8. Defining, Measuring, and Reporting ES&G Performance

Very few people who have worked in or around business have not heard the phrase “What gets measured gets managed.” As discussed in Chapter 5, I am a firm believer in the importance of defining what outcomes are desired from a business-related activity; establishing metrics or indicators to evaluate whether those outcomes are being attained (or are likely); and collecting and periodically reviewing information to determine whether an activity, initiative, or organization is on course and likely to succeed. This chapter discusses in a bit more detail why this type of mindset and approach is important; how sustainability performance is typically defined and measured, and by and for whom; and typical reporting conventions and practices. Following this discussion, I return to the issue of how this information is received and interpreted by participants in the capital markets—in particular, ES&G investors and analysts. The chapter closes with some recommendations for how the whole process, from defining relevant performance dimensions and metrics through use in investment analysis, might be improved. As I will demonstrate, the current status quo has many deficiencies and gaps that limit companies’ ability to optimize their responses to sustainability issues. These limitations also constrain investors’ ability to fully appreciate and act on the factors that will increasingly separate the firms that can best adapt to sustainability challenges and opportunities from those lacking this capability.

• Desired outcomes are stated either at the outset or following a brief exploratory effort.

• Appropriate interim milestones and time frames are defined.

• There is a means of regularly collecting and reporting information on what has happened (both resources used and accomplishments).

• Management has had an opportunity to either endorse the current process or make appropriate adjustments.

At the bottom is ES&G data. Most regulated companies (and many other entities) produce basic data on EHS performance in great quantity. Regular reporting on certain defined elements (such as waste generation, pollutant emissions, and accident rates) is an ongoing and often mandatory activity. Regulatory agencies, particularly EPA headquarters and regional offices and state regulatory agencies, are repositories of vast quantities of data addressing the regulated behavior of companies operating within their jurisdictions. Most of these data are in “raw” form, meaning that they are submitted in the required format (a number or set of numbers in defined units). Often the receiving agency does nothing more with the data than compare the numeric values received against any relevant performance standards or limits.

At the next level is ES&G information, which involves putting the basic data into a relevant context. Thus, when a set of data is connected with the circumstances in which it has been generated, it acquires more meaning and is more useful.

Interpreting ES&G information in a way that yields one or more conclusions produces knowledge, which is needed to inform decisions about which sustainability issues are important, how best to address them, whether current activities are on track, and a variety of other issues.

Finally, wisdom, or at least insight, involves applying judgment and previous experience to knowledge, which enables an understanding of the implications of ES&G issues and organizational posture and performance. Insight is required to decide how best to retool a sustainability initiative that is not attaining its goals, or how to set priorities among many seemingly important sustainability objectives.

These terms and the distinctions among them are not simply a matter of semantics or academic interest. In observing the ways in which different actors produce, use, and interpret ES&G data and information over a period of many years, I have concluded that confusion about how these levels of meaning differ often leaves participants frustrated. For example, a company’s EHS staff might believe that the performance data they are conveying are suitable in the form in which they have chosen to report them. But the recipient actually requires input at a different level of the hierarchy. To me, it is obvious that in and of themselves, ES&G data tell us little about an organization’s sustainability posture, performance, or future prospects. As you will see, however, this limitation has not prevented many parties that evaluate such questions from making judgments based on these indicators. Indeed, many ES&G researchers explicitly request performance data so that they can use their own internal methods to transform it into useful knowledge and insight that may be useful to their customers. Although these organizations may be using extensive intellectual capital and other resources to convert these data into knowledge and insight, in many cases, the ways in which they are doing so are unstated or unclear. This mismatch between what is reported and what is ultimately needed presents a substantial opportunity for improvements to the typical patterns of ES&G data development, reporting, and investment analysis now in widespread use. I share some recommendations on this point at the conclusion of this chapter.

• Whether the firm’s leadership has identified all the important sustainability-related issues and has complete and coherent plans for how best to address them

• How internal staff and other resources are being deployed in pursuit of risk and cost reduction and revenue enhancement opportunities

• What results are being obtained

• How the firm’s standing and performance are being evaluated by important stakeholders

In this world, apart from specific compliance-driven obligations, decisions are made on the basis of return-on-investment considerations. They are heavily influenced by competing priorities and, often, fluid market and overall economic conditions. Key performance indicators tend to be relatively few in number and speak to explicit goals/commitments or business drivers.

The “Green Metrics That Matter” is an ongoing project by the National Association for Environmental Management (NAEM), the leading professional association for the corporate EHS community. This project is focused on identifying, through use of a survey, the metrics member companies use internally to track sustainability performance. The Association’s corporate members (corporate EHS/sustainability vice presidents, directors, and managers) represent approximately 70 companies that could be considered sustainability leaders. The survey addressed six categories of metrics that are typically included in a corporate EHS and sustainability management structure—Resource Consumption; Resource Conservation and Recovery; Emissions and Waste Management; Health and Safety; Compliance; and EHS/Sustainability Management Practices. The following highlights from the research (NAEM, 2011, forthcoming) illustrate the previous points concerning what types of endpoints matter most to those in the executive suite.

