Indicators for Corporate Sustainability - Analyzing Social-Environmental Costs
Posted in Finance Articles, Total Reads: 1125
, Published on 18 April 2016
The world today is displaying increased attention towards understanding and identification of sustainability issues. Corporate talks about “Triple Bottom Line”, i.e. People, Planet and Profit against the traditional bottom line “Profit”. The concept of triple bottom line offers an opportunity to move towards an accounting framework which deals with three pillars of sustainability: Social, Ecological, and Financial (Wayne Norman and Chris MacDonald, 2004). Even management intent towards incorporation of sustainability concerns can be gauged from the amount of efforts management has been taking towards increased environmental disclosures. An increased number of companies are adopting the practice of environmental and social reporting within their annual reports.
Following the lead provided by corporate, the article dwells into the pros and cons of adopting a triple bottom line approach of reporting. The article puts forth an argument for the inclusion of social and environmental costs in the evaluation of performances of the businesses. Further, the article discusses the factors that influence corporate decisions associated with environmental reporting. The Article hopes to provide an approach towards standardization of social and ecological indicators to enable truthful evaluation of corporate performance.
PROS AND CONS OF SUSTAINABILITY ACCOUNTING
Sustainability accounting is an approach to address the accountability issues for environmental damages. It is based on the assumption that sustainability crisis is the result of our failure to account social and environmental costs in businesses (Anthony G. Hopwood, 2009). This assumption is true to some extent, as management is possible only when the impacts get measured. Thus, socio-environmental accounting can serve an effective tool to calculate social and environmental costs of managing the system better. This assumption also forms the foundation of polluter pays principle.
However, the counter view is that the assumption of accounting of damages before management of resources may lead to the commoditization of ecological services. Assigning economic value to ecological services neglect the inherent values of these services. Thus, environmental accounting may be seen as our failure to appreciate the inter-linkages and complex nature of environmental (Larry Lohmann, 2009). Thus, the idea that environment must be protected for the sake of protection might get obscured.
Further, Sustainability accounting involves a lot of subjectivity. It’s difficult to arrive at standardized parameters that can reasonably capture social and environmental costs. Our failure to standardize sustainability accounting parameters provides a scope for creative accounting (Roger L. Burritt, T Hahn, S Schaltegger, 2002). Subjective nature of sustainability accounting arises from the fact that the impact of business operations on the environment has not been fully understood.
Disclosure of environmental information is usually a costly affair. One, companies are required to make a tremendous amount of effort towards the collection of raw data. However, the cost of data collection reduced in successive years of reporting. Second, the qualitative nature of social-environmental information needs to be converted into comparable quantitative parameters (Daryl Ditz, Janet Ranganathan, 1997). For example, not all types of pollutant emissions and environmental damages can be assigned numbers in equivalent carbon terms. Further, corporate responsibility would not end with mere reporting of numbers. Having calculated the environmental losses within a reasonable degree of certainty, it’s natural to expect companies to bear the cost of rehabilitation, protection, and conservation of the environment. These mitigation and adaptation measures further add to the cost of corporate sustainability disclosure.
FACTORS INFLUENCING THE DISCLOSURE OF ENVIRONMENTAL INFORMATION
There is a host of factors that motivates or influences management for disclosure of sustainability report. The increased awareness about environmental issues in the general community is one such factor that pushed companies for voluntary disclosure of their efforts towards environmental protection. Since, members of the community are interested in understanding the environmental impact of companies; management can enhance their relationships with the community by taking a more proactive position on environmental issues.
Secondly, the government, being an elected body, is expected to respond to pressure groups and the community at large. It is the outcome of this response that there has been significant growth in legal requirements and regulations imposed on business activities in the last few decades. Normally, a company would adopt social-environmental reporting under the influence of some or all the factors mentioned below:
• To address community concerns about the operations of the company
• To meet legal obligations or pre-empt legally imposed requirements
• To address customers’ concerns about its products
• To meet requirements of financial institutions
• To thwart environmental lobby pressure
• To gain strategic advantage over its competitor: pre-emptive response to environmental issues
• To provide information to shareholders/investors
• To address supplier concerns
Out of all these, a shareholder or an investor right to information is considered the most significant factor influencing the decision of the management. Given the significant increase in number of environmental legislations, desire to meet legal obligations is identified as the second most significant factor. Factors such as supplier concerns, financial institutions concerns are of lowest importance to management in the disclosure of environmental information (Trevor D. Wilmshurst Geoffrey R. Frost, 2000).
Thus, social-environmental reporting provides to the company an opportunity to guard against potential future business risks. It is also an opportunity to project a new and different image. Such a company can position itself to a segment which is relatively niche and relatively lesser competitive. Such a step not only increases its legitimacy and acceptance in the wider world but also provides a cushion to any unexpected future shock.
On the other hand, accounting changes make environmental costs more visible. By taking environmental accounting in consideration, one would be better equipped to analyze pros and cons of a business decision from the environment stand point. It encourages the corporate to remain prepared to share the burden of environmental damage caused by its operations and not just the profits.
