Evaluating Company Sustainability Performance
In today’s business environment, there has emerged an unprecedented expectation on companies to provide explicit information on their performance across the triple bottom line or what is more common terminology today, ESG (environmental, social and governance). Consumers, employees, investors, civil society, government, and the media are increasingly interested in knowing how companies shape up when it comes to things like resolving social issues, reversing environmental degrading, and stemming unethical practices in their supply chain.
In response, many companies now publish Sustainability Reports (also called Corporate Social Responsibility Reports or Corporate Citizenship Reports) or reveal comprehensive information on their website that, in theory, set out to mimic the highly institutionalized and reliable financial statements by presenting their performance along non-financial indicators.
In the last decade alone, the number of companies listed on the S&P 500 index publishing sustainability (or ESG) reports increased from 47 percent in 2005 to 92 percent in 2015. According to KPMG, whereas only 25 percent of the top 250 companies reported on sustainability in 1999, 96 percent of these companies report on sustainability as of 2019. The increase has been truly unprecedented. By region, sustainability reporting has increased dramatically in the Americas with 90 percent of companies reporting while 84 percent of companies report on sustainability in the Asia Pacific region, an 80 percent increase from 2011. KPMG concludes that sustainability reporting “is now undeniably a mainstream business practice worldwide, with 80 percent of the top 100 companies across 41 countries reporting on sustainability. Whereas only 39 percent of the top 100 companies connected their business activity to the United Nations Sustainable Development Goals (SDGs), 69 percent have done so in 2020. Major gains in connecting business activity to SDGs were seen by the automotive and oil and gas sectors with increases of 38 and 39 percentage points respectively (i). The International Council on Mining and Minerals mandates the completion of GRI reports (sustainability/ESG measuring) for all member companies as a condition of their membership.
Deloitte points to six key drivers of sustainability or ESG reporting. The first was that reporting mitigates regulatory risks and secures a social license to operate. The second is that it cultivates positive brand recognition. The third is that it attracts, engages and retains high level talent in the organization. The third is that it taps into new financial instruments that are linked to sustainability performance. The fifth is that it improves operational efficiency and reduces costs. The last is that in provides opportunities for innovation and differentiated business models(ii).
But the growth of sustainability/ESG reporting has been met with an onslaught of criticism by anti-corporate groups and civil society organizations who claim that companies are using these reports to green wash (or rainbow wash) what is otherwise business as usual, thereby disguising their destructive behaviour. Some of these criticisms are not necessarily unfounded. Studies have also shown that despite a significant increase in reporting on environmental, social, and governance practices by companies, global measures of issues associated with these dimensions (e.g EDI, poverty, climate change) have in fact worsened. A quick look on the first few pages of mainstream sustainability reports and the reader will be bombarded with large high gloss pictures of the rural poor, for example, smiling ear to ear for all the wonderful things the company has done for them or of green pastures fronted by a farmer and his/her partner with seemingly content pigs and cows enjoying life as they collectively watch the beautiful sunset.
Yet these same companies find themselves on the front pages charged with complicity in major social, ecological, and governance issues like the death of over 1100 people in the 2011 collapsed Bangladeshi garment factory (Loblaw, Wal-Mart), the breach of consumer privacy through a tracking app (Tim Horton's), the mistreatment of animals revealed through undercover videos (Tyson Foods), the contamination of natural ecosystems (DuPont), the laundering of money for terrorist groups (HSBC), or the rigging of centralized interest rates by inflating or deflating their own rates to profit from trades (major banks). If you look at the sustainability reports of the companies associated with these charges, you’ll find a completely different story, one that conveys the firm as a beacon for corporate responsibility.
Part of what explains this confusion is that we are no where near the level of standardization of non-financial metrics as we are with traditional financial metrics. This has led to a smorgasbord of ESG or sustainability standards that are often developed with greenwashing in mind. Even the more objective standards are highly fragmented. For instance, the Sustainable Development Goals provides a framework of 17 ESG topics from human rights to anti-corruption to climate change, the United Nations Global Compact has 10 Principles businesses must adhere to for membership in this easily accessible club, and the Global Reporting Initiative provides dozens of metrics that companies must complete to have the right to claim that they are GRI compliant. Add to this dozens of other standards that ultimately leads to companies picking and choosing those standards that give the impression that they are leaders in responsible business. It's no surprise then that company after company claims that they have "embedded sustainability" when the reality is far from the truth.
