As evidence mounts that the financial performance of companies corresponds to how well they contend with environmental, social, governance (ESG), and other nonfinancial matters, more investors are seeking to determine whether executives are running their businesses with such issues in mind. When companies report on ESG-related activities, they have largely continued to address the diverse interests of their many stakeholders—a long-standing practice that involves compiling extensive sustainability reports and filling out stacks of questionnaires. Despite all that effort, a recent McKinsey survey uncovered something that should concern corporate executives and board members: investors say they cannot readily use companies’ sustainability disclosures to inform investment decisions and advice accurately. 1
Investors say they cannot readily use companies’ sustainability disclosures to inform investment decisions and advice accurately.
What’s unusual and challenging about sustainability-focused investment analysis is that companies’ sustainability disclosures needn’t conform to shared standards in the way their financial disclosures must. Years of effort by standard-setting groups have produced nearly a dozen major reporting frameworks and standards, which businesses have discretion to apply as they see fit (see sidebar, “A short glossary of sustainability-reporting terms”). Investors must therefore reconcile corporate sustainability disclosures as best they can before trying to draw comparisons among companies.
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In this article, we use the following terms for certain elements of sustainability reporting:
- Sustainability disclosure. This disclosure is an item of qualitative or quantitative information about a company’s performance on a topic not addressed by standard financial and operational disclosures. Sustainability disclosures ordinarily relate to environmental, social, and governance matters, including companies’ sustainability impacts and responses to external sustainability trends. These disclosures sometimes encompass other topics, too, such as HR and intellectual property.
- Sustainability report. This report is a document containing a set of sustainability disclosures from an organization for a period of time. It can be a stand-alone document or a component of the annual report.
- Sustainability-reporting requirement. This requirement is a mandate from an authority (such as a regulator, a stock exchange, or a civil-society group) about a sustainability report’s content and nature. Some requirements apply to all companies in a given jurisdiction—for example, Directive 2014/95/EU of the European Parliament and the European Council, requiring some large companies to issue nonfinancial disclosures. Others, such as the UN Global Compact, apply only to companies that have voluntarily pledged to abide by them.
- Sustainability-reporting framework. This framework is a set of guidelines for determining what topics and disclosures a sustainability report should cover. The International Integrated Reporting Framework, published by the International Integrated Reporting Council (IIRC), is one example.
- Sustainability-reporting standard. This standard is a set of specifications for measuring and disseminating sustainability disclosures. Examples include the Global Reporting Initiative’s GRI Standards and the 77 industry-specific standards published by the Sustainability Accounting Standards Board.
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Corporate executives and investors alike recognize that sustainability reporting could improve in some respects. One advance that executives and investors strongly support, according to our survey, is reducing the number of standards for sustainability reporting. Many executive respondents said they believe this would aid their efforts to manage sustainability impacts and respond to sustainability-related trends, such as climate change and water scarcity. And many investors said they expect greater standardization of sustainability reports to help them allocate capital and engage companies more effectively. While these findings might not surprise readers involved with sustainable investing or sustainability reporting, it was striking to learn that investors also support legal mandates requiring companies to issue sustainability reports (Exhibit 1). In this article, we offer executives, directors, and investors a look at how sustainability reporting has evolved, what further changes investors say they want, and how investors can bring about those changes.
Reporting today: Externality focused and inconsistent, yet informative
The current practice of sustainability reporting developed in the 1990s as civil-society groups, governments, and other constituencies called on companies to account for their impact on nature and on the communities where they operate. A milestone was passed in 2000, when the Global Reporting Initiative (GRI) published its first sustainability-reporting guidelines. The following year, the World Business Council for Sustainable Development and the World Resources Institute released the Greenhouse Gas Protocol. The same period also saw the creation of voluntary initiatives, such as the UN Global Compact and the Carbon Disclosure Project (now CDP), encouraging corporations to disclose information on sustainability. Since the financial crisis, additional frameworks and standards have emerged to help companies and their investors develop a greater understanding of the risks and benefits of ESG and nonfinancial factors. For example, the International Integrated Reporting Council (IIRC) advocates integration of financial and nonfinancial reports, the Sustainability Accounting Standards Board (SASB) identifies material sustainability factors across industries, and the Embankment Project for Inclusive Capitalism assembles investors and companies to define a pragmatic set of metrics to measure and demonstrate long-term value to financial markets.
