Sustainability/Corporate Social Responsibility (CSR) - PDF

Sustainability/Corporate Social Responsibility (CSR) from an accounting and financial managment perspective Henrik Nilsson, SSE [email protected] 1 Motivation: • We have 12 years to limit climate change catastrophe (IPCC, 2020) • Natural disasters cost 520$ billion a year (World Bank, 2017) •...

Sustainability/Corporate Social Responsibility (CSR) from an accounting and financial managment perspective Henrik Nilsson, SSE [email protected] 1 Motivation: • We have 12 years to limit climate change catastrophe (IPCC, 2020) • Natural disasters cost 520$ billion a year (World Bank, 2017) • Air pollution to cause 6-9 million premature deaths by 2060 (OECD, 2016) • Since 1970, wildlife populations have fallen by 60% (WWF, 2018) • $21-$32 trillion of global private financial wealth have been invested virtually tax-free through more than 80 ”offshore” secrecy jurisdictions (Henry, 2012) Globalization Disparate prosperity Resource scarcity Ecological decline Accelerated consumption EU directive??!! During the last ten years the scrutiny has become more thorough and stakeholder expectations on corporate responsibility has widened 10 SEK is all that is needed – Fashion giants refuse to pay Agenda 1. 2. 3. 4. 5. Definitions of CSR (Corporate Social Responsibility) Research on CSR and value creation CSR as an investment case CSR reporting and auditing Corporate governance and CSR Some definitions Sustainability and CSR Sustainability: 1. “Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.“ (Bruntland) 2. "A process of change in which the exploitation of resources, the direction of investments, the orientation of technological development and institutional change are all in harmony and enhance both current and future potential to meet human needs and aspirations" (The World Commission on Environment and Development) 3. “A sustainable business is one that delivers financial returns in the short and long term in a way that generates positive value for society and operates within environmental constrains” (A4S, Accounting for Sustainability) Corporate Social Responsibility (CSR): 1. “The responsibility of enterprises for their impacts on society” (EU, 2011) 2. “The social responsibility of business encompasses the economic, legal, ethical and discretionary expectations that a society has of organizations at a given point in time“ (Carroll, 2008) 3. “CSR is concerned with treating stakeholders of the firm ethically or in a responsible manner” (Hopkins, 2004) 4. “The Social Responsibility of Business is to increase its profit” (Friedman, 1970) Malik, 2015 ”Our sustainable development strategy comprises two dimensions – a business dimension and a sustainability dimension – that together contribute to bottom-line performance.” BHP Billiton, 2020 Do CSR activities creat value? Two ”schools” among researchers • The cost-concerned school: – CSR investments and high CSR performance represent mostly increased costs, resulting in decreased earnings and lower market values. – The relationship between environmental performance and market value of a firm is expected to be negative (e.g. Jaggi and Freedman 1992; Walley and Whitehead, 1994, Flammer, 2013). • The value creation school: – Regards environmental efforts and other CSR efforts as a way to increase competitive advantage and improve financial returns to the investors. – The relationship between environmental performance and market value is expected to be positive (e.g., Konar and Cohen 2000; Dowell et al., 2000, Hassel and Semenova, 2012; Malik, 2015; Serafeim, 2018). The relation between CSR performance and company financial performance: ”Some evidence” • • • • • Orlitzky et al. (2003) ”Corporate Social and Financial Performance: A Meta-analysis” – The metaanalytic findings suggest that corporate virtue in the form of social responsibility and, to a lesser extent, environmental responsibility is likely to pay off, although the operationalizations of CSP and CFP also moderate the positive ass.. Margolis et al. (2009) “Does it Pay to Be Good...And Does it Matter? A Meta-Analysis of the Relationship between Corporate Social and Financial Performance” – The overall effect is positive but small and results for the 106 