Promoting Corp Social Responsibility

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NEW ECONOM Y

Promoting corporate social responsibility

ELLA JOSEPH Institute for Public Policy Research

Is market-based regulation sufficient? ILO, OECD and UN, for protecting workhe unsustainable depletion of natural ers, human rights and the environment. resources, perpetuation of poor health However, where these are not incorporatand imposition of dangerous working ed into national legislation, or are not conditions are just some of the worrying applicable to overseas operations, their external costs imposed by international comeffectiveness is much diminished. mercial operations. These costs are borne Companies take voluntary action when especially by developing countries that do market forces reward them not receive adequate comfor doing so. The commercial pensation from companies “Corporate practices imperative for a company to responsible for social and advocated in codes of improve its perormance can environmental damage. conduct may not be driven by the reaction of However, at a national have the same force institutional investors and level there are significant as law, but pressure shareholders, employees, barriers to regulating comfrom stakeholders suppliers, customers, companies to ensure that they can in theory be a munity representatives and manage their social and formidable force for NGOs. Corporate practices environmental impacts improvements in advocated in codes of conproperly. Prescriptive legisbehaviour” duct may not have the same lation often leads to tokenisforce as law, but pressure from tic responses and regulation these stakeholders can in thecan quickly become an inacory be a formidable force for improvements curate reflection of society’s concerns, lagin behaviour. ging behind public opinion. At an Clearly this market imperative needs international level, with inadequate global support. For it to work effectively, inforgovernance and discrepancies between mation about business activity has to be national social and environmental laws, made accessible so interested groups can improvements in corporate practices often make informed decisions about their relahave to rely on voluntary action. There is tionships with companies. But accessible an abundance of recognised international information alone is not enough for marketstandards, for example those set by the

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based regulation to take place. A critical Some key issues to consider are: question for policy-makers is how far dis● on which issues should reporting be closure of social and environmental impacts mandatory and how detailed should legcan be an effective means to improve corislation be about the content and format of porate behaviour. To make it effective, a reports? number of other criteria for reporting must ● is there a trade-off between imposing stanalso be met (Adams 2002): dardisation and the quality of information ● the issues that can be reported on must that is provided? match the interests of stakeholders ● should there be a distinction between the ● there must be a measure or a metric that requirements made on companies of difaccurately captures performance and can be ferent sizes and in different sectors? applied across organisations (ideally across ● should external verification be required? sectors and geographic boundaries) ● should interested parties have a formal ● that measure or metric should be audited method of redress if they believe the pub● that measure or metric should be commulished information to be a misrepresentation? nicated to the appropriate stakeholder(s); and Current levels of “A critical question ● the relevant stakeholder(s) voluntary disclosure for policy-makers is should respond Analysis by KPMG of the 100 how far reporting on largest companies in 11 of the social and A mandatory approach? world’s industrialised counenvironmental At present, these criteria are tries showed that only 13 per impacts can be an a long way from being fulcent produced environmental effective means to filled, so that marketreports in 1993, 17 per cent improved corporate enforced regulation based on did so in 1996, rising to 24 per behaviour” informed choice is still poorcent in 1999. However, in ly developed. In response the October 2000, the Prime MinUK and the EU are currently grappling with ister challenged the UK FTSE350 to publish arguments over the relative merits of annual environmental reports by the end of mandatory as opposed to voluntary social 2001 and that summer the European Comand environmental reporting. The urgency mission recommended that companies should of this debate has increased with the publirecognise, measure and disclose environcation of proposals by the UK Department mental issues in their annual reports and of Trade and Industry’s (DTI) influential accounts. Company Law Review and the European Recent surveys differ as to how far reportCommission’s Employment and Social ing has taken off in the UK. In 2000, analysis Affairs Directorate. The former advocates by Pensions Insurance Research Consultants reporting on non-financial performance as (PIRC) claimed that 81 per cent of the FTSE350 a means to an ‘enlightened shareholder’ were disclosing their environmental impacts approach to corporate governance. The latcompared to 52 per cent in 1998. However, ter has broader aspirations to improve EU more conservative estimates are that almost companies’ social and environmental perhalf of the UK’s top 200 quoted companies do formance. not adequately disclose on social and enviBoth reports confront similar questions ronmental issues, and that the Prime Minisabout the most effective way to get suffiter ’s challenge to the FTSE350 went cient, accurate information from companies. unheeded.

