Mandatory corporate reporting on sustainability: what is the likely impact?

Corporate social responsibility (CSR) reporting by businesses has the potential to deliver social, environmental and financial rewards. But its success rests on carefully considered standards and the credible – if costly – enforcement of these rules.

In 2019, nearly 200 US chief executives (CEOs), including the leaders of Apple, Pepsi and Walmart, issued a bold new statement of purpose. These members of the Business Roundtable – the prestigious corporate association for the bosses of leading US firms – declared that they were now fundamentally committed to serving all their stakeholders. And by ‘all’ they meant not only the shareholders to whom they had long catered, but also employees, suppliers, customers and communities.

The Roundtable CEOs were responding to mounting pressure to do ‘good’ while doing business. Their statement was widely hailed as a radical move in the world of corporate social responsibility (CSR) – the broad spectrum of activities that signal a firm’s sustainability, whether these be efforts to tackle carbon emissions and child labour, moves to pay workers fair wages or sponsorship of community events.

Serving stakeholders beyond shareholders means that far more people can have a say on how a business is run. For with society’s growing interest in CSR comes a greater expectation for businesses to report their CSR activities publicly and usher in this new era of accountability. And they are doing so: in 2020, 96% of the world’s largest 250 companies and 80% of large firms worldwide reported on their sustainability performance, according to KPMG’s Survey of Sustainability Reporting.

New economic analysis of CSR reporting

CSR reporting is hotly debated. Does it really make any difference to sustainability? Exactly what information should businesses report? And by laying their sustainability cards on the table, could the likes of the Roundtable’s members open themselves up to business risks, which may, in turn, threaten the integrity of their CSR reporting – or even CSR itself?

These are tough questions to answer, but a recent economic analysis provides some initial insights (Christensen et al, 2021). The research explores the potential effects of mandatory CSR reporting – that is, what would happen if companies had to report their CSR activities while following a common set of reporting standards.

Based on relevant evidence from across the fields of accounting, finance, management and economics, the analysis suggests that mandatory CSR reporting could have significant capital market benefits as well as altering a business’ social and environmental impact. But this does not come without risks and is conditional on well-designed reporting rules being in place. The study highlights avenues for standard setters to explore when establishing these rules (discussed in more details below).

While the analysis is focused on the United States, the insights are applicable for developed countries the world over.

Why might we need mandatory CSR reporting standards?

One criticism of current CSR reporting is that the choice of topics included in reports is almost entirely voluntary. Only 129 of S&P 500 firms chose to report on the percentage of their ethnic minority employees in 2017, for example, and just 184 revealed their total greenhouse gas emissions (Li et al, 2021).

How firms portray outcomes related to those topics is also a matter of choice. A business may only report on a more ethnically diverse workforce or a reduced carbon footprint if it carries a benefit to that company. Or they may opt to offer little in the way of meaningful information: about 50% of US companies registered with the Securities and Exchange Commission (SEC) provide fairly generic or ‘boilerplate’ sustainability text in their regulatory filings, research shows (Christensen et al, 2018; SASB, 2017).

This selective approach does not engender stakeholder trust in the reporting – even if it is accurate. Moreover, stakeholders cannot hold businesses to account if they do not disclose the relevant metrics. While reporting on employee ethnicity has gone up since the Black Lives Matters (BLM) protests, those that do reveal these figures are likely to be ‘best in class’. Stakeholders have no way to keep the remaining, and presumably worst-performing, firms accountable for diversity.

Further, voluntary reporting also makes for huge variation in reporting practices, and limits stakeholders’ ability to compare companies’ performance (Bernow et al, 2019). Quantitative CSR metrics are rare in US regulatory filings (SASB, 2017), for example, but fairly common in stand-alone CSR reports (Li et al, 2021). Disclosure levels also differ greatly across sectors and firm size: large firms and those in heavily regulated industries tend to cover more CSR topics. We also see more CSR reporting from more ‘controversial’ industries, such as tobacco and alcohol (Grougiou et al, 2016), as a tool to shape public reputations.

