Companies and investment analysts are divided on the benefits of integrating non-financial information into annual reports

When the Danish government passed legislation in December requiring the country’s largest 1,100 companies to include information on corporate social responsibility in their annual reports, many championing the responsible business cause will have been pleased.

However, while the Danish move may put corporate social responsibility reporting on a new footing, the issue of mandatory reporting, and specifically the idea of incorporating non-financial information within annual financial reports, is more nuanced than at first appears.

The Danish legislation may represent some of the most exacting reporting requirements on corporate social responsibility to date, but it is not quite as radical as some first thought. While integration within the annual report is an important feature of the mandatory reporting legislation, it does not mean that all 1,100 companies will from 2010 onwards be producing integrated reports.

Under the new law, companies can simply reference separate responsibility reports or refer readers to information on their websites. Companies that are members of the UN Global Compact or UN Principles for Responsible Investment can refer to submissions under those schemes without adding any further detail. Conversely, a company with no corporate social responsibility policy can simply declare that in its annual report and say no more.

Carsten Ingerslev, who heads a unit specialising in corporate social responsibility at the Danish Commerce and Companies Agency, which operates under the Danish Ministry of Economic and Business Affairs, says that given the option for simply referencing external material, “integration is a possibility but not really a demand” of the legislation.

But in any event, how much sense does it make for companies to make non-financial information part of their disclosures to shareholders and investment analysts?

Uneasy bedfellows?

By requiring public companies to publish non-financial information, just as they are required to publish financial statements under listing rules, the Danish legislation appears to put the two sorts of data on a par. Both are essential for valuing a company, the law implies. But do financial and non-financial information belong together?

One company that believes it does is Novo Nordisk. The Danish pharmaceuticals firm has been integrating corporate responsibility information into its annual reports for five years. While stating that the company feels the new law “gives some validation” to its approach, Susan Blesener, international project manager for corporate accountability, admits there are “process challenges” to integration, not least pulling together all the information within 30 days of the year’s end.

Blesener adds that the board places an emphasis on being concise and had insisted that integration did not add to the size of the annual report. She says the company includes the information that is “most relevant” and makes other information available online.

Danish shipping giant AP Moller-Maersk does not plan to follow Novo Nordisk’s lead. Maersk plans to publish its first sustainability report next year, and will not be changing its plans as a result of the new legislation. “We will briefly account for some of the aspects that we will cover in the sustainability report in the financial report but we won’t go into detail,” says Annette Stube, director of corporate social responsibility.

Practical barriers

Outside Denmark, major global companies have practical objections to integrating social reporting into the annual report. Julia King, vice-president for corporate social responsibility at GlaxoSmithKline, says incorporating the company’s social responsibility reporting into its annual report in anywhere near the same detail as the financial information would be “unmanageable” on grounds of length.

Arjan de Draaijer, associate director at KPMG Sustainability, believes some flexibility is lost by complete integration. Some companies find that the strict format of the annual report and the need for brevity mean there is less scope for the explanation and context-setting that are needed when discussing sustainability issues. “For a few topics, integration is becoming more and more logical, for instance climate change. Other topics may not be of much relevance for the annual report but stakeholders would still want more information about it,” de Draaijer says.

Reservations over the practicalities of producing a combined report may go some way to explaining the low prevalence of integrated reporting. According to the 2008 KPMG International Survey of Corporate Social Responsibility Reporting, 79% of the world’s biggest 250 companies now publish corporate social responsibility reports, up from 52% in the last survey in 2005. However, only about 4% currently integrate social responsibility reporting into their annual financial reports.

Novo Nordisk is not the only company that backs integrated reporting, however. David Harris, director of corporate social responsibility and ethics at Lockheed Martin UK, favours a non-mandatory approach to social reporting generally, saying this enables a company to focus on the issues that are most relevant to its business. Lockheed Martin is planning to publish its first sustainability report in March 2010, and Harris says the company would not be averse to the idea of integrating corporate responsibility information into the annual report “where it makes sense”.

US clothing company Timberland showed itself to be a pioneer in this area by moving to quarterly social reporting last year. Beth Holzman, CSR strategy and reporting manager at Timberland, suggests integration “could be the way of the future”, though she concedes that any form of regulation on social reporting in the US is a long way off.

One reason behind Timberland’s move to quarterly reporting, Holzman explains, was to put social reporting on the same footing as the established financial timetable, thereby helping to make the information more relevant to investors.

However, Craig Mackenzie, senior lecturer in sustainable enterprise at the University of Edinburgh, who supports the idea of mandatory social reporting where there are clear data points, such as carbon emissions, has some doubts about integration. He says adding 50 pages to the annual report might be “counter-productive”, and that social reporting in an annual report might work best if restricted to the most financially salient information.

De Draaijer says the responsible business areas most likely to have a direct bearing on financial performance, such as carbon data or climate change issues in the automotive sector, are likely to be measurable. “If there are any sustainability topics that are highly influencing financial performance, they probably are measurable and yes, then they should be integrated.”

By the same token, he casts doubt on whether the financial community would be interested in more narrative and qualitative social reporting. This poses the question of whether only information that can be readily quantifiable, and shown to have a direct bearing on the bottom line, can appear in the annual report, while other possibly equally significant information to a company’s long-term value remains in the sustainability report.

Engaging with investors

The point here is that in spite of the mainstreaming of corporate social responsibility, the sustainability report and annual financial report are aimed at different audiences, albeit ones that increasingly overlap.