• Resource consumption, conservation, and recovery—The vast majority of respondents track energy, electricity (apart from total energy), and water use. Interestingly, most also have established targets (presumably, use reduction) for all three and also track quantities conserved of these three major inputs relative to targets. The recent focus on these parameters may be related to general economic conditions, in that firms usually focus on cost reduction opportunities during recessions or declines in demand that occur for other reasons. In addition, a significant majority also track consumption (or percentage) of energy use provided by renewable sources, although a smaller number and percentage of firms have established targets in this regard. Conservation and/or recovery of a number of other materials also are tracked by a substantial number of responding firms. These include metals, paper, plastic, and end-of-life electronics, among others. In general, roughly half of the firms that track these endpoints also have established corresponding performance targets for them.

• Emissions and waste management—A majority of the 50 or so respondents’ firms track TRI emissions, greenhouse gases (GHG), and solid and hazardous waste. Regulated air and water emissions, although tracked by a majority of responding firms, are monitored by fewer firms. A compelling finding is that two distinctly unregulated metrics (greenhouse gases and solid waste) have corresponding targets at a majority of responding firms.

• Safety—Survey respondents clearly indicated that safety remains a primary concern and most track several different endpoints. These include injuries and fatalities, lost workday injuries, and the like as well as non-regulated issues such as near-misses, unsafe exposures, and driving safety.

• Compliance—Most responding companies track an array of different metrics to ensure continuing regulatory compliance and monitor possible or actual legal sanctions. These include formal notices of violation (NOVs), fines and penalties, excursions beyond permit conditions, spills and other unplanned releases, remediation costs, consent orders, and lawsuits or other legal actions.

• EHS/sustainability management practices—Some of these practices are established and have been widely adopted, such as deployment of formal management systems, employee training, and audit programs. Others are more forward-looking and address emerging issues. It appears that most of the responding firms use many, if not most, of these indicators, which cut across a number of different topics, from internal program execution to ES&G-related investments and savings to philanthropy and community investment. For some of the more established and readily quantifiable metrics, many or even a majority of firms have established targets. This applies to management systems deployment, auditing, training, employee and supplier diversity, and philanthropy. Others, which may be in more formative stages, such as investments in sustainability products and services or alternative energy, are being monitored by many of the responding companies but less frequently companies have accompanying targets.

• Assurance of compliant behavior. All stakeholders have an interest in receiving assurance that a company understands all pertinent legal and regulatory requirements and has taken effective steps to ensure that it is in compliance with them. This applies just as surely to the Board of Directors as it does to a citizens’ group or regulatory agency. This type of endpoint has at least two major threads. One is evidence of current compliance, such as audit results that document conformance with all stipulated controls and limits. The other is the existence of management processes, and preferably systems, that provide some assurance that as circumstances change, the firm can adapt without undue disruption that might bring about noncompliant behavior or episodes.

• Appropriate management approaches. Although the connections may not be apparent to some, considerable overlap exists in some of the social concerns expressed by many NGOs and the interests of long-term investors and the general public. As discussed in Chapters 4 and 5, viewing the organization’s employees and suppliers as important assets and sources of competitive advantage rather than as components of the means of production leads naturally to management practices that are more respectful, likely to achieve productivity gains, and effective in improving retention and recruiting success over the longer term. These outcomes include building important intangible assets that can be leveraged to increase the firm’s value-creation potential and hence are or should be of interest to investors. The general public also has an interest in supporting these types of behaviors, because it makes firms stronger, more stable, and a better long-term source of employment, tax revenue, and support for local communities. As discussed in Chapters 6 and 7, abundant evidence exists that disciplined investments in proactive, supportive management practices routinely produce financial benefits in excess of their costs. There also is evidence that firms taking this type of approach outperform their peers in the marketplace over time.

• Value creation orientation. In similar fashion, it may be unclear to a member of the public or a regulator why he or she should care whether companies optimize their financial resources in addressing ES&G issues. But if you consider the economic aspect of the sustainability concept, it is clear that companies must be economically competitive to be sustainable in the long term. As discussed in Chapter 5, choosing to not carefully consider the financial costs and benefits of ES&G activities is to make less and/or less rapid progress toward a sustainable future than would be possible otherwise. Accordingly, although most company stakeholders outside the firm and the financial sector do not presently much care about the costs of sustainability activities even if they do care about the associated benefits, they should.

These core issues have important implications for how firms and their leaders might want to structure their approaches to developing and populating metrics to document ES&G posture and performance and to report their results to external parties. It seems to me that reporting performance using metrics that address one or more of the three core issues just defined is more likely to satisfy the needs and expectations of multiple stakeholder groups with one set of disclosures than would be likely otherwise. Certainly, there is at least the potential for companies to reduce both the volume of information they need to develop and report and the effectiveness and consistency of their communications efforts. The alternative is to continue the typical practice of speaking in one voice and delivering information on one facet of sustainability with investors while using another with EHS regulators and a third with host communities, interested NGOs, and the general public.

In a number of areas there is hope that most or all company stakeholders might reach agreement about key sustainability indicators, or at least the general categories of interest. But a number of important gaps remain. This is true despite the emergence in recent years of some widely used corporate sustainability reporting frameworks. Sustainability reporting is the subject of the next section.