Unlike financial reports, which adhere to accounting standards that help investors interpret the figures in front of them (in turn, helping them decide what to do with their investments), CSR reporting typically follows a plethora of recommendations – leading to criticisms of an ‘alphabet soup’ of standards.

Mandating a set of reporting standards can help to overcome concerns around ‘greenwashing’ and comparability, through rules that shape what information is presented to stakeholders (Christensen et al, 2021). If these rules are enforced, we are more likely to see real impact from CSR reporting, altering how businesses affect society and the environment and business.

Moves are afoot to strengthen current practices through standards for voluntary CSR reporting. These include those from the Global Reporting Initiative (GRI) and the International Financial Reporting Standards Foundation (IFRS). The latter has consolidated several standard setters and established the International Sustainability Standards Board (ISSB) that will be working towards a new global approach. While these efforts make it easier to compare firms, it is mandatory standards that could generate greater impacts by forcing even those firms that are currently more reluctant to provide information about their CSR performance to do so.

Research shows substantial non-compliance or underreporting of important CSR information by businesses. On average, US SEC-registered firms provided only about 18% of the disclosure items that the Sustainability Accounting Standards Board (SASB) considers material. These vary by industry and include metrics for environmental performance and health and safety (Grewal et al, 2020). Meanwhile, disclosures have increased in volume and quality in countries with CSR reporting mandates, for example, China, Denmark, Malaysia and South Africa (Ioannou and Serafeim, 2017).

What are the possible effects of mandatory CSR reporting?

Determining the impact of CSR reporting is no simple task. Patchy research on the topic, coupled with the voluntary, unstandardised nature of most CSR reporting, renders it hard to draw firm conclusions on which features of reporting lead to which outcomes.

But the research that is available provides important clues from which some tentative conclusions can be drawn. The results of both theoretical and real-world studies point to both intended and unintended consequences, many positive but some also negative.

Sustainability impacts

The positive effects of mandatory standards for society can arise through various channels, each reflecting different motivations for CSR reporting. The first is to ensure that businesses deliver genuine social and environmental benefits or minimise harmful activities. CSR reporting exerts various pressures on firms to make these changes happen – and research predicts that these are likely to be realised more effectively through the higher transparency and greater credibility awarded by mandatory standards (Christensen et al, 2021).

Stakeholders can use the newly disclosed CSR information to place meaningful pressure on firms to change for the better, whether by avoiding purchases from these companies, withdrawing their business, divesting their holdings or instigating activist campaigns to persuade the company to, say, cut pollution, use renewable energy or buy ethically-sourced materials. It is thought that these reactions create a feedback loop in which firms respond to anticipated or actual stakeholder reactions by adjusting their CSR activities (Leuz and Wysocki, 2016).

These theoretical predictions of mandatory CSR reporting’s effects are backed-up by pockets of real-world evidence. For example, in 2014, the European Union passed its CSR directive, which mandated CSR reports for some firms from 2017. Many companies responded by increasing their CSR activities even before the first mandatory disclosures (Fiechter et al, 2019).

CSR disclosures can also be used in more ‘positive’ ways. Shareholders may funnel their investments towards companies that share their social and environmental values, for example, providing further incentive for businesses to improve their CSR credentials. A similar picture is true of consumers: CSR activities can build loyalty and trust for a firm and its brands (Öberseder et al, 2013; Sen and Bhattacharya, 2001).

With more public information on what other businesses are doing in the name of sustainability, a CSR reporting mandate could also create a sense of competition and help firms learn from one another. In 2010, the United States mandated greenhouse gas emissions reporting for thousands of manufacturing facilities. In response, these facilities reduced emissions by 7.9%, largely because the reports allowed companies to compare themselves with each other (Tomar, 2021). Similarly, when the UK introduced a carbon reporting mandate for listed companies in 2013, emissions subsequently dropped by 10-18%, as a result of investor pressure and comparisons with business peers (Jouvenot and Krueger, 2020; Grewal, 2021; Downar et al, 2021).

