P2 Chp 6 Considering Company-Specific Context

Question 1

What is the learning objective associated with considering company-specific context? (two main elements)

Answer 1

COMPARE industry peers’ sustainability performance in light of their external
operating context (e.g., business climate, economic climate, regulatory climate,
operating location[s]) and in the context of their management and governance
decisions (e.g., strategic decisions and risk management)

Question 2

While ___________ can help improve data’s usefulness by modifying it to be more comparable, ______________ information can shed additional light on both absolute and __________ data.

Answer 2

While normalization can help improve data’s usefulness by modifying it to be more comparable, contextual information can shed additional light on both absolute and normalized data.

Question 3

What are three types of contextual information (not reports) that can improve the accuracy and completeness of analysis?

Answer 3

-a company’s operating environment
-strategy
-historical performance

Question 4

Consider the following data and compare company A and company B as it relates to considering company-specific contextual information:

PROCESSED FOODS INDUSTRY FOOD & BEVERAGE SECTOR
CUSTOMER WELFARE Health & Nutrition FB-PF-260a.1: Revenue from products labeled and/or marketed to promote health and nutrition attributes

METRIC COMPANY A
Year 1 Year 2 Year 3
Total revenue (million $) $4,132 $4,555 $4,786
Revenue from products labeled and/or marketed to promote health and nutrition attributes (million $) $413 $502 $479
Percent revenue from products labeled and/or marketed to promote health and nutrition attributes 10% 11% 10%

COMPANY B
Year 1 Year 2 Year 3
$7,124 $7,333 $7,893
$1,197 $2,053 $2,447
25% 28% 31%

Answer 4

Consumers, regulators, and other key stakeholders have increasingly scrutinized
the health and nutrition attributes of processed foods, which has resulted in growing markets for products with health and nutrition-related attributes (e.g., artificial additives, fat and sodium content, etc.). Companies in the industry may be able to better position themselves to capture new market share and manage regulatory risk by aligning their product mix with this market trend.

Without additional context,
a user would likely conclude that Company A lags behind its peer on this topic. However, if the company recently launched a line of organic foods that is not yet reflected in its latest disclosure, a user of the data would benefit from considering the potential impact this new line could have on the firm’s performance. With this knowledge, a user might deem Company A to be more competitive against peers than the most recently available data might otherwise indicate.

Question 5

Explain the contextual information for these three companies

ELECTRICAL & ELECTRONIC EQUIPMENT INDUSTRY RESOURCE TRANSFORMATION SECTOR
ENERGY MANAGEMENT
RT-EE-130a.1: Total energy consumed, percentage grid electricity, percentage renewable
RT-EE-000.A: Number of units produced by product category
RT-EE-000.B: Number of employees

METRIC
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5
Company A
Total energy consumed (GJ) 873,098 880,435 893,200 891,908 750,098
Number of units produced by product category 45,952 47,591 48,290 49,006 41,670
Energy consumed per unit produced (GJ per unit) 19 18.5 18.5 18.2 18

Company B
Total energy consumed (GJ) 1,230,093 1,220,766 1,200,032 1,110,000 1,088,208
Number of units produced by product category 72,358 70,975 71,430 66,564 65,162
Energy consumed per unit produced (GJ per unit) 17 17.2 16.8 16.7 16.7

Company C
Total energy consumed (GJ) 990,870 1,003,455 1,108,088 1,230,077 1,280,987
Number of units produced by product category 60,790 62,716 71,490 79,360 83,181
Energy consumed per unit produced (GJ per unit) 16.3 16 15.5 15.5 15.4

Answer 5

A company in this industry may have been a laggard in total energy consumption relative to its peers, and then it might suddenly report better performance compared to both its peers and its own past performance. If normalized data confirms the improvement, a user might conclude the company has greatly improved its energy efficiency.
However, it is important to understand what factors contributed to the change and whether these factors are short term and fleeting or if they represent a trend indicating operational improvements that are likely to continue. If the change is simply a blip—say, a factory has been shut down for an extended period to retool for a new product but does not have significant energy efficiency improvements planned—then the user might conclude that the company is likely to return to its previous standing as a laggard in energy efficiency.

Though total energy consumption markedly decreased in Year 5 for Company A, the company also experienced a drop in production, and its normalized energy consumption per unit produced did not significantly improve. Despite the year-over-year improvement, users may not change their long-term view of the company’s energy management relative to its peers

Question 6

_________metrics can provide important
context when used alongside ___________
metrics.

Answer 6

Qualitative metrics can provide important context when used alongside quantitative metrics.

