Get Ready: Mandated Integrated Reporting Is The Future of Corporate Reporting

Robert Eccles, professor of management practice at Harvard Business School

As co-author of One Report: Integrated Reporting for a Sustainable Strategy (Wiley, 2010), Building Public Trust: The Future of Corporate Reporting (Wiley, 2002) and The ValueReporting Revolution: Moving Beyond the Earnings Game (Wiley, 2001), Robert Eccles has carved out a unique role. He has become, as he puts it, part of “this tiny little network, maybe 10 to 20 people at its core, in this bizarre little domain of standard-setting for nonfinancial information.”

Eccles’ great passion is integrated reporting, the concept of having public companies publish annual reports that include not just the now-required financial information, but information on their environmental, social and governance (ESG) performances, too.

Integrated reporting, also known as “One Report,” has been taken up by a handful of companies, including United Technologies Corporation, American Electric Power, Southwest Airlines, Germany’s BASF, Denmark’s Novo Nordisk, Brazil’s Natura and the Netherlands’ Philips. For most companies, the question of whether to pursue integrated reporting is optional, and one that they have not yet chosen to pursue.

Eccles wants to change that. When a company is forced to look at and report on the resources it consumes, the wastes it creates, the human capital it uses and develops, the way it manages risk and the communities it helps or disrupts, the reporting, he says, has the potential to be a mechanism for not just articulating actions more clearly but for spurring them, too.

In a conversation with David Kiron, executive editor of Innovation Hubs for MIT Sloan Management Review, Eccles, a professor of management practice at Harvard Business School, explained why it’s critical that integrated reporting be mandatory, standardized and backed by clear enforcement — and why the current hodgepodge of overseers makes the field too chaotic.

There has been conversation for years about getting corporations to report their ESG performance, their efforts at sustainability-related issues. When you think about the constellation of factors that influence how companies approach sustainability-related issues, how big of a factor do you think these reporting measures are?

In most cases, not much. Many, if not most, sustainability reports are more window dressing than substance and so aren’t very effective at influencing the company’s resource allocation decisions.

So why are you focused on developing integrated reporting, if reporting in the past doesn’t seem to be a strong influence of corporate behavior?

I’ve been studying corporate reporting and trying to change it for 20 years. I think reporting can be an enormously strong influence on corporate behavior. But it’s the difference between CSR [corporate social responsibility] or sustainability reporting by itself and integrated reporting.

If you really think that how you’re managing environmental, social and governance issues is at the core of what you do, if those things are core to how you create value, you need to explain why they are, and that’s why I think an integrated report is so powerful. It’s not, “here’s my financial report and here’s my green strategy.” Or, “here’s my financial report and here are my human rights policies.” Integrated means that you’re not thinking of these larger efforts as simply an appendage, but in terms of how they support the company’s value creation strategy.

What integrated reporting does is say, “All right, let’s look at the resources we’re consuming and the outputs that we’re generating — the positive ones as well as the negative externalities — and make a decision on where we come out.” When you do that, integrated reporting is a mechanism, it’s a discipline; it’s not just the report. Integrated reporting is as much about listening as talking. If you look at companies that are really sophisticated at this — and there’s not a lot — engagement is a big part of it.

What is the incentive to do integrated reporting if it’s not mandatory?

Good companies will see integrated reporting as an opportunity to communicate on and implement a sustainable strategy, which I define as one that creates value for shareholders over the long term while contributing to a sustainable society. But accomplishing this at a global scale means that integrated reporting needs to be a mandatory, not voluntary, exercise. It also needs to be done to a set of standards. Think of financial reporting. We wouldn’t have the capital markets we have today if companies didn’t have to do it. Some people have said, “Oh, integrated reporting, if it’s really good for companies, they’ll do it on a voluntary basis, so we don’t need to regulate them.” I mean, that’s bullshit, right? Good companies would and bad companies wouldn’t and the market would have an incomplete set of information for making decisions.

United Technologies Corporation was the first Dow Jones Industrial Average member to produce an integrated report.

On the other hand, the first company to produce an integrated report in the United States was United Technologies Corporation. Go figure, huh? Not Ben & Jerry’s, not Seventh Generation. This old-line, diversified manufacturing company that’s a military contractor. And they were quite proud of it. They had their press release touting that they were the first Dow Jones 30 company to issue an integrated report.

So how will mandated integrated reporting come about?