Over the years, I have reviewed scores, if not hundreds, of corporate environmental, EHS, and sustainability reports produced by companies. It is fair to say that the state of the art in this regard has advanced considerably during the past 15 years or so. These reports display far more depth and uniformity in their content and organization than they did years ago. As I discuss further later, this trend is both positive and important. A principal driver and, at the same time, beneficiary of this trend toward a more consistent approach to ES&G reporting is the GRI, which has used an extensive and interactive multistakeholder process to develop and refine its reporting guidelines. These guidelines are intended to meet the needs of a wide array of organizations, ranging from small NGOs to major multinational corporations. The guidelines include a substantial number of endpoints and reporting metrics, most of which are viewed as universal and of interest to a wide array of stakeholders. At this point in time, it is fair to characterize the GRI reporting format as the de facto global standard for sustainability reporting, because it is by far the most commonly used approach and has no serious rival.

With that said, the number of U.S. corporations reporting their ES&G practices and performance in a structured GRI report is somewhat limited. A much larger number report at least some information to the CDP⁴ and/or the UNGC. Many companies also issue environmental, CSR, or sustainability reports that are not prepared according to the GRI guidelines. Or they publish or post on their web sites data, documents, exhibits, and other materials that address some or all aspects of their ES&G policies, practices, and performance.

In 2009, I conducted with a colleague a review of the disclosed environmental management practices of the 1,000 largest publicly traded U.S. companies (Soyka and Bateman, 2009). The findings indicated that many firms report at least some of the types of information that would likely be of interest to external stakeholders, including investors. The great majority, however, provided either no information or insufficient information to enable a stakeholder to understand whether and to what extent the company’s senior management fully understands and is actively managing the firm’s environmental risks and opportunities. Specific highlights of the study include the following:

• Only 60 percent of the largest publicly traded U.S. companies have an environmental, EHS, or sustainability policy.

• Most policies lack rigor and sophistication:

• Less than 28 percent have any two of six key policy elements, and less than 9 percent have three or more of these elements.

• Only 8 percent of firms vest oversight responsibility for ES&G issues with the Board of Directors, and only one in 18 has delegated responsibility to a “C-level” (CEO, COO, or CFO) executive.

• Two-thirds of firms with policies make clear that requirements apply to all employees and operations, but only one in four includes specifics, as opposed to general principles and/or aspirations.

• Only 13 percent have published a corporate environmental, CSR, or sustainability report.

• Twenty-seven percent have disclosed their direct GHG emissions. But only about 16 percent have a corporate climate change policy, and only 60 percent of these make clear that it applies to all company operations and employees.

• Only 11 percent of firms have disclosed their annual energy costs, and about 7 percent have disclosed their total water use and/or cost.

Given that environmental management has received focused, and often high-profile, attention for many years, you might expect environmental reporting practices to be advanced among major corporations. Hence, there is little reason to believe that broader ES&G reporting practices, the major topic of this chapter, are any more extensive or informative.

We conducted a more in-depth evaluation in 2010. We found that (again) across the 1,000 largest publicly traded U.S. companies (962 with complete data), coherent environmental (and broader ES&G) management approaches appear to be absent in most companies. The study was based on application of a new environmental rating methodology, the Governance and Environmental Management Strength (GEMS) rating. It was designed to rigorously evaluate companies’ ability to anticipate and actively manage the EHS issues that pose risks to and present opportunities for their operations by assessing the presence or absence of 49 distinct indicators. These indicators and their relative importance closely parallel the recommended elements of a corporate sustainability program that I outlined in Chapter 5. Scores are normalized to a 100-point scale. In addition to generating a ranking of the companies with the strongest apparent environmental governance and management strength, this study revealed the following:

• Company scores ranged from 0 to 82, with nearly half of firms (448) earning total scores of less than 10.

• Every major economic sector had strong performers. This suggests that the means to achieving excellence in environmental management practice are widely understood and spreading from the traditional industrial base to more sectors, industries, and companies. That said, at a general level these concepts remain infrequently practiced.

• Across the 12 major sectors comprising the U.S. corporate economy, the clear leaders are the firms in the consumer staples, materials, and utilities sectors. At the other end of the spectrum, the real estate, services, and telecommunications services sectors are among those in which the typical firm has the least (and often no) disclosed environmental management expertise or activity.

• Even in sectors in which most firms have little apparent environmental management sophistication, a number of noteworthy firms stand out. For example, 17 firms have GEMS Rating scores within the top quartile of all Russell 1000 firms that also are more than twice those of their closest industry competitor.

• On the other hand, a significant fraction (170, or 18 percent of the total) have a total score of 0. This means that they have no disclosed environmental governance; no environmental, climate change, or health and safety policies; and no management systems or significant environmental improvement programs. Also, they do not measure and report environmental results (Soyka & Bateman, 2010).

