The world, or rather capitalism, has come a long way since Milton Friedman’s 1970 New York Times opinion piece The Social Responsibility of Business is to Increase Its Profits. Corporations, he argued, have no responsibility beyond the duty they hold to shareholders. 

  • Corporate responsibility is shifting from maximising returns to driving sustainability
  • Accounting for a firm’s ESG performance presents challenges
  • The new Value Reporting Foundation is set to simplify reporting standards

This is a far cry from today’s kaleidoscope of investor objectives and motivations that broadly fall under the umbrella of Environmental, Social, and Governance (ESG).

Friedman’s essay was a clarion call to a world in which investors assailed the closeted management cadres of Corporate America and UK plc. Their goal was to tap the hitherto unexploited value of the era’s somnambulist corporations. The balance sheet was key, returns mattered. 

Recently our priorities have changed. The plight of our climate was easy to acknowledge, but somehow lacked the urgency to propel itself to the top of the agenda for senior managers. Now those shifting priorities have added new urgency to the push for a reliable gauge of corporate sustainability. 

This was always going to be easier said than done. First, it is difficult to assign a financial value to an outcome such as becoming a better custodian of the environment. Then there is the challenge of who sets the rules and whose rules do corporations follow? And where is the assurance to give them bite? Finally there is the timing mismatch between well-trod financial short-termism and the unfamiliar terrain of sustainability’s far-off horizon. 

However, an answer might be closer than we think. In 2020, the International Financial Reporting Standards (IFRS) Foundation launched a consultation asking whether it should tackle sustainability reporting. Yes, came the response.

Fast forward to this June, and the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) announced their merger to form the Value Reporting Foundation. One of the objectives of this new partnership is to achieve greater alignment between the various sustainability reporting objectives. 

In many ways, the developments are complementary. The SASB and the IIRC are members of the Group of Five, which late last year unveiled a prototype global sustainability reporting framework. Group of Five members were eager to explain that their framework was complementary to the IFRS Foundation’s work and the EU’s sustainable finance taxonomy.

Nonetheless, the SASB’s leadership is aware of the challenges: “Fifty years ago,” says its CEO Janine Guillot, “most of a company’s market value was reflected on its balance sheet in the form of fixed assets like plant, property, and equipment.”

She continues: “In today’s knowledge economy, it’s the opposite – value is now driven significantly by off-balance-sheet intangibles like a company’s workforce, intellectual capital, customer and supplier relationships, and brand equity.

“Companies have increasingly provided information on many of these topics in sustainability reports. However, efforts to explicitly connect that information to its implications for financial performance and market valuations have been far less common.”

And this, says Guillot, was a motivation for the merger with the IIRC: “We believe integrated reporting is the key to creating needed connectivity between accounting information and sustainability information, because it encourages a more holistic assessment of how a business creates value.

“As a complement to that, SASB standards enable companies to provide markets with consistent, comparable, reliable metrics on key value drivers that aren’t always effectively captured by traditional financial reporting. Together, these resources enable both businesses and investors to make better informed judgments about how sustainability factors might influence valuation models or capital allocation decisions in the context of their risk-and-return objectives.”

Someone else who sees the challenges is Tim Hodgson, the co-head of Willis Towers Watson’s Thinking Ahead Group, who sees investment as an open-ended activity in most cases.

And just as the question of the timeline is uncertain, so too is the challenge of deciding whether sustainability is represented by an absolute goal or relative measures of attainment. “ESG has effectively set itself up as a win-win proposition,” says Hodgson. “Its definition of sustainability is relative. As long as a company is more sustainable than it was last year, all is good.” The tension between these two definitions, he adds, will play out against each other.

Global vision 
These tensions are familiar for standard setters. “The big shift in the economy through the rise of sustainability means thinking of value creation not as a purely financial paradigm,” says Jonathan Labrey from the International Integrated Reporting Council. “We are moving away from a purely financial way of looking at value creation from short termism to long termism.

“Alongside this much greater stakeholder focus, there is also a greater understanding of the limitations of financial reporting – it is historic, not forward looking, and focused on just one dimension. At the same time, sustainability reporting was looking at externalities and no-one was linking the two and asking how businesses should adapt both their business model and strategy. That is what we tried to do with integrated reporting.”

He continues: “Given our merger with the SASB, and also the work of the IFRS Foundation and IOSCO [the International Organization of Securities Commissions], I think we are on track to find out whether sustainability standards are capable of being enforced. That will be crucial because I think it will operate as the mechanism for getting those standards adopted. What is important to us is a vision of a single system. We hope they will use existing frameworks rather than start from scratch. There is a fast track here that we are on, but it’s also important not to lose sight of the fact that we need connectivity. 

“We also need interoperability between the standards for capital markets and the standards for broader society such as ESG objectives. In the end what you want is one system. At the moment we have a system of different underlapping and overlapping systems, but our vision is to have one globally accepted corporate reporting system.”

So what does the future hold? There are, says Labrey, two ways events might play out. One is through corporate governance codes and references in those codes to broader value creation and stewardship. The other is through IOSCO’s endorsement of the standards that will come out of the boards.

If, as Hodgson suggests, Friedman’s 1970 paper did the world a great disservice, is Stafford Beer’s heuristic The Purpose of the System is What It Does a more trustworthy gauge? 

“This was essentially an examination of the purpose of capitalism. I would now suggest ‘the purpose’ [of capitalism] is to find and exploit externalities.

“What we have done in running the investment system – capitalism – is that we have funded corporations and allowed them to pursue financial profits and incentivised them to find ways to dump their waste.

“So the question we now find ourselves having to address is how accurate was the finance-only reporting that we had? And did we do ourselves a disservice by having finance-only reporting for all that time.”