But GlaxoSmithKline’s King suggests they should not be different audiences. One of the key advantages of integration is that it brings social reporting to investors. The argument is that investors require these disclosures to make fully informed investment decisions. The undoubted subtext is that investors – mainstream equities analysts in particular – need some prodding to embrace the role corporate responsibility now plays for companies, and placing the information in the annual report is one way of doing this.

If the views of one prominent UK retail analyst are anything to go by then persuading analysts to take more notice of social responsibility reporting may take greater effort than incorporating a limited amount of information in the annual report. He told Ethical Corporation he never read corporate social responsibility reports and was no more likely to do so if “all that self-serving CSR stuff” was integrated into the annual report.

While the US is many years behind Europe in terms of formalising social responsibility reporting, US retail analyst Karen Short of equity investment firm Friedman Billings Ramsey has no doubt that social responsibility reporting will become more important within the annual report over time. She says the introduction of emissions trading schemes, for example, will make a company’s disclosure of climate data a “tradeable event”.

As one might expect, there is a range of views in the investment community about social reporting and integration, from the highly sceptical to the supportive. What is clear is that engaging with the investment community is an important challenge for corporate social responsibility practitioners and integration may help. “It is time the finance community commits to and comes to the debate,” says GRI chief executive Ernst Ligteringen. “They can no longer afford to sit on the sidelines.”

Global agenda

David Paterson of the National Association of Pension Funds expects integrated reporting to become more common in the UK over time. Indeed, one could argue that the measures announced in Denmark are not that different from the requirements now in place in the UK under the 2006 Companies Act, which mandate at least some commentary on corporate responsibility within the annual report. And, Mackenzie points out, had the original plans for the Operating and Financial Review become law, as seemed likely at one point, the stipulations under UK regulations would be even closer to the Danish model.

The UK legislation stemmed in part from the European modernisation directive, which has influenced legislation elsewhere in Europe. Last year, Sweden introduced legislation requiring state-owned companies to submit sustainability reports. France has long-standing stipulations over social reporting.

Pressure on US companies to be more transparent about the social and environmental performance could increase under president Barack Obama, Ligteringen says. He also points out that some emerging markets are not far behind developed countries in encouraging companies to report non-financial information. He highlights China and Brazil as countries where sustainability reporting is firmly on the agenda.

The economic crisis has shown that current methods of financial reporting and forecasting are far from perfect. Many in the corporate social responsibility field feel that, conversely, the financial sector has much to learn from the forward-thinking ethos of sustainability reporting.

De Draaijer for one feels that the whole argument could be looked at in the other direction. It is not that social reporting needs to fit in with financial reporting but that annual reports need to take on more of the forward-thinking attributes that characterise sustainability reports. “You already hear some issues around financial reporting saying that it is just backward-looking, whereas investors would expect more information about the drivers for business,” de Draaijer says. “In that respect you could say that if you look ahead maybe 10 or 20 years, a sustainability type of report would be the future of both sustainability reporting and annual reporting.”

Ligteringen adds that as corporate social responsibility becomes, by necessity, more integrated into business practice this should lead naturally to integrated reporting.
Clearly the changes in Denmark raise broader questions about corporate social responsibility as well as specific issues of reporting. While it is tempting to view the Danish legislation as a major step forward, setting a new template for social and environmental reporting, a more realistic appraisal may be that, like so many developments in this area, it represents a work in progress.

The world’s social reporting laws

Sweden: By 2009, state-owned companies will be required to produce annual sustainability reports in accordance with G3 guidelines.

France: Since 1977, companies with more than 300 employees have been required to file a “bilan social”, reporting on 134 labour-related indicators. The 2001 New Economic Regulations Act further requires listed companies to disclose data on 40 social and environmental criteria in their annual reports.

UK: Under the 2006 Companies Act, companies listed on the London Stock Exchange have to report on non-financial issues relevant to their business within annual reports.

Germany: Since 2004, companies have been required to report within annual reports on key non-financial indicators that materially affect their performance.

US: There is little regulation on sustainability reporting, apart from rules regarding hazardous waste and toxic chemicals disclosure. The New York Stock Exchange requires listed companies to publish a code of business conduct and ethics.

Japan: Under a 2004 law, certain companies and government agencies are required to produce annual reports on environmental impacts.

China: The state-owned Assets Supervision and Administration Commission issued a directive in January 2008 encouraging state-owned companies to report on responsible business activities.

Malaysia: From 2007, the government has required all listed companies to publish corporate social responsibility information in their annual reports.

Norway next to demand non-financial reporting

Norway could be the next country to introduce mandatory social and sustainability reporting, if proposals in a recent white paper eventually pass into law.

In its white paper, the government has sought to clarify the responsibilities companies have regarding human rights, working conditions, environmental impacts and corporate probity.

The proposed changes to Norway’s 1998 Accounting Act would extend the duty of Norwegian companies to provide information on what they are doing to implement ethical guidelines.

Norway already has some legislation covering social and environmental reporting. Norwegian companies are already required to report on the external environment, the working environment and gender equality, and must include in their reports information on environmental factors such as raw-material usage, emissions and waste.

Japanese companies do most non-financial reporting

Eighty-six of the largest 100 companies in Japan report publicly on corporate responsibility strategy, according to the 2008 KPMG International Survey of Corporate Social Responsibility Reporting.

The top 10 countries where the 100 largest companies publish non-financial reports are:
Japan – 86%
France – 79%
UK – 65%
Norway – 63%
US – 61%
Brazil – 60%
Netherlands – 55%
Sweden – 54%
Finland – 44%
Spain – 44%

Source: KPMG Global Sustainability Services October 2008

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