Finance

Sustainability reporting and "conscious capitalism"

As demand grows for more corporate accountability and transparency, are companies finally moving away from a solely profit-driven approach to business?
Environmental activists protest against the World Bank\'s participation at the 2010 U.N. climate .../ Credits: Reuters
In 1970, Nobel prize-winning economist Milton Friedman delivered an influential treatise to the New York Times Magazine titled 'The Social Responsibility of Business is to Increase its Profits'. Friedman’s position was that a company’s only obligation to society is “to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” The corporate world agreed, and this became the predominant narrative of business and free-enterprise capitalism in the United States and elsewhere.

Forty-three years later, Friedman’s words may ring hollow in view of the problems confronting the modern world. Climate change, human rights abuses, and habitat destruction are just a few of the issues that have been demonstrably aggravated by business activity, even when operating within the law.

A single-minded focus on profit is now arguably a direct threat to business, potentially resulting in the squandering of resources needed to produce goods and services, as well as alienating customers and damaging the communities corporations operate in. The financial crisis and innumerable corporate scandals have soured public opinion and crippled customer trust – a vital commodity for organizations in an age when a single negative Tweet can create a PR disaster and real financial consequences.
Edelman, the world’s largest PR agency, recently released its annual Trust Barometer survey results. It reported that financial performance is becoming a less important factor in earning customer’s trust, whereas the importance of how business behaves is growing. Edelman’s President and CEO, Richard Edelman, explained:

“Running a profitable business and having top-rated leadership no longer, alone, build long-term trust… Business must … [serve] the needs of shareholders and broader stakeholders by being profitable and acting as a positive force in society.”

In his recent book 'Conscious Capitalism', Whole Foods CEO John Mackey makes the case for the expanded role business must play. Far from creating more problems in society, business has the potential to solve problems, Mackey says – but for that to happen, the old narrative of business described by Friedman must change. “Free enterprise capitalism must be grounded in an ethical system based on value creation for all stakeholders,” Mackey argues. “Money is one measure of value, but it is not the only one.”

Some argue that not only can business create change, it must: with governments worldwide saddled with debt and mired in political gridlock, business may be one of the last sectors of society with the power to address our most pressing problems.
The corporate world has slowly begun to undergo an ideological shift, perhaps most visibly reflected in the rise of “sustainable business”. Initially dismissed by some critics as merely a buzzword, “sustainability” was first officially defined by the United Nations’ Brundtland Commission in 1987 as “meeting the needs of the present without compromising the ability of future generations to meet their own needs.”

Sustainable business is now often described as focusing on the “triple bottom line”, an idea introduced in 2009 by British sustainability proponent John Elkington, which is a focus on the combination of profit, people, and planet, with the goal of limiting or eliminating the negative impacts of business on the environment and society.

Comprehensive frameworks have been developed that enable organizations to formally measure and report on their sustainability initiatives; building on the triple bottom line principle, sustainability reporting is now typically focused on measuring performance in three areas: environmental, social and governance (ESG).

As the Financial Times explains, ESG is also now a generic term used in the investment industry to describe the performance of both companies and investment portfolios on environmental, social and governance criteria. This analysis can be used to gain insight into a company’s long-term prospects and future financial performance, as well as identify new market opportunities.

The most widely accepted sustainability reporting framework was developed by the Global Reporting Initiative (GRI), a nonprofit network-based organization claiming participation from 30,000 researchers, business leaders and industry experts and strategic partnerships with the United Nations Environment Programme, the UN Global Compact and the Organization for Economic Cooperation and Development (OECD).

According to the GRI, nearly 5,000 organizations worldwide use its sustainability reporting framework, which was developed in collaboration with partners, including businesses, within its global network. GRI claims that the increased transparency and accountability builds stakeholders’ trust, and following a similar framework makes the reporting exercise more broadly useful and consistent across different companies and industries.

In December 2012, the U.S.-based Governance & Accountability Institute, Inc. (G&A) released a report asking the question, “Corporate Responsibility / ESG / Sustainability / Responsibility Reporting: Does It Matter?” The answer appears to be “yes”: in a financial performance analysis of S&P 500® companies, G&A research showed that over the long term, companies that manage sustainability and ESG initiatives and report on their progress “tend to perform better in the capital markets, and appear to be given a premium by investors.”
Outside of the U.S., the reporting trend has steadily gained traction over the last several years, particularly in Europe; one example is the development of the German Sustainability Code (GSC). 

Introduced in 2011 and developed in collaboration with over 300 representatives from German business and industry, the GSC was to some extent a shrewd effort by business to beat regulators to the punch, as the European Commission has for several years been discussing the possibility of introducing EU-wide regulations on corporate social responsibility and sustainability.

Emphasizing voluntary participation and its 'comply or explain' approach, the GSC describes ESG along 20 criteria with up to two key performance indicators each. Participating companies are expected to publish a standardized 'Declaration of Conformity' that discloses how it has measured and monitored its sustainability activities and to what extent it adheres to the standards set forth in the GSC. No official certification is offered, but to increase credibility organizations can opt for third-party verification or 'limited assurance' via auditors or NGOs.

The German Sustainability Council, which oversaw development of the code, emphasizes that the code is based on the most important reporting indicators from a variety of mechanisms, thereby making it more concise and effective than other frameworks. The GSC now has almost 40 participating companies across all business sectors, and the support of the German government – Chancellor Angela Merkel lauded the initiative and urged more companies to apply the code. 
However, not everyone is convinced of the value of the GSC, or of sustainability reporting in general. In the testing phase of the GSC, companies cited a lack of added value as one of the primary barriers to implementation; it was also noted that smaller and medium-sized companies would have difficulties in meeting the GSC’s high reporting standards.

More broadly, critics of international reporting initiatives like the GRI have complained that the framework is too complicated, the information it requires is too difficult and time-consuming to obtain, and that companies can abuse the system by using it to disguise or excuse poor financial performance.

On the other hand, NGOs and sustainability organizations caution that sustainability reporting does not mean the reports contain good news; in other words, good sustainability reporters aren’t necessarily good sustainability performers. Some argue that only the rule of law can ensure good corporate behavior.

For consumers and advocates of ethical business, however, the rise of sustainability reporting would seem to be a clear harbinger of positive change. While it remains to be seen what role regulation will play, for now businesses seem to be willing to engage in self-regulation and have begun to openly acknowledge the importance of social responsibility and accountability – perhaps putting Milton Friedman’s vision of capitalism aside for good, and venturing into broader definitions of responsibility and success.


Search for related articles