Going Green in Annual Reports

Co-authored with Michael P. Krzus

Over 1,000 supporters of corporate reports that go beyond the financials to include information about a company's environmental, social, and governance (ESG) performance are attending the Global Reporting Initiative's (GRI) Global Conference on Sustainability and Transparency in Amsterdam this week to advocate greater and more rapid adoption of sustainability reporting.

More attention to sustainability reporting comes on top of decades of new accounting standards and regulatory disclosure requirements that have made companies' financial statements long, complex, hard to understand, and costly to prepare. While each new standard and disclosure requirement is well-intended, the cumulative effect has been to reduce the usefulness of financial statements for all but the most sophisticated consumers of this information.

In the United States, the Securities and Exchange Commission (SEC) has tried to address this problem in two ways. First, the Advisory Committee on Improvements to Financial Reporting made some modest recommendations for reducing complexity. Second, the concept of Extensible Business Reporting Language (XBRL) was introduced for the filing of financial statements. XBRL is the use of electronic tags to make it easier to report, receive, and analyze financial information.

Despite these worthy efforts, the fact remains that the burden on companies for reporting to shareholders and other stakeholders--something that is especially great for publicly-listed small and medium-sized enterprises--continues to grow. Indeed, as society's concerns about sustainability increase, institutional investors see that good performance on ESG dimensions is essential for creating long-term economic value, and they are placing increasing demands on companies for greater transparency and reporting.

A few innovative companies around the world--such as American Electric Power in the U.S., Philips in The Netherlands, Novo Nordisk in Denmark, BASF in Germany, Anglo Platinum in South Africa, and Natura in Brazil--are responding. They have recently started issuing a single "integrated report" that combines information on financial, environmental, social, and governance performance. Companies issuing "One Report" note that it is a logical consequence of having a sustainable strategy to support a sustainable society, a way of ensuring a consistent message both internally and externally, and an important step towards reducing complexity and costs. Although analysts and investors are still learning how to incorporate sustainability into their investment analysis, they want to know about a company's commitments in this area. What better way to make this clear than by integrating this information into the document they are used to reading--the annual report?

We expect this practice to become increasingly common all over the world. But companies can do only so much on their own. Ultimately, it is regulators like the SEC and the European Commission, accounting standard setters like the Financial Accounting Standards Board and the International Accounting Standards Board, and groups seeking to establish standards for nonfinancial performance such as the GRI that determine the level of complexity in external reporting. Thus we strongly urge the SEC to implement a voluntary filing program for integrated reporting, just as it did for XBRL; securities regulators in other countries should do something similar. Under this program, companies would be able to file a report on what they consider to be the key metrics for their financial and nonfinancial performance on a completely voluntary basis. In doing so, they would disclose the standards on which these metrics are based and whether they have been audited and by whom.

Of course, a voluntary filing program will have value only if companies participate in it. We see three major objections in their doing so: the time and cost to prepare an integrated report, shareholders and other stakeholders seeking information not included in the integrated report, and potential legal liabilities. All are easily addressed. First, companies already producing One Report have found it to be enormously valuable in implementing a sustainable strategy and communicating with their board. Second, One Report doesn't mean "only One Report" and companies can use the Internet to provide more detailed information to specific stakeholders, a practice followed by companies already producing an integrated report. Third, regulators implementing voluntary filing programs can simply provide the necessary legal protections, as the SEC did with its voluntary filing program for XBRL.

The benefits of such a program would be enormous. Investors and securities regulators would get a clear view on what companies regard as their key performance metrics. This would be useful input in future efforts to simplify financial reporting, codify standards for nonfinancial reporting, and begin to establish guidelines for companies to publish a single integrated report. In identifying and reporting in a single document the truly material financial and nonfinancial metrics and relationships between them necessary to understand a company's past performance and future prospects, an integrated report will reduce the complexity that comes from detailed information of little value and the cost of issuing multiple reports. Integrated reporting is a way of solving two problems at once: the burden of increasing complexity and cost of financial reporting, and the growing demands for nonfinancial information.

Integrated reporting is a simple idea, but it is an idea whose time has come. Voluntary filing programs are an easy and practical way to make this idea the common practice in companies' external reporting. It is now up to regulators to make it happen.

Robert G. Eccles is a Senior Lecturer at Harvard Business School and Michael P. Krzus is a partner at Grant Thornton. They are the authors of "One Report: Integrated Reporting for a Sustainable Strategy."