The pattern here is clear. A limited number and relatively small percentage of U.S. companies have established leadership regarding ES&G data development and reporting practices. In so doing, the senior managers within these firms have provided significant assurance that they understand their sustainability aspects and have taken appropriate actions to ensure that their respective firms are in a position to adequately control ES&G risks and capture opportunities to create value. They have demonstrated that this can be done and have blazed a trail that others can follow. Based on the available evidence, and with the caveats just stated, it seems equally clear that the great majority of U.S. companies (publicly traded and otherwise) have substantial work to do to build their ES&G capabilities and provide the information and assurance of their sustainability posture and performance that their stakeholders are increasingly demanding.

Indeed, notwithstanding the limited extent of corporate ES&G reporting just documented, more and more companies are compiling and reporting information on their environmental, health and safety, social, and governance posture and performance every year. Both the number of companies reporting information and the range of indicators provided have been steadily expanding in recent years. Moreover, there has been a progression from the traditional media-focused reports (data on emissions, waste) that have been with us for the past two decades. Recent disclosures increasingly embody sustainability concepts and reflect a more comprehensive and sophisticated examination of the full range of ES&G issues and their interactions, at least among the leading companies. The following sidebar gives an example of why companies are moving in this direction and what they are increasingly experiencing as a result.

So it would seem that trends are moving in the right direction and that, at first glance, all the conditions required to stimulate widespread, high-quality corporate ES&G reporting are in place. This would suggest that it is only a matter of time before such reporting is as common as financial reporting, or nearly so. A deeper examination of the facts on the ground, however, suggests otherwise. As discussed earlier, most companies, large and small, do not provide much, if any, substantive information on their ES&G policies, goals, practices, or performance. Fewer still issue GRI or other formal sustainability reports, despite the public prominence of the GRI and persistent demands for greater corporate ES&G disclosure from the SRI community and other stakeholders. These facts suggest that in the majority of cases, corporate decision-makers have yet to be convinced that sustainability reporting is in their best interests. Even if they think it is, they may be unconvinced that such reporting is worth the investment of time and resources needed to assemble and ensure the quality of the required data and, possibly, prepare an attractive and sophisticated report. Some remarks I have heard from corporate EHS professionals over the years tend to corroborate this view. The business case for widespread reporting has yet to be presented to all corporate decision-makers in a compelling way.

Another point of view is presented by those who collect, analyze, and report information on corporate ES&G posture and performance, generally on behalf of professional investors. These ES&G researchers are described later. Over the past ten years or so, I have had the pleasure of working with one of the more experienced and insightful people within this small industry. He offers some interesting thoughts on where we are and what will be required to advance the current state of the art. Mark Bateman is a friend and frequent colleague who is the Director of Research for ES&G research firm IW Financial. He also recently formed a new venture, Segue Point, LLC. Previously, Mark served as Director of the Environmental Information Service and as the Vice President for Research and Operations of the Investor Responsibility Research Center (IRRC). Accordingly, he has an unusually deep understanding of the challenges and opportunities involved in ES&G reporting:

“I would offer two perspectives here:

“Investors. The biggest hurdle is that a lot of investors need to evaluate hundreds to thousands of companies, and be able to apply the same kind of analysis to each of them. The biggest impediment in doing so is a lack of information. We lack comprehensive disclosure across sectors and even industries, so investors often have to evaluate transparency, policy, or even be left with the transparency of a firm’s policies. For example, how can someone evaluate the energy use/performance of an industry or portfolio if most firms don’t disclose this information? Should you penalize a company that discloses but is not a top performer relative to a peer company that doesn’t disclose at all? The good news is that today, versus ten years ago, we have a good spectrum of disclosure, so the factual basis for evaluating companies is getting stronger.

“Corporate. Here the issue is more related to leadership and culture. When you hear stories about companies that have really taken this on and are moving in the right direction, there is almost always a major component speaking to leadership. Sometimes this is provided by top management, and sometimes from the rank and file. More than just serving as an internal champion, the most influential people had both the skills and the ‘permission’ to become an external voice, create a network, and bring key voices back to the company to inform decisions.”

(Bateman, 2011)

My own assessment is that there are several reasons for the absence of widespread, meaningful corporate sustainability reporting. One is that in many companies, as suggested in previous chapters, only a tenuous connection has been made between EHS and other sustainability-related practices and the determinants of value for the business. Beyond anecdotal evidence of value arising from energy efficiency and other “P2” projects, most companies have relatively little in the way of quantified results that directly show financial benefits relative to costs. In even fewer cases have company leaders made the effort to systematically quantify the costs and benefits of their ES&G activities and link them to the primary value drivers that apply to their business. As I suggest in Chapter 5 and elsewhere in this book, this orientation will need to change if corporate sustainability is to take root and flourish in as many organizations as it should.

On a related note, in many cases it is not apparent how the typical ES&G metrics that are requested, or at least collected and tracked, by ES&G researchers are related to company objectives and goals. Much tighter linkages must be established in this area so that both company employees and external stakeholders understand which particular metrics are being tracked and why. Metrics of interest to ES&G researchers and analysts that may not be tracked by companies should generate more dialogue. It should be discussed why these endpoints are of interest, what they signify to the stakeholder, and why it is in the company’s best interests to collect and report information on these issues.

