Companies reporting on their environmental, social and governance (ESG) initiatives would lead to broad improvement in their socially responsible management practices, according to a new academic research titled “The Consequences of Mandatory Corporate Sustainability Reporting”.
The study reports that after the adoption of mandatory sustainability reporting laws and regulations, the social responsibility of business leaders increases. The study also finds that both sustainable development and employee training become a higher priority for companies, and that corporate governance improves. Furthermore, the companies implement more ethical practices; reduce bribery and corruption; and their managerial credibility increases. These effects are more pronounced for countries with stronger law enforcement and more wide-spread assurance of sustainability reports.
ThinktoSustain.com interacts with the authors of the report – Prof. Ioannis Ioannou from London Business School and Prof. George Serafeim from Harvard Business School – to know about the study’s findings.
There are proponents who believe that ‘mandatory’ corporate sustainability reporting would relegate sustainability reporting to a compliance-seeking practice, where corporate would tend to seek to fulfill a minimum criterion as a ‘symbolic compliance with law’. They argue the case for a ‘voluntary’ reporting practice and to ask companies not reporting on sustainability to ‘explain’ reasons thereof.
ThinktoSustain.com: How do you see the quality of sustainability reporting getting influenced by its ‘mandatory’ or ‘voluntary’ nature?
Georgios Serafeim: Arguments exist in favour of both approaches. Voluntary reporting may allow firms, through disclosure, to signal the quality of and detailed information about their sustainability initiatives. Mandatory reporting, on the other hand, tends to pool all firms together since all firms are required to report. This makes it more difficult for firms that take sustainability seriously, to distinguish themselves from the rest of the pack. Moreover, a race to the bottom effect may develop, with firms making boiler plate disclosures.
However, mandatory reporting has the potential to generate positive country-wide effects by forcing almost all large firms in the economy to report on their sustainability performance. In addition, mandatory reporting has the potential to increase the comparability and credibility of these disclosures.
In our work, we find that mandating sustainability reporting generates significant benefits. Voluntary disclosures, however, produced smaller and, in many times, insignificant effects.
In your report, you have mentioned that in the last decade, a wave of corporate scandals has raised eyebrows on corporate governance. Much of the problems are believed to have been exacerbated by the lack of public information on executive pay, environmental and social impacts of business, on financial restructuring and on managerial practices.
ThinktoSustain.com: In retrospect, how effective mandatory corporate sustainability reporting would have been to fore-warn public or regulators of an impending crisis?
Ioannis Ioannou: Our work suggests that some of the corporate scandals could have been prevented. Mandatory sustainability reporting not only sheds more light on current managerial practices, but in fact in our work, we find that it causes positive changes in such practices due to greater levels of managerial accountability towards the law, and society more broadly. In other words, mandating greater transparency forces firms to take a closer look at their current sustainability and ethical practices before exposing them to the world, and positively affects corporate behaviour towards becoming more sustainable in the long run.
In this sense, mandatory sustainability reporting could have exposed potential inadequacies in such things as ethical codes of conduct, for example, potentially preventing phenomena of unethical or even illegal behaviour by firms.
It is widely believed that “much of companies’ short-term orientation comes from the short-term orientation of investors” (to quote from your report).
ThinktoSustain.com: Did the study seek to understand investors’ behavior towards companies that adopted sustainability reporting (in both cases – mandatorily and voluntarily)? If yes, how did the investors react to the company’s efforts to report on sustainability issues?
Ioannis Ioannou: No, in this study, we haven’t explored investors’ behaviour towards companies that adopted sustainability reporting. However, in a prior related study titled “The Impact of Corporate Social Responsibility on Investment Recommendations”, we investigated the impact of CSR rankings by KLD (in the United States only) on sell-side analysts’ investment recommendations.
In that study, we found that in recent years (post 1997), firms with superior sustainability performance were rewarded with more favourable recommendations by analysts. In fact, the effect was stronger for larger firms, for analysts with longer experience following the focal firm, with broader awareness of sustainability issues or analysts with more research resources available.
Given that prior research suggests that firms with superior sustainability performance are also more likely to issue sustainability reports, our study suggests that superior sustainability performance is positively perceived by the investor community.
In another recent study we have just completed, and which is related to the broader issue of how capital markets perceive and assess sustainability initiatives, we find that firms with superior sustainability performance have better access to finance. In other words, they are able to obtain funds for their strategic projects more easily compared to firms with lower sustainability performance.
Companies reporting on sustainability issues need to bring about a change in their outlook towards mandatory disclosures. It is a challenging task.
ThinktoSustain.com: What are the major challenges faced by companies reporting on sustainability parameters?
Georgios Serafeim: One of the biggest challenges is for a firm to identify which specific sustainability initiatives are linked to the core business. Different stakeholders and different initiatives will be relevant and material for different firms. Corporations would need to focus on the core issues to avoid information overload and the tendency to “green-wash”.
Moreover, companies need to improve the information systems that they have in place for collecting and evaluating sustainability metrics. Because such systems have been traditionally used to collect and disseminate financial information, changes would need to be made in order to accommodate the collection, potential integration and dissemination of non-financial information as well.
Your study included companies from 58 countries that included both developed and developing nations.
ThinktoSustain.com: Out of these, could you identify one country that provides an enabling environment for mandatory corporate sustainability reporting?
Georgios Serafeim: One country that stands out is South Africa. Through the King Report on Governance for South Africa 2009 (King III), South Africa became the first country to require integrated reporting, where companies integrate their financial, social, environmental, and governance performance, of all listed companies in the Johannesburg stock exchange. Companies that do not prepare an integrated report need to explain why. South Africa has a long tradition being a leader in corporate governance and the complex web of social, economic and environmental challenges that the country is facing has pushed regulators to mandate integrated reporting.
Check the following link to read/download the Working Paper based on the research:
About the Authors:
About Ioannis Ioannou
Ioannis Ioannou is an Assistant Professor of Strategy and Entrepreneurship at the London Business School. As an undergraduate at Yale University, he double majored in Economics and Mathematics and graduated magna cum laude. Professor Ioannou holds a Ph.D. in Business Economics, a doctoral degree offered jointly by the Harvard Economics Department and the Harvard Business School, and has specialized in Strategic Management.
Professor Ioannou’s research focuses on sustainability and corporate social responsibility from a strategic perspective. He has written extensively on a range of issues including the relationship between corporate social responsibility and capital markets, as well as the determinants of corporate social performance internationally.
About Georgios Serafeim
George Serafeim is an Assistant Professor of Business Administration in the Accounting and Management Unit of Harvard Business School. Professor Serafeim earned his doctorate in business administration at Harvard Business School, where his dissertation was recognized with the Wyss Award for Excellence in Doctoral Research. He received a master’s degree in accounting and finance from the London School of Economics and Political Science, where he was awarded the Emeritus Professors’ Prize for best academic performance.
Professor Serafeim’s research interests are international, focusing on capital markets and on the economic, social, environmental, and governance performance of firms, and his work has been widely published.
