Corporate Reporting

John C. Wilcox is Chairman of Morrow Sodali. This post is based on a Morrow Sodali memorandum by Mr. Wilcox.

Corporate reporting in today’s environment is like a puzzle whose pieces are spread across the table waiting to be fitted together to form a clear picture. While disclosure rules and audit standards still dictate strict and relatively uniform financial reporting requirements, expectations for big-picture corporate reporting have become more complex and open-ended. This results primarily from the introduction into the company narrative of factors referred to collectively as “ESG” (environmental, social and governance practices) or “sustainability” (the ability to create value over the long term). Corporate reporting about these topics (which are sometimes characterized as “non-financial” or “extra-financial”) is now deemed by institutional investors—and increasingly by issuers—to be essential for an accurate picture of a company’s culture, risk profile, financial health and long-term outlook. While financial reporting at many companies is still largely a compliance exercise, how a company should “tell its story” now opens the door to nearly unlimited possibilities.

Here are some of the factors that are shaping and will continue to shape corporate reporting for the foreseeable future:

  1. Investor demand for more detailed, substantive information about ESG and sustainability will continue to grow. There is no longer any doubt that environmental practices, social policies and corporate governance represent both risks and business opportunities that can have a substantial impact on a company’s financial performance. Recent high-profile corporate scandals have drawn further attention to the risks, confirming the materiality of ESG issues for the analysis of companies’ financial health and sustainability.
  2. Investors, led by global index funds, have adopted stewardship principles and confirmed that their role as fiduciaries requires them to concentrate on the long-term performance of portfolio companies. They are demanding information relating to corporate purpose, corporate culture, human capital management and reputation management for their investment decisions, their oversight of portfolio companies and their proxy voting decisions.
  3. Stakeholders, in addition to shareholders, now define the audience for corporate reporting. Stakeholders are company-specific, generally including customers, employees, suppliers and the communities impacted by the company’s business, including foreign operations. In addition, changes in shareholder demography, new technology and social media are expanding the audiences for corporate reporting, their means of access and their potential impact on the company’s business.
  4. Academics and governance advocates are asking whether traditional financial audit standards are sufficient to present a complete picture of a company’s financial health and risk profile. The outcome of a debate at the Oxford Union in December 2018 supported the resolution that the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) should collaborate with the Sustainability Accounting Standards Board (SASB) to establish ESG reporting standards for corporations. In December 2018, the Australian Accounting Standards Board and the Auditing and Assurance Standards Board published a guidance statement entitled “Climate-Related and Other Emerging Risks Disclosures: Assessing Financial Statement Materiality.” This type of guidance is expected to increase disclosure of the financial implications arising from non-financial risk factors. Over time, audit firms’ decision to either stick with “pure financial reporting” or adopt “broader financial reporting” will have a lasting impact on corporate reporting globally.
  5. Global standard-setting organizations such as SASB and GRI (Global Reporting Initiative) have already developed comprehensive sets of ESG metrics for use by both investors and issuers. In addition to serving as a potential basis for audit standards, the use of standardized ESG metrics allows for greater comparability among companies and industry peers.
  6. The IIRC (International Integrated Reporting Council) is gaining support in countries around the world. Its seven guiding principles read like a framework for effective corporate reporting, with particular focus on stakeholder relationships, materiality and a holistic picture of the business enterprise. South Africa mandates integrated reporting and in Japan and Europe integrated annual reports (strategic reports in the UK) are increasingly common. A few companies in the U.S. also publish integrated annual reports. In addition, the IIRC has convened the Corporate Reporting Dialogue, whose purpose is “to strengthen cooperation, coordination and alignment between key standard setters and framework developers that have a significant international influence on the corporate reporting landscape.”
  7. Regulators around the world are giving more attention to ESG/sustainability disclosure. The European Commission has strengthened the Shareholder Rights Directive and increased pressure on companies to improve the quality of explanations under the voluntary comply-or-explain governance regime. The EC has also issued regulations regarding the reporting of non-financial information. French companies publish specific information about their non-financial performance. In the U.S., a group of academics and investors representing $5 trillion in AUM submitted a petition to the U. S. Securities and Exchange Commission on October 1, 2018 specifically requesting rulemaking on ESG disclosure.

