Most companies now account for social good in their financial reports in some way, but with regulation scattershot and evolving, it’s complicated for investors to assess so-called ESG reports.
The disclosures, known as Environmental, Social, and Governance reports, have multiplied over the past decade, as companies look to impress stakeholders with their commitments to initiatives like fighting climate change, says a new working paper. By 2021, 86 percent of S&P 500 firms regularly issued some kind of ESG-related report, up from 35 percent of publicly traded companies in 2010, the paper finds.
ESG has just become such a part of the cultural language of business that I don't really remember a time when there were no firms doing this.
The difference feels almost unthinkable today, as US and European regulators are poised to mandate some ESG disclosures—starting with carbon emissions.
“What surprised me was that so few companies were reporting in 2010,” says coauthor Ethan Rouen, a Harvard Business School assistant professor. “ESG has just become such a part of the cultural language of business that I don't really remember a time when there were no firms doing this.”
What’s more, S&P 500 companies disclosed 11 percent more material information—data that directly impacts operations—after the release of voluntary standards from the Sustainability Accounting Standards Board (SASB) between 2013 and 2016. Rouen conducted the study with Rice University assistant professor Kunal Sachdeva and Northwestern University assistant professor Aaron Yoon.
Until regulations with teeth hold companies accountable, though, differentiating meaningful reports from marketing remains tricky. The paper comes as stakeholders demand more from companies than just profits, and executives increasingly try to demonstrate positive returns from doing good.
Analyzing ESG reports
To ferret out companies that release sustainability reports, researchers turned to machine learning—and some sweat equity. They limited their scope to the S&P 500 index and hand-collected ESG reports from company websites to fill in gaps.
Using a sample of 3,600 reports, an algorithm scanned for ESG keywords, such as those tied to SASB’s definition of material disclosures. These include events or practices that are “reasonably likely to significantly impact the financial condition, operating performance, or risk profile” of a company’s operations.
That can be anything from the cost of climate change and carbon emission disclosures, to hiring practices and “human capital” investments, to governance practices at the board level.
In the study period, those ESG keywords rose 11 percent and were tied mostly to industry-specific terms. Of the companies that authors found disclosing voluntarily, most did so for metrics tied directly to their industry.
What’s included in ESG metrics?
Information about ESG at companies—and how it is defined—was haphazard before SASB and groups like it began releasing detailed disclosure standards. SASB, which Rouen says has become the “standard-setter of record,” releases guidelines for 11 sectors comprising several industries.
Still, even as regulators move toward mandating some ESG-related disclosures, it can be difficult to figure out how firms decide what material issues to disclose in their reports.
“Given the voluntary nature of both ESG disclosures and the adoption of SASB standards, understanding how firms converge toward material disclosures remains an outstanding but important question,” the researchers write. “ESG reports are vastly different from financial disclosures, given that they cover numerous subjects and appeal to several stakeholders.”
There are still outlying companies that don’t yet issue ESG assessments, Rouen notes. He went into the study guessing that more than 90 percent of S&P 500 companies would have published some kind of sustainability report.
Some risks stand out: the words “vaccine” and “virus” weren’t in any ESG reports back in 2010. By 2020, of course, they had become two of the most important words, the researchers found. Another theme? Animal welfare, which the researchers tie back to the treatment of farm animals.
In environmental disclosures—or the E in ESG—non-specific disclosures are known as “greenwashing,” which is when a company tries to look as if it is taking action without actually mapping out specific commitments and metrics.
What can investors do?
So, how can investors separate marketing ploys from substantial disclosures?
Look for numbers. Specifically, scan for data about quantity and quality that’s tied to material and financial specifics as outlined by SASB.
“That's really important. If a firm talks about the products that it gives away to charity, as opposed to how it ensures that it’s building opportunities for its low-wage employees, that's probably less informative and not necessarily something particularly relevant to investors,” Rouen says. “You might start hesitating and looking at a report like that with a little more skepticism.”
I wouldn’t bet all my money on regulation coming to solve this problem, at least in the short term.
Use your influence as an investor. Investors should seek information they believe is financially material to companies, Rouen says. And make it clear that investors intend to act on that information.
Ideally, thoughtful regulation would bridge a company’s ESG activities with its operations, Rouen says. In the meantime, the Securities and Exchange Commission is slated to announce its final climate disclosure rule in coming months, while European regulators are continuing to work on a more specific set of rules through SASB and other guidelines.
“I wouldn’t bet all my money on regulation coming to solve this problem, at least in the short term,” Rouen says. “And it is very much a problem that needs to be addressed immediately.”
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