Question 7

Since _______ metrics include no numerical data and cannot be normalized, _____________ analysis provides an important tool for gaining a more complete and accurate snapshot of relative performance.

Answer 7

Since qualitative metrics include no numerical data and cannot be normalized, contextual analysis provides an important tool for gaining a more complete and accurate snapshot of relative performance.

Question 8

Where are three common sources of contextual / qualitative information?

Answer 8

• narrative information in company reports, such as annual reports, quarterly presentations, and sustainability reports
• unstructured data from third parties such as news outlets and industry briefings
• industry reports, which can include sell-side reports

Question 9

To effectively evaluate company context, it is helpful to revisit the frameworks introduced in Part I. Recall that two main lenses can be used to evaluate if any industry standards apply to a company beyond its primary industry, and if any sustainability topics within those standards are or are not likely to be relevant given its differences with the typical company in its industry.
What are the “two lenses”? (three answers)

Answer 9

The first lens focuses on internal operating factors, including a company’s main revenue streams and inputs for value creation.
The second lens focuses on external operating context, such as business climate, regulatory climate, and other factors. Users can additionally support analysis using a third lens to analysis: a company’s governance and management practices, which can be thought of as the crucial interface between internal operations and external environment that ultimately dictates company performance.

Question 10

Which two (of three total) lenses can be leveraged to build a strong contextual understanding of sustainability performance?

Answer 10

• external operating environment
• governance and management practices

Question 11

When considering a company’s operating environment, there are four categories of important factors. Name the four and the examples / subcategories underneath each.

Answer 11

Business Climate
Economic Climate
Regulatory Climate
Operating Location(s)

Business Climate:
*Competitive drivers including competition for resources
*Peer behavior
*Pricing power
*Technological innovation
*Expectations of key stakeholders

Economic Climate
*Commodity prices
*Taxes, inflation, interest rates, etc

Regulatory Climate:
*Current regulation
*Future regulation
*Enforceability and severity of penalties

Operating Location(s)
*Exposure to environmental changes
*Availability of natural resources
*Local ecosystem changes

Question 12

Understanding the differences in operating environment between a company and its competitors can help explain differences in ________ performance on a metric, including _______ performance of normalized data, and can help inform assumptions regarding _____ ________ performance.

Answer 12

relative performance on a metric, including relative performance of normalized data and can help inform assumptions regarding projected future performance.

Question 13

While it is helpful to define the components that together make up a company’s operating environment, it is important to remember that these characteristics, too, are often ________________

Answer 13

interrelated

Question 14

Recall that a company’s business climate / environment is defined by ______ _____, _______ of industry peers, expectations of non-investor_________, and broader industry _______.

Answer 14

Recall that a company’s business climate / environment is defined by competitive landscape, behaviors of industry peers, expectations of non-investor stakeholders , and broader industry trends.

Question 15

For a business to achieve a sustainable competitive advantage, it must have a clear understanding of the factors that drive competition in its industry. Name the two ways that competition within an industry is typically shaped.

Answer 15

• the number of competitors (i.e. how concentrated the market is)
• the extent to which competitors provide comparable products or services (i.e. the presence of substitutes)

Question 16

What concerns get raised where companies have concentrated market power?

Answer 16

Antitrust concerns given they are exposed to risks related to anti-competitive practices

Question 17

What might you conclude about the performance between these two companies? What if they focused on the same or different market segments?

The SASB Standard for the Auto Parts industry includes the following disclosure topic and associated metric:
AUTO PARTS INDUSTRY TRANSPORTATION SECTOR
CATEGORY: COMPETITIVE BEHAVIOR
Disclosure Topic Sustainability Accounting Metric(s) Competitive Behavior
TR-AP-520a.1:Total amount of monetary losses as a result of legal proceedings associated with anti-competitive behavior regulations

Say that two companies in the Auto Parts industry report the following information on this metric:
COMPANY A COMPANY B
Total amount of monetary losses as a result of legal proceedings associated with anti-competitive behavior regulations (JPY)
¥1 billion ¥0

Answer 17

A user might conclude that Company B, with no fines, has performed better on this topic. But what if the two companies focus on different industry segments? Say that Company A is one of seven major transmission manufacturers and that no single company dominates the segment. Meanwhile, Company B dominates the auto glass market and has only a single competitor. In this case, a user might conclude that Company B still faces a significant risk of anti-competitive behavior because it operates in an oligopolistic market. A user of the data needs to delve deeper to understand each company’s risk management practices and policies for preventing anti-competitive behavior in order to better assess its relative risks.

