI reporters enjoyed slightly lower share-price volatility, in ad-

Emergence of Governmental Regulations

As sustainability risks and opportunities con-

Government regulations specifically requiring various types of environmental reporting began

The Evolution of Business Reporting: Make Room for Sustainability Disclosure


to emerge in the late 1990s in recognition of the material importance of environmental risks and

U.S. Securities and Exchange Commission Requirements

liabilities. In 1997, the Netherlands became one of the first countries to mandate environmental report-

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ing for listed companies. In 2003, the Netherlands upgraded its requirements to embrace the full spectrum of sustainability and align with the GRI’s framework. Economic regulations adopted in France in 2001 required listed companies to include detailed social and environmental information in their annual reports, starting with data for the 2002 fiscal year. Other national governments such as Japan, Korea, and Denmark have published guidelines for environmental reporting.

MD&A currently is the vehicle through which much sustainability information is incorporated and reported in the United States.

Vehicles for Environmental Reporting Environmental reporting (a key aspect of sustainability reporting) has found its way into financial reports—and therefore to mainstream investors—through two vehicles. The first, and most common, has been through the development of environmental cost accounting techniques that enable more consistent and accurate assessment of how well environmental costs and liabilities are incorporated into the preparation of financial statements. Second, there are well-established networks such as EMAN (Ecological Monitoring and Assessment Network) that are active in further advancing this area as an extension of professional accounting. Accounting bodies have developed guidance on environmental accounting and have integrated this into standard practice.


Management Discussion and Analysis

The U.S. Securities and Exchange Commission (SEC) guidelines require companies to disclose known future uncertainties and trends that may materially affect financial performance in their management discussion and analysis (MD&A). MD&A currently is the vehicle through which much sustainability information is incorporated and reported in the United States. In the case of certain industry sectors or companies, discussion of sustainability performance in the MD&A would be merited where environmental or social concerns may affect a company’s ability to expand operations, or where mishandling these issues could lead to significant damage to corporate reputation and brand value. A WRI study revealed that only three of 16 companies in the oil sector mentioned certain significant environmental issues in their annual reports; none attempted to quantify or interpret the implications for their businesses (Austin & Sauer, 2002).

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SEC Regulation S-K

Item 103 of SEC Regulation S-K requires SEC registrants (such as publicly traded companies) to make specific disclosure of the material effects that compliance with federal, state, and local environmental laws may have upon the capital expenditures, earnings, and competitive position of the reporting company. Although there is some latitude for companies to interpret the term material, the regulation specifically requires the disclosure of potential monetary sanctions imposed by a governmental authority greater than $100,000, or legal proceedings where claims may exceed 10 percent of a company’s value.


Despite the regulatory mandate, these specifics often go unreported because of the SEC’s failure to

law requires that pension funds must explain their investment principles and detail the extent to

fully enforce this particular regulation. Indeed, a 1998 study by the U.S. Environmental Protection Agency (EPA) found that 74 percent of companies

which social, environmental, and ethical issues are taken into account. At the same time, a growing number of pension funds believe that sustainability

failed to report environmentally related governmental enforcement proceedings that could result in monetary sanctions greater than $100,000.

disclosures are key to assessing investment options. In this context, the GRI guidelines have been welcomed as a tool for ensuring the emergence of

In response to this finding, EPA’s Office of Planning and Policy Analysis issued guidance on SEC registrants’ duty to disclose environmental

consistent information on sustainability issues that can help investors fill the current gap.

legal proceedings (US EPA, 2001).

The Gap between Financial and Sustainability Reporting: Not as Broad as It Seems

Is There Space for a Voluntary Approach?

How well do the innovations in sustainability reporting translate into disclosures useful for financial markets? SusSustainability reporting is typically tainability reporting is seen as separate from financial typically seen as separeporting, since it is not solely done rate from financial refor investors. porting, since it is not solely done for investors. Nonetheless, ample opportunity exists to translate it into a form that speaks to the needs of financial analysts. As the business case for sustainability practices becomes increasingly clear, reporting offers real value to those whose business is to assess the current financial health of companies and anticipate future performance.