I think two things will happen to move this forward. The first will be legislation. You wouldn’t want to legislate it real quickly in the United States, for sure. In the EU, it’s different; they’ll pass legislation between now and June of 2013 that will mandate ESG reporting. Maybe they’ll call it integrated reporting, maybe they won’t. South Africa has already mandated integrated reporting and it is a requirement on a “comply or explain why not” basis for all companies listed on the Johannesburg Stock Exchange.

The other thing I think will happen, probably over the next two to three years, will be more leading companies getting out ahead on this. That’s good, because then it becomes something that’s more driven by the business community as a kind of reporting best practice and by investors saying, “We’d like to get this.” But ultimately I think it has to be mandated.

So you think there’s real potential for me-too-ism to carry this movement forward.

Oh, yes, a lot. If Pepsi produced an integrated report, and it got a lot of accolades, Coca-Cola would say, “Well, geez, I guess I’d better do it, and I wish I’d done it first.” If you get the leading companies, the big brand companies in a sector, like JPMorgan Chase in banking, to come out and say, “We think integrated reporting is the right thing to do, and we’re doing it, and here’s why,” then I think you’d quickly see your Citibank, your Bank of America doing the same thing.

This is part of the strategy for people like me, who work with NGOs [non-governmental organizations] that think about these things. There’s a global pilot program being sponsored by the International Integrated Reporting Committee to work with 100 companies around the world in different sectors to produce integrated reports based on a draft framework this group has developed. If big names like Marks & Spencer and Microsoft come out with an integrated report in a year or two, then Tesco and Oracle and other competitors of the companies in the pilot program will say, “Oh gosh, I guess we to have to do it.”

But for any of this to be really useful and to be really high quality, you still have this question of standards.

And that’s going to require some political action.

In the end, yes.

Standards is one of those things that, to most people, it’s, “Gosh, this is about the most boring thing you can possibly talk about.” Me, I find it fascinating. It is contested terrain. It is fraught with conflict. Just by definition, nobody’s going to be totally happy in the end. Everybody thinks their situation is unique, whether they’re the company preparing their report, or they’re somebody that’s going to be using the report and they want more detail, or they want it put this way or put that way. So it’s this almost political adjudication process.

Can you explain who oversees nonfinancial reporting now?

The problem is that you have this somewhat chaotic domain. Nobody has been institutionally legitimized with the Good Housekeeping Seal of Approval from some regulator to say, “These are the standards that you need to use for your “sustainability reporting.” In the domain of accounting standards, the two main ones being U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards, government bodies, like the Securities and Exchange Commission in the U.S., enforce the application of these standards. In the world of nonfinancial reporting on environmental, social, and governance performance, one set of standards, probably the most well-known, are the G3 Guidelines from the GRI, the Global Reporting Initiative. And they’re working on an updated G4 set of guidelines.

There’s the International Integrated Reporting Committee, which I mentioned before but it is about developing an overall framework for integrated reporting, not the standards for ESG information. More recently, the Sustainability Accounting Standards Board (SASB) has been formed in the U.S. and I am its chairman. The focus here is on developing sector-specific key performance indicators (KPIs) for the truly material ESG issues that affect a company. By material I mean they matter to financial performance.

Some good work has been done by the German-based DVFA, which is the Society for Investment Professionals in Germany. It’s part of EFFAS, the European Federation of Financial Analysts Societies. They have put out some KPIs . There’s another group that I was involved in that never really went anywhere called the World Intellectual Capital Initiative. There also are specialized groups trying to come up with metrics, like the Climate Disclosure Standards Board. The secretariat for this is the Carbon Disclosure Project. They’ve done some good work in developing essentially came out with definitions and metrics for reporting on climate change issues like carbon. And you’ve got groups that are trying to do those same things on water.

And it’s such an interesting dynamic, because what these groups are trying to do is largely highly complementary, but there’s some overlap and some potential points of conflict. And many of these people know each other at a personal level. Standard setting is not exactly the kind of thing the man on the street gets excited about. Most of my colleagues don’t get excited about it, even the accounting faculty. My wife certainly doesn’t get excited about it.

It’s almost guerilla score-carding, in a way.

Well, the GRI, SASB and the IIRC are social entrepreneurs. In terms of standards for nonfinancial information and frameworks for integrated reporting, because the State isn’t doing it, and the private sector isn’t doing it, so then it ends up, as often happens in these things, as a civil society thing that’s being instantiated in these three NGOs and some others. So in that sense I guess you could say it’s a guerilla activity. It’s pretty typical for NGOs to be on the bleeding edge of change. What is controversial today becomes an accepted practice tomorrow. I kind of think of NGOs as society’s conscience, kind of social canaries in the coal mine.