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Reporting on social performance is even further behind. Although, between 2000 and 2001 the number of FTSE100 companies issuing information on their social performance doubled to 79, very few produce more than ‘corporate gloss’, with only 16 using quantitative performance data to back up their claims. A regularly cited problem with social reporting is that the indicators are less well developed than indicators established for environmental performance. However, evidence shows that even with issues on which companies have explicit policy statements, and where easily identifiable and quantifiable data exists, the UK’s largest companies still fail to provide information on their performance. For example, only ten of the FTSE100 report data on the ethnic diversity of their workforce and none provide quantitative data on child labour in their supply chain or on workdays lost through stress (ERM 2001). Analysis of published reports also show that practices differ widely between sectors. Those most forthcoming with information on their environmental policies and/or performance tend to be those that have a high environmental impact, such as the chemicals and transport industries, or those which are particularly sensitive to political or regulatory factors, for example, utilities. Non-industrial sectors, such as insurance, communications, retail and banking traditionally report at below average rates as environmental issues are seen to be less relevant. Among the top four banks in the UK, three provide limited environmental data, and only one has reference to social issues beyond basic philanthropic contributions (Doane 2002). Company size is also an indicator of reporting behaviour. Unsurprisingly, due to different levels of demand as well as resource constraints, there is a disparity between the reporting practices of large and small companies. In 2000, only one in ten SmallCap companies satisfied PIRC’s core reporting criteria, compared to half of the FTSE100.

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The general upward trend in the quantity of reports does not, however, equate to the provision of improved quality of information. Of the reports analysed by KPMG in 1999, only half mentioned their progress on prior years’ targets and the proportion of reports that contained quantitative data on environmental performance and described future targets remained constant between 1996 and 1999. Few reports – KPMG estimates one in six – are checked by third parties for accuracy and where they are it tends to be the data collection processes rather than the end results that are audited. There is a range of verification methods that can be employed from truly independent audit of both internal management and data through to informal peer review. The lion’s share of third party auditing is conducted by the ‘big five’ accountancy firms. However, their ability to provide these services on social and environmental information has been brought into doubt following the Enron debacle, provoking questions on their ability to provide accurate and accountable financial audits. And organisations charged with auditing or verifying reports rarely comment on issues that the report has failed to include.

Direction of future policy The UK regulatory framework for the reporting of social and environmental issues is due to shift significantly. The DTI’s Company Law Review published its recommendations in July 2001 after three years’ deliberation and a new Companies Bill is expected after consultation. The new Act will require large public and private companies to produce an enhanced Operating and Financial Review (OFR) as part of their annual report. This is likely to mean that it will be mandatory for directors to report on non-financial issues that are material to understanding the firm. These issues are likely to include factors that may substantially affect future performance; an

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account of the company’s key relationships for reports to be independently verified and with employees (such as disability and noninclude all levels of the company and its supdiscrimination policies); and policies and ply chain as well as for the Commission to supperformance on environmental, community, port and assist corporate watch groups and social, ethical and reputational issues includother civil society initiatives aimed at moniing compliance with relevant laws and regtoring corporate behaviour. Of course, such ulations. This requirement is expected to reforms would be a significant boost to marapply to public companies that satisfy at ket-based regulation. least two of the following three criteria: they The reaction to these ambitious proposals have a turnover in excess of £50 million, a balhighlights the tensions caused by mandatoance sheet total of at least £25 million and ry reporting. At the end of March 2002, the over 500 employees. European Parliament’s Industry Committee The European Commission’s Green Paper rejected demands for all EU firms to be subon the development of a European frameject to mandatory social and environmental work for encouraging corporate social reporting along the lines of GRI and instead responsibility advocates it endorsed the original volreaching an international untary approach implied in “even if laws are put consensus on reporting. It the Green Paper. The comin place, disclosure is highlights the use of the mittee agreed that the EU a necessary but not Global Reporting Initiative should focus on better comsufficient condition (GRI), probably the most pliance with existing codes for market forces to widely recognised voluntary of practice such as those apply pressure to reporting guidelines to cover developed by the OECD and companies” economic, social and envishould encourage sectorallyronmental issues. A draft driven campaigns by indusreport from the European Parliament’s Comtry bodies themselves. This is in line with mittee on Employment and Social Affairs has business campaigns claiming that European called on the Commission to bring forward firms are too diverse to have a single reporta proposal for a Directive, requiring entering requirement imposed upon them. prises with more than 250 employees or a From disclosure to improved turnover of J4 million to undertake annual practices social and environmental reports, by the Unsurprisingly, legislation does affect the end of 2003, with an implementation period rate of reporting. For example, in Denmark of three years. The content of these annual the proportion of the largest companies to social and environmental reports should be report rose from eight per cent in 1996 to 29 set according to the evolving international per cent in 1999, partly as a result of the range of economic, environmental and social ‘Green Account’ requirement from 1996 on standards identified by the GRI which companies with a significant environmental launched its latest guidelines in March 2002. impact. However, the number of reports These aspirations, due to be voted on by the prompted by legislative changes does not Committee and Parliament, far outstrip those always equate to the provision of useful or of the DTI’s Company Law Review. At early indeed accurate information and some believe 2002 exchange rates, such a directive would that the quality of information suffers if comrequire all UK companies with a turnover of panies are simply complying with imposed approximately £2.5 million to report. Furlegal frameworks. thermore proposals from the Committee are