To date, disclosure under financial reporting rules has failed to clearly illuminate for investors the role of sustainability performance in driving value creation—and people are noticing. This has created interest in an emerging voluntary framework for sustainability disclosure. The GRI’s Sustainability Reporting Guidelines have emerged as the leading global framework for sustainability reporting. Used by nearly 500 companies from 45 countries, the guidelines provide a standard set of disclosures and performance measures for organizations reporting on their economic, environmental, and social performance. They offer both a road map of key risks facing companies and a common platform that helps ensure consistent and timely release of comparable information. Sustainability reporting allows companies to capture the influence they have on their stakeholders and the physical environment—and vice versa. Good investors understand that the fate of the companies they own is tied to the nature of the relationships these companies have with other stakeholders. The emergence of sustainability reporting has been catalyzed by the financial sector, through both its investment process and its need to explain that process. In countries such as the U.K., national

At present, the content of sustainability reports tends to appear in nonfinancial terms (such as kilograms or tons), or as qualitative policy descriptions. Many of these data can readily be translated into financial terms, or can, at a minimum, imply figures more accessible to the financial community. For example: •

Indicators on the volume, trends, and nature of pollution releases will allow investors to assess whether individual facilities are at risk from pending environmental regulations or



whether they are likely to become the target of regulatory authorities.

and measures in financial reports, for example, can and should incorporate aspects of environ-

Performance indicators related to worker health and safety support assessment of the risk of costly accidents or workers’ compensa-

mental performance. To illustrate: Reductions of waste streams that lead to lower costs should appear in the form of decreased expenses on the fi-

tion demands. Even sustainability data that defy traditional

nancial report, while revenue from productive use of waste streams should be included as income. A recent GRI survey of 112 organizations asked

accounting methods can still be relevant to businesses and investors. Many facts and trends translate into intangibles or risks and opportunities

how easy it would be for respondents to link and/or cross-reference financial and sustainability reporting when using the GRI guidelines. The chart in

that define business prospects. For example:

Exhibit 1 shows the breakdown of responses. As this exhibit reflects, there are encouraging signs that financial and sustainability reporting

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Comparing the eco-efficiency of two companies can give an indication of their relative ability to innovate efficient processes and technologies. Understanding a company’s biodiversity impacts can suggest how the organization’s level of customer loyalty may change in the future.

Over time, the ability to translate sustainability data into financial outcomes will likely improve. But, as is the case in financial reporting, there will always be inMany facts and trends translate formation that cannot into intangibles or risks and be converted into a sinopportunities that define business gle figure. This does prospects. not necessarily diminish the importance of the information, but rather suggests the need for applying it differently. Information on sustainability performance has started to appear in corporate annual reports

could evolve as closer cousins. As indicated, 19 percent of respondents felt it would be “very easy” or “easy” to combine their reports. Another 39 percent felt there would be no significant challenge in mixing the reports. Thus, a majority of almost 60 percent believe that such combined reporting could be done. Although 39 percent of respondents felt it would be difficult to link the two types of reports, only 3 percent felt it would be impossible. For more information on this questionnaire, see www.globalreporting.org/sfp.

The Evolution of Business Reporting: Going Forward The outlines of a new model for business reporting are starting to emerge as investors begin to formally recognize that financial performance is affected by a range of areas traditionally left outside the scope of financial statements. A clear business case has emerged that sustain-

and financial statements. Some leading companies have already begun to experiment with

ability performance is relevant to creating or destroying shareholder value, but traditional financial reporting structures are ill equipped to deal

merging their sustainability and financial reports into a single annual report. Even with separate documents, however, there

with it. The growing field of sustainability reporting has begun to contribute to closing this gap. The future may lie in a new paradigm for busi-

exists substantial opportunity and value in crossreferencing. Certain standard reporting categories

ness reporting that combines financial statements with a range of other, nonfinancial disclo-



Exhibit 1. Linking Financial and Sustainability Reporting: How Easy Is It? A survey conducted by GRI in October 2003 asked 112 organizations, “How easy is it to link and/or cross reference financial reporting and sustainability reporting when using the GRI Guidelines?” Their answers broke down as follows:

sures. The challenge for market institutions (such as stock exchanges and standards bodies) is to develop a structure for business reporting that enables existing financial reporting systems to work in a synergistic manner with other disclosures— some of which may be in the form of financial figures and others that will not. Some aspects of sustainability reporting will fit easily into the existing framework of financial statements and accounts. However, some information will never translate into a valuation precise enough for financial statements, yet will remain material for investors. Sustainability reporting will need to sit alongside accounting standards in some form to provide investors with a complete picture of the business prospects of a company. Developing such a framework will require adopting commonly accepted measures for reporting sustainability information that allow analysts to compare and contrast performance. This will involve both a technical process (determining the specific causal relationships that drive value creation) and a social process.

