Today, investment analysts take for granted that the financial statements of listed companies provide a solid foundation on which to build an understanding of business profitability. Modern financial reports are heavily regulated and signed-off by teams of qualified auditors. But this was not always so. Pre-2000 BC, financial statements were a crude ledger of livestock exchanged, for the promise of grains at harvest time. Pacioli didn’t introduce double-entry accounting until the 15th century.
In contrast, reporting frameworks that quantify a company’s environmental and social footprint have developed rapidly, though of course, they continue to evolve. For one thing, reporting of statistics like workplace injuries and carbon emissions is not compulsory for listed corporates in Australia or New Zealand. This makes it difficult to compare ESG credentials between companies (where ESG refers to Environmental, Social, Governance), and creates a limitation, referred to as “disclosure bias”.
Disclosure bias means, that using any system of ESG scoring, a company that consistently reports quantified ESG outcomes and targets, all else being equal, will outrank a company that does not.
Is this fair? Not always. Disclosure bias favours large companies over small ones, who may not have the head office resources or budget to consider measurement and reporting that is not strictly required by regulators. It also favours developed countries over emerging markets, where ESG practices are generally at an earlier stage of development.
But disclosure bias is not entirely unfair either. Consider two competing food retailers. Company A is reporting historic, current and targeted rates of staff turnover, lost time injury frequency rates, volume of food wastage and carbon emissions. Company B is not.
Simplistically, the lack of disclosure by Company B implies one of two things. Option one is that these metrics are not being measured, implying they are not considered important or necessary. If we use a fitness analogy, under this scenario, Company B is blatantly unfit and totally unaware of the existence of the app, Strava, or that there is even an option to monitor their abysmal attempts at exercise.
The second explanation for Company B’s silence is more cynical – that ESG metrics are being measured, but remain confidential because they are not flattering. In this case, Company B is on Strava, but doesn’t want anyone to know about it, given its embarrassingly poor performance and lack of commitment.
On the other hand, we can draw the following inferences from Company A’s transparency in terms of its sustainability disclosures. Firstly, the fact historic figures are available tells us these ESG metrics were recognised as valuable some time ago, and resources were put in place to begin monitoring them. In the very first year these figures were measured, internal work was likely done at Company A, to understand how the firm ranked versus competitors and compared to best practice guidelines. Targets and timelines were formulated, a strategy developed, partner candidates vetted and budgets approved to fund any new resources required.
This time period equates to Company A’s early days on Strava, keenly monitoring their own performance and determined every run would be further and faster than the last. Quietly plugging away, without anyone following their progress.
Once Company A’s management had confidence to commit to sustainability targets publicly, an announcement was made about the company’s current ESG metrics and plans. In fitness terms, by now, Company A had been running three times a week for a year and begun training for a half-marathon. Assured, they invited everyone they’d ever met to follow them on Strava.
Company A is a long way down a road, and Company B may not have even taken the first step. To some extent, disclosure bias is valid.
However, a definitive assessment of health and wellbeing cannot be made based on Strava records alone. At Milford, we look at corporate sustainability disclosures as a critical aspect of a comprehensive company analysis, that also includes detailed work around industry structure, competitive dynamics, management strategy and financials. Taken to an extreme, excessive focus on quantified metrics can distort the worthwhile goals that motivated the collection and analysis of data in the first place. I recently saw a runner whose fitness ambitions had clearly been corrupted in this way. The message written across his t-shirt said – “If I collapse, can someone pause my Strava.”