studies from the past decade are even smaller. Malik (2015) “Value-Enhancing Capabilities of CSR: A Brief Review of Contemporary Literature” – “The thrust of the CSR literature largely acknowledges the value-enhancing capabilities of firms’ social and environmental activities.” Wang et al 2015 “A meta-analytic review of corporate social responsibility and corporate financial performance: The moderating effect of contextual factors” – This work proposes that CSR in the developed world, with a relatively mature institutional system and efficient market mechanism, will be more visible than CSR in the developing world. The results show that the CSR–CFP relationship is stronger for firms from advanced economies than for firms from developing economies. Flammer and Ioannou (2018) – After the financial crisis in 2008, companies that sustained their R&D and CSR did much better once the economy recovered. 12 SRI: Sustainable Responsible Investing Sustainable Responsible Investing considers CSR (ESG) factors in the investment process. The motives behind SRI vary a lot: “Some investors embrace SRI strategies to manage risk and fulfill fiduciary duties. Others are driven by their personal values, their institutional mission, or the demands of their clients, constituents, or plan participants. Some are seeking hidden sources of alpha (financial outperformance); others are seeking long-term sustainable social and environmental impact. Many institutions and individuals mobilize SRI strategies for a complex combinations of reasons.” (p. 91) ** Source: Meg Voorhes and Joshua Humphreys, “Recent Trends in Sustainable and Responsible Investing in the United States”, Journal of Investing, vol. 20, 2011 13 CSR as an investment case: Old and Recent views CSR (responsible) Investment: Help or Hurt? • CSR / RI too subjective • CSR: reputational benefits • Costly at outset, benefits unsure • CSR: operating efficiency • Screening: investment restriction • Stock neglect: “sin” outperforms • CSR: lower risk / cost of capital • CSR factors “mispriced”? If so, which? Larry Fink’s 2020 letter to CEOs in portfolio comp. SOME ACADEMIC HYPOTHESES • 1A. “The Neglect Hypothesis” – Why can controversial companies deliver higher stock returns? – Because certain (latent) risks are priced in the market? • 1B. “The Errors-in-Expectations Hypothesis” – Why can responsible companies earn higher returns? – Because ESG (Environmental, Social and Governace) advantages mispriced by most investors and analysts? • 1C. “The Irrelevance Hypothesis” – ESG factors are not priced in the market 1A: THE “NEGLECT HYPOTHESIS” Information on ESG-factors is relevant for the pricing and valuation of companies because there is a significant group of investors with “social preferences”. Their “boycotts” lead to “imperfect” markets – E.g., not investing in so-called sin stocks (Alcohol, Tobacco etc.) – Those who invest against “the social norm” have difficulties to share risk and to sell stocks (less liquidity: not a lot of people want to hold these stocks) – Also heightened litigation and regulatory risks will be factored into share prices – This group requires higher returns to be compensated for these risks – Hypothesis: “Neglected” stocks have higher returns as a compensation for these additional risks Hypothesis 1A: Performance of controversial stocks Study Region and Period U.S. Hong and Kacperzyk (2009) 1926-2006 U.S. Kempf and Osthoff (2007) 1991-2004 U.S. Statman and Glushkov (2009) 1992-2007 Europe Salaber (2007) 1975-2006 21 countries Fabozzi et al. (2009) 1970-2007 China Visaltanachoti et al. (2009) 1975-2006 Tobac. Alc. Gambling Weap. Nuke X X X X X X X X X X X X X X X X X X X X X X X Biotech Adult Alpha Positive Positive (non-significant) Positive (non-significant) Positive X Blitz and Fabozzi, 2017 X X X Positive Positive Hyp 1B: ERRORS-IN-EXPECTATIONS HYPOTHESIS • Information on ESG factors is relevant for the pricing and valuation of companies on the stock market. • Question: is this information already used by analysts and investors, and subsequently priced on the stock market OR NOT? – Short-term performance focus, fixation on quarterly earnings, investors evaluated with short-term measures – Long-term benefits of (ESG) projects overlooked – Change