Intangible assets such as reputation are very much determined by how the actions of the company intersect with the priorities of its stakeholders. As such, it is necessary to involve those stakeholders in order to identify measures for performance that matter with respect to customer loyalty, reputational risk/premium, or market access. In its role as a global, multi-stakeholder body, the GRI has been working to fill these gaps. We will specifically address direct linkages between GRI reporting and financial reporting standards during the current guidelines revisions process (2004–2006). The combination of better analytical methods and rising stakeholder demands for richer disclosure is likely to continue this movement toward a new generation of performance reporting. As this critical mass continues to grow, several outcomes related to reporting can be expected: •

Investors and analysts will begin to have access to comparable information.



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Companies will begin to better understand their environmental impacts and make improve-

For More Information on the GRI’s Sustainability Reporting Guidelines

ments in both performance and reporting. As GRI-based reporting becomes the industry standard, reporting with consistent metrics

For more information on the GRI Sustainability Reporting Guidelines, see the GRI Web site at

will begin to spread through business sectors and supply chains. Sustainability reporting will remain useful for investors into the future and will likely become more important over time as sustainabilityrelated pressures continue to reshape market conditions. Eventually, companies’ annual reports may evolve into “total performance reports” that capture all the material factors that affect the prospects of the company and its ability to execute its corporate strategy. One thing is clear, however. Regardless of how standards develop, they will need to take a more sophisticated approach to ensuring that investors have transparent and complete information on corporate performance.

http://www.globalreporting.org/index.asp.

References Austin, D., & Sauer, A. (2002). Changing oil: Emerging environmental risks and shareholder value in the oil and gas industry. Washington, DC: World Resources Institute. Lintstock and Imagination. (2004, February). Added values? Measuring the “value relevance” of sustainability reporting. Liptak, A. (2004, January 29). $4.5 billion award set for spill of Exxon Valdez. New York Times, p. A18, Column 5. Repetto, R., & Austin, D. (2000). Pure profit: Financial implications of environmental performance. Washington, DC: World Resources Institute. US EPA, Office of Planning and Policy Analysis. (2001). Guidance on distributing the “Notice of SEC Registrants’ Duty to Disclose Environmental Legal Proceedings” in EPA administrative enforcement actions.

Note 1. As used throughout this article, the term sustainability reporting is meant to be interchangeable with similar terms such as triple bottom line reporting and corporate responsibility reporting.

Alyson Slater has an extensive background in sustainability issues and international multi-stakeholder work. In 2003, she joined the GRI Secretariat, where she currently serves as associate director. Prior to relocating to Amsterdam, Ms. Slater spent several years with the interim secretariat in Boston, where she contributed to the communications program and managed the GRI’s HIV/AIDS resource document development process based in South Africa. She also spent a year in Geneva as communications assistant at the World Business Council for Sustainable Development (WBCSD). Ms. Slater holds degrees from McGill University and the University of British Columbia, both located in Canada, her home country. Sean Gilbert is responsible for developing the GRI framework (guidelines, supplements, and protocols), including the facilitation of working group processes. He has an extensive background working with business environmental issues and regional experience working in Asia. From 1995–2000, he worked as a consultant in Taipei, Taiwan, for Bayshore Pacific Environmental Business Services and later with its partner company, Strategic Analysis Asia. His work included assessing business approaches to environmental management, analyzing policy trends, and conducting market research for environmental technologies and the chemicals sector. During this time, he also worked with the American Chamber of Commerce Environmental Committee, including serving as chair of the committee. Prior to joining the GRI, Mr. Gilbert also worked as an independent consultant to investor, nonprofit, and business organizations on issues related to sustainability performance measurement. He is from New York.