A lot of research is taking place across the globe towards unification of various approaches of accounting environmental impacts. However, not enough time and energy is being devoted towards standardization of indicators to account for social costs of environmental damages (Xander Olsthoorn, D Tyteca, W Wehrmeyer et al., 2001). Some of the recent initiatives on environmental indicators are:
• Eco-efficiency Metrics of WBCSD
• ISO 14031 for environmental performance evaluation
• Environmental Performance Index (World Economic Forum, 2001)
• World Resources Institute Report (Daryl Ditz, Janet Ranganathan, 1997)
• GRI’s standards for corporate sustainability reporting
• Report on Environment-Related Performance Measurement (Bennett & James, 1998), etc.
Each of the above mentioned initiatives highlights our achievement towards capturing socio-environmental impacts. However, each of these indicators has its own limitations. These indicators try to understand a problem from limited number of variables. An ideal index should account for complex interrelationships and interactions of businesses with the environment. However, in reality, development of such an index is next to impossible (Thomas Dyllick, Kai Hockerts, 2002). The article suggests a combination of approaches in the following paragraphs to arrive at the relevant index to capture social-environmental costs.
A. To serve the purpose of practical utility, a relevant social-environmental index should satisfy the following four conditions:
• Workable- An indicator should be such that it is easier to capture the value in quantitative terms. Further, it should be easier to gather data.
• Credible- Index should flexible enough to offer third party verifiability. It should be responsive to the stakeholder’s expectations (Janet Ranganathan 1998).
• Comparable- Index should be such that it allows comparison over the years. Therefore, it should be guided to form value judgment (Janet Ranganathan 1998).
• Relevance with objectives- Index should encourage management to focus on achievement of socio-environmental objectives. Thus, it should bring out improvement in performance in clear terms.
B. Apart from the satisfying the above four conditions, it can be argued that type of indicators would depend on the type of industry and the audience of the social-environmental report. There can’t be one size fit approach.
B.1. Industry type: Type of pollutants, emission levels, and stress on the environment are very different from industry to industry. For example, a paper industry requires much more water compared to other industries. Some industries, such as chemical industry, may not wish to reveal information because that information may be sensitive for the survival of their businesses. Thus, it is better-compared companies within an industry than designing a universal indicator valid across industries.
B.2.User Segments: Similarly, as each user segment has different expectations from the report, there is a need for standardization of information as per user’s category. Audiences of the report can be divided into two broad segments: Direct stakeholders and Indirect stakeholders.
B.2.1. Direct Stakeholders: Direct stakeholders are those who have direct interactions with the company, its operations, finance, processes, products, and so on. These include company’s own employees, consumers, investors, competitors, and members of the community who lives in the vicinity of the industry (Ans Kolk, 1999).
B.2.2. Indirect Stakeholders: Indirect stakeholders are those who don’t have any direct involvement in the company’s operations, finance, processes, and products etc, but carry concerns about the environment in general. These include members of media groups, political parties, activist groups etc (Ans Kolk, 1999).
Exhibit 1 represents the interests of four major stakeholders viz. Employees, Customers, Communities, and suppliers, against all the three dimensions of sustainability, i.e., Social, environment and economy. Tables offer a starting point for the design of a sustainability index as per major interest groups. It looks at the interests of both internal (employees) as well as external stakeholders (customers, communities, and suppliers). For example, corporate social performance can be evaluated for employees based on parameters like company’s investment in employees’ health, education, etc. Appropriate weights should be assigned to each category of users.
C. Socio-Environmental Impact Categories: Any environmental pressure caused by business operations has an impact across categories. Impact categories can be broadly classified under two domains: Environmental impact categories and Social impact categories. Under each category, there are a number of parameters which measures the impact of business operations both along the length and the breadth of these broad categories. The impact categories along with broad parameters are described under Exhibit 2.
The environment impact category is divided into eight broad heads. These are – Material Consumption, Energy Consumption, Waste-types, Pollution, Biodiversity loss, Climate changes, Health hazards and Environmental spendings. To measure the impact under these broad heads, a number of environmental indicators are identified. Any relevant socio-environment index or accounting measure should try to analyse the impact under these heads with the help of a number of parameters described under each head. For example, the study of ‘Material Consumption’ involves studying the material usage of the business. It involves studying the composition of the product manufactured by the business. The material used could be bio-degradable, non biodegradable but recyable such as metals, or non-biodegradable & non-recylable such as petrochemicals. Material consumption efficiency involves studying the use of material through a life cycle approach. By including factors like material composition, it offers management an opportunity to evaluate alternate options with regard to material use. Similarly, the inclusion of renewal vs. non-renewal factors under Energy Consumption will motivate the management to analyze their energy composition from time to time.
Further, management should understand that the list is not exhaustive. There are certain heads which might be irrelevant for a particular type of industry. Therefore, an agreement should be sought to list relevant impact categories only.
Several independent efforts towards standardization of sustainability indicators need to find ways to unite. Further, it should be noted that good intent expressed by corporate will not per se reflect into actions without the system of incentives and punishment. Non-calculative society is an ideal for internalizing the importance of the environment. However, Environmental reporting makes an environmental crisis more visible. Thus, in the short run, calculative methods are the most important means to establish corporate responsibility towards environmental and social issues. New technologies and research will provide a methodology to report social and environmental performance in better quantitative terms.
The article has been authored by Robin Singla, XLRI Jamshedpur.
Exhibit 1: Interests of four major stakeholders against three dimensions of corporate performance
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