Authors: Ioannis Ioannou (London Business School) and George Serafeim (Harvard Business School)
Publisher: Harvard Business School Working Paper No. 11-100
Date Published: March 2011
Because of growing concerns over corporate corruption and the impact of business on society and the environment, some companies have released sustainability reports touting their achievements in these areas and their ability to self-regulate. According to the Global Reporting Initiative, the group behind the most widely used standards for sustainability disclosures, the number of firms releasing reports that follow its guidelines grew from 44 in 2000 to 1,973 in 2010. Increasingly, though, national governments and stock exchanges have been adopting laws and regulations that make sustainability reporting mandatory for companies.
Although some business leaders see these requirements as onerous, this paper identifies important benefits. Mandatory reporting on environmental practices, proponents say, forces companies to adopt more ethical and effective practices in general, including in sensitive areas such as those where bribery and corruption could take place. In addition, the researchers found that sustainability reporting efforts tended to lead companies to train employees more effectively, to put in place better practices for board supervision, and to gain credibility in the marketplace. Far from holding companies back, the researchers argue, the reporting requirements help make companies more competitive.
To measure the impact of mandatory reporting, the researchers built a model that analyzed data from 1995 to 2008. They collected country-level information on laws and regulations that mandated a base level of reporting. Among the nations that had passed such laws were Australia, Canada, Denmark, France, Germany, Italy, Malaysia, the Netherlands, Sweden, and the United Kingdom.
During the period covered in the study, several countries adopted new laws mandating one aspect or another of sustainability reporting, which the researchers incorporated while controlling for the specific impact of each requirement. For example, the Canadian Environmental Protection Act of 1999 requires companies to disclose particular pollutant emissions; in Denmark, the 1995 Green Accounts law mandates that more than 3,000 firms detail their management of environmental issues; and in the U.S., the Sarbanes-Oxley Act of 2002 imposes a number of reporting requirements concerning corporate governance.
The researchers obtained information on socially responsible management practices from the IMD World Competitiveness Yearbook report, which analyzes and ranks nations based on their ability to establish and maintain a competitive business environment. The report uses more than 300 sources — as varied as statistical databases and executive surveys — to measure competitiveness and performance in 58 countries. To isolate the effect of mandatory disclosures, the researchers controlled for several factors, including a country’s living standards, economic development, and level of government influence on business practices.
Finally, the authors gathered data from the Global Reporting Initiative on all companies that published sustainability reports in 2008, and then determined the percentage of those reports that had been certified by a third party. The authors treated that percentage as a surrogate for corporate commitment to sustainability, reasoning that companies that spend more time addressing risks and opportunities would be more likely to want their disclosures verified by an outside source.
Overall, the authors’ analysis confirmed that after mandatory disclosure laws are enacted, corporations implement more ethical practices and see a decrease in bribery and corruption, long recognized as major threats to sustainable development. Investments in employee training increase, the supervision of senior managers by boards of directors improves, and sustainable development becomes a higher priority.
These effects were even stronger in countries such as Austria, Finland, and Italy, where the third-party assurance of sustainability reports was more common, and in Denmark and Singapore, where the government and legal agencies were more likely to enforce rules and regulations. The results applied to both economically advanced and developing nations. But the effects of mandatory reporting on sustainable development and ethical practices in developing nations were stronger, which “underscores the importance that such policies have,” the authors write.
In discussing the practical implications, the researchers note that reporting can improve communication between the firm and its stakeholders, making the company more transparent and accessible. Earning a reputation for responsible corporate conduct can give firms a competitive advantage in labor, product, and capital markets. In developing nations, establishing social legitimacy can even help firms secure a license to operate.
Sustainability reporting forces companies to manage their corporate affairs effectively in order to avoid the embarrassment of disclosing bad performances to their stakeholders, the authors conclude. As a result, they streamline their operations so that “efficient and prudent use of resources...reduces the likelihood of higher costs in the future through tax mechanisms.” And boards of directors, in turn, function more effectively when they consider a broader set of issues that corporations must address to be sustainable and competitive in the long term.
Mandatory reporting on sustainability issues pays off in ways that boost a company’s standing and competitiveness. The disclosure of corporate management practices increases the social responsibility of leaders and enhances their credibility. As companies put more emphasis on sustainable development, they become more ethical in their business practices, with a resulting decline in incidents of bribery and corruption. They also invest more in employee training and benefit from better supervision of senior managers by their board.