With these inherent contradictions growing in number, there is a widespread need across multiple stakeholders to effectively evaluate sustainability to see whether the claims embodied in the report or on their website are in fact testament to their commitment to sustainability. How does an analyst distinguish rhetoric from reality when assessing whether a company is prepared for increased environmental regulation? How can the consumer figure out which sustainability report is in fact a reflection of a serious commitment to sustainability rather than greenwashing? How can an investor, concerned about the risk associated with investing in a firm that overlooks social and ecological externalities, figure out which sustainability reporting firm is more or less risky? And how would an NGO know which firm is legitimately addressing issues? In the absence of available information, all of these stakeholders want to know how to objectively evaluate a company’s adoption level of sustainability using the information provided in the report.
This feels like a daunting challenge considering the millions of dollars allocated to marketing and brand development that include reporting tactics meant to convince the reader that their commitment to sustainability is genuine. What is more, unlike the institutionalized nature of financial statements that multiple stakeholders can rely on as a means of comparison, there is virtually no legitimate and substantive equivalent for non-financial indicators. There are currently up to three dozen reporting platforms companies can pick and choose, many of which have conflicting measures. While there is growing commitment to the Global Reporting Initiative – a standard set of non-financial measures companies agree to provide to be a member – and SASB (Sustainability Accounting Standards Board) these measures are regularly criticized because they are self-reported and require no substantive basis upon which to demonstrate authenticity in the commitment to sustainability. For instance, one of the required measures under the social dimension is to indicate whether the company provides employees with training on human rights. A simple ‘yes’ or ‘no’ question means that the company is not obliged to indicate the content of the training, how long it lasts, whether it was provided by professional independent bodies and, perhaps most importantly, whether there is any enforcement of employee behaviour based on this training.
Despite these challenges, a growing repository of tools is emerging to assist readers in conducting evaluations of companies along non-financial indicators. Introduced here are four such criteria one can consider when reading about a company's commitment to sustainability. Incidentally, an important and often overlooked consideration across these criteria is to assign as much value to what is missing from the report as to what is in it. Let’s look at the four criteria in more detail:
1. Purpose of Reporting
The reader should begin by trying to uncover the overarching purpose of the report. This is less difficult than it might seem. To simplify, imagine a continuum that reflects the purpose of reporting where on one side the main purpose is for marketing and public relations while on the other side the main purpose is organizational development and change towards sustainability where only what is measured can be managed. These are highly different objectives and there are signals in the report to help the reader position the report on this continuum and simultaneously determine their commitment to sustainability. Let’s consider the first side of the continuum. Most companies still use the report for the purpose of marketing. The company’s objective in this instance is to paint a positive picture of their relationship with society and the environment, oftentimes to deflect any negative publicity they might have received. Signals of this in the report will be obvious, such as the fact that the company doesn’t report on anything negative, doesn’t acknowledge any bad publicity they might have received or, more importantly, on what they are trying to do to rectify issues or criticism they are facing. The reader will also get the impression that much of what they’re presenting in the report has very little to do with their core business. Much of the content will discuss their philanthropic endeavors and charity giving. For instance, a mining company might avoid reporting on its actual relationship with the community but will instead report on the amount of money donated for community causes. Similarly, a bank will disclose how much they have spent on charitable groups but will avoid presenting the extent to which their daily business decisions that can affect these very charitable groups are considering social and ecological issues, such as whether they are curbing the provision of finance to companies with poor environmental records. Analysts must assess whether companies are reporting on issues that are material. Material issues are those that are highly important to society and also relevant to the firm. In the above example, financing fossil fuel companies is a material issue for banks because society perceives climate change to be of major concern and financing is a key part of a bank's business. Contrast this to charitable donations which may be associated with issues that have varying degrees of importance to society but, more importantly, do not have an impact on the bank in any significant way. Beyond philanthropy, companies will often list a myriad of seemingly innovative initiatives without providing solid evidence that these initiatives are interwoven throughout core business operations. Consider an automotive company describing their recyling/take-back program. While an important initiative to respond to the material issue of waste in the sector, unless it is incorporated into the design division of the company or in the communication to consumers at the dealer level, it remains decoupled from the business. With this in mind, readers of ESG information that is on the marketing side of the continuum will perceive an alarming sense of hypocrisy in what is presented. From a stakeholder perspective, the company’s objective in reporting is to appease concerns, to quell criticism, and to defend their behaviour by providing evidence of positive contributions to the groups these stakeholders care about. Fundamentally, like many marketing strategies, the purpose is to divert attention away from relevant social and ecological issues to give investors, consumers and government the impression that the company “can’t be that bad. After all, "look at all the good they are doing”.
