The skyrocketing demand for information from companies on their environmental, social, and governance (ESG) activities has been among the most interesting corporate phenomena of the last century. By 2021, more than 75% of large US firms had published a standalone ESG report, despite an absence of regulation requiring them to do so.
The growing amount of corporate ESG disclosure — in standalone reports, more nuanced disclosures, conference calls, social media, and less traditional venues — around the globe suggests this information may be of use to various stakeholders, including investors, who are demanding more and better ESG disclosures.
However, the usefulness of these disclosures remains in question, in large part because the lack of regulation and the broad umbrella of topics that falls under ESG means companies can discuss issues that may not be comparable across time (or within industry) or that may be irrelevant to investors but of interest to other stakeholders.
For example, in researching a working paper I coauthored that examines regulated human capital disclosures after the US Securities and Exchange Commission (SEC) required firms to begin discussing this topic in their Form 10-Ks, we found that firms disclosed across nine metrics categories (e.g., workforce diversity, employee turnover, safety), but few disclosed on more than two. Although the variety of disclosures was similar across sectors, no sector reported uniformly on a single metric, or even a single topic.1
This outcome is a result of the principles-based approach to the rule — with the SEC acknowledging it could not even define “human capital” because it expected the definition to vary across firms, and even within the same firm across time. This argument jibes with an article I cowrote in Harvard Business Review that involved asking more than a dozen executives what is meant by “human capital” and receiving a dozen different answers, an outcome that is likely frustrating to investors looking for comparability to make judgements about firms’ strategies.2
The most common metric that firms began disclosing in response to the SEC’s rule change relates to diversity, equity, and inclusion. This is unsurprising for numerous reasons. First, the rule was introduced shortly after the murder of George Floyd, when racial and gender diversity had taken center stage in the media. Second, asset managers like State Street were actively campaigning for firms to release this type of information, believing that diversity data could provide valuable insights into human capital development. Third, firms were already collecting this data through their Equal Employment Opportunity-1 forms, which the US Equal Employment Opportunity Commission requires firms to report confidentially (so the common complaint that developing new disclosures is costly did not hold for this information).
Overall, companies have been incredibly responsive to the rule change. The amount of publicly traded US companies devoting a section of their 10-K to a discussion of human capital increased from 0% to more than 85% in a year.3 This reaction underscores companies’ desire for clearer insights into what ESG information investors want.
In another paper of mine, we found further evidence of companies’ belief that ESG information is valuable to investors. Using advanced machine learning techniques, we examined the content of all ESG reports for S&P 500 firms from 2010 to 2021. Using the Sustainable Accounting Standards Board’s (SASB) industry-level definitions of financially material ESG information, we found that, on average, the amount of material information is 40% higher than the amount of information deemed less relevant to investors.4
The amount of material information in these reports has increased over time, driven by two market forces. First, in the years immediately following the release of SASB standards, firms increased the amount of material information by more than 10%. Second, firms that voluntarily provided feedback to SASB on the standard-setting process had been increasing material information in their ESG reports in the years leading up to SASB’s creation. These findings suggest two important aspects of the current ESG disclosure landscape. First, even without regulation, firms are coalescing around specific types of disclosures on ESG topics. Second, firms believe this information is relevant to investors. Still, firms have unlimited leeway in what, if anything, they choose to disclose, so investors likely are not getting the full picture, especially on topics that might make a firm or its management look bad.
A compelling body of evidence points to the benefits of regulation to shape ESG disclosures in ways that are useful to investors and ESG behaviors in ways that are useful to society. A paper examining the 2014 EU directive that required large companies to publish nonfinancial reports found that those impacted by the directive increased their ESG activities in meaningful ways, and the companies with the weakest ESG disclosures and activities had the greatest improvements.5 Another paper looking at the introduction of mandated ESG reporting in countries in Africa, Asia, and Europe showed that firms disclosed not just more but also better ESG information after the mandate, and the increase in disclosure also led to an increase in firm value.6
Currently, the SEC and European regulators are contemplating sweeping changes to the corporate reporting landscape that would require firms to provide detailed data on their ESG activities. Yet even with evidence of the potential benefits of such mandates, political winds are fickle, and there remains tremendous uncertainty about when, or even if, effective regulation will go into effect.
In This Issue
This issue of Amplify provides insights into how to interpret ESG information in the current environment, what information is needed to make better decisions, and why we need increased disclosure and greater transparency. The articles offer guidance on how to act now and how to prepare for a more regulated future.
In our first article, Alex Saric looks at applying circular economy principles to supply chain emissions. Sustainability goals consistently rank as a top corporate priority, and Scope 3 sources (greenhouse gases produced by external suppliers and customer activities) make up at least 70% of overall emissions for most industries. Saric says companies should leverage data provided by suppliers and third-party data sources to create a verification framework and, with that in hand, look for circular economy methods to reduce emissions.
Next, Cynthia E. Clark focuses on strategies for navigating the climate-related information-disclosure landscape. Clark describes the current status of disclosure regulations in the US and Europe, as well as actions being taken by various stock exchanges. She then delves into strategies for boards of directors, including avoiding greenwashing, staying up to speed on potential regulatory changes, reporting on the risks of transitioning to net zero, and having a dedicated team accountable for ESG reporting to ensure information accuracy.
Following Clark's piece, Rachael R. Doubledee, Matthew Nestler, and Kelley-Frances Fenelon highlight focus group data on the American public’s perception of corporate disclosures and corporate transparency. Spoiler alert: Americans want more accessible, honest disclosures, including confessions about missteps. After showing how low disclosure rates are in America’s largest public companies, the authors go into detail about how business leaders can meaningfully communicate corporate impact on people and communities.
Finally, T. Robert Zochowski and Ryan Daulton argue that most mainstream ESG reporting frameworks don’t capture the ultimate social and environmental effects of corporate activities. They propose an alternative called the Impact-Weight Accounts Product Framework and say data from such an approach shows a close correlation between a company’s product impact and profitability. They conclude that “firms that quickly adopt methodologies that allow them to evaluate alternatives in product design to maximize impact will have a significant advantage over firms that do not.”
We hope this issue of Amplify guides you toward more meaningfully understanding the need for better ESG information disclosure and puts you on the path to improve decision-making in your organization around this important topic.
1 Bourveau, Thomas, Maliha Chowdhury, Anthony Le, and Ethan Rouen. “Human Capital Disclosures.” SSRN, September 2022.
2 Rouen, Ethan, and Marcela Escobari. “Does Your Company Offer Fruitful Careers — Or Dead-End Jobs?” Harvard Business Review, 3 March 2022.
3 Rouen, Ethan, Kunal Sachdeva, and Aaron Yoon. “The Evolution of ESG Reports and the Role of Voluntary Standards.” SSRN, 31 October 2022.
4 Rouen et al. (see 3).
5 Fiechter, Peter, Jörg-Markus Hitz, and Nico Lehmann. “Real Effects of a Widespread CSR Reporting Mandate: Evidence from the European Union’s CSR Directive.” Journal of Accounting Research, Vol. 60, No. 4, September 2022.
6 Ioannou, Ioannis, and George Serafeim. “The Consequences of Mandatory Corporate Sustainability Reporting.” Harvard Business School Research Working Paper No. 11-100, SSRN, 1 May 2017.