TAKEAWAYS
It is widely recognised that there is no single universally accepted definition of sustainability. For example, the United Nations describes business sustainability as “conducting operations in a manner that meets existing needs, without compromising the ability of future generations to meet their needs and has regard to the impacts that the business operations have on the life of the community in which it operates and includes environmental, social and governance issues”. The book, Business Sustainability in Asia, defines sustainability as “a process of focusing on the achievement of all five dimensions of sustainability performance namely economic, governance, social, ethical and environmental in creating shared value for all stakeholders”1. The terms sustainability and corporate social responsibility (CSR) are often used interchangeably, especially in accounting academic literature. For example, one study defines CSR as corporate activities and policies that assess, manage, and govern a firm’s responsibilities for and its impacts on society and the environment. In a review of definitions for the terms “CSR” and “sustainability” in academic literature conducted by the study, it is found that the meanings of both terms are similar and are often used interchangeably.
Sustainability reports can be conceptualised as non-financial disclosure documents intended to inform stakeholders of a company’s environmental, social and governance (ESG) performance and impacts for a specific period. Sustainability reporting can be considered synonymous with other terms for non-financial reporting including CSR reporting, triple bottom line reporting, etc. It is also an intrinsic element of integrated reporting that combines the analysis of financial and non-financial performance.
With the emergence of the business case for sustainability, there is an exponential growth in demand by investors for integrating ESG criteria in their investment decisions. For instance, the Forum for Sustainable and Responsible Investment (USSIF) reports that the amount of all professionally managed assets in the US that were under ESG investment strategies experienced a 42% growth to US$17.1 trillion from 2018 to 2020. There is also a heightened focus by stakeholders other than investors to consider sustainability issues in their decision-making. For example, it is reported by Deloitte that almost six in 10 consumers have changed their behaviours to help address climate change, and with the race for talent in the consumer industry, one quarter of employees say that they have considered switching jobs to work for a more sustainable company. The increase in demand by various stakeholders, including investors, to incorporate sustainability in their decision-making drives the demand for companies to report on their sustainability-related activities.
Sustainability reports come in various content, format, and language styles as they are subjected to limited regulatory oversight and guidance in many countries. Academics have put forward two theories as to the impact of sustainability performance on the quantity and quality of information disclosed in sustainability reports. In academic literature, sustainability performance (which is how well a company manages relevant ESG risks and opportunities) is typically measured using ESG ratings provided by rating agencies such as MSCI or Refinitiv. Given the global increase in demand for sustainability reporting, we summarise recent research insights into the quantity and quality of sustainability reports in this article.
The signalling theory of information disclosure suggests that companies with better sustainability performance (that is, higher ESG ratings) can enhance their reputation and market value by disclosing more relevant information. In contrast, companies with poor sustainability performance (that is, lower ESG ratings) would provide less or even no voluntary disclosures of information beyond that mandated by regulation. This is to avoid disclosing information that draws stakeholders’ attention to their performance.
A recent study by the authors, using 2,774 US standalone sustainability reports, concludes that companies with better sustainability performance issue longer reports with more words. These companies also disclose more incremental information in their sustainability reports beyond the sustainability-related information disclosed in their mandatory annual financial reports. Examples of such incremental information include disclosures on greenhouse gas emissions and diversity, while examples of similar information include disclosures on tax and anti-corruption issues. To the extent that a longer sustainability report with more incremental information is associated with greater quantity of relevant sustainability information, the findings are consistent with the signalling theory. Moreover, an international study finds that independent directors support voluntary sustainability disclosure policies only for companies with better but not poor sustainability performance. This is because the directors are trying to avoid reputation risks from the potential dissemination of misleading information by companies with poor sustainability performance. Thus, consistent with the signalling theory, companies with poor sustainability performance are likely to disclose lower quantity of sustainability information.
The political legitimacy theory of information disclosure predicts that companies with poor sustainability performance seek to gain or maintain legitimacy by using impression management in their disclosure to potentially influence stakeholder perceptions. In their attempt to address legitimacy threats, poor sustainability performing companies will project an idealised image of themselves by obfuscating their sustainability disclosures, which lowers information quality.
As predicted by the political legitimacy theory, the earlier-mentioned study by the authors finds that sustainability reports issued by companies with poor sustainability performance contain more uncertainty or imprecise language. The use of imprecise language adversely affects understandability, which lowers disclosure quality. In contrast, the study finds sustainability reports issued by companies with better sustainability performance are less focused on short-term issues, reflecting a greater emphasis on forward-looking information that aligns with the long-term nature of sustainability issues. Similarly, an international study finds that companies that engage in controversial sustainability practices use more narrative and deceptive language style in their sustainability reports instead of more technical and analytical language. For example, such reports tell a story without providing specific details by incorporating text such as “continuously improving the ways we monitor training effectiveness. We recognise that the working conditions in the factories we have audited have improved …” and “an extensive range of activities is being implemented to promote awareness of and support for conservation projects …”.
In contrast, a more detailed and analytical disclosure will include more specific categorical and numerical outcomes, such as “34 lost‐time accidents and 27 accidents without lost time were reported …” and “the Company pays days off granted to mothers or fathers to take care of a sick child, according to specific rules”.
Besides textual content, companies can also manipulate the visual presentation of their sustainability reports as part of their obfuscation strategy. For example, one study finds that US companies with poor sustainability performance are more likely to systematically manipulate the visual presentation of their reports. Techniques such as incorporating more graphs that only depict or exaggerate favourable trends through scale distortion are used to distract readers. Similarly, another study in Spain finds that companies that disclosed less standardised sustainability information tend to divert readers’ attention by using larger-size pictures and colour tones that are associated with nature in their sustainability reports (for example, blue and green).
Based on these studies, we caution stakeholders about companies’ potential greenwashing attempts via textual and visual manipulation of sustainability reports to obfuscate poor sustainability performance.
Among recent developments, the creation of the International Sustainability Standards Board (ISSB) in November 2021 represents a step towards creating a set of globally aligned standards that will drive more transparent, reliable, and comparable sustainability reporting by companies. In March 2022, ISSB released two exposure drafts of its first two proposed IFRS Sustainability Disclosure Standards. The proposed IFRS S1 sets out overall requirements with the objective of disclosing sustainability-related financial information while the proposed IFRS S2 focuses on climate-related risks and opportunities. When the new sustainability disclosure standards come into effect, it is likely that greater standardisation will mitigate greenwashing via manipulation of textual and visual content in sustainability reports, which will in turn enhance the information quality of these reports.
Kevin Koh and Tong Yen Hee are both Associate Professor of Accounting, Nanyang Business School, Nanyang Technological University.
1 Rezaee, Z., Tsui, J., Cheng, P. & Zhou, G. (2019). Business Sustainability in Asia. Wiley ISBN 978-1-119-50231-9
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