Improving Stakeholder Value through Sustainability and Integrated Reporting

Corporate social responsibility (CSR) is a term used to describe an organization's awareness of its operations' impact on economic, social, environmental, and governance concerns, as well as the steps it takes to communicate and address those concerns. CSR activities focus on a company's long-term value by enhancing strategic operations and improving its reputation and risk management. CSR typically results in a concerted effort to improve the community and workplace, as well as to decrease the organization's consumption of natural resources.

Skeptics might question whether these sustainability initiatives are beneficial to shareholders, because resources diverted to sustainability initiatives (e.g., the development of environmentally friendly products or the provision of higher, "living" wages) could make companies less competitive. A study published by Harvard Business School in July 2013, however, found that companies that embraced a long-term corporate culture of sustainability outperform their peers in terms of reputation, net income, and stock price (Robert G. Eccles, Ioannis Ioannou, and George Serafeim, "The Impact of Corporate Sustainability on Organizational Processes and Performance"). Investors and other stakeholders are increasingly relying on nonfinancial data to make investment, credit, and other decisions. Furthermore, they are placing more pressure on management to promote CSR, rather than focus solely on maximizing short-term profits.

According to the Global Reporting Initiative (GRI), a nonprofit that promotes corporate sustainability activities and reporting-

Many organizations find that financial reporting alone no longer satisfies the needs of shareholders, customers, communities, and other stakeholders for information about overall organizational performance.

Sustainability reporting is one method for companies to publicly communicate information about their CSR activities and initiatives. In "Integrating Sustainability into the Reporting Process and Elsewhere: Obstacles and Best Practices for CPAs," Jill D'Aquila discussed the challenges faced by CPAs with respect to sustainability reporting, as well as the opportunities available to them (The CPA Journal, April 2012, pp. 16-24). Because accountants are typically involved in measuring and reporting business risks, opportunities, and performance, they are highly suited to analyzing returns on CSR investments and reporting that information to stake- holders. There is a growing need for accountants to become more involved with measuring and managing sustainability initiatives and integrating socially responsible investments into financial disclosures.

Companies around the world have chosen to engage in significant sustainability initiatives; however, there is a scarcity of U.S. companies that have integrated these activities into their financial reporting. Opportunities exist for CPAs to promote integrated reporting at U.S. companies; they can play a key role in expanding corporate reporting to include sustainability issues and can contribute to the development of financially successful sustainability strategies. This discussion reviews the recently proposed global framework for integrated reporting; shows how integrated reporting should ideally drive, as well as reflect, integrated thinking and decision making within organizations; and describes the benefits that companies can expect to achieve by engaging in sustainable activities and integrated reporting.

Rising Trends in Sustainability Reporting

KPMG'sInternational Corporate Responsibility Reporting Survey of 2011 found that 95% of the 250 largest companies in the world currently report on their CSR activities, and that nearly half of these companies reported gaining financial value from such initiatives. Although there is no single platform for companies to file information about their CSR activities, the GRI maintains one of the most comprehensive online global databases of organizations' sustainability reports and allows stakeholders to view them without charge. The authors' analysis of sustainability reporting, based upon information published on the GRI website (https://www.globalreporting.org), revealed that the number of sustainability reports filed with the GRI has grown tremendously in recent years. Using data from the GRI's sustainability disclosure database, Exhibit 1 summarizes the number of sustainability reports filed by companies from the 13 largest GRI-filing countries in 2012.

CSR disclosures are gaining importance both globally and in the United States. As shown in Exhibit 1, China, Japan, Spain, South Africa, and the United States had the highest number of GRI reports in 2012. Exhibit 2 summarizes this trend over the 2008 to 2012 period. The number of U.S. companies that have sustainability reports included in the GRI database has increased by 275% over the five-year period. Only China-a latecomer to GRI reporting-is ahead of the United States (at 985%) in filis respect.

Exhibits 1 and 2 help demonstrate the rising trend in CSR reporting globally for the broad set of companies included in the GRI database. Ranking the countries based upon the raw number of CSR reporting companies can be misleading because the overall number of companies varies by country. In order to address this concern, Exhibit 3 reports the percentage of CSR reporting for the largest 100 companies by country, using the data in the 2011 KPMG study.