What do you think are the top three challenges for creating some nonfinancial standards?

The first challenge is how to do it fast. Those of us that play in this space say, look, this can’t take 20 years like we’ve seen with some accounting standards. If reporting is going to have a meaningful impact upon behavior and how we use natural resources and our impact on people and the planet, taking 10 years to come up with a set of standards is like, game over. You need to have a different approach to standard-setting so that you can get a set of standards in a period of time that’s relevant. Doing this will require leveraging technology and the Internet. This is what SASB plans to do.

The second challenge is, how do you make those legitimate? It’s a tough question, because you have to answer the question of who the primary audience is for the information that’s going to be based on these standards. The shareholders? The stakeholders? Both? When you answer the question of who it’s for, that then tells you who you should involve in the standard-setting process. If you want to have this information be meaningful to the markets, the sell-side and the buy-side, then you need to make sure that you’ve got enough participation and buy-in with them. Ultimately, I think shareholders are the primary audience and thus groups like the SEC will be the ones that provide institutional legitimacy for integrated reporting and its accompanying set of standards for sustainability performance.

The third challenge is how do you make them institutionally legitimate? How do you make them universally applied? What’s the enforcement mechanism? Should integrated reports have integrated audits to ensure their quality, like is done with financial reporting? There are a variety of ways institutional legitimacy can be created, such as through stock exchanges making it a listing requirement. It could be passed through legislation. Here in the United States, it could be overseen by the SEC. There’s a new legislation that’s coming up here that’s going to mandate ESG reporting through the Single Market Act. It probably won’t specify the standards, though. Most recently, there is some exciting action on the global front from two recent publications. First, there is the document being prepared for the Rio +20 United Nations Conference on Sustainable Development that will be taking place this June called The Future We Want [PDF]. Clause 24 calls for a “global policy framework requiring all listed and large private companies to consider sustainability issues and to integrated sustainability information with the reporting cycle.” Second, Recommendation 30 in a report of the U.N. Secretary General’s High-level Panel on Global Sustainability (Resilient People, Resilient Planet: A future worth choosing) for the development of “a framework for sustainable development reporting.” I don’t really understand how these transnational organizational processes work, but my understanding is that a number of countries have already agreed to both documents and more are likely to do so. If things go well, by this summer we could have a number of countries at least verbally supporting integrated reporting. I don’t know the position of the U.S. government on this, but I expect it will be a laggard rather than a leader both because of its history with organizations like the U.N. and the still-earlier stage of awareness here about the importance of sustainability and how integrated reporting can support it.

Can there be one set of standards that apply to all companies, or will they need to be modified by industry?

Good question. Generic set of standards applicable across all industries, or sector-specific. That would be a fundamental, strategic decision. On the one hand, it’s good to have a set of metrics that are applicable to any circumstances, so that you can compare apples to apples.

On the other hand, when you get into the sustainability, nonfinancial measures, ESG metrics, whatever you want to call them, what’s important tends to vary by sector. It’s not like financial reporting, where this whole accounting technology of standards enables you, in theory, to compare revenues and earnings and stuff like that across different sectors

So, carbon emissions is a big deal for utilities. It’s not such a big deal for a bank. For banks, managing risk is a big deal. Or, if you’re a fast-moving consumer goods company in clothing, then human rights and supply chain stuff is a big deal.

My bottom line on this is that the baseline standards for sustainability metrics need to be sector specific, which is the approach being taken by SASB.

What do you think will be required to make integrated reporting on a global basis?

I got my Ph.D. in Sociology so I tend to look at the world through this lens. What we’re dealing with is a giant collective action problem. No one group — companies, investors, accounting firms, civil society through NGOs or even the government — can make this happen in an effective way by itself. All groups have something to contribute and need to collaborate with each other to pull this off. Leadership amongst all groups will be required. This makes taking some risks, for which they will be private benefits but also public gain. Even academic rabble-rousers like me have a role to play and I’m doing whatever I can in my own small way to push things along. Not to sound too corny about it, but anybody who cares about our capital markets and their contribution to creating a sustainable society should think about how they can get involved to support the integrated reporting movement. We’re running out of time and we’re all living together on Planet Earth — at least until some scientist at my beloved alma mater MIT invents faster-than-light and economical spaceships.