Another possible barrier concerns incentives and their impact on behavior. As mentioned previously, it may be somewhat unclear to corporate executives what is to be gained from regular and extensive ES&G disclosure. But it may be very clear how such practices could potentially damage the firm and its interests. Because of the high profile and emotional content of certain ES&G issues, some executives may believe that the less said about these topics, the better. Given the volatility of public opinion and the generally negative attitudes toward corporate behavior within the American general public, corporate leaders may believe that greater disclosure offers relatively little upside but significant downside potential.

Two other concerns also may inhibit greater willingness to develop and share ES&G data. One is company culture. The simple fact is that some firms by their nature tend to hold information “close to the vest,” and always have. For them, openly and voluntarily reporting on a wide array of practices and performance is a somewhat alien concept and may push them well out of their comfort zone. The other potential concern, which may have more impact in the future than it does now, is competition. In contrast to many other areas of business, the world of EHS management has tended to operate in a collegial and cooperative way. Many industry initiatives and organizations have worked over the past two decades to develop and share best practices, tools, and other information. This openness and willingness to share has been of great benefit to those who have participated in these (generally) industry-led efforts, and many others as well. It is important to realize, however, that all that may change with the emergence of sustainability and the likelihood that increasingly, firms will try to leverage ES&G excellence not just to control costs but to create and capture new markets and other revenue streams. If ES&G management practices can be leveraged to capture market share and new customers, we can reasonably expect that companies will safeguard their knowledge in this domain much more aggressively than they have in the past. Accordingly, in the future, companies may be far less willing to share the specifics of their sustainability-related activities, approaches, methods, results, and lessons learned.

Finally, we must confront the fact that the prevailing framework for sustainability reporting is simply not entirely suitable or adequate to meet the information needs of some stakeholders, particularly investors and their information providers. Firms can reasonably be expected to be responsive to the interests and information demands of a variety of external stakeholders, including customers, suppliers, regulatory agencies, and the general public and organizations asserting that they represent the interests of the public (NGOs). In general, these stakeholders have an interest in ES&G posture and performance information for two reasons. First, it provides some level of accountability and assurance that the company is being operated in a responsible manner, that commitments are being upheld, and that goals are being attained. The second reason is that some stakeholders seek evidence of leadership and/or competitive advantage. Generally, in addition to evidence of responsibility, these stakeholders are interested in distinguishing among companies (or sectors) so that they can identify appropriate business partners, firms worthy of recognition, and/or sources of guidance and best practices.

The dominant existing framework for ES&G reporting, the GRI, responds to these needs quite well. The current incarnation of the GRI reporting guidelines (the so-called “G3”) requests narratives on how the organization addresses each of the major “legs of the stool.” It also includes a substantial number of quantitative performance indicators in such areas as waste, pollutant emissions, injury and illness rates, diversity, training, respect for human and labor rights, and many others. When augmented with the appropriate “sector supplement” for particular industries,⁶ the GRI can provide a comprehensive and thought-provoking framework. Through applying this framework, a company (or other organization) can examine its operations, develop a coherent picture of its current posture and recent performance, and provide information to external stakeholders in a form that is useful, well-understood, and, increasingly, expected.

With that said, the GRI has some important limitations, some of which are particularly acute in the context of information development for use by the financial sector. First, it is clear that despite the fact that the GRI has operated a remarkably open, transparent, and inclusive process in developing and revising its reporting guidelines, in the final analysis, social considerations (the S in ES&G) dominate. The general reporting guidelines contain no less than 40 Social indicators, more than the total of the Environmental (30) and Economic (9) indicators combined. Within the general domain of Social indicators are four defined subcategories: Human Rights (9), Labor (14), Product Responsibility (9), and Society (8). Of greater consequence in the current context, however, is a far bigger issue: unclear linkages between the GRI indicators and key business endpoints. In other words, there is little or no apparent relationship between the G3 indicators and the widely used financial indicators (revenues, earnings, cash flow, capital structure) described in Chapters 6 and 7. Nor is there any substantial connection to some of the key intangible assets (such as intellectual capital, brand value, and supply chain relationships) that increasingly determine competitive advantage and the potential for long-term financial value creation.

This depiction of what the GRI is and why it is insufficient may seem like an indictment of the GRI process and those involved in it. But I want to emphasize that it is not. The GRI and its supporting organizations, and many hundreds of dedicated professionals from (literally) around the world, have invested great effort and energy working to ensure that the GRI reporting guidelines were made as complete, balanced, and meaningful as they could be. Considering that they are the product of a consensus-based, multistakeholder process and hence are no one’s absolute ideal, the guidelines are remarkably thorough, focused on many of the most important sustainability issues, and accessible and relevant to a wide range of organizations. The fact that the guidelines do not adequately represent the interests of a wide range of (mainstream) investors and analysts reflects a failure—not on the part of the GRI, but on the part of the mainstream financial community. The simple fact is that during the decade or so when the guidelines were being scoped, developed, and refined, representatives of large mainstream investment companies (Wall Street, large mutual fund companies) were invited (repeatedly) to participate. But they declined to do so. As a consequence, now that many of these firms are experiencing the dawning realization that ES&G issues really do matter to securities valuation, they find themselves on the outside looking in. Unfortunately, those of us who have a natural affinity for and focus on the value-creation perspective similarly find ourselves with an incomplete set of tools with which to work when evaluating disclosed corporate sustainability data prepared according to the GRI guidelines. Because the guidelines are reviewed and revised every few years, there will be future opportunities to amend them to include all (or more) of the relevant endpoints.⁷ But it is not certain that all stakeholders will agree that the financial criteria of interest to investors should be included. In any case, in the interim, the G3 guidelines will continue to serve as the standard, or baseline, for corporate sustainability reporting.