Given the proliferation of reporting frameworks and standards, companies have had to decide for themselves which ones to apply. These frameworks and standards allow businesses considerable freedom to choose their sustainability disclosures. Many companies select their disclosures by consulting members of stakeholder groups—consumers, local communities, employees, governments, and investors, among others—about which externalities, or impacts, matter most to them and then tallying the stakeholders’ interests in some way. More recently, stakeholders have asked for increased disclosure about how companies address opportunities and risks related to sustainability trends, such as climate change and water scarcity, which can meaningfully affect a company’s assets, operations, and reputation.
The scope and depth of these disclosures differ considerably as a result of the subjective choices companies make about their approaches to sustainability reporting: which frameworks and standards to follow, which stakeholders to address, and which information to make public. According to the executives and investors we surveyed, the diversity of these disclosures is a defining feature of sustainability reporting as we know it—and a source of difficulty, as we explain in the following section of this article.
The scope and depth of these disclosures differ considerably as a result of the subjective choices companies make about their approaches to sustainability reporting: which frameworks and standards to follow, which stakeholders to address, and which information to make public. According to the executives and investors we surveyed, the diversity of these disclosures is a defining feature of sustainability reporting as we know it—and a source of difficulty.
Nevertheless, 30-odd years of sustainability reporting have produced a trove of useful data. Stakeholders can use this information to track the relative sustainability performance of companies from year to year. By aggregating data from many companies, stakeholders can not only discern patterns and trends in companies’ responses to sustainability issues but compare and rank businesses as well.
Analysts in academia, government, and the private sector have also used these sustainability disclosures to examine the link between sustainability performance and financial performance. A substantial body of research shows that companies that manage sustainability issues well achieve superior financial results. 2 (Researchers have shown only that these two phenomena are correlated, not that effective sustainability management leads to better financial outcomes.)
Investors and asset owners appear to be taking note of corporate sustainability disclosures and adapting their investment strategies accordingly. The Global Sustainable Investment Alliance has found that the quantity of global assets managed according to sustainable-investment strategies more than doubled from 2012 to 2018, rising from $13.3 trillion to $30.7 trillion. 3 BlackRock reports that assets in sustainable mutual funds and exchange-traded funds in Europe and the United States increased by more than 67 percent from 2013 to 2019 and now amount to $760 billion. 4 And research by Morgan Stanley indicates that a majority of large asset owners are integrating sustainability factors into their investment processes. Many of those asset owners started to do so only during the four years before the survey. 5
What investors want: Financial materiality, consistency, and reliability
With so much capital at stake, investors have begun to question prevailing sustainability-reporting practices. The shortcomings investors now highlight have existed for some time but were mostly acceptable to early sustainable investors and the diverse civil-society stakeholders that used to be the primary readers of sustainability reports. But now that more asset owners and asset managers are making investment and engagement decisions with sustainability in mind, a louder call has gone out for sustainability disclosures that meet the following three criteria.
Investors acknowledge that their expectations for sustainability disclosures have shifted. As the head of responsible investing at a large global pension fund remarked, “The early days of sustainable investing were values based: How can our investing live up to our values? Now, it is value-based: How does sustainability add value to our investments?”
Investors want companies to provide more sustainability disclosures that are material to financial performance.
From our interviews and survey results, it is apparent that investors want companies to provide more sustainability disclosures that are material to financial performance. According to a senior sustainable-investing officer at one top 20 asset manager, “Corporations do not provide systematic data on one-third of the sustainability factors [that we consider] material.” This could change as more companies issue reports in line with the sector-specific standards that SASB created in consultation with industry experts and investors.
Government authorities and civil-society organizations also appear to be coming around to investors’ views about the material connection between a company’s handling of sustainability factors and its financial performance. The European Union’s 2014 directive on nonfinancial reporting and the Financial Stability Board’s creation of the Task Force on Climate-related Financial Disclosures in 2015 are two signals that financial regulators realize sustainability-related activities can materially affect the financial standing of companies and should be reported accordingly.
With so many reporting frameworks and guidelines to choose from, and so many potential stakeholder interests to address, companies rarely make sustainability disclosures that can be compared as neatly as their financial disclosures can. This circumstance makes the job of investors more difficult, as they indicated in response to our survey (Exhibit 2). As the head of sustainable investing at a major asset manager explained, “We have positions in over 4,500 companies. Unless [sustainability information] is comparable, hard data, it is of little use to us.”