Consistent with the increasing global trend in CSR reporting shown in Exhibit 2, the percentage of the largest 100 companies (by country) engaged in CSR reporting increased in all reported countries from 2008 to 2011; in the United States, for example, it increased from 74% to 83%. But the relative U.S. ranking, in terms of the percentage of CSR-reporting companies, declined from 4th in 2008 to 7th in 2011 (out of the 11 countries surveyed). Moreover, the percentage of CSR-reporting U.S. companies in 2011 (83%) was far lower than the percentage in the three leading countries (South Africa, Japan, and the United Kingdom), which had 97%, 99%, and 100% reporting rates, respectively. Overall, the results indicate that the United States still has a long way to go to catch up with the global leaders in CSR reporting, despite the rapid increase in the number of U.S. companies engaging in CSR reporting in recent years.

The CPA's Role

Connecting CSR reporting to business performance strengthens the case for sustainability and bolsters the CPA's role in advocating CSR reporting. The business case for sustainability must be made; otherwise, environmental, social, and governance initiatives will appear as merely disjointed and costly actions. Companies choosing to make substantial, long-term investments in sustainability initiatives are likely to be highly engaged with stakeholders; long-term oriented; and have better relationships with employees, customers, suppliers, regulators, and local communities (Eccles et al. 2013). These benefits ultimately increase shareholder value.

Because CPAs are already skilled at measuring inputs and outputs, performing analytical procedures, quantifying cost savings and return on investment (ROI), and producing reports to stakeholders and providing assurance, they can play an essential role in measuring, reporting, and verifying CSR initiatives. There are some specific ways for accountants to get involved with CSR activities, as discussed below.

CPAs are well suited to compile data and conduct analyses related to many of the most widely published CSR areas, such as environmental management and climate change, by measuring and monitoring greenhouse gas emissions, energy consumption, and reductions in waste. They can compile metrics and key performance indicators related to employment conditions (e.g., workforce diversity, training investment, employee turnover). Product innovation and redesign are key elements of CSR, and CPAs are the obvious choice to assess sales growth from product innovation, as well as reductions in waste and the company's carbon footprint as a result of changes to the manufacturing process. For example, the Clorox Company stated in its 2013 annual report that its water bottle containing a filter can replace 300 plastic bottles, reducing waste and potentially saving consumers $45 per month (http://annualreport.thecloroxcompany.com/ resourceCenter).

Accountants can research and examine cost savings from tax planning strategies related to sustainability incentives and credits, such as investments in alternative energy. They can be involved in measuring the benefit of reducing the company's dependence on natural resources, such as oil and gas. This CSR activity not only helps the environment; it also limits the company's exposure to sudden price increases and subsequent income volatility. CPAs are skilled in identifying and analyzing investment opportunities and evaluating the return on those investments; they can conduct these analyses in the context of CSR activities.

For example, Southwest Airlines recently renovated its aircraft lighting system to more energy efficient LED lighting, which is expected to last 10 times longer than the previous lighting system. The company also replaced the steel brakes on its aircraft with new, lighter-weight carbon brakes, resulting in reduced fuel consumption and greenhouse gas emissions (http ://www. south we stoner eport .com/2012/). Southwest's decision to replace older aircraft with new, more fuelefficient ones with reduced greenhouse gas emissions requires a cost-benefit analysis already familiar to accountants; in this case, however, the results being measured reflect environmental benefits as well as increased margins.

Recently, the SEC instituted filing requirements enacted by the Dodd-Frank Reform and Consumer Protection Act of 2010 in order to address the human rights abuses occurring in the Democratic Republic of Congo (DRC), a mass producer of minerals essential to most consumer electronics. Under the recent conflict minerals disclosure requirements, companies must disclose if they originated in the DRC, as well as the fact that management has examined the supply chain (see Greg Gaynore, Katherine Campbell, Dee Ann Ellingson, and Matthew Notbohm, "The Dodd-Frank Act's Conflict Minerals Provision: What CPAs Should Know about the SEC's Final Rule," The CPA Journal, April 2013, pp. 20-25). This is an example of how accountants are already involved in documenting issues related to human rights.

