Risk Management

BP’s Spillover Effect

More environmental disclosure is almost a certainty in the wake of the Gulf of Mexico oil spill.
Scott Leibs and Kate O'SullivanJuly 15, 2010

“When you fool with trust, you fool with the capital markets.” So warned Marianne Jennings, a professor of legal and ethical studies at Arizona State University, in a speech at the Institute of Management Accountants’s annual meeting last month. She was referring to the BP oil disaster, but her observation applies to companies from Toyota to Dell to any number of Wall Street banks: when a company missteps egregiously, the impact to its reputation is devastating, and the effect on its cost of capital can be severe.

If there is a silver lining to recent corporate debacles, it may be that companies will now reframe “corporate sustainability” reporting as a genuine risk-management priority rather than a hollow public-relations exercise.

“Sustainability” and “corporate responsibility” are synonymous terms that cover so much ground they can be almost meaningless. Derided by many as “birds and bunnies” reports because they are heavy on imagery and light on substance, sustainability reports are intended to go beyond traditional financial reporting and disclose a range of economic, environmental, and social risks and practices.

In the wake of the BP disaster, it’s a certain bet that regulators and shareholders alike will push for more sustainability disclosure and transparency from companies in all industries. In March, a McKinsey & Co. survey found that more than 50% of executives regard sustainability as “very” or “extremely” important, but less than a third said their companies look for ways to actively embed it into business practices.

Yet companies are beginning to do more than simply publish glossy brochures that tout recycling programs or employee volunteer days. Global companies like Dow Chemical and smaller ones like North Carolina–based Polymer Group have detailed in their most-recent sustainability reports how (and how often) they inform their boards and CFOs about a range of sustainability risks.

Wal-Mart, an ardent sustainability advocate, now requires its suppliers to disclose the environmental impact of their products and factors that data into its decisions on which products get shelf space. Hewlett-Packard traces the minerals used in its products and reports their sources in an effort to avoid purchasing metals mined by participants in armed conflict in the Congo and Rwanda.

Behavior that qualifies as noble today may be mandatory tomorrow. In February, the Securities and Exchange Commission provided interpretive guidance on how public companies should integrate climate-change risks into financial statements. What may hit closer to home are the accounting and SEC rules that require reporting and recognition of environmental contingent liabilities — the potential future costs associated with cleaning up pollution and toxic messes. Companies must set aside cash reserves to pay for environmental damages they are deemed responsible for; that balance-sheet burden can become significant depending on the scope of the problem.

Jeffrey Garten, dean of the Yale School of Management, asserts that for better or worse, more regulations are coming, and quickly. “The probability game is over,” he said recently. “If it can happen — if we can envision it — the government is likely going to want to be sure there is a plan to deal with it. This is not just about offshore drilling. This is about the whole logistical system.”