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Why investors should look beyond a company’s financials

Massive Oil Slick Threatens U.S. Gulf CoastMassive Oil Slick Threatens U.S. Gulf Coast
Oil burns during a controlled fire May 6, 2010 in the Gulf of Mexico. The U.S. Coast Guard is overseeing oil burns after the sinking, and subsequent massive oil leak, from the sinking of the Deepwater Horizon oil platform off the coast of Louisiana. Photograph by U.S. Navy/Getty Images

Sustainability reporting — the disclosure of non-financial information into financial reports — is becoming routine in Europe. Last year, the E.U. adopted an amendment to its general accounting directives, requiring that certain large companies include reporting of “sustainability” factors—such as environmental aspects, social and employee-related matters, respect for human rights, anti-corruption and bribery issues, and diversity on boards of directors—in their management reports.

News outlets are calling the move “historic,” but many people don’t know that the U.S. passed a similar regulation — more than eight decades ago. You wouldn’t know it, though, because it’s not always enforced. According to an annual publication covering the social and environmental shareholder resolutions filed each proxy season, 63% of all shareholder proposals filed relate to social and environmental issues, suggesting that companies are not disclosing sustainability information that investors deem to be material. If the U.S. were to enforce its own regulation, the country could dramatically improve corporate performance.

A growing number of companies realize the financial impact associated with environmental, social and governance (ESG) factors. There’s risk —consider the 2013 Target (TGT) data breach, which cost the company an estimated $146 million and a 16% drop in earnings. But there’s also opportunity — according to Nestlé Inc.’s 2013 Corporate Sustainability Report, the company saved more than $170 million by reducing the amount of packaging it used, a significant impact to the bottom-line.

Investors are following suit. CalPERS, the California-based company administering health and retirement benefits, announced in May that it will now require its investment managers to integrate ESG factors when making investment decisions.

Investors are increasingly demanding information about corporate sustainability performance. Luckily, the legal framework to provide investors with this information has long been established.

When the SEC was formed in the 1930s, Congress empowered it to require the disclosure of material information. Regulation S-K says that information is material if it impacts the financial condition or operating performance of a company. When considering material information and whether to disclose it, the corporate community has typically emphasized financial information. But in today’s world, where intangible value accounts for 80% of market valuation, material factors can be financial or non-financial.

Now, more than ever, sustainability issues are impacting the bottom line. Investors want to know how apparel manufacturers are dealing with rising commodity prices; how software companies are recruiting skilled labor; how insurance companies are addressing rising sea levels and intensifying storms; and how pharma companies are managing counterfeit drugs in the distribution chain. Simply put, they demand better insight into risk factors.

Sustainability reports are a good starting point, but they typically don’t provide investors with the information they need to make decisions to hold, buy, or sell stocks. Reporting varies widely between companies, and performance can’t be compared or benchmarked.

Consider the 2010 Deepwater Horizon oil spill, which cost BP $5 billion in liabilities and millions more in tarnished public trust. Prior to the spill, if investors had data on BP’s (BP) safety culture, emergency preparedness and safety risks — and could compare BP’s performance on these factors to those of its peers — would they have remained invested? Investors could have seen warning signs if better sustainability information had been available.

Just like our already established financial accounting and reporting standards, we need accounting standards for sustainability factors. The Sustainability Accounting Standards Board is an independent, non-profit organization that arose to fill this need. Using its standards as a framework, professors at Harvard Business School found that companies with strong performance on “material sustainability issues significantly outperform firms with poor ratings on these issues.”

The world is evolving. Megatrends like population growth, resource constraints, and climate change mean that certain sustainability factors can make or break business success. Under existing securities law, that means they are material to an investor. Companies can and should be disclosing these issues.

This is not about creating new regulation — this is about refining an existing one with relevant, decision-useful accounting standards.

Jean Rogers is the founder and CEO of the Sustainability Accounting Standards Board.