Closely related to human rights is the CSR element of ethics. CPAs became largely responsible for ethical management and reporting in the post-Enron era following the enactment of the Sarbanes-Oxley Act (SOX) of 2002. They have since become more familiar with documenting processes and assessing internal controls to ensure reporting accuracy. Accountants are also familiar with ethical management, due to the SEC's recent increased enforcement of the Foreign Corrupt Practices Act of 1977, which requires companies to maintain accurate accounting records and prohibits the payment of bribes to foreign officials.

After the data collection, ROI and costbenefit analyses, and documentation of internal processes and controls are complete, this information will need to be communicated to stakeholders. CPAs can show how CSR activities impact the financial statements and can assist companies with reporting this information in the annual report to show how these investments improve shareholder value.

Integrated Reporting

CSR activities may be reported in various ways-as a separate section in the annual report; in a separate, stand-alone sustainability report; or, as is becoming increasingly popular, in a report that integrates sustainability reporting together with financial reporting. The International Integrated Reporting Council (IIRC)- founded by the GRI and composed of investors, managers, regulators, and others in the accounting profession-was established in 2010 to create a globally accepted framework for a financial reporting model that includes the integration of financial data with sustainability information (i.e., integrated reporting).

Financial reporting is often criticized for its focus on historic and short-term performance, rather than on long-term value creation. Integrated reporting combines information about a company's strategy, performance, governance, and sustainability activities and aims to show how these various factors connect in order to provide stakeholders with a complete picture of how the company creates value over time. It goes beyond disclosures of historical information and provides investors and other stakeholders with information about a company's current and prospective risks and opportunities.

The IIRC and the GRI are devoting significant resources in order to understand current reporting practices and promote the use of integrated reporting. In the May 2013 GRI publication, "The Sustainability Content of Integrated Reports-A Survey of Pioneers," the frontrunners of integrated reporting revealed three common reasons to choose this reporting method:

* Companies want to avoid the inefficiencies associated with distinct financial and sustainability reports and operational processes.

* Companies want to provide investors and other stakeholders with a more complete picture of how they create value over file long term.

* The majority of respondents indicated that because sustainability was already a part of core business processes, combining financial and sustainability reporting was "the logical and natural thing to do."

In 2010, only 14% of global reports published in the GRI's sustainability disclosure database were self-declared as integrated by reporting organizations; this number rose to 20% in 2011 and fell to 17% in 2012. Part of the increase is due to a change in South African governance and disclosure requirements established by the King Report on Corporate Governance, which mandates that all companies listed on the Johannesburg Stock Exchange file an integrated report rather than a separate sustainability report (http://www.iodsa. co.za/?page=kingIII), making the country an outlier. The percentage of integrated reports for the 13 countries with the largest number of GRI reports in 2012 is shown in Exhibit 4.

Although the number of companies choosing to integrate sustainability reporting with financial reporting is trending upward, there is still a burgeoning opportunity for CPAs to promote and pursue integrated reporting. In the United States, it is far more popular for companies to provide stand-alone sustainability reports, rather than integrating CSR issues into corporate strategy or connecting CSR activities to costs, revenues, or other financial reporting metrics. A study of the CSR reporting practices of companies in the Standard & Poor's (S&P) 500 Index reported that only seven companies (1%) filed an integrated financial-sustainability report and, as shown in Exhibit 4, about 3% of U.S. companies filing reports with GRI are classified as integrated ("Integrated Financial and Sustainability Reporting in the United States," IIRC, May 2013, http://irrcinstitute.org/projects.php? project=63). Only China has a lower rate (less than 1%) of integrated GRI reports. Furthermore, the study noted that most companies that claim to use integrated reporting use the term loosely; approximately one-half of GRI reports classified as integrated consisted of an annual report and a separate sustainability report published together under one cover.

Recognizing that a globally accepted, uniform framework for integrated reporting would drive consistency and quality in CSR reporting, the IIRC has been working to fulfill this mission. In early 2013, the IIRC and the IASB announced a memorandum of understanding that formalized the two organizations' commitment to achieving a framework for integrated reporting. The IIRC published a draft framework in April 2013, which was open for comments through July 2013. The framework contains a set of principlesbased voluntary guidelines that companies may choose to follow in order to report how they help create value. The questions listed below are presented on page 7 of the "Consultation Draft of the International (IR) Framework" and serve as an illustration of the main items that an integrated report should address (http://www.theiirc.org/consultationdraft2013):

* What does the organization do, and what are the circumstances under which it operates?

