Have you ever wondered what large multi-national companies are doing in terms of climate change mitigation? There is an easy way to find out. H&M is doing it, Coca Cola is doing it, Volkswagen is doing it, and even the National Bank of Canada. I am talking about the disclosure of corporate action on climate change in annual reports.
Nowadays, it is quite common for international businesses to report on risks and opportunities arising from global warming, corporate CO2 emissions and initiatives to reduce these emissions. Carbon disclosure, as it is often called, represents a form of non-financial reporting. While companies have published financial data for centuries or decades already, the disclosure of non-financial, i.e. sustainability related information, constitutes a rather recent trend. This trend is closely related to a major paradigm shift in what is seen to determine the success of a business.
In the second half of the 20th century, management scholars and subsequently practitioners realized that a product-centered approach to doing business might not be enough to secure long-term success. The prevailing belief that offering products of high quality represents the most important factor for profit generation got contested. The result was a major shift towards customer orientation, culminating in the concept of ‘marketing’. Today, companies do not simply focus on the quality of their products anymore. They rather aim at identifying and satisfying (and sometimes even creating) the needs and desires of their (potential) customers. Customers, in turn, are one of several so-called stakeholders, i.e. individuals, or a group of individuals, that are affected by the business operations of a company and therefore have a ‘stake’ in the company. (In order to prevent confusion at this point: stakeholders should not be mixed up with ‘shareholders’ who legally own a share in a company.) The term ‘stakeholder’ was popularized by Ed Freeman in the 1980s and adopted by both the business and research community alike. Freeman was one of the first to argue that the consideration of stakeholder interests is vital for a successful business strategy. Which brings us back to climate change and sustainability reporting.
When sustainable development and climate change in particular turned into a public concern in the late 1990s and early 2000s, it also entered the business agenda. Both shareholders and stakeholders started to exercise increasing pressure on corporations to demonstrate action on major sustainability issues such as global warming. Consequently, companies began to realize the importance of disclosing sustainability-related information about their business operations. However, in contrast to financial reporting, no standards for sustainability reporting existed back then. It does not come as a surprise that the first attempts by companies of walking in this area where rather inconsistent, hardly comparable and of low quality. In subsequent years, several initiatives attempted to overcome these shortcomings by developing standards, guidelines and measurable indicators for corporate sustainability and reporting.
One of the most prominent initiatives is the Global Reporting Initiative (GRI), brought into being in 1997 with the support of the United Nations Environmental Programme (UNEP). While the GRI focuses on all three dimensions of sustainability (ecological, social, economic), an international group of investors founded the non-profit organization CDP (formerly known as Carbon Disclosure Project) in the year 2000 in order to make companies report about their action on climate change in particular. Over the years, an increasing number of especially large multi-national corporations has publicly disclosed such information. According to CDP, more than 5.500 companies representing 55% of the world’s market capitalization gave account of their responses to climate change in 2015. In their 2015’s report, the organization furthermore states that corporate engagement has significantly increased in the last five years and that “what was leading behavior in 2010 is now standard practice”. Ergo: more transparency and more action in the context of climate change.
Development of corporate climate action between 2010 and 2015 based on companies’ responses to CDP (Source: CDP Global Climate Change Report 2015)
Those numbers are encouraging. But how do these figures come about? Well, obviously by analyzing what companies tell us about themselves. Yet, in contrast to financial reporting, which is governed by legislation in many countries, sustainability reporting predominantly remains a sort of voluntary action. Certainly, companies may decide to follow the above-mentioned guidelines and standards. This, however, does not alter the fact that most non-financial reports still lack third-party verification. Statements about the evolution of corporate strategies with regard to climate change mitigation that are based on voluntarily disclosed information should therefore be treated with caution. In short, ostensible advancements in corporate action might be a result of ‘green-washing’.
Let me use a simple example to illustrate the above-mentioned problems. Since 2010, CDP grades companies according to their amount of disclosed information (0 to 100%) and their performance in terms of climate change mitigation (from A to E; while A is the highest). Scores for performance are based on the reports that companies have send to CDP in response to a standardized questionnaire given to the companies by CDP beforehand. In 2014, 1,621 corporations received both a disclosure and a performance score from CDP. Putting those two figures in a bar chart allows us to examine if there is a relationship between disclosure and performance.
Average CDP Disclosure scores of companies in the different CDP Performance bands in 2015 (own illustration based on CDP data from 1,621 companies)
Interestingly, the chart clearly indicates a connection between the amount of information disclosed and the performance score received by CDP. Having said that, the chart does not allow for conclusions about the direction of the relationship between the two figures. This raises (at least) the following question: Why is there a positive relationship between the quantity of disclosed information and the CDP performance rating?
Let me give you two possible answers. First, the found relationship hints at corporate green-washing. One could suspect that businesses want to demonstrate action on climate change by simply increasing the quantity of disclosed information instead of increasing their action on climate change. But do companies that disclose less really perform worse in terms of climate change mitigation? That’s hard to tell if one has to base the judgement on voluntarily disclosed information. Second, the question might be answered by arguing that companies, who are indeed more active in terms of mitigating climate change, simply want to show both their shareholders and stakeholders that they are more active.
Although being a frequently discussed issue since years, business scholars still quarrel with the question whether companies actually ‘walk the talk’. Or to put it differently: are we talking about actual emission reductions or rather shiny words? Several studies have pointed out that although the amount of carbon disclosure has significantly increased in the last ten years, the quality of reports also varies significantly. Major problems arise from the usage of different conversion factors for calculating corporate CO2 emissions, non-harmonized reporting guidelines (e.g. GRI vs. CDP vs. ISO 26000) and the ex-post correction of past CO2 emissions due to a change in accounting standards (which might turn current emissions levels into an improvement without actual reductions).
To wrap it up: although the quantity of disclosure has significantly increased in recent years, corporate carbon disclosure is still in its infancy. This is mainly due to a lack of an appropriate regulatory regime that harmonizes reporting standards and makes third-party verification of non-financial data obligatory. Voluntarily published information in the context of climate change should thus be treated with caution.
Climate Footnotes 