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E-MailRichard Barker is Professor of Accounting and Robert G. Eccles is Visiting Professor of Management Practice at the Saïd Business School at the University of Oxford. This post is based on their recent paper.
We have written a paper by this title whose goal is to contribute, in a neutral way, to a conversation that has been going on for some time amongst a variety of actors, concerning whether mandatory reporting standards are a prerequisite for effective “sustainability” or “nonfinancial” corporate reporting. Specifically, we ask whether the existing standard-setting regime for financial reporting—that of the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)—should be extended to include setting standards for nonfinancial information. This paper was background reading for a live debate (transcript) held at The Oxford Union on December 11, 2018 between teams in Proposition and Opposition to the motion “This House believes that corporate sustainability reporting should be mandated, and standardised by FASB and IASB, for it to be most useful for investors.” Our work was informed by interviews we did with 50 experts in this field (listed in the Appendix of the paper). We are grateful to them for taking the time to share their views with us.
We focus on the arguments for and against FASB and IASB setting standards for nonfinancial information. How this might happen would be different in each situation, but our question is whether it is these bodies (and their associated foundations) that should be given this responsibility. It is possible that there are institutional solutions to this problem other than FASB and IASB, but that is beyond the scope of our paper. If the political decision is made that only a regulatory solution can create standards, FASB and IASB are the obvious places to start, because they are the “monopoly” providers of corporate financial reporting standards. Our question is whether or not that political decision should be made.
As a consequence, we are focused on the nonfinancial information needs of investors, since this is whose information needs FASB and the IASB exist to serve. We define “nonfinancial information” as information that is not recognised in the financial statements but is nevertheless useful in investors’ decision-making. Such information can be either quantitative or qualitative, and either historical or forecast.
There are, of course, stakeholders other than investors who have a great interest in nonfinancial information but for a different purpose. This is particularly true for environmental, social and governance (ESG) information, a subset of nonfinancial information. An obvious example is corporate reporting with respect to climate change, where information on carbon emissions might be directly relevant to investors, for the purpose of evaluating the economic sustainability of the reporting entity’s business model, yet also relevant, for different purposes, for stakeholders such as government and environmental NGOs.
We are focused on ESG information for five reasons:
- There is a growing demand in the investment community for relevant and reliable ESG information for making investment decisions.
- The investment community feels that its current sources of ESG information, whether by companies or from ESG data vendors is inadequate.
- ESG provides a common theme in all of the major institutional initiatives that are designed to address nonfinancial reporting. The same cannot be said for intellectual capital, nor for any other aspect of nonfinancial reporting. ESG therefore provides a natural focus for an overall evaluation of the corporate reporting landscape.
- There is a considerable body of work relating to ESG reporting in corporate practice, reporting frameworks, academic research, and so on. An ESG focus allows us to draw upon this body of work.
- A reasonable presumption is that the “right” institutional structure for setting ESG standards would also be appropriate for other aspects of nonfinancial information. While maintaining a narrow ESG focus in our paper has the benefit of reducing complexity, it most likely does not reduce the generalizability of our arguments.
There are five reasons which suggest that FASB and the IASB should set standards for nonfinancial information:
- FASB and IASB each have an infrastructure and staff of highly skilled professionals, and a long track record of expertise in standard setting, including the process for getting input from all relevant stakeholders, drafting and re-drafting official positions, and publishing and disseminating authoritative documents (which, in the case of IASB, includes a formal process of translation into multiple languages). Both also have relatively secure sources of funding, coupled with widespread acceptance that maintaining such funding is important for the ongoing effective functioning of capital markets.
- FASB and IASB also each have well-established governance structures for overseeing their work, coupled with a high level of credibility in the investment community.
- The unambiguous materiality perspective for FASB and IASB is that of the investment community, which aligns with the scope of nonfinancial information as defined in our paper.
- FASB and IASB also each have credibility in the corporate community. With respect to financial reporting, there is absolute clarity within the corporate sector about the standards that are applied by all companies in such a way that is perceived to help create a level playing field. In contrast, there is no unambiguous and accepted authority with respect to nonfinancial reporting, and instead there is a confusing and costly plethora of disclosure burdens for companies.
- The natural focus for both FASB and IASB would be on integrating nonfinancial information into mainstream corporate reporting, and into existing security market filings. This would most likely also imply an emphasis on how financial and nonfinancial information should be integrated with each other, thereby enhancing the usefulness of both.
At the same time, there are three reasons why they are not the appropriate bodies for doing so:
- At present, the necessary preconditions might not exist for regulatory standard setting to be effective. At current levels of knowledge, many material ESG issues are difficult to quantify, and so do not lend themselves to standardisation. This may be in part because conditions remain at the “experimentation” phase. It is arguably difficult, and perhaps too soon, to “pick a winner” among the many NGOs working to develop standards for nonfinancial information, and so the natural foundation for standardisation may not yet be in place.
- It is not obviously the case that expertise in setting financial accounting standards “translates” into a corresponding capacity to set nonfinancial standards; indeed, it is possible that an excessive anchoring in the financial might actually be detrimental. Material nonfinancial information is commonly entity- and location-specific, while financial data are instead inherently amenable to aggregation and to similarity of treatment across different organisations. It is accordingly possible that a different mindset is called for in setting nonfinancial standards.
- Finally, there are practical concerns over assigning responsibility for nonfinancial standards to FASB and IASB. It is questionable, for example, whether nonfinancial is within their remit, and whether political support and funding could realistically be found to extend the scope of activity. It might also be that, at least in their current respective states of evolution, the financial and nonfinancial worlds are just so different that they call for a fundamentally different institutional approach.
In conclusion, while we firmly believe that there is a need for better nonfinancial reporting, we have yet taken a position on how such a need should be met. We will be expressing our view in a planned “White Paper” which will be heavily informed by the debate at The Oxford Union.
The complete paper is available here.