On the flip side, companies may also use the report to facilitate organizational change towards greater performance in sustainability. Here companies hold employees and managers accountable by reporting on performance levels across non-financial indicators through a balanced scorecard. Now made public, there is greater pressure by these organizational members to demonstrate improvement. It also sends an important signal to employees that the company is closely monitoring social and ecological performance as a fundamental attribute of their organizational processes. At the extreme, companies would use this report as one of many mechanisms to transition the company where sustainability and ESG is fundamental to its existence. With this in mind, the focus of reporting is less on initiatives and more on the performance along social and ecological dimensions as they relate to the core business of the firm. Readers therefore get the sense that the company is reporting comprehensively. That is, rather than presenting small parts of their business that might be doing well, they are reporting across all dimensions of the business. From a stakeholder perspective, the goal is not to appease stakeholders but instead to engage them. More progressive reports provide detailed accounts of stakeholder interactions, publishing stakeholder input and providing avenues through which stakeholders can get involved in the company’s reporting. Put another way, the purpose is not to report on the past but to facilitate a platform for discussion in the present. A fundamental difference between these two objectives is that the second is using this report as a mechanism for change, to hold those in decision-making authority accountable for these issues by explicitly reporting them.
2. Metrics and Performance
The second criterion used to evaluate a sustainability report is perhaps the most intuitive of the four. It asks what the company is measuring and how well they are performing on these measurements. Again, we can use a continuum to understand the disparity in reporting practices. On the one hand, companies with poor reporting provide stories and anecdotes while listing the many awards they have received related to social and environmental performance. Importantly, these stories and anecdotes are just that – they are not representative of the performance of the firm more broadly. The reporting will be full of ‘feel-good statements’ as proxies for performance levels. If the company on this end of the continuum did use measures, they would be very vague and ad hoc, likely customized in such a way that they can demonstrate positive performance. For instance, a product’s environmental footprint encompasses a wide range of components including its carbon footprint, water footprint, materials footprint, among others. But companies may choose to only report on those components of the environmental footprint that improved while omitting others. At the same time, measures they are using for one of these footprint components are not provided within any context. For instance, a company may indicate that its water usage has decreased by 2,000,000 litres or its carbon footprint has been reduced by 25%. In the first instance, there is no reference point to gauge how much of a drop this represents. For the second, without the use of a benchmark such as sales or number of employees, both of which are common proxies for company size, this percentage drop is meaningless. Omitting this information leaves open the possibility that the company got smaller by 30%, indicating that its carbon footprint as a percentage of dollars sold or employees actually increased. Similarly, companies often fail to provide historical performance levels, from which readers can assess performance over time. Perhaps most important is that the measures companies use are not linked to any social or ecological impact. The evidence is quite clear that despite a significant increase in sustainability reporting, social and ecological conditions have worsened. From a company perspective, this is largely because what gets measured doesn't have an impact. As a result, there is little evidence that something of strategic value around ESG is emerging in the firm.