The modest market penetration of the GRI, coupled with the absence of any significant interindustry competitor, is no small matter. The limited uptake of the GRI in the U.S. constrains its utility to investors and to others interested in industry-wide or sector-level best practices or norms, or in conducting comparative analysis. Compounding the issue is the perception by some that the indicators are too backward-looking, do not provide actionable information, and/or are too focused on the agenda of key interest groups (such as organized labor). However, the existence and magnitude of these issues is understood within the leadership of the GRI. The new “Focal Point USA” initiative was created to bring renewed attention to promoting more extensive use of the GRI by U.S. companies. Moreover, several planned or ongoing efforts are under way to promote “integrated” ES&G reporting, both within the GRI and by other entities.

The most prominent among these is the recent formation of an International Integrated Reporting Committee (IIRC) convened by the Accounting for Sustainability project of the Prince of Wales Charities and the GRI. The IIRC also has attracted support from and participation by representatives of the accounting profession and its standards-setting bodies, as well as a small number of companies, environmental NGOs, investors, and academics.

The IIRC seeks to promote development of an integrated reporting framework to accomplish several related needs:

• Support the information needs of long-term investors by showing the broad and longer-term consequences of decision-making

• Reflect the interconnections between ES&G and financial factors in decisions that affect long-term performance and status, and illuminate the link between sustainability and economic value

• Provide the necessary framework for environmental and social factors to be taken into account systematically in reporting and decision-making

• Shift the focus of performance metrics away from an undue emphasis on short-term financial performance

• Bring sustainability reporting content closer to the information used by management to run the business on a day-to-day basis (The Prince’s Accounting for Sustainability Project and the Global Reporting Initiative, 2010)

It is important to understand what is implied by these goals. In the minds of some people, integration means far more than elucidating the cause-and-effect relationship(s) between particular EHS and social issues, and their expression as changes in revenues, earnings, cash flow, and/or risk. I recently had an opportunity to discuss the IIRC and its goals and likely direction with a member of its Steering Committee, as discussed in the following sidebar.

Regardless of the specific direction taken by the IIRC, if this initiative is successful, even in part, it will help resolve at least some of the major limitations of currently used sustainability reporting approaches.

At present, only a small number of companies in the U.S. and other markets are developing and issuing integrated sustainability/annual reports. Few, if any, of these reflect the sort of intimate integration of ES&G factors into core business practices and financial results that are desired by many observers (myself included). But at least these reports represent an initial step on what will doubtless be a challenging path. As these companies gain experience, and if and as the integrated reporting movement gathers strength and support from a critical mass of key participants and stakeholders, we may see a substantial, and perhaps sudden, acceleration in the practice of integrated ES&G reporting. There are some early, encouraging signs, as discussed in the following sidebar. If you’re interested in corporate sustainability and/or sustainability investing, you might want to monitor developments in this area closely.

Recent years have witnessed new initiatives to promote more coherent and relevant corporate sustainability reporting as well as pioneering efforts by a number of leadership firms. But for the present and the near-term future, we will continue to have patchy and incomplete information on the sustainability practices and performance of U.S. firms. To fill the needs of investors and others interested in this topic, and in response to the paucity of complete and representative information, a small industry has taken shape over the past 15 years or so, as described in the next section.

Although relatively few in number, ES&G research firms are increasingly of significant scale and growing sophistication and financial strength. As shown in Table 8-1, many of the most prominent research firms (and ES&G research staffs within larger investment firms) have 50 or more professional staff, and several have 100 or more. In terms of their basic business model, the predominant use of corporate ES&G data is to support investment analysis. Therefore, virtually all the major ES&G research organizations cater exclusively (or nearly so) to investors. Most of these investors are institutional, rather than retail (individual), investors.

Table 8-1. ES&G Research Firm Demographics

ES&G research is international in scope. This applies to both the firms being evaluated and the location of the major ES&G research organizations. This “industry” is centered in the Northeastern U.S. and the UK, Switzerland, and Germany, roughly corresponding to the financial center of each geography. That said, ES&G research (and investing) is quite active in several other European countries, including France, the Netherlands, and the Nordic countries.

Interestingly, and as an indicator of the dynamism of the field, market entry into the ES&G research/investing space by several large, mainstream financial institutions has unfolded during the past four years or so. Several of the leading ES&G data vendors/research firms are now subsidiaries of much larger corporations. Notable events include the acquisitions of RiskMetrics by MSCI, SAM Group by Robeco, and ASSET4 by Thomson/Reuters, as well as the launch of GS SUSTAIN by Goldman Sachs.