Research also highlights potential unintended outcomes of a CSR reporting mandate. There is a risk, for example, that instead of incurring the expense or difficulty of tackling a harmful activity, say one that is highly polluting, a reporting mandate could lead to a business moving this activity to an overseas subsidiary that is not subject to reporting requirements (Rauter, 2020). Similarly, we may see more high-profile firms giving up unsustainable practices only for them to be taken up by smaller companies that fly under the public radar.

An example of supporting evidence for this scenario comes from the world of mining: SEC-registered firms subject to mine-safety disclosure rules are more likely to shut down dangerous mine facilities than unregulated firms (Christensen et al, 2017).

Business and financial impacts

Available research shows that the effects of CSR reporting on business and finance can come via both customers and investors (Christensen et al, 2021).

As with financial reports, standardised CSR reports could provide information to shareholders to inform their investment decisions by offering insight on issues that may affect future income. For example, companies that are slow to shift away from fossil-fuel dependence could represent risky investments in a future that favours carbon neutrality. Investment-swaying information ought also to have effects on capital markets in the form of improved liquidity, lower cost of capital and higher asset prices (Leuz and Wysocki, 2016).

The ‘moral capital’ generated by CSR – for example, through customer trust, employee loyalty or goodwill with regulators – can provide insurance-like protection against negative business events (Luo and Bhattacharya, 2009). In other words, stakeholders are more likely to stay loyal to firms, which limits the risk of volatile finances.

Similarly to sustainability impacts, a CSR reporting mandate could also carry risks for business. Forcing firms to reveal CSR information could, in some cases, reduce their competitiveness (for example, their development of low-carbon emission technologies), in turn, diminishing their incentives to innovate (Breuer et al, 2020). In addition, the interests of diverse stakeholders may clash. Poor CSR, as revealed by reports, and subsequent damage to reputation and regulatory action are not necessarily beneficial to shareholders.

How can CSR reporting standards be designed and enforced to ensure they are effective?

For CSR standards to lead to real benefits, they must meet certain conditions. To this end, research provides a number of considerations for standard setters (Christensen et al, 2021).

CSR reporting is a far more multidimensional affair than financial reporting. Deciding what information to include and ensuring that it is easy to understand for the target audience is paramount. It will vary depending on whether the aim of reporting is to shape businesses’ CSR activities or to provide financially relevant details to investors.

A careful balance must be struck between specificity and breadth. Ideally, the information must be sufficiently specific to be insightful about firms’ CSR performance and also verifiable. But the rules for reporting must also be flexible enough to accommodate the broad spectrum of CSR activities, and the needs of diverse stakeholders.

Making the rules too broad can risk creating more room for managers to bury bad news in a bland statement, or even sidestep the issue altogether. Demands for specific information may also backfire by providing companies with an excuse to only reveal what is required by the letter of the law, even if other, less favourable, disclosures are of more interest to their stakeholders. Further, specific information can also be difficult and expensive for companies to gather – especially for smaller firms.

Big moral, social and political judgements must also be made in deciding what information to include and, correspondingly, CSR reporting standard setters must engage in many more forms of debate than their financial counterparts.

Lessons from financial reporting teach us that the effectiveness of CSR reporting depends on, among other things, credible enforcement (Daske et al, 2008; Christensen et al, 2013). To ensure that standards are met, major investments in enforcement infrastructure and human expertise are needed. CSR auditing is quite a different game to financial auditing, for instance. To verify a CSR report, auditors must understand carbon footprints, materials sourcing or any of the many other aspects of CSR.

While mandatory disclosure regimes are costly to design, implement and enforce, it could be important to do so and to get the details right. Investors are increasingly focused on sustainable investments and CEOs are acknowledging the importance of a greater range of stakeholders beyond investors. Indeed, it may only be through a reliable reporting framework that the well-meaning intentions of CEOs to do good – while doing well – will become a reality.

Where can I find out more?

Mandatory corporate carbon disclosures and the path to net zero: VoxEU summary of a Centre for Economic Policy Research (CEPR) Policy Insight by Patrick Bolton, Stefan Reichelstein, Marcin Kacperczyk, Christian Leuz, Gaizka Ormazabal, Dirk Schoenmaker.