Environmental, social, and governance (ESG) has been the important focus of many corporations to integrate it into and align with their corporate strategy for some time now. The unprecedented and very challenging Covid-19 crisis and the recent protests against racial injustice have forced some companies to rethink and reevaluate their corporate strategies and commitments to the ESG priorities and goals. Companies that are better prepared to handle and overcome these challenges are often those which integrate and align ESG goals as part of their corporate strategy rather than standalone initiatives.
In terms of investors’ expectations and demands placed on publicly listed companies, major investors have adamantly pushed companies to address ESG matters as it will influence and affect share prices. In order to respond to this demand, it goes without saying that companies must benefit alltheir stakeholders, including shareholders, employees, customers, and the communities in which they operate. Consequently, companies must serve a social purpose. To achieve business sustainability, every company must not only deliver financial superior performance, but also it must stay committed to ensure environmental sustainability and make a positive contribution to society.
In addition to increased pressure from investors, publicly-listed companies are facing growing expectations to take positions on ESG issues that are important to stakeholders and customers. On top of that, ESG disclosures are also being tallied and sought more now than ever – with stakeholders searching for company commitments to ESG through public disclosure of information on a website, sustainability reports, annual reports, or via business publications.
Finally, companies may have to monitor their ESG objectives and achievements through Key Performance Indicators (KPIs) and ESG metrics which are used to assess a company’s exposure to a range of environmental, social and governance risks. For sustainable growth and development, companies should also consider the importance of circular economy which puts redesigning production, reuse, resource efficiency and recycling forefront in their business models by limiting the environmental impact and waste of resources, as well as increasing efficiency at all stages of the product economy.
Embedding and Building Sustainability into Corporate Strategy
Corporations are increasingly building environmental, social and economic sustainability into their corporate strategies, evaluating and assessing and linking outcomes to the Sustainable Development Goals (SDGs) that can be depicted in the chart below (The Integrated Reporting - Value Creation Framework (2021) and The 17 UN SDGs mandated by the United Nations). Many companies have been issuing annual sustainability or corporate responsibility reports in accordance with the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) as part of ESG disclosures in their annual reports. The SASB and the IIRC have recently merged to form the Value Reporting Foundation (VRF). Corporate Strategy development framework as depicted in the chart below plays a very important role to capture the sustainability issues with the aim to contribute to the achievement of the SDGs by demonstrating how the International Integrated Reporting Framework can help organizations align their contribution to the SDGs with how they create value in their respective organizations as well as stakeholders (employees, customers, investors, communities, etc).
Many corporations do not automatically make the link between their mission and sustainability, or simply review the SDGs and sign on. They go through a rigorous and lengthy process. First, a progressive acknowledgement of the importance of environmental, social, and governance issues (ESG) to the company’s business interests. That leads to an understanding of the relevance of the broader issue of sustainability and, for some companies, subsequently seeing how specific SDGs fit with their business interests. They select the SGDs that best fit with their corporate strategy in line with their respective industry classification.
The “drivers” that link sustainability and the SDGs to the corporate interest can be either business-case or values-case. Business-case drivers involve maximizing growth opportunities and minimizing risk and are the rationale for many companies.
Some of them have moved a step further to a values-case by adopting a corporate values or vision and mission statement that moves the corporate strategy beyond just financial return but also covering environmental and social impacts. Eventually, they link their corporate strategy to specific SDGs connected to their business activity which they plan to contribute. The SDGs provide a useful frame, both internally and externally, to organize and articulate a company’s sustainability goals.
Companies embed sustainability in their corporate strategies through three mechanisms:
Strategic Integration is the starting point. This takes place with the transition of the corporate strategy from concentrating just on creating shareholder value to creating shared value. It involves incorporating ESG, alongside financial returns, into the corporate strategy.
Operational Integration involves identifying and communicating specific, measurable, time-bound goals to hold the company accountable for the strategy. Companies sets key impact areas by engaging stakeholders in identifying and managing sustainability issues that are likely to affect the business the most and where the company can have the greatest impact. The SDGs most frequently linked to corporate strategies are 3 (good health and well-being), 8 (decent work and economic growth), 12 (responsible consumption and production), and 17 (partnerships for the goals), however, it all depends on each respective industry.
Organizational Integration is a complex process that extends from the boardroom to the channels. It calls for strong thought leadership from the board and senior company executives and buy-in all the way down the line. At the governance level, companies execute this function through a board committee on sustainability, an executive providing oversight on sustainability, and/or cross-functional sustainability management.
The Role of Sustainability Accounting in Corporate Strategy
According to Wikipedia, sustainability accounting (also known as social accounting, social and environmental accounting, corporate social reporting, corporate social responsibility reporting, or non-financial reporting) is considered a subcategory of financial accounting that focuses on the reporting and disclosure of non-financial information about a firm's performance to external stakeholders, such as capital holders, creditors, and other authorities. Sustainability accounting represents the activities that have a direct impact on society, environment, and economic performance of an organisation.
Sustainability accounting in managerial accounting contrasts with financial accounting in that managerial accounting is used for internal decision making and the creation of new policies that will have an effect on the organisation's performance at economic, ecological, and social (known as the triple bottom line or Triple-P's; People, Planet, Profit) level. Sustainability accounting is often used to generate value creation within an organisation (Perrini, Francesco; Tencati, Antonio, 2006). Sustainability accounting is a tool used by many corporations to become more sustainable and respond to investors’ expectations.