Table 8-1 provides some general information about the size and complexity of their evaluations of corporate sustainability. ES&G research firms generally evaluate a large number of indicators, often more than 100. In contrast, particular ES&G investors (who are not developing data or products for sale to others) may focus on a smaller number, in keeping with their particular investment thesis.

ES&G researchers examine entire markets and multiple geographies and collect their information using different combinations of a limited set of methods. According to their web sites and publicly available documents, most major ES&G researchers routinely or continuously evaluate 3,000 to 5,000 companies and may provide more limited coverage of as many as 7,000. Virtually all publicly traded mid-cap to large-cap firms in the U.S. and Europe typically are included, as are some firms in Japan and Australasia. Coverage of companies in emerging markets is far more limited. To build baseline information on companies, most ES&G researchers (as well as ES&G investors that develop their own data) collect company data from company web sites, regulatory agency filings, and other sources of information publicly disclosed by the company. Some limit their data gathering to this step (such as IW Financial). Most, however, supplement this information with accounts presented in the news media, input from labor unions and/or NGOs, trade or industry associations, and/or think tanks. Many also seek direct interaction with the companies in question. This may occur through administration of a survey or questionnaire (SAM Group, EIRIS) or take the form of an interview or structured dialogue (RiskMetrics, KLD, Oekom Research, Maplecroft). In addition, many firms solicit feedback on the accuracy and completeness of their preliminary research findings from the firms involved prior to the release of data and/or analytical results. Finally, a few ES&G research and/or investment firms make use of data, rankings, or ratings produced by others in the ES&G information space.

With a few exceptions, the range of issues of interest to these entities includes multiple ES&G endpoints, although the specific emphasis on and indicators used to evaluate each may vary. As discussed in Chapter 2, “ESG” has taken hold as the common terminology used by both investors and the organizations that provide information and analysis to them. This term also has been adopted by the multilateral organizations and initiatives described earlier that promote more extensive and consistent corporate disclosure, including the GRI, CDP, Investor Network on Climate Risk⁸ (INCR), and United Nations (in the context of UNGC and PRI). In contrast, a few evaluators and investors have chosen to address a more limited set of issues:

• Goldman Sachs GS SUSTAIN is limited to environmental and financial criteria.

• The Trucost methodology considers only environmental emissions and related criteria, which it evaluates using an economic input-output model.

• Maplecroft has developed an evaluation method and index for one set of environmental endpoints—climate change management.

As described in Chapter 6 and in keeping with broader overall trends, the focus of ES&G evaluation has shifted during the past ten years or so away from the negative screens originally developed for traditional SRI investing practices and toward a distinct value-creation orientation. Although a few of the more established, traditional SRI firms still apply negative screens, these tend to not be absolute. Examples of ES&G research providers that still use negative screens include Jantzi-Sustainalytics and EIRIS; among ES&G investors, Calvert and Trillium do as well. Others will apply them at the request of a particular customer.

This latter point reflects a larger trend among ES&G research providers: They increasingly offer partially or entirely customized approaches to defining important ES&G criteria, establishing weighting schemes, and selecting specific asset groups. In other words, the ES&G research community is increasingly allowing its customers to make their own decisions about which ES&G factors are important (and how important) while still providing, in many cases, an evaluation/investment philosophy and recommended approach. Some have taken this approach, along with advances in information technology, to its logical conclusion by establishing subscription-based ES&G data web portals for their customers. Often, these portals allow investment portfolio screening and/or assembly, monitoring for compliance with expectations, and many other functions using the ES&G data they contain. As an added feature and to increase utility and foster ES&G integration, many also offer company financial and operating data. ES&G research firms that offer ES&G data web portals include KLD, Jantzi-Sustainalytics, EIRIS, IW Financial, and Oekom Research. Table 8-2 summarizes the major activities of and products and services offered by most of the major ES&G research/investing firms active in the U.S.

Table 8-2. Major ES&G Research Firms

As opposed to the “in or out” evaluation method commonly used by SRI practitioners in the past, most ES&G researchers now use a more nuanced ES&G assessment of firms. It tends to be on a relative rather than absolute scale, and it also may be applied at the industry/sector level. The goal of these evaluations is to identify the best-in-class companies within each group of interest. Also, reflecting the typical or most common use of third-party corporate ES&G ratings, many of the entities producing these ratings have adopted a scoring/rating scale that resembles that of another commonly used corporate evaluation metric: the bond rating. Using this approach, a particular company’s stock (or fixed income) securities might receive a rating ranging from D– to A+ (or CCC to AAA). Firms using this type of approach include RiskMetrics, KLD, ASSET4, and Oekom Research.

Finally, and perhaps most importantly, a few firms have developed and applied a coherent theory of how ES&G improvements (or the lack thereof) affect a given company’s liabilities, costs, revenue-generation opportunities, cash flows, and/or other operational or financial endpoints.