Question 18

The actions of peer companies, or competitors, in an industry may ______ or ________ shape a company’s sustainability performance.

Answer 18

may directly or indirectly shape a company’s sustainability performance

Question 19

Name four ways that peer behavior can shape the way investors and other stakeholders interpret a single company’s performance. (competitive behavior)

Answer 19

*competing for talent or other limited resources
*racing to develop new innovations
*competing on margins
*disclosing information on material topics itself

Question 20

If a company is a(n) _________ on a certain sustainability topic, a user would likely benefit from understanding the factors that influence peer performance as well as the company’s _______ performance.

Answer 20

If a company is a(n) outlier on a certain sustainability topic, a user would likely benefit from understanding the factors that influence peer performance as well as the company’s unusual performance.

Question 21

What is the following an example of?

If Company A discloses marginal improvements while peers are disclosing significant improvements on the same topic, then the industry dynamic could be shifting in such a way that Company A may lose market share.

Answer 21

Peer actions can also shape how a user interprets expected future performance.

Company A may actually lose market share despite taking action to improve its own performance.

Question 22

Consider the following and explain why this disclosure topic applies to this industry, as well as interpret the following company results if Company B released new product offerings.

BUILDING PRODUCTS & FURNISHINGS INDUSTRY CONSUMER GOODS SECTOR
CATEGORY: PRODUCT QUALITY & SAFETY
Disclosure Topic Sustainability Accounting Metric(s)
Management of Chemicals in Products
CG-BF-250a.2:
Percentage of applicable products meeting volatile organic compound (VOC) emissions and content standards

Companies A and B report the following data:
PERCENTAGE OF APPLICABLE PRODUCTS MEETING VOLATILE ORGANIC COMPOUND (VOC) EMISSIONS AND CONTENT STANDARDS
YEAR 1 YEAR 2
Company A 88% 87%
Company B 84% 65%

Answer 22

In many jurisdictions, building products manufacturers must ensure that their products meet relevant standards for emissions of harmful chemicals. Such standards are often required for the product to be legally offered for sale. In addition, consumers increasingly base their purchasing decisions on the perceived safety of products.

Company B appears to have suffered a large setback regarding adherence to VOC standards, potentially compromising future sales. Company A shows little change and appears to be the stronger competitor. However, additional narrative disclosure reveals that in Year 2, Company B launched a new suite of office furniture products, substantially increasing its product offerings. The company was unable to meet VOC standards for all the new products, given time constraints, as conducting the necessary testing, verification, and documentation takes a considerable amount of time. However, the company made a substantial commitment in R&D to meet standards across all product lines. Certifications to VOC standards are expected to be completed early in Year 3, at which time the company expects more than 95 percent of its products to comply. With this contextual information, a user’s understanding of Company A’s future performance may change, as its competitive position relative to Company B’s is not quite as strong as the data indicates on a stand-alone basis.

Question 23

Consider and interpret the results if in the following example there was a third company, Company C, operating in the same industry but not disclosing key information about the management of chemicals in its products in a way that is comparable with information from its peers.

BUILDING PRODUCTS & FURNISHINGS INDUSTRY
CONSUMER GOODS SECTOR
CATEGORY: PRODUCT QUALITY & SAFETY
Disclosure Topic Sustainability Accounting Metric(s)
Management of Chemicals in Products
CG-BF-250a.2:
Percentage of applicable products meeting volatile organic compound (VOC) emissions and content standards

Companies A and B report the following data:
PERCENTAGE OF APPLICABLE PRODUCTS MEETING VOLATILE ORGANIC COMPOUND (VOC) EMISSIONS AND CONTENT STANDARDS
YEAR 1 YEAR 2
Company A 88% 87%
Company B 84% 65%

Answer 23

Consider also that a user’s interpretation of a company may be influenced by the disclosure behavior of its peers. Drawing on the above example, say that a third company, Company C, operates in the same industry but does not disclose key information about the management of chemicals in its products in a way that is comparable with information from its peers. While a user may try to fill in the data gap with other information that can be gathered, providers of capital may assume that a company has a higher level of risk related to this material issue, given the disclosure of low or no information on the topic. The quality of disclosure also can directly influence a user’s interpretation of a company. If, for example, ESG data is hard to access or is presented in a way that lacks conciseness and/or is difficult to navigate, a user may be less likely to interpret performance favorably.

