Investors, financial analysts, and rating agencies around the world are increasingly seeking relevant and trustworthy reports on sustainability performance to help guide their assessments of a company’s value-creation capacity and capability. Therefore, companies that utilize effective internal controls around nonfinancial data will earn greater confidence from key stakeholders and likely earn a value premium relative to their peers.
It is in this spirit that Brad J. Monterio, Jeffrey C. Thomson, and I have coauthored a thought paper, Leveraging the COSO Internal Control—Integrated Framework to Improve Confidence in Sustainability Data. Stated simply, we believe that effective internal controls are good for business and good for society.
Sustainability performance data — often referred to as “nonfinancial,” “balanced scorecard,” “performance dashboard,” “environmental, social, and governance (ESG),” or “integrated reporting” data — continues to increase dramatically in importance as organizations seek to improve their enterprise performance systems and processes. They are doing so to generate sustained value — ethically and responsibly — over the longer term in an increasingly complex and demanding global economy.
In a 2015 CFA Institute survey, 73% of institutional investors indicated they take ESG issues into account in their investment analysis. In a March 2017 State Street study, 92% of institutional investors revealed they want companies to explicitly identify ESG factors that materially impact performance.
Thousands of companies around the world have responded to this investor demand by issuing “sustainability,” “corporate social responsibility,” and “integrated” reports. In some jurisdictions, companies are now required to or are voluntarily providing varying degrees of information on ESG and other sustainability matters in statutory filings.
Yet, additional recent surveys have also revealed a gap in confidence among investors in both the relevance and reliability of the sustainability information reported by companies. In many cases, investors find nonfinancial data to be of lower quality and less actionable than financial information and are concerned it hampers their ability to compare sustainability information and performance within a peer group of companies, let alone across an industry or sector.
Confidence in the accuracy, timeliness and relevance of performance data is critical to effectively managing corporate activities, communicating reliably to the capital markets, and building confidence among stakeholders. In the financial reporting ecosystem, confidence is bolstered in part by the implementation and application of effective, integrated internal controls — controls established using the framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Originally issued in 1992 and refreshed in 2013, the COSO Framework aims to enable “organizations to effectively and efficiently develop and maintain systems of internal control that can enhance the likelihood of achieving the entity’s objectives and adapt to changes in the business and operating environments.”
Today, internal controls developed under the COSO Framework are a critical, core element of financial reporting in the United States and in many other countries. But, as the 2013 update of the framework makes clear, the same principles are intended and designed to apply to other types of information, including nonfinancial data.
The use of effective internal controls around sustainability performance data is not just nice to have; it’s a must-have to enhance confidence in this information in the capital markets. This will not only help companies successfully manage their internal sustainability-related activities, it will also boost confidence among external stakeholders for information — often not captured in financial statements — that is critical to corporate performance and value creation or destruction.
Our new paper outlines how the COSO Framework can be used by organizations to improve confidence in sustainability performance data, adding value for both internal and external decision making. The real-world case studies we offer illustrate how some companies have begun their journey toward more reliable sustainability information through effective internal controls.
We hope the paper serves as a catalyst for dialogue and helps the reporting ecosystem evolve further toward improving confidence in sustainability performance data, ultimately satisfying investors’ need for improved organizational capability, performance, and long-term value creation, strengthening the social “license to operate,” improving the effectiveness of capital markets, and serving the public interest.
As the old axiom says, “What you measure matters.” Implicit in this, in our view, is that information used internally for performance management and accountability, and reported externally to stakeholders, should be accurate and trustworthy. Sound internal controls over the collection, measurement, and disclosure of sustainability information will help achieve those objectives.
Robert H. Herz is a board member of the Sustainability Accounting Standards Board (SASB) Foundation and former chairman of the Financial Accounting Standards Board (FASB).