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What Does Sustainability Really Cost?

Integrated financial reporting, which combines financial reporting with reporting of intangibles and other off-balance-sheet factors, needs CFOs' support, investors say.
Kathleen Hoffelder, CFO.com | US
August 28, 2012

Companies ranging from Clorox to Microsoft to the Coca-Cola Company are among 70 corporations testing the use of an integrated financial reporting model that combines tangible financial results with  environmental, social and governance (ESG)  factors.

Unlike the more widely known efforts of sustainability reporting, integrated reporting seeks to go beyond how "green" a company is by factoring in the costs of that sustainability.

Integrated reporting would require companies to report all material information, not just that which appears in financial statements. Very few companies do that today, says Julie Gorte, senior vice president for sustainable investing at PAX World Management, one of 20 institutional investors helping to shape the framework. "Most companies tell you all kinds of things financially and they tell you what they're supposed to with [corporate] governance," but not much else, she adds.

But in the case, for instance, of "a $100,000 fine for violating the Clean Air Act, an awful lot of companies don't tell you that, or they don't tell you if they have a Superfund site. Those things can cost upwards of $30 million to actually clean up," Gorte notes.   

The program, which began under the supervision of the International Integrated Reporting Council (IIRC) last year, is still sparking interest amongcompanies seeking to sign up to test the reporting model. Most of the organizations in the program are European, along with others from the United States, Asia, and Latin America. The IIRC, a consortium of corporations, investors, and regulators, is slated to issue a prototype framework shortly, followed by an exposure draft in 2013.

The IIRC insists that added material information will make investors a happier group. A more comprehensive approach to reporting would help investors more easily determine a firm's ability to generate future cash flows, says Ian Ball, chief executive officer of the International Federation of Accountants and chair of the IIRC working group for integrated reporting. "Financial reporting on its own isn't any longer telling us enough about a company to really understand its prospects," he adds.

In recent years, about 80% of a company's value was on the balance sheet, which contrasts to about 20% today, notes Ball.  The reversal stems from the burgeoning presence of intangible assets among corporations. "If you're trying to figure out whether a company's worth investing in, you've got to understand the other 80% to understand the company," he adds.  

To maintain a needed flexibility, the IIRC is presenting the model as a framework, not a formal set of rules. Mary Falconer, group controller of Vancouver-based Vancity, Canada's largest credit union and one of the corporations testing the reporting method, says integrated reporting "by definition is going to be unique to every single organization."  

But while the program has begun to gain traction among a range of corporations, it's those companies who take sustainability seriously that are leading the charge for integrated reporting.  

Edelman, a public relations agency taking part in the program, backs the model unequivocally. The company joined the testing group because its executives felt that it was important to "walk the talk" the firm dishes out to its clients, says Michael Holland, executive vice president and group head of business and social purpose at Edelman.

Clorox, another participant, is focusing on how integrated reporting will be used in term of its product lineup. While it supports the IIRC project, it's still in the initial stages of moving towards such reporting, according to a Clorox spokesperson. "We do believe it is important to report holistically," she adds.

But some CFOs and other senior executives are still lax about reporting ESG factors, contends Pax's Gorte, noting that this could hinder those companies' efforts to fully adopt integrated reporting. Most CFOs "are focused on what already is a very challenging job, which is to get the numbers right," she adds.  

Thus, sustainability reporting hasn't penetrated the corporate world very widely or deeply. Even those CFOs who do keep an eye on ESG efforts often tend to separate them from their financial performance, Gorte asserts.

To be sure, corporate ESG activities, which used to be regarded as mere philanthropy "has become more mainstream in the last two decades," she acknowledges. But it hasn't really reached very far down. Large companies do have sustainability reports, but almost no mid- or small- caps do," she says.  

CFO involvement is critical to moving forward with integrated reporting, adds Mike Krzus, a senior advisor to Edelman and a former Grant Thornton partner. "Having the CFO involved or heading up the integrated reporting effort gives it a level of credibility that publicly traded companies may not have found in having separate sustainability groups," he said.


Countries appear to be realizing the value of integrated reporting at different paces. South Africa, for instance, has a formal mandate for integrated reporting. The Johannesburg Stock Exchange requires that a listed company must produce an integrated report, or explain why it hasn't.

European countries, while not as far along as South Africa in adopting integrated reporting, are far more advanced than corporations in the United States. Still, some U.S. efforts are notable. Nasdaq OMX Group last June signed up, along with stock exchanges in Johannesburg, Sao Paulo, Istanbul, and Cairo to begin requiring more material information on ESG operations for listed companies.

Some hope that Nasdaq's move could lay the groundwork for more integrated reporting efforts.

 




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