Cash Flow

The Value of Sustainability

A group of companies is trying out a new reporting framework that integrates financial and sustainability data.
Kathy HoffelderNovember 15, 2012

Clorox, Microsoft, and Coca-Cola are among more than 80 corporations testing out an integrated financial reporting framework that combines tangible financial results with environmental, social, and governance (ESG) factors.

Unlike more traditional sustainability reporting initiatives, integrated reporting seeks to go beyond how “green” a company is by factoring in the costs and benefits of that sustainability. This model requires companies to report all material information, not just the data that typically appears in financial statements. As an example, under this framework, a company would report its environmental goals and metrics, such as its water and energy use.

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Very few companies currently use an integrated-reporting style, says Julie Fox Gorte, senior vice president for sustainable investing at PAX World Management, one of 20 institutional investors helping to shape the framework. Many companies, for instance, do not alert investors if their business is fined for violating the Clean Air Act or is responsible for a Superfund site, which could cost millions of dollars to clean up, Gorte says.

The framework’s pilot program, which began last year under the supervision of the International Integrated Reporting Council (IIRC), a consortium of corporations, investors, and regulators, is sparking interest among companies. Most of the organizations involved are European, although some are based in the United States, Asia, and Latin America. The IIRC is slated to issue a prototype framework soon, followed by an exposure draft in 2013.

A Comprehensive Approach
The IIRC believes that investors need information about the nonfinancial and intangible factors that help companies generate value, factors that are not currently accounted for in financial statements. A more comprehensive approach to reporting would help investors determine a firm’s ability to generate future cash flows, says Ian Ball, CEO 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 says.

Ball compares the gap in using integrated reporting to the dearth of information currently available about companies’ intangible assets. (According to Ocean Tomo, a specialist in valuing intellectual property, nearly 80% of the market value of the S&P 500 could be attributed to intangible assets that are not reported on the balance sheet.) Having data on both intangible assets and ESG factors is key to making informed investing decisions, Ball contends.

To maintain needed flexibility, the IIRC is presenting a framework for integrated reporting, not a formal set of rules. Mary Falconer, group controller of Vancity, Canada’s largest credit union and one of the corporations testing the framework, says integrated reporting “by definition is going to be unique to every single organization.”

While integrated reporting has begun to gain traction among a range of corporations, firms that take sustainability seriously are leading the charge. Edelman, a public-relations agency taking part in the program, fully backs the framework. The firm joined the pilot program because its executives felt that it was important to “walk the talk” that Edelman dishes out to its clients, says Michael Holland, the firm’s executive vice president and group head of business and social purpose.

Clorox, another participant, is focused on using its integrated-reporting style for all of its products, striving to increase transparency with its policies and product ingredients. While the company supports the IIRC project, it is still in the initial stages of moving toward such reporting, according to a Clorox spokesperson.

Behind the Curve
Still, many CFOs and other senior executives are lax about reporting ESG factors, says Gorte. Indeed, sustainability reporting has not yet penetrated the corporate world widely or deeply. To be sure, corporate ESG activity “has become more mainstream in the last two decades,” but it has not trickled down to many smaller companies, adds Gorte. “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, says Mike Krzus, a senior adviser to Edelman and a former Grant Thornton partner. “Having the CFO involved in 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 says.

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 produce an integrated report, or explain why it hasn’t. European countries are not as far along as South Africa in adopting integrated reporting, but they are far more advanced than the United States.

Still, some U.S. efforts are notable. In June, Nasdaq OMX Group, along with stock exchanges in Johannesburg, Sao Paulo, Istanbul, and Cairo, signed up 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.

Five Principles

In a 2011 discussion paper, the International Integrated Reporting Council proposed the following guiding principles for preparing an integrated report:

• Strategic focus. An integrated report provides insight into the organization’s strategic objectives, and how those objectives relate to its ability to create and sustain value over time and the resources and relationships on which the organization depends.

• Connectivity of information. An integrated report shows the connections between the different components of the organization’s business model, external factors that affect the organization, and the various resources and relationships on which the organization and its performance depend.

• Future orientation. An integrated report includes management’s expectations about the future, as well as other information to help report users understand and assess the organization’s prospects and the uncertainties it faces.

• Responsiveness and stakeholder inclusiveness. An integrated report provides insight into the organization’s relationships with its key stakeholders and how and to what extent the organization understands, takes into account, and responds to their needs.

• Conciseness, reliability, and materiality. An integrated report provides concise, reliable information that is material to assessing the organization’s ability to create and sustain value in the short, medium, and long term.