ES&G research firms have moved aggressively in recent years to raise their profile and that of their methods and products. Several ES&G research firms have established alliances with major stock exchanges and related entities to form new stock indexes, exchange traded funds (ETFs), and other products of interest to institutional and retail investors. Table 8-3 shows some examples. Among the more prominent are the Dow Jones Sustainability Index (DJSI) series developed by a venture between Dow Jones and the SAM Group.⁹ It has expanded rapidly and now consists of 46 distinct indices with coverage of companies in global (15), European (16), North American (6), Asian (6), and country-specific (3) markets. Similarly, EIRIS teamed with the Financial Times and the London Stock Exchange to form FTSE, which is now a separate company, and to develop and publish the FTSE4Good index, which is populated using EIRIS data and analysis. Most recently, CRD Analytics teamed with NASDAQ OMX to produce the CRD Global Sustainability 50 Index, and Bloomberg has developed a set of screens and ratings based on the GRI reporting criteria. As shown in Table 8-3, ES&G researchers also have collaborated with specialty and mainstream media to publicize the results of newly developed and preexisting rankings/ratings of corporate citizenship, “green” characteristics, and/or sustainability:

• Newsweek has enlisted the assistance of KLD and Trucost, as well as corporateregister.com, to prepare a ranking of the top 500 “green” U.S. firms.

• Corporate Responsibility magazine has published a CR Top 100 list assembled by IW Financial using a tailored scoring methodology for this purpose.

• For the past few years, Canadian CSR-focused media company Corporate Knights has published its Corporate Knights Global Top 100, which is based on assistance and data provided by ASSET4 and Bloomberg.

Table 8-3. Examples of Major External Uses of ES&G Ratings

These developments have brought substantially more scrutiny from a larger set of actors to corporate ES&G behavior. This has created increasing pressure for companies to secure or maintain a place on and, ideally, at or near the top of these lists.

Over the past 15 years or so, this formerly small and fragmented ES&G data and research provider community has evolved considerably. It now has the financial backing and wherewithal to provide more-or-less continuous coverage of virtually any publicly traded company that is within the reach of U.S. investors. The ES&G research community has become more flexible in terms of its philosophy and approach. It continues to adapt to client demands for greater access to underlying data, useful tools, and Internet-based access. All these developments make the ES&G data and products generated by these companies more accessible and useful to the investor. They also suggest that this industry may be moving toward more of a commodity orientation. This would mean that increasingly, companies will compete on price, further stimulating greater access to corporate ES&G data.

To conclude this discussion, and to put the ES&G research industry and its evolution into appropriate perspective, Table 8-4 summarizes its major characteristics and how they have changed over the past 20 years or so. As shown in this table, the remaining players in this field comprise an increasingly influential, well-capitalized, and aggressive community that can no longer safely be ignored by corporate senior managers. With the market entry of major multinational financial and media companies in recent years, the ongoing acquisition and/or restructuring of many of the smaller players, and an ever-increasing diversity and flexibility of offerings, ES&G researchers represent a powerful but underrecognized conduit. Using this emerging channel, a sophisticated approach to corporate sustainability management can garner additional favorable attention, improved image with the public and activist NGOs (among others), and enhanced investor support. At a minimum, sustainability professionals working both inside and on behalf of companies should be aware of what these entities are, what they do (and, to some extent, how they do it), and how their principal products and services are used.

Table 8-4. Evolution of the U.S. SRI/ES&G Research Community

The next and final chapter returns to and expands on this idea. It is set in the context of a broader discussion of creating sustainable value for the enterprise and what this means to those who are involved in (or who want to become involved in) the EHS/sustainability profession.

2. These sites include the EnviroFacts data warehouse and the recently deployed Facility Registration System (FRS).

3. A few exceptions to this general rule exist, as discussed in Chapter 6. These include the recent SEC guidance clarifying that it expects companies to carefully evaluate the climate change issue and how it might affect their operations.

4. Note that CDP reporting takes the form of responding to a questionnaire. As discussed earlier, response rates are high, particularly among larger corporations. That said, the completeness and quality of the responses vary widely, with many companies providing little if any meaningful information.

5. As discussed in Chapter 6, these include contaminated site liabilities and vulnerabilities to climate change and possible greenhouse gas emission limitations.

6. When this book was written, the GRI had published five supplements (electric utilities, financial services, food processing, mining and metals, and NGO). Five others had been tested, and five more were under development.

7. When this book was written, the GRI had announced the launch of a development effort to produce the G4 version of the guidelines, tentatively scheduled for public release in May 2013. A “call for sustainability topics” for possible inclusion in the G4 closed at the end of June 2011.

8. INCR is a program of the NGO Ceres.

9. In its original incarnation, the venture included a third partner (STOXX), which is no longer involved in the DJSI.

10. One example is a major meeting cosponsored by the U.S. EPA and the New York Society of Security Analysts held in New York City in June 2008. Another example is a workshop hosted by the National Association for Environmental Management (NAEM) in Fort Lauderdale, Florida in May 2011. It involved NAEM members and representatives of a number of ES&G research and investment firms and sustainability reporting initiatives.

11. As discussed in Chapters 3 and 4, Walmart’s Supplier Sustainability Assessment is a noteworthy example (see http://walmartstores.com/Sustainability/9292.aspx).