* How does the organization's governance structure support its ability to create value in the short, medium, and long term?

* What are the specific opportunities and risks that affect the organization's ability to create value over the short, medium, and long term, and how is the organization dealing with them?

* Where does the organization want to go, and how does it intend to get there?

* What is the organization's business model, and to what extent is it resilient?

* To what extent has the organization achieved its strategic objectives, and what are its outcomes, in terms of effects on the capitals?

* What challenges and uncertainties is the organization likely to encounter in pursuing its strategy, and what are the potential implications for its business model and its future performance?

The capitals referenced above refer to the resources that a company uses and impacts as it creates value over time; they are defined in the framework as financial, manufactured, intellectual, human, social, and natural. CPAs interested in integrating CSR activities into the reporting process might want to consider discussing the answers to the seven questions above, because this is the information that stakeholders will want to learn from integrated reports.

High-quality CSR reporting that is not backed by meaningful business change will come across as an empty public relations ploy, often referred to as "greenwashing." Such a strategy carries the risk of failing to deliver on reported sustainability promises, and it leaves corporations underprepared for potentially significant sustainability risks. The IIRC's 2012 report, "Understanding Transformation: Building the Business Case for Integrated Reporting," demonstrated that integrated reporting is beginning to lead to CSR changes within organizations-that is, accountants preparing integrated reports are impacting the sustainability culture of their companies.

Furthermore, the report outlined five major benefits that companies reported following the implementation of integrated reporting. The most widely cited benefit was the connection and cooperation of various business units within an organization, because each one placed a greater emphasis on the company's core strategy rather than on its own specific functional area. Second, as integrated reporters shifted focus to the items most relevant and important to the company, they noted an improvement in internal processes. Third, integrated reporting requires, and therefore results in, more involvement by senior management in sustainability activities. Fourth, integrated reporting enhances a company's ability to communicate its strategy and business model and to provide more transparency to stakeholders. Finally, integrated reporting helps stakeholders better understand business prospects and value.

Developing Sustainability Strategies

The management of sustainability initiatives is clearly a crucial factor in determining the financial success of sustainability. Implementing sustainability programs and producing integrated reports does not guarantee its success. The challenge is to manage sustainability strategies so that financial performance is also enhanced. A recent article in the Harvard Business Review describes four key steps involved in implementing sustainability initiatives into business strategy and operations, while increasing shareholder value (Robert G. Eccles and George Serafeim, "The Performance Frontier: Innovating for a Sustainable Strategy," May 2013).

Eccles and Serafeim emphasize the importance of first building a sustainability strategy-that is, a cohesive set of programs to address a company's most relevant and pressing sustainability issues. Second, managers should assess the ROI of each potential sustainability initiative. Third, companies must be prepared to introduce major innovations into their business models, products, and processes; this is a key factor in linking sustainability to profits. For example, Dow Chemical Company, in shifting its focus from waste reduction to waste elimination, undertook massive innovations in products and processes. It also developed a new market in consulting with customers on environmental issues. These innovations in products, processes, and business model are backed up by enhanced financial performance. Finally, management is responsible for communicating sustainability investments and innovations to stakeholders; integrated reporting has a clear role in this process.

Increasing numbers of investors and broader ranges of stakeholders are demanding more information on the social, environmental, and governance issues that affect businesses. Integrated reporting is becoming the new reporting standard. It is a driver of sustainability strategies; evidence shows that such strategies lead to enhanced financial performance when they incorporate an innovative business model. By promoting integrated reporting and its business benefits, accountants can play a key role in the development of financially successful sustainability strategies. ?

CPAs can show how CSR activities impact the financial statements and how these investments improve shareholder value.

Linda Hughen, PhD, CPA, is an assistant professor, Ayalew Lulseged, PhD, is an associate professor, and David R. Upton, PhD, CA, is an associate professor, all at the University of North Carolina at Greensboro.