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It is likely that tough proposals to introduce mandatory reporting into UK and EU law will be watered down, but even if they were not, for this disclosure to translate into improvements there would have to be interest from stakeholders and a willingness to act on this information. In 2001, MORI showed that there are widely differing levels of interest: 87 per cent of shareholders would expect to see a copy of a social and environmental report, compared to 63 per cent of employees and only 25 per cent of customers. Furthermore, whilst one in nine British consumers say that they are concerned with social and environmental issues, less than a fifth reflect this in how they spend their money and less than 5% make an active and informed choice in the majority of their purchasing decisions (Cowe and Williams 2000). Indeed, NGOs and advocacy groups may not have the resources to make comparisons across companies and mediate this information to help inform consumers. The perceived importance of different social issues varies across borders and this creates another set of problems for international companies. However, there are internationally agreed issues of concern, such as health and safety at work, and the most pressing environmental concerns have global implications. This is reflected by pressure from the international investment community for companies to provide information on their non-financial performance. This demand for information has been boosted by recent amendments to the UK’s Pension Act that requires pension fund trustees to state whether they take social and environmental issues into account in their investment decisions. There have been similar legislative changes elsewhere in Europe. This increased demand for reports has been further boosted by similar initiatives from the Association of British Insurers and requirements to be eligible for a place on the ‘ethical’ FTSE4Good index. However, interest from investors will fail to promote quality

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reporting if analysts continue not to consider social and environmental performance to be important.

Conclusion There is a range of possible approaches that governments can take that fall short of prescriptive reporting requirements: ● legislation that indirectly encourages reporting by stimulating the demand for information ● indicating good practice by naming and shaming companies that perform poorly and ● providing practical guidelines as well as leading by example. To date, UK government intervention has gone some way to doing all these: ● amending the Pensions Act ● publishing environmental reporting guidelines ● supporting awards for some of the best reports and ● naming and shaming large companies that fail to comply voluntarily. More could be done, for example requiring greater disclosure in public procurement, but it may not be enough. However, the rationale for a mandatory reporting structure needs to be clear. If the objective is to make markets work more effectively, for example by ensuring that shareholders have adequate information on the management of the social and environmental risk that a company faces, then allowing directors discretion over the information that they provide and tailoring it to the financial community is acceptable. However, if the objective is to encourage a wider group of stakeholders to press for improved corporate behaviour then there is a clear case for exposing companies to the risk of market punishment by mandating them to report on a wide range of indicators that are clearly comparable across similar companies as well as sectors and countries.

PROM OTING CORPORATE SOCIAL RESPONSIBILITY

There are a range of issues to be resolved if government intervention is to go beyond exhortation: how can the problems of commercial confidentiality be negotiated, should there be a discrepancy between the requirements made of big and small firms and those in sectors with differing environmental impacts? A recognised side-effect of mandatory reporting is low-grade and unadventurous reporting. However, the use of voluntary guidelines such as GRI reduces the ability of stakeholders to make comparisons across companies, as there is flexibility over what individual companies

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report on. One way of getting round the issue of what information should be provided is to have a three-tiered requirement depending on the relevance to the organisation: core (for all companies), sectoral (for those in certain industries) and company specific. However, even if laws are put in place, disclosure is a necessary but not sufficient condition for market forces to apply pressure to companies. There has to be a widespread willingness from stakeholders to use this data to inform market decisions. Unfortunately, at present this looks unlikely ●