With the corporate reporting puzzle pieces still scattered, issuers in different markets have undertaken a variety of measures to meet investor and stakeholder demand for a more meaningful and complete picture of the business enterprise. Many companies now publish detailed reports on a variety of ESG topics such as Corporate Governance, Social Responsibility, Climate Change, Environmental Practices, Codes of Business Conduct, Strategic Vision and more. Separate reports, however, fall short of the ultimate corporate reporting goal of a narrative that combines and integrates financial performance, strategy, ESG policies and sustainability.

In the US, the proxy statement is often the vehicle for companies to address ESG issues. A number of progressive companies have introduced improved graphics and highly creative methods to make proxy statements more readable, more informative and more concise. Innovations such as the board skills matrix and summaries of complex topics such as executive compensation supplement required disclosures and help reduce reliance on boilerplate. A review of Morrow Sodali clients reveals how the design of corporate proxy statements continues to offer new and creative ways to present information clearly and effectively.

Issuers understand that corporate reporting is fundamental to their relations with shareholders and their preparedness to deal with market challenges. Companies are building internal resources and providing more information on ESG and sustainability. They are also working to increase internal collaboration and coordinate their communication strategies. Companies increasingly recognize that basic IR and shareholder relations activities such as ownership profiling, market surveillance, investor engagement, proxy solicitation, governance road shows, board evaluation and activism preparedness can help them understand both the audiences they serve and the issues they need to address in their corporate reporting.

Conclusion: When the dust settles, corporate reporting that fully incorporates material ESG and sustainability issues will be more detailed, more customized, more company-specific. It will be shaped by materiality standards that depend less on one-size-fits-all regulatory compliance and more on business fundamentals, market conditions and strategic goals. A communication regime that includes fit-for-purpose disclosures will enable each company to tell its own unique story.

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2 Comments

  1. Madelyn Antoncic, Ph
    Posted Sunday, May 12, 2019 at 7:42 pm | Permalink

    In recent years, environmental, social, and governance (or “ESG”) factors have emerged as key signals of risk and return for both financial and nonfinancial organizations. Most notably, investors in global capital markets have demonstrated a rapidly increasing appetite for incorporating key ESG information into their allocation decisions, not the least of which is evidenced by the swelling assets under management, to the tune of US$81 trillion, by signatories to the Principles for Responsible Investment.

    What these investors intuitively understand is that sustainability is the latest point along the continuum of the evolution of risk management which we’ve watched unfold for decades. Since the 1980s, our understanding of risk has become more nuanced—beginning with fundamental credit risk and adding new layers of market, model, operational, reputational, and cybersecurity risk, for example—and it will continue to do so. Sustainability—like reputational risk and others before it—is simply the next step forward.

    Not coincidentally, this trajectory mirrors that of the most pressing global risks identified by the World Economic Forum (WEF) in a recent annual report. Over the past decade, the profile of those risks has gradually shifted from traditional economic considerations toward an emphasis on environmental and social ills that pose significant economic threats

    In such cases, mismanagement of what would traditionally have been considered “non-financial” risks and opportunities can have clear, direct, and significant financial impacts for both companies and their investors. In other words, “non-financial” risks become financial risks—just as in traditional risk management we have seen market risk become counterparty credit risk, which can become liquidity risk, which ultimately and quickly can become fatal for a company.

    SASB is the only organization in the sustainability space which provides a complete set of robust industry-specific ESG standards and metrics, across a wide spectrum of 77 industries and subsectors and a full suite of 26 financially-material risk dimensions — designed to facilitate more effective communication between companies and investors. Companies can use these standards and metric as part of their business strategic planning and decision making processes as well as to measure, manage, mitigate and/or where appropriate eliminate these material ESG related risk exposures; creating value and enhanced financial performance.

    SASB also provides investors with the standards and metrics needed to identify inefficiently priced, residual ESG risks embedded in their portfolios so they can analyze performance across corporations and allocate capital to the best, most efficient users of that capital.

    By providing tools for transparency, SASB incentivizes corporations to become better global citizens leading to more sustainable and inclusive economic growth and development. We believe business is the best agent for change to help enable a transition toward a low-carbon economy. And together, this group of increasingly risk-aware market participants can foster economic growth that is both sustained and sustainable.
    Madelyn Antoncic, PhD
    CEO
    Sustainability Accounting Standards Bopard

  2. Shaun LI
    Posted Sunday, May 12, 2019 at 8:54 pm | Permalink

    I fully agreed but the issue is if corporate reporting turns into an opus or a dictionary, does it lose its initial points?

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