"Prove it."
Last year, the Business Roundtable expanded the purpose of a corporation to focus on stakeholders, including customers, employees and communities, not just shareholders.
This year, COVID-19 — echoing the recent acceleration of climate change commitments — spawned a powerful effort and commitment by businesses to support their many stakeholders.
This summer, the death of George Floyd and far too many other Black citizens, as well as the related protests around the world, led many businesses to announce donations and make statements on their diversity and inclusion efforts.
Each of these actions have been followed by the same demand: "Prove it."
Social washing — statements that make companies appear more socially responsible than they actually are — might seem like just a viral PR risk. Yet, increasingly, investors, customers and employees are demanding that companies adopt more strategic, impactful and measurable environmental, social and corporate governance policies, and the stakes are real.
Access to — not cost of — capital is on the table, with leading asset managers such as BlackRock and State Street pledging to hold companies accountable for meeting ESG commitments. In fact, this year investors have put a record amount of dollars into ESG funds, with $71 billion flowing between April and June alone. Talent and customers are voting with their feet and their wallets, respectively.
Audit committees — independent bodies that oversee the financial reporting by public and private companies — have an important role to play in meeting the demands of all these stakeholders. In short, audit committees need to effectively answer, "Did they prove it?"
Providing the assurance audit committees need in order to “prove it” is where auditors come in.
But what's "proof," and what is "it?” Regardless of whether the audit committee has direct responsibility for ESG, here are five questions auditors can bring to audit committees as part of their broad oversight role — not only to meet stakeholders’ powerful demands, but better empower companies to engage in the ESG opportunity on their own terms:
Question 1: Which ESG topics are you measuring and reporting, and why? Audit committees will not set a company's ESG strategy, but they must understand stakeholders' priorities and material ESG topics, and, most importantly, the intersection between the two. This mapping exercise helps focus decisions on initiatives and reporting strategies. Ultimately, reporting should reflect both current state (what the company is doing) and future state (what the company intends to do), with metrics providing evidence of the efficacy of initiatives.
Question 2: Where are you currently publishing your ESG reporting? Different reporting styles come with different levels of rigor. Is the data in a catchy infographic on the website for consumers, a detailed PDF, proxy statement, or a 10-K for investors? The data's importance to a company's overall ESG strategy and financial materiality should align with the corresponding regulations and levels of risk associated with the data. Altogether, this should determine the reporting method. Likewise, ESG information included in a 10-K should be monitored with the same rigor as traditional financial metrics. Audit committees should be wondering about the risks that come with various reporting strategies for certain metrics, especially as stakeholder demands rapidly increase.
Question 3: What processes and controls already exist over the data being collected and reported? Data collection — especially in global, multi-line businesses — can be challenging. For instance, many businesses currently report on their greenhouse gas emissions, and the Greenhouse Gas Protocol outlines a clear standard recognized by almost all investor groups.
However, simply tracking greenhouse gas emissions requires that each office, division, region and business line is aligned on metrics, reporting style, cadence and more. Further, the people overseeing that data collection need to be both data savvy and knowledgeable on greenhouse gas reporting. Audit committees should be asking probing questions to understand the procedures and controls in place.
Question 4: Are you getting assurance on ESG metrics? Do you know what’s being assured, by whom, and the value of the assurance? There’s no cookie-cutter approach to ESG assurance. It’s a journey unique to every industry and company, but it's critical to start somewhere now before you don't have a choice, facing pressure from customers, shareholders, or others with high expectations and tight timelines. Carbon, as described above, is a common and oft-recommended first place to start because standards are well-known.
Yet, as a business moves forward, audit committees are positioned to understand which metrics merit assurance. For example, a retail company's customers may want assurance around reporting related to labor in its supply chain. Or a consumer goods company's shareholders may want assurance on the use of proceeds of a green bond. Ultimately, an audit committee can decide how far the journey goes, even potentially working toward assurance of a full corporate social responsibility report.
Question 5: How should audit committees think about value creation and competitors when engaging on ESG? Audit committees should step back and understand the landscape. How do competitors differ in measurement and reporting? What emerging regulatory requirements should a company proactively prepare for?
A comprehensive understanding of the landscape coupled with strategic investment in ESG assurance not only responds to stakeholder demands, but may broaden an organization’s lens, revealing new risks to its business model and opportunities for growth and transformation. This is the real value of bringing sophistication to the measurement and reporting of ESG metrics.
A data-driven ESG lens helps make conceptual tail risks real and can more practically inform corporate strategy. For example, understanding and quantifying an investment portfolio's exposure to climate change or a supply chain's risk for inhumane labor practices as well as a company's own actions to tackle those issues will allow management to track progress and better adjust strategy. It can elevate an audit committee's impact in helping companies drive long-term financial sustainability and value creation for all stakeholders.
ESG strategy and reporting truly is an opportunity for a company to stand out. No matter where a company is in its ESG journey — initially developing goals and policies, working to improve the sophistication of metrics and credibility in reporting, or pushing on the edge of innovation — effectively addressing ESG topics should be a long-term strategy embedded into the company's core business activities.