short-term obsession into long-term satisfaction by exploiting the systemic flaw: use ESG in investment decisions. – Hypothesis: Strong-ESG portfolios have relatively higher returns (even after correcting for portfolio risk) Hypothesis 1B: “The Errors-in-Expectations Hypothesis” CFA institute, 2015 CFA institute, 2015 22 Challenges in ESG analysis • Insufficient comparability of ESG metrics across peer groups of companies • Time lags between disclosure of financial information and ESG information by companies • Insufficient disclosure of ESG metrics by companies • Unaudited sustainability reports • Risks of greenwashing • Value judgment in ESG ratings – lack of disclosure of rating institutes ** Source: CFA Institute 23 Tripple bottom line Theories explaining the level of vouluntary sustainability reporting • Socio-political theories 1. Stakeholder theory – Organisations and society are tightly interwoven – one cannot function without the other. – For an organisation to achieve its targets it needs to interact with its stakeholders and fulfil their interests. 2. legitimacy theory – Organisations gain legitimacy from abiding to “social contracts” with its stakeholders – A company needs to have legitimacy in the sense of a social “license to operate” to access the necessary resources to successfully conduct business. • Economic theories 1. 2. Positive accounting theory – tries to explain and predict the choice of accounting policies and approaches across organisations, recognising that economic consequences exist. – Authorising expenses for sustainability reporting and/or performance in order to avoid costly repercussions and thus postponing current earnings Agency theory: Information asymmetry between management and capital providers – Signaling theory: Reduce information asymmetry. Credibility? – Voluntary Disclosure Theory: Firms will disclose “good” news and withhold “bad” news 3. The proprietary cost theory: Well known and large firms are easily scrutinized by investors and regulators as compared to small firms => Disclose more and better information What motivates companies’nonfinancial reporting? Källa: Studie ‘Is your nonfi nancial performance revealing the true value of your business to investors?’, EY 2017 Corporate Responsibility reporting has gone mainstream Source: KPMG Survey of Corporate Responsibility Reporting 2022 EU-Directive on (Non-Financial ) Sustainability Reporting (DIRECTIVE 2014/95/EU Increase in non-financial reporting frameworks and initiatives EU Sustainable Finance legislation TCFD Nasdaq Nordic ESG Reporting Guide GRI Standards UNGP with Swedish Action Plan GRI G4 <IR> Framework Nasdaq Global ESG Reporting Guide SASB industry standards Statutory sustainability reporting EU Conflict Minerals Regulation EU energy and climate targets for 2030 Agenda 2030 GRI guidelines is the main standard for reporting Source: KPMG Survey of Corporate Responsibility Reporting 2022 GRI (Global Reporting Initiative) www.globalreporting.org • Developed a comprehensive Sustainability Reporting Framework that is widely used around the world • The Framework enables all organizations to measure and report their economic, environmental, social and governance performance – the four key areas of sustainability. • Stakeholder focus: “More stakeholders than ever – including regulators, investors, rating agencies and NGOs – are asking for non-financial data.” • G4 was launched summer 2013 and will be replaced by GRI standards in 2018 (early adoption encouraged) Reporting principles, GRI 101: Content: 1. Stakeholder Inclusivenes 2. Sustainability Context 3. Materiality 4. Completeness Quality: 1. Balance 2. Comparability 3. Accuracy (Precision) 4. Timeliness 5. Clarity 6. Reliability Reporting principles according to IFRS’s conceptual framework: https://www.youtube.com/watch?v=AGqE4OO0_7g • • • • • • • • • • CG SUSTAINABILITY (General principles) (reporting principles) Management oversight Structure Decision-making Integrity in reporting Timely and balanced disclosure Rights of shareholders Recognise and manage risk Encourage enhanced performance Remunerate fairly Recognise the legitimate interests of stakeholders • • • • • • Balance Comparability Accuracy (Precision) Timeliness Clarity Reliability Video: https://youtu.be/AGqE4OO0_7g Materiality Analysis Ericsson, 2018 Ericsson, 2018 Each standard contains: 1. Requirements 2. Recommendations 3. Guidance Sustainability reporting by Hemtex GRI index Sustainability reporting by Assa Abloy Controlling climate related risks a necessity for maintaining financial stability (TCFD) • The report provides voluntary climate-related financial disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders • Key features: – Adoptable by all organizations – Designed to solicit decision-useful, forward-looking information on potential financial impacts of climate change – Brings the “future” nature of climate-related issues into the present through scenario analysis – Strong focus on risks and opportunities related to the transition to a lower-carbon economy SKF, 2019 The demand for sustainability reporting Källa: Studie ‘Is your nonfinancial performance revealing the true value of your business to investors?’, EY 2017 Investor perceptions of sustainability Source: Study ‘Is your nonfinancial performance revealing the true value of your business to investors?’, EY 2017 Reporting on sustainability risk Source: Study ‘Is your nonfinancial performance revealing the true value of your business to investors?’, EY 2017 What about the quality of the information contained in Sustainability reports? “Although there is increasing agreement on the need to address high level issues such as climate change, diversity and inclusion and corporate governance, companies may be motivated to control their sustainability “narrative” by disclosing information that promotes their positive image and conceals their negative societal or environmental impact. Source “IMPACTONOMICS: The Evolution of Corporate Sustainability Reporting” Merrill Lynch, 2017 Assurance of sustainability reports What do we mean by an independent assurance service? • The auditor is an important part of the overall corporate governance framework • A professional accountant assesses sustainability information and gives an independent opinion on the outcome • An assurance service should build trust in the sustainability information. • A three-party relationship – management, users, and the professional accountant – is a key aspect of an assurance service. • Assurance of sustainability reports is NOT mandatory Assurance of sustainability reports Study: What Determines Environmental Performance? Unconditional analysis of determinants of Environmental Performance and Environmental Reporting Quality* Panel A: Environmental Performance LOW (n=492) Medium (n=150) High (n=110) ENVPER ENVREP 1,41 3,54 5,327 -41.89 (0.000) BCRIME 2,03 4,59 5,982 -34.14 (0.000) 0,31 0,29 0,211 6.44 (0.000) 0,32 0,41 0,318 -0.02 (0.982) 0,41 0,37 0,246 6.94 (0.000) 0,14 0,08 0,100 2.10 (0.036) 0,49 0,44 0,377 2.79 (0.005) 0,82 0,80 0,771 3.64 (0.000) 0,12 0,22 0,197 -4.10 (0.000) 0,17 0,17 0,205 -2.81 (0.005) 6,97 8,33 10,233 -18.95 (0.000) 0,17 0,25 0,226 -3.70 (0.000) 2,99 3,33 2,683 1.54 (0.124) CEOCRIME BCRIME BOARDOWN CEOOWN GENDER ROE PROF SIZE LEV PB *Source: Hassel, Kallunki och Nilsson, 2015 t-Test for difference Table 4 Environmental Performance and Criminal Convictions and Excessive Risk Taking Behaviour* Variable Exp. (1) (2) (3) (4) (5) (6) (7) (8) sign BCRIMEit -0.81*** -0.66*** -0.48** -0.71** -0.58** (0.009) (0.001) (0.020) (0.011) (0.031) CEOCRIMEit -0.03 -0.04 -0.10 0.04 0.01 (0.689) (0.770) (0.287) 0.715) (0.903) ? -0.15 BOARDOWNit -0.21 -0.15 -0.07 -0.21 (0.316) (0.474) (0.684) (0.340) (0.507) -0.22 -0.20 CEOOWNit ? -0.34** 0.14 -0.30** (0.019) (0.126) (0.246) (0.039) (0.185) GENDERit -1.82*** -0.73** -1.88*** -0.94*** -1.72*** (0.000) (0.029) (0.000) (0.001) (0.000) ROEit ? -0.20 -0.29 (0.213) (0.103) PBit ? 0.06*** 0.07*** (0.000) (0.001) LEVERAGEit ? -0.39 -0.51 (0.198) (0.119) SIZEit ? 0.44*** 0.45*** (0.000) (0.000) Year fixed effects YES YES YES YES YES YES YES YES Ind. fixed effects YES YES YES YES YES YES YES YES Model F-stat 12.05 12.49 21.21 10.41 10.71 18.49 10.21 10.41 2 Adjusted R 0.425 0.442 0.602 0.409 0.423 0.588 0.413 0.425 Observations 752 752 752 752 752 752 752 752 (9) -0.49** (0.031) -0.05 (0.594) -0.09 (0.609) 0.15 (0.215) -0.83** (0.026) -0.27 (0.132) 0.07*** (0.000) -0.48 0.14 0.45*** (0.000) YES YES 17.96 0.589 752