Question 24

What are two ways that industry trends can affect a company’s competitive landscape?

Answer 24

*raise opportunities for innovation through new technologies
*shape demand for products and services as consumer awareness and preferences shift

Question 25

What factor is exemplified by demand for organic goods rising or falling and digitization increasing consumer concerns about data security and customer privacy?

Answer 25

Industry trends and stakeholder concerns

Question 26

In some cases, societal and stakeholder pressures can alter the ___________ landscape, which makes it important when analyzing a company’s performance over time or when making peer-to-peer comparisons.

Answer 26

societal and stakeholder pressures can alter the regulatory landscape

Question 27

Provide interpretation on why the following is a disclosure topic for the industry, and why SASB has a qualitative metric for this industry trend and stakeholder concern.

The SASB Standard for the industry includes the following disclosure
topic and associated metrics:
CONTAINERS & PACKAGING INDUSTRY
RESOURCE TRANSFORMATION SECTOR
CATEGORY: PRODUCT QUALITY & SAFETY
Disclosure Topic Sustainability Accounting Metric(s)
Product Safety RT-CP-250a.1:
Number of recalls issued, total units recalled
RT-CP-250a.2:
Discussion of process to identify and manage emerging materials and chemicals of concern

Answer 27

Consumers, both businesses and individuals, use containers and packaging to hold food, beverages, pharmaceuticals, and other products for human ingestion.
Product quality is therefore determined in part by the safety and integrity of packaging.

Consumer awareness of recalls and defects can be quite high, as they are often widely publicized, and in many cases, companies are legally obligated to report recalls and defects to consumers. Companies can encounter not only regulatory sanctions but also reputational damage.

A variety of packages contain plastics and other chemicals that can leach into the products they contain. Leachate has historically included carcinogens and other substances that harm human health. Where stakeholders such as NGOs, public interest groups, and other consumers expose the presence of harmful leachates in products, consumers increasingly base purchasing decisions on health risks attributed to chemicals in packaging and switch to safer alternatives. Thus, a
company in this industry, along with analysts and investors looking at the company, can benefit from an awareness of chemicals of concern as well as emerging leachate-free materials that might provide insight into the company’s future risks and opportunities.
To provide information on how well companies manage this issue, the SASB Standard for the Containers & Packaging industry includes a qualitative metric (RT-CP-250a.2, identified above). While disclosure aligned with this metric can provide important information about how a company might handle this issue in general, recent shifts in consumer sentiment may add extra urgency (e.g., have financial impacts sooner than initially projected) that points to a potential shift in
market share.

Question 28

Consider this industry sector and disclosure topic and interpret a scenario in which a new packaging material recently emerged that is proved to be free of harmful leachates.

The SASB Standard for the industry includes the following disclosure
topic and associated metrics:
CONTAINERS & PACKAGING INDUSTRY
RESOURCE TRANSFORMATION SECTOR
CATEGORY: PRODUCT QUALITY & SAFETY
Disclosure Topic Sustainability Accounting Metric(s)
Product Safety RT-CP-250a.1:
Number of recalls issued, total units recalled
RT-CP-250a.2:
Discussion of process to identify and manage emerging materials and chemicals of concern

Answer 28

News of the product is widely publicized, raising consumer awareness. In this case, innovation and increased consumer awareness alter companies’ business climate in a way that may increase the importance of information reported using the metric. If some companies appear
better positioned than others to shift their packaging materials, as evidenced by disclosure, then those companies may be positioned to capture additional market share. A user of the data may want to increase the magnitude of financial impacts related to this topic accordingly, based the company’s performance within the broader industry context.

Question 29

A company’s exposure and sensitivity to ______ - ________ growth, _______ ________, and other economic factors can be important considerations when evaluating performance on sustainability topics.

Answer 29

company’s exposure and sensitivity to emerging-market growth, commodity prices , and other economic factors

Question 30

Describe why in the Oil & Gas Industry, government relationships are important to gaining and maintaining access to a country’s oil & gas reserves and potential costs.

Answer 30

The enactment of anti-corruption and anti-bribery laws in jurisdictions around the world raises the risk of regulatory sanctions, particularly for companies operating in corruption-prone regions.

Question 31

With an understanding of the issue of business ethics (Section 2.1.5.), what economic conditions might influence company performance on the below metrics?

OIL & GAS—EXPLORATION & PRODUCTION INDUSTRY
EXTRACTIVES & MINERALS PROCