Sustainability Disclosure: A Matter of Public Trust

ESG disclosure can build public trust and thereby influence a company’s ability to operate.
Alan Beller and Jean RogersOctober 31, 2016
Sustainability Disclosure: A Matter of Public Trust

Public confidence depends on transparency and trust. And lack of transparency provides the opportunity for obfuscation, deception, and corruption that erodes and ultimately destroys public trust.

Alan Beller

Alan Beller

Unsubstantiated claims and false statements have become an all-too common feature of our political discourse, and the damage to public trust is obvious. The U.S. presidential election, leading to the tumultuous political landscape of 2016, is only the most recent obvious example of the continuing decline of transparency and public trust in the U.S. political system.

Business leaders and stakeholders in business can ensure that business does not fall into the same downward spiral and can indeed take advantage of the current opportunity to lead. As with government, the most valuable asset for business is public trust; the ability of business to operate in its interest and society’s interest depends on it. And as in the case of government, trust in business is engendered by the widest degree of transparency.

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Ironically, while the media unleashes an army of fact-checkers to verify politicians’ every assertion, it’s worth noting that this function has long been built in to the American business infrastructure. Since the Great Depression, federally mandated financial reporting and increasingly rigorous auditing practices for public companies have provided investors with reliable, trustworthy information on corporate performance and condition.

This information has also been available to other stakeholders. These federal accounting and disclosure requirements have become more comprehensive, demanding, and nuanced over the decades. As a result, this financial information has become increasingly valuable.

Jean Rogers

Jean Rogers

However, it also tells an incomplete story. Because more data and thus more information is becoming available to companies — and because investors demand disclosure of some of this additional information, in areas that go beyond purely accounting and financial information — available disclosure is in fact becoming increasingly incomplete.

Moreover, the world of business and the spectrum of information that is important both to a company in its operations and to its investors has changed since disclosure requirements were established in the 1930s and updated since.

For example, in today’s knowledge-driven economy, a company’s ability to succeed relies increasingly on intangible assets — things like patents, processes, brand value, intellectual capital, and customer or supplier relationships. Among the S&P 500, for example, intangibles account for more than 80% of market capitalization.

However, these crucial assets are poorly captured by traditional accounting methods and, in the absence of increased transparency and suitable metrics to aid efficient pricing, their value is especially vulnerable to mismanagement or malfeasance.

Against this backdrop, the U.S. Securities and Exchange Commission has prioritized efforts to improve disclosure effectiveness. While the SEC has been criticized in some quarters for embarking on an effort to reduce disclosure, we interpret this initiative as an effort to improve disclosure — to make existing disclosure more useful, to eliminate duplicative, outdated, or unhelpful disclosure, and to increase or enhance helpful disclosure where warranted.

In a recent request for comments, the commission sought public input on a variety of possible updates to its disclosure rules, including the disclosure of information on “sustainability matters.” These include the environmental and social impacts of business, as well as their governance (collectively known as ESG disclosure) — the same aspects of corporate behavior that can build (or destroy) public trust and thereby influence a company’s ability (including social sufferance, a sort of implicit social license) to operate.

Interestingly, this idea — improved transparency around corporate sustainability performance — has a business as well as a “social” purpose. As per the business axiom, “you can’t manage what you can’t measure.” The right sustainability standards and metrics can help companies understand how to create competitive advantage by mitigating risks, cutting costs, increasing efficiency, and identifying opportunities for innovation.

Many business leaders recognize this. In an Accenture survey of senior executives, 77% of U.S. respondents said they believe that sustainability is “vital to future growth.” Indeed, 88% of them indicated that sustainability expenditures are an investment, not a cost.

Similarly, the positive responses to the SEC by investors, including in particular value-driven investors, calling for increased and improved ESG disclosure suggest a commonality of interest between well-managed companies and value-driven investors for decision-useful ESG information.

How can we identify decision-useful information? The economic principle of comparative advantage states that an entity should focus its efforts on those value-creating activities it is able to perform more efficiently than others can. The subset of sustainability factors that improve financial performance vary at the industry and company level — ranging from safety of clinical trials in the biotech and pharma industries, to privacy issues in technology companies, to energy efficiency in real estate, to fracking in oil and gas.

Therefore, an industry approach is key and would identify factors on an industry basis and then have individual companies assess those factors against their circumstances. A Harvard Business School study found that companies can achieve superior results — including return on sales, sales growth, return on assets, and return on equity, in addition to improved risk-adjusted shareholder returns — by focusing on the subset of sustainability issues most relevant to their industry, as identified, for example, in the Sustainability Accounting Standards Board (SASB) standards.

As 21st century markets are reshaped by resource constraints, climate change, population growth, technological innovation, and globalization, sustainability is poised to be the next competitive frontier. And a focus on sustainability can be a pathway to achieving success and avoiding detrimental strategies and decisions.

To leverage this pathway, we need transparency. In the words of former New York City mayor and Bloomberg CEO Michael Bloomberg, “in the financial markets, transparency serves as an economic engine, by allowing investors to allocate resources more efficiently and productively.”

Public pressure on government to address global challenges is on the increase, but public trust in the ability of government to do so effectively is dwindling. Investors and other stakeholders are fairly looking to business to move forward. With bold action now, we can secure and strengthen the future of our business model. Companies that take up this gauntlet stand to gain a first-mover advantage, and perhaps more.

Alan Beller is senior counsel at Cleary Gottlieb and a member of the Sustainability Accounting Standards Board (SASB). Jean Rogers is CEO and founder of the SASB.