Inconsistencies among sustainability disclosures, which arise through no fault of the companies producing them, can also create problems for the many investors that obtain sustainability data from third-party services rather than individual sustainability reports. These services use different methods to estimate missing information, so there are discrepancies among data sets. Some services normalize sustainability information, replacing actual performance data (such as measurements of greenhouse-gas emissions) with performance scores calculated by methods the services don’t reveal. Research shows a low level of correlation among the data providers’ ratings of performance on the same sustainability factor. 6
Similarly, proprietary indexes and rankings of sustainable companies, which some asset managers use to construct index-fund portfolios, can also diverge greatly. It is not unusual for a company to be rated a top sustainability performer by one index and a poor performer by another. 7 And some data services fail to include sustainability data companies have disclosed. 8
As the head of responsible investing for one of the world’s five largest pension funds put it, “Many companies do not have the systems in place to collect quality data for [sustainability] reporting.” For certain tangible sustainability factors, such as greenhouse-gas emissions, performance-measurement systems are generally well established. For other factors, such as corporate culture, human capital, and diversity and inclusion, clear ways to gauge performance are more elusive.
Investors also harbor doubts about corporate sustainability disclosures because few of them undergo third-party audits. Nearly all the investors we surveyed—97 percent—said that sustainability disclosures should be audited in some way, and 67 percent said that sustainability audits should be as rigorous as financial audits (Exhibit 3).
Refining the practice of sustainability reporting
In our survey and interviews, one priority for improving sustainability reporting stood out: ironing out the differences among reporting frameworks and standards. When we asked survey respondents to assess the challenges of sustainability reporting, executives and investors both rated “inconsistency, incomparability, or lack of alignment in standards” as the most significant challenge. A majority of respondents to our survey—67 percent—said there should be only one standard, and an additional 21 percent said there should be fewer than exist now.
In our survey and interviews, one priority for improving sustainability reporting stood out: ironing out the differences among reporting frameworks and standards.
The investors and executives who participated in our research also described several benefits of making reporting frameworks and standards more uniform. Investors expect greater uniformity to help companies disclose more consistent, financially material data, thereby enabling investors to save time on research and analysis and to arrive at better investment decisions. Some efficiency gains would accrue as third-party data providers begin aggregating sustainability information as consistent as the information they get from corporate financial statements.
Most of the investors we surveyed—63 percent—also said they believe that greater standardization will attract more capital to sustainable-investment strategies. However, about one-fifth of the surveyed investors said that uniform reporting standards would level the playing field, diminishing their opportunities to develop proprietary research insights or investment products (Exhibit 4).
Executives made clear, in our conversations, that they devote excessive effort and expense to answering numerous specialized requests for what is essentially the same information, such as greenhouse-gas emissions data that must be tabulated in different ways to conform to different standards.
This kind of burden would be lessened if the providers of reporting frameworks and standards combined or rationalized their rules and thereby reduced the number of major frameworks and standards to one or two. Companies could then use the same disclosures to fulfill the reporting demands of multiple authorities. (They could still develop additional sustainability disclosures if they chose to address stakeholder queries or concerns that the main mechanism didn’t cover.) Establishing one or two reporting standards would also simplify the task of auditing sustainability disclosures, making it more economical for companies to have their reports independently verified.
How investors can help effect change
Reducing the number of reporting frameworks and standards will probably involve several more years of effort by businesses, investors, and standard-setting organizations—which have begun to identify gaps and redundancies among disclosures—and by other stakeholders, such as civil-society groups and regulators. As it is, many investors avoid participating in standard-setting efforts. Some we interviewed said they distance themselves because they feel that standard setting should address their needs as a matter of course. Yet some standard setters told us they assume that investors can readily obtain the sustainability information they value and therefore focus on the interests of other stakeholders.
Our conversations lead us to believe that there’s some truth to both viewpoints. Yet our survey findings and interviews also suggest that investors could make valuable contributions to standard-setting efforts if they chose to increase their participation. Active investors are likelier to do so, since they pay more attention than index investors to the sustainability disclosures of individual companies. Until investors clarify which sustainability disclosures they want and help to rationalize frameworks and standards, sustainability reports might continue to deliver less material information than they would like.
Investors can do several other things to make better use of the sustainability-related information companies now make available. First, they can articulate the sustainability disclosures that matter most for their investment decisions and convey these interests to businesses. Going a step further, more investors could engage companies (through direct dialogue and shareholder voting) about their approach to managing sustainability issues.
More investors could also adopt the still-uncommon practice of collecting and analyzing data from sources other than corporate sustainability reports and disclosures. Some investors have developed algorithms that automatically gather nonfinancial data from public sources (such as government databases of health and safety incidents or websites where people post comments about their employers) and scan these data for patterns that relate meaningfully to corporate financial performance.
Until investors clarify which sustainability disclosures they want and help to rationalize frameworks and standards, sustainability reports might continue to deliver less material information than they would like.