Companies on the other side of the continuum provide readers with a comprehensive snapshot of their performance over long periods of time (or at least when they starting reporting on these items). Highly progressive companies will also provide performance indicators on the entire supply chain rather than on the part of the supply chain the firm controls. Although a more daunting feat, several companies are doing this now to provide readers with the full product life cycle analysis that includes the social and ecological footprint of the raw materials all the way to the disposal of the product. Apple, for instance, provides the ecological footprint of all components and stages of the product’s manufacturing, including those activities done by contractors used to make the product. That said, they are not yet able to include the environmental footprint of second and third tier suppliers with any level of accuracy. More obviously, the reader is easily able to see improvements in the company’s performance over time or, perhaps less ideal, transparency in the areas where they need improvement. Apparel company Patagonia pioneered an initiative that provided consumers with a detailed breakdown on the carbon footprint of their products. Incidentally, their honesty was more important to the consumer than any claims that they had the lowest carbon footprint among competitors. Companies that embed sustainability understand what metrics elicit social and ecological impact and thus incorporate these metrics in-house. For instance, if a key explanation of poverty in marginalized communities was a lack of access to financial services, then a bank's metrics that tracks their commitment to black and indigenous groups, for example, should be based on what percentage of customers fit this profile rather than the standard philanthropic contributions most banks include and measure. Finally, these metrics have line of sight to a balanced scorecard to which key decision-makers are accountable. Once this happens, over time, new competencies around sustainability start to emerge that moves them to an isolated or embedded strategy.
3. Future Commitment and Progress
The third criterion readers should consider when evaluating sustainability reporting is the extent to which the company provides future targets and reports on progress to these targets. Because many companies consider sustainability and ESG reporting as a marketing initiative, readers are often frustrated with a lack of information on what they plan on accomplishing in future years. But even when companies provide future targets and commitments, they are often decoupled from broader planetary and social goals, leaving the targets meaningless. Equally frustrating is when companies provide numerical or qualitative targets but give little or no action plan on how they plan on achieving those targets. Naturally questions of concern emerge such as how executives are going to make sure that these targets are achieved, how are they being worked into their performance evaluation, who is overseeing these targets, what resources have been expended for the achievement of these targets, how will the firm ensure that employees are involved at contributing to these targets, how these targets are connected to planetary boundaries and social goals, and what happens if they don’t meet these targets. With this in mind, targets would need to be incorporated into the existing management systems of the firm through a balanced scorecard. The reader needs to know how and to what extent these targets are incorporated into executive level decision-making. Are these non-financial measures prioritized alongside other traditional employee, manager, director, and VP performance expectations or does it reside exclusively with the CSR manager? These sorts of questions are instrumental and should be laid out in the report because they give the reader some sense of how feasible it will be to achieve these targets.
In addition, the company often fails to provide detailed summarizes of how well they’ve progressed on targets they’ve set in the past, with details on how and why they’ve struggled to meet their targets and what they intend to do to make up for the failure. All of this information is pivotal for any reader to make a sound judgment about whether sustainability is being taken seriously by and in the firm. Oftentimes, employees see progress on non-financial measures in the same sustainability reports read by external stakeholders, meaning that they don’t feel any sense of urgency in the need to achieve these targets in their everyday behaviour. Although this goes without saying, the targets set out by the firm should be stretch targets that demonstrate that the firm is interested in pursuing radical change towards sustainability. Incremental changes, while still improvements, are less demonstrative of a company’s commitment to sustainability than those targets that push the company into thinking of radical ways of operating. That said, the fact that they set targets represents more of a commitment than not revealing any targets at all. But what is really important is that these targets are linked to broader planetary and social goals as determined by independent third party experts. For instance, if nutritionists argue that sugar and salt intake among consumers needs to drop by 50% over the next 5 years, a food and beverage company's target of reducing salt and sugar by 20% in this period is simply insufficient and cannot be taken as a serious commitment to sustainability goals. Similarly, if there is international agreement to reduce carbon emissions by 75% by 2030 based on 2020 levels, a serious commitment by a company would demonstrate an equivalent commitment.
The final criterion relates to the legitimacy of the reporting. The more obvious indicator of this criterion is whether the reporting is audited by an external, objective organization. That said, auditing doesn’t evaluate the performance of the company along non-financial measures, nor does it evaluate the types of measures used. It only verifies that what the company is saying in its reporting is accurate. This is indeed a start no doubt. But measuring the legitimacy of the report goes beyond whether it was audited. The reader needs to ascertain whether the company selected its non-financial measures or whether they got their measures from an established source or is using measures that have become standard by external stakeholders. Too often, readers are fooled by impressive numbers without realizing that the company made up particular measures that allowed them to bend their data in ways that looked good. Consider an oil and gas company’s efforts to report on their community commitment. There are a number of social impact indicators out there along with many qualitative indicators the firm could rely on from independent organizations, however many of them use their own made up measures such as the number of children that have attended a particular school they support or the number of patients served at a hospital they support. For the latter, while having a health facility available is important, there is no indication of whether the community is positively impacted by it partly because it neglects to consider that the increase in patients may not be due to the presence of the facility but instead by the absence of education and preventative measures that are more effectively at improving social welfare.
