ESG Metrics and Disclosure
The absence of reliable reporting metrics is a considerable obstacle to assessing the degree to which a company invests in stakeholder initiatives and to measuring their effectiveness. A 2020 survey by the National Association of Corporate Directors (NACD) found that lack of uniform disclosure standards was the single greatest challenge directors face in providing oversight of ESG matters. If directors, who have access to nonpublic information, struggle with this challenge, then external observers no doubt struggle even more so.
To increase transparency, some companies are disclosing information about their stakeholder-related initiatives through supplemental reports to their required financial disclosure. Examples include:
Sustainability report—A report that describes the economic, environmental, and social impact of a company’s activities, and describes the link between corporate strategy and sustainable outcomes.
Human capital report—A report that includes qualitative and quantitative information about a company’s workforce, critical skills and expertise requirements, workforce development initiatives, diversity initiatives, training, human resource policies and practices, and trends within the company.
Climate change impact report—A report that enumerates the potential impact of climate change on a company’s governance, strategy, and risk management including metrics and targets to assess and management climate-change risk. These reports are often developed in accordance with the recommended guidelines of the Financial Stability Board Task Force Recommendations (TCFD).44
In addition to these, some companies voluntarily disclose ESG-related initiatives in the annual proxy. The NACD reports that approximately 23 percent of Russell 3000 companies make a statement on sustainability in their proxy statement, 6 percent on human capital management, and 6 percent on climate change.45 ESG disclosure is more prevalent among large corporations. For example, Ernst & Young found that half of the Fortune 100 voluntarily highlight workplace diversity initiatives, and between a quarter and third highlight workplace compensation, culture initiatives, or workplace health and safety initiatives.46 Some companies disclose the use of ESG-related metrics in their executive compensation programs (see the following sidebar).
A lack of rigorous, quantitative, and uniform metrics makes it difficult to assess the quality of stakeholder-related efforts across large samples of companies. Without uniform metrics, companies effectively can choose what variables to report and how to calculate them.
To address this challenge, a nonprofit organization called the Sustainability Accounting Standards Board (SASB) developed a set of standards for companies to make consistent and comparable disclosure about ESG-related issues. These standards are organized into five dimensions: environment, social capital, human capital, business model and innovation, and leadership and governance. Each dimension is further organized into three to seven general-issue categories. Additionally, SASB provides a materiality map to identify the dimensions and general-issue categories that are relevant to each industry. For example, the general-issue category “greenhouse gas emissions” is considered material to the transportation industry but the category “water and wastewater management” is not.51
SASB standards are therefore tailored to each industry and, as a result, a sustainability report compiled by a company in the commercial banking industry would include different metrics from one compiled by the casinos and gaming industry. A commercial bank SASB report includes metrics and disclosure language on financial inclusion through the availability of lending and savings products in underserved communities.52 By contrast, the casino SASB report includes metrics on responsible gaming.53
Despite the similarity of its name to the Financial Accounting Standards Board (FASB) and International Accounting Standards Boards (IASB) that develop the accounting standards used to prepare public financial statements, SASB standards are not officially endorsed by the SEC. As a result, few companies include SASB metrics in their Form 10-K disclosure. Instead, companies that report SASB metrics do so through separate sustainability reports on their website.54
Furthermore, sustainability metrics are generally not audited by a public accounting firm. In some instances, companies will engage independent third-party organizations to certify their report, although the verification procedures of these organizations are not overseen by Public Company Accounting Oversight Board (PBAOC).55 As a result, some shareholder groups are skeptical of the quality of the ESG-related information they receive from companies. PricewaterhouseCoopers found that only 29 percent of investors are confident in the quality of ESG disclosure.56
The research on sustainability reporting is mixed. Christensen, Hail, and Luez (2019) provided a literature review on corporate social responsibility (CSR) reporting. They found that CSR information can benefit capital markets through greater liquidity, lower cost of capital, and better capital allocation. At the same time, CSR disclosure might also be associated with higher litigation risk. The authors found large variations in disclosure (length and quality) across firms, which likely reflect heterogeneity in firms’ business activities, the materiality of CSR to firms’ activities, and the perceived cost and benefits of disclosure. Because most CSR initiatives and disclosure are voluntary, it is difficult to measure the impact of these on performance and valuation. The authors concluded that mandatory CSR reporting standards “have the potential to improve information to investors and other stakeholders” but the “net effects of a CSR mandate are not a priori obvious.”57