As the market for sustainable investments expands, more investors are taking a keen interest in sustainability reports from companies. Yet the information these investors find seldom meets their expectations. From an investor’s standpoint, sustainability disclosures tend to be loosely related to financial performance, difficult to compare from one company to another, and less than reliable. Investors who take part in efforts to improve sustainability-reporting practices could gain an edge over their more detached peers. Executives and board members should stay attuned to these efforts, and even participate in them, to maintain their companies’ standing with shareholders.
Sustainability reporting helps make organizations' decision-making processes more efficient and, in turn, enables them to reduce risk across their supply chain. This process reduces waste, yielding significant cost savings.Why is sustainability reporting important for investors? ›
Sustainability reporting in the corporate setting is an important factor to improve a company's green initiatives and its relationship with investors and clients, inline with stakeholders' demand for transparency and accountability.Do investors value sustainability reports? ›
Investors can thus interpret the issue of a sustainability report as a sign of credibility. A company with poor sustainability development performance would not likely invest the same resources as one that publishes a standalone sustainability development report.What is the value of ESG reporting? ›
Once more, an ESG report is designed to provide full transparency over an organization's environmental, social, and governance impact across a multitude of stakeholders, including investors, employees, and customers.What is the main benefit of sustainability reporting? ›
The benefits of sustainability reporting include improved corporate reputation, building consumer confidence, increased innovation, and even improvement of risk management.What is sustainability reporting and why is it important to today's assessment of a company's performance? ›
Sustainability reporting allows private companies, public and third-sector organizations, to affirm their mission and pursued values, to acknowledge and measure their economic, environmental, social and governance performance and improvement, and, accordingly, to set goals and develop strategies in order to make the ...What are the benefits of sustainability reporting to the company and its stakeholders? ›
- Demonstrating commitment to transparency. ...
- Measuring impacts to improve performance. ...
- Vision & strategy. ...
- Motivating employees. ...
- Improving reputation & increasing trust. ...
- Attracting capital and investment. ...
- Improved stakeholder engagement. ...
- Competitive advantage.
It turns out that 71% of the survey's respondents also think companies with good sustainability strategies make good investments, and that 44% say they consider environmental, or social, and governance factors when making a new investment.Why is sustainable investment important? ›
Providing sustainable investing opportunities enables firms to not only capture financial returns for clients, but also to realize intrinsic returns not replicated elsewhere. These intrinsic returns lead to deeper connections between the clients and their investing habits, creating long-term customer appetite.Why is sustainability reporting difficult? ›
Sustainability reporting contains data that is highly complex, interconnected, and technical, and as such there will always be a privileged group who have the time and know-how to evaluate and use such information, which limits its use and creates different interpretations of the data provided.
Companies that look at their ESG initiative as value generation gain more positive outcomes. Investing in ESG requires a significant cost commitment and creates considerable value over time. For instance, transitioning to new, more sustainable operations puts your company ahead of the regulatory curve.How do you write a sustainability report? ›
- Set your goals before you start. ...
- Identify issues and choose indicators. ...
- Expect trouble in data collection. ...
- Analyse the data critically. ...
- State key observations. ...
- Communicate in a way that people will listen.
Environmental, social, and governance (ESG) investing refers to a set of standards for a company's behavior used by socially conscious investors to screen potential investments. Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example.Does ESG really matter and why? ›
Even when ESG can be measured, there is no meaningful relationship with financial performance. Accordingly, the responses to ESG critics coalesce on three critical points: the acute reality of externalities, the early success of some organizations, and the improvement of ESG measurements over time.Why do investors care about ESG? ›
By considering ESG factors, investors gain a more holistic view of the companies they back, which can help mitigate risk and identify opportunities for growth and improvement.What are the main characteristics of a sustainability reporting approach? ›
Quality sustainability reports will have all five of these characteristics. So, make sure your report has transparency, authenticity, stakeholder engagement, intuitive structure and design, as well as meaning.What is the benefit of a company public in a sustainability report? ›
A sustainability report, similar to a financial annual report, helps an organization identify its cost savings. It emphasizes a link between non-financial, and financial performance of the company. The publishing of the report influences company policy, business plans and a long-term management strategy.What is core feature of sustainability reporting? ›
Sustainability reporting is based on performance-based management and is a cycle to promote continuous improvement. There are four steps in the sustainability reporting process: (1) define performance goals and metrics, (2) measure performance, (3) evaluate performance, and (4) manage performance.Does sustainability reporting improve performance? ›
Companies that report their environmental, social, and governance practices have more sustainable operations and, generate higher profitability and market value improvements over time, as shown by a survey from BCG consulting company.What is one of the biggest challenges when companies are committed to sustainability? ›
One of the biggest challenges that the companies are committed to sustainability faces are; Operations are impacted the most due to a reduction in procurement. The surrounding community needs to understand the environmental impact of the changes.