Low levels of reporting legitimacy are also associated with high level performance indicators that lack the raw data through which readers can follow the trail of how the measure was calculated. Readers of progressive companies are able to verify the claims put forward by companies. Balancing the need for more raw data is an effort to make the report user friendly for the reader. Believe it or not, some reports are so poorly formatted and disorganized that the reader is unable to find critical information within a reasonable amount of time. Legitimacy also represents the extent to which external stakeholders are involved in the creation of the report. Very seldom do companies present data they collected with those critical of their performance. Although some NGOs are hostile, most are very eager to work alongside the company to collect and measure performance levels. Their involvement provides a fundamental source of legitimacy. Finally, as already mentioned, legitimacy stems from the incorporation of reporting measures into the systems, processes, policies, and procedures that already exist in the firm so that it garners as much attention from key decision-makers to those at the front lines as other business activities.
Example: Domino's Pizza
Let's apply the four criterial to Domino's Pizza. Domino's has information on their website that paints an accurate picture of the purpose of their reporting. For instance, Domino's highlights a number of initiatives they skirt around the core health issues related to fast food. While they explain that they do not use fillers, they are quite silent on salt and sugar levels in their products. Most of the reporting highlights all the wonderful things that they are doing in terms of providing consumers choice and distributing a portion of their profit to community needs that are not relevant to the health issues of the industry. The flashy pictures of happy consumers and employees combined with a focus on where they do well, particularly in areas that are not that relevant to the industry's negative externalities suggests that the purpose of their reporting is ultimately to distract readers from the real issues. Put differently, they deny or defend against their role in contributing to negatives externalities of consumer health and environmental issues.
From a metrics perspective, it is worth noting that they provide consumers with nutritional information about their products. This is a very important step. But the reporting is peppered with a lot of feel good statements like, "Challenge ourselves everyday to be the best we can be” and “Helping our neighbours has been a part of our brand character”. Without objective metrics to back this up, it is hard to know where and how to assign accountability for performance. The measures that are provided are incomplete. They measure fillers but do not measure sugar and salt content, particularly as it relates to the difference between added sugar and salt and natural sugar and salt found in their ingredients. For antibiotics, they deny any responsibility to go beyond the minimum regulatory requirement. Finally, with agricultural practices being a significant issue in fast food, Domino's provides no information on how they are measuring their environmental footprint based on the ingredients they are procuring.
There are virtually no targets provided by Domino's. There are no targets on improving nutrition, no action plans, no performance tracking and no perceived accountability associated with achieving those targets. Any mention of future plans appears ambiguous and open to interpretation: “look to always offer best products”. What does this statement mean?
For the final criterion - legitimacy - Domino's is not affiliated with any third party ESG or sustainability standard. There is no external oversight, no certifications and, perhaps most importantly, no evidence of internal accountability associated with non-financial measures.
Based on the above, Domino's employs a classic denial strategy. There is very little acknowledgement of the key issues associated with their industry and their role in these issues. They point to the fact that they are adhering to regulatory standards and openly suggest that they rely on consumer choice to determine their progress on these issues. Finally, their philanthropic endeavors are very much geared towards demonstrating that while their products might not be healthy, they distribute some of their profits to demonstrate their corporate citizenship.
In sum, sustainability reporting among companies is at unprecedented levels. Yet our ability to assess these reports in such a way that we can confidently and objectively determine performance levels to compare firms with one another is very limited. The above four criteria represent a starting point in this direction.
i) KPMG The Time has Come: The KPMG Survey of Sustainability Reporting, 2020. https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/11/the-time-has-come.pdf. Accessed, June 7th, 2021
ii). Deloitte (2020). Sustainability Reporting Strategy: Creating Impact through Transparency. https://www2.deloitte.com/content/dam/Deloitte/my/Documents/risk/my-risk-sustainability-reporting-strategy.pdf. Accessed June 7th, 2021.