Being a public company requires being, well, public. The burden of reporting is such that most companies tell you only what they have to. Voluntary reporting — on anything — requires a good deal of pressure from stakeholders. Most companies still don’t adequately report on measures that address environmental, social, and governance issues (ESG). The argument against better reporting relies on a cost-benefit analysis from the shareholder point of view.
A broader stakeholder perspective would lead most companies to conclude that detailed disclosure of ESG metrics is valuable. Adoption of Global Reporting Initiative (GRI) standards would provide stakeholders most of the information needed to evaluate the social impact of a business.
The False Premise
Studies find mixed results on the value of Corporate Social Responsibility (CSR) reporting. Miralles-Quiros et al. (2017) examine several European countries and show that the value of CSR reporting differs across countries and time periods. But the conclusion of this study and others in this area of research rely upon a particular valuation model. The model states that the market value of a company is related to its book value, accounting earnings, and non-financial information (like social responsibility disclosure).
Added disclosure reduces uncertainty and enhances value according to this view. CSR reports only have value to investors if a positive relationship can be established between the presence of CSR disclosures and the market value of a firm’s equity. However, this ignores the fact that additional information can have a negative impact on perceived value. A negative relationship, or absence of any relationship between a company’s CSR disclosure and it’s stock price is just that — not evidence that CSR reporting is worthless.
Sure, CSR reports have an overly positive bent due to their voluntary nature. But ongoing pressure from shareholders and advocacy groups has led to increased adoption of GRI standards. Most disclosures are still incomplete. As companies report more complete Scope 3 carbon emissions, for example, it is inevitable that negative surprises will occur that hurt the value of certain companies. This information is valuable to shareholders — even if the truth hurts.
It’s Not All About You (the Shareholder)
The irony of the research on the value of CSR reporting is that it evaluates its importance solely from the perspective of shareholders! The absence of proof that additional non-financial disclosures help boost share prices is practically an indictment. It neglects the ability to use CSR reporting to value the social costs and benefits of business operations.
More reporting does have a cost. The better question to ask is whether the push for social responsibility reporting is worth the expense. One way to look at this is by comparison to the costs imposed by the Sarbanes-Oxley Act. The Act requires U.S. companies to assess internal financial controls annually and have that procedure audited by a third party. It created an enormous outcry when it first took effect for large businesses in 2004.
Fifteen years later, you hear a lot less about Sarbanes-Oxley compliance costs. A survey from consulting firm Protiviti suggests that even the biggest companies spend an average of less than $2 million internally each year meeting the law’s requirements. This doesn’t include the added external auditing costs. But Jia et al. (2014) peg the increase at only 5% of auditing fees after aspects of the law were relaxed after 2007.
A $2 million annual hit to a multi-billion dollar enterprise does not harm the shareholders of the largest public companies. Sarbanes-Oxley compliance can be punitive for smaller businesses. At what point does the cost of Sarbanes-Oxley compliance become too burdensome?
The SEC exempts companies with market capitalization under $75 million from the need for audits of their internal controls. For these companies, their annual internal compliance costs are under $1 million, on average. Companies of this size make up a very small percentage of the portfolios of most investors.
If relatively small companies can handle Sarbanes-Oxley, I would argue they can also absorb the cost of social responsibility reporting using the GRI standards. Start with my premise that one extra dollar earned by the lowest income households is equal in utility to $20-$80 earned by the typical stock holding household. Those lowest earning households are the ones that bear the brunt of social costs imposed by corporate activity. If I value them like the SEC does shareholders, social responsibility reporting should be imposed on virtually all companies.
And this conclusion implicitly assumes meeting GRI reporting standards costs as much as Sarbanes-Oxley compliance! We don’t know the typical cost of CSR reporting, though it’s fair to assume it’s a good deal less than the requirements of Sarbanes-Oxley. The cost of verification services offered by GRI run well below six-figures.
GRI or Die
The world wants four things — reduced inequality, sustainable economic growth while achieving sustainable use of resources, healthy lives, and effective government. Every company needs to provide evidence that its existence contributes to those goals. Compliance with GRI standards is a great place to start.