What are the theories that have been used to explain sustainability reporting practices? Stakeholder theory and legitimacy theory.What are the challenges of sustainability reporting? ›
- You have to gather data from many different sources.
- Sustainability reporting is time consuming.
- You have low-quality data.
- Your sustainability reporting is not actionable.
- You're suffering from data overload.
- You can't make sense of all your data.
As a management and communication tool, sustainability reports reveal the company's performance in economic, environmental, and social areas, allow to know the impact on stakeholders and help assess improvement opportunities.What issues do investors who want sustainability face? ›
Sustainability-motivated activist investors often address topics like board diversity, employee retention, climate change, environmental impact, supply chain ethics, and data security and privacy.What are the sustainability risks for investors? ›
'Sustainability risk' is to be understood as risk that has a financially material impact to the expected return on investment. The financial impact may be on the investment or the target company itself, arising from environmental, social, and governance considerations.What type of investors care about sustainable investing? ›
Sustainability-focused investors wish to advance environmental, social, or governance principles, as they see value in bringing about positive change. Sustainable investing comes in many forms, including stock purchases of eco-friendly companies or investing in the formation of a non-profit.What does sustainability mean for investors? ›
Sustainable investing directs investment capital to companies that seek to combat climate change, environmental destruction, while promoting corporate responsibility.What is a sustainable investment objective? ›
Sustainable investment means an investment in an economic activity that contributes to an environmental or social objective, provided that the investment does not significantly harm any environmental or social objective and that the investee companies follow good governance practices.What is the importance of environmental reporting? ›
The purpose of environmental reporting is to provide a significant tool for environmental communication and to fulfill organizations' accountability in regards to the environmental burden. Therefore, there are certain common items or contents that should be included in environmental reporting.How sustainability reporting SR can benefit consumers? ›
One of the benefits of sustainability reporting is that it's the best way to make sure you're not washed away in the tide of changing consumer preferences. Transparency turns your company from a faceless corporation into a company consumers feel they can trust and develop a bond with, boosting customer loyalty.
It sets out your vision, principles and policies and defines your approach to governance, stakeholder engagement and reporting. Sustainability Report Assurance instils confidence that what you are saying about your performance has been subject to proper scrutiny.What are the issues with sustainability reporting? ›
Some common problems in sustainability reporting include: You have to gather data from many different sources. Sustainability reporting is time consuming. You have low-quality data.What are the qualities of a good environmental reporter? ›
One must have the ability to follow environmental policy decisions and environmental organizations. An environmental journalist should have a general understanding of current environmental concerns, and the ability to communicate information to the public in a way that is easily understood.How do you write an environmental report? ›
- 8 Steps to Better Environmental Report Writing.
- 7 Steps for Revising a Technical Report.
- 8 Techniques for Clear, Concise Writing. #1 – Shorten sentences. #2 – Put actions in verbs. #3 – Put the main topic in the subject. #4 – Keep subjects near verbs. #5 – Keep subjects simple. #6 – Use passive and active voice judiciously.
Internally speaking, CSR reports are important because they allow companies to estimate the impact their operations have on the environment, society, and the economy.How can sustainability be improved in reporting? ›
- Consider reporting frameworks and wider context. Sustainability is fundamentally contextual – and the key is to present performance in your report in relation to the broader limits and demands placed on the environment and society. ...
- Show real commitment, not just compliance. ...
- Choose the right channels for your audiences.
Quality sustainability reports will have all five of these characteristics. So, make sure your report has transparency, authenticity, stakeholder engagement, intuitive structure and design, as well as meaning.What are the six key steps in sustainability reporting? ›
- Set your goals before you start. ...
- Identify issues and choose indicators. ...
- Expect trouble in data collection. ...
- Analyse the data critically. ...
- State key observations. ...
- Communicate in a way that people will listen.
What are the theories that have been used to explain sustainability reporting practices? Stakeholder theory and legitimacy theory.Which reporting framework should be applied in developing the sustainability report? ›
Global reporting initiative (GRI)
The GRI Sustainability Reporting Standards (GRI Standards) are a reporting framework for organizations to disclose both positive and negative impacts on the environment, society and the economy.
ESG refers to the environmental, social and governance information about a firm. There is growing evidence that companies that take their environmental and social responsibilities seriously perform better financially.