Over so many years the requirements of sustainability accounting were involved into the corporate strategy of many companies. Besides the economic goals they also determine the exemplary social as well as environmental and governance (ESG) considerations. The application of the appropriate management methods and tools are needed to measure of the economic, social and environmental impacts of the strategic decisions and activities within the organization. The interaction between the corporate strategy and sustainability accounting as its key success factor can be further elaborated. First, it starts from the conceptual definition of the sustainability and process of the sustainability strategic management. Then, it introduces the new approaches for the appraisal of the strategic performance beginning with the conventional accounting, through the environmental accounting, to the sustainability accounting. Finally, it demonstrates the role and contribution of the sustainability accounting to the successful implementation of the corporate strategy.
Measuring Sustainability Through KPIs and ESG Metrics
Company is always faced with the challenge of measuring goals. They face the lack of consistent tools and methodologies to assess impact, especially for social and governance issues. Resource constraints also limit impact measurement, with corporations having to incur a substantial cost for the assessment with limited visible value-add. Measuring outcomes is more readily performed at the program level and more difficult in aggregation and determination of overall impact. Efforts to standardize the field include the Global Reporting Initiative, the Worldwide Benchmarking Alliance and the Sustainability Accounting Standards Board which connect businesses and investors on the financial impact of sustainability.
The last two decades have seen a rise in genuine commitment by corporations to sustainability and, more recently, by retail and institutional investors as well. These investors are realizing that how a company performs on a relatively small number of ESG issues will limit downside risk and create upside opportunities in their business undertakings, especially as it relates to the environmental, social and governance issues in the respective industries they are operating. These investors usually want to practice “ESG integration,” which means considering a company’s nonfinancial performance just as they do its financial performance.
In the ESG metrics, the financial impact of the environmental accounting and social activity accounting can be categorized as follows:
- Environmental conservation costs: investments and expenses (prevention of atmospheric pollution, water pollution and soil contamination, bad odors and noise), mitigation of climate change, prevention of ozone layer depletion and management of chemical substances; efficient use of waste, conservation of water and treatment of waste.
- Administration costs and R&D cost.
- Environmental remediation costs
- Social activity costs
- Governance costs (audit and assurance)
(Source: KPIs for ESG, DVFA, EFFAS, 2009)
The above KPIs for ESG Framework (EFFAS, 2009) outlines that the reported ESG-KPIs must be accurate (i.e. free from significant errors), plausible, and definitive, and not in contradiction with current measures, other company documentation (including annual reports). The information, data, processes, and assigned competencies required for the preparation of ESG reports should be recorded, analyzed, documented, and disclosed in such a way that they would stand up to an internal and external audit or review.
An independent audit by well-qualified third parties is a particularly good way to increase the assurance capability (i.e. perceived reliability) of the reported ESG-KPIs. This also serves to ensure the credibility and acceptance of ESG communication among the target groups. As a rule, external auditing carries the additional advantage that ESG reporting and ESG management can be improved based on the best practices referred to by the auditor. For any recommendation other than these, corporates should generally align ESG reporting with all other reporting to the capital markets.
Implementing Best Practices in Sustainability Accounting
Since companies operate in industries with different business and regulatory landscapes, there is no one identified best practices that result in a sure success of sustainability integration. Nevertheless, there are usually eight good practices of companies adopting, building and implementing a sustainability strategy:
- Identify, assess and evaluate the key drivers of sustainability
- Set up a strategy that encompasses both sustainability and corporate goals
- Determine and communicate specific, measurable, and time-bound sustainability goals
- Create a stakeholder management strategy on sustainability issues
- Build partnerships and alliances that leverage core capabilities
- Embed and integrate sustainability within main business functions
- Monitor, analyze and measure KPIs and Metrics and its impact on the Triple Bottom Line (environmental, social and economic)
- Measure value creation for the organization and other stakeholders
Companies tend to prioritize SDGs that align with their core business, rather than taking an all-encompassing approach. Most companies see their contribution to the SDGs directly through corporate sustainability goals and practices.
Global companies annually report their SDGs results in annual corporate or sustainability reports, they identify priority SDGs and mention them in their business strategy in their annual financial statement disclosures. There clearly is a broad trend, to which it is hoped that it opens a window on how companies are adapting to the SDGs.
The Importance of Sustainability Reporting and Disclosure in Publicly-listed Companies
Sustainability reporting and disclosure on environmental, social, and governance (ESG) issues is increasing globally. Many publicly-listed companies publish sustainability reports and disclosures This initiative reflects how sustainability reporting is increasingly seen as a way for companies and their stakeholders to see a changing world more clearly and create long-term value.
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. The following SASB Disclosure Topics and Their Financial Impact chart clearly explains the choices companies take in the development of their sustainability reporting and disclosures and its financial impact on each of the disclosure topics selected. The Conference Board Inc. (2018) further explains the comparative sustainability reporting standards by the leading sustainability standards boards in the subsequent matrix indicated below which helps organizations in reporting different aspects of their non-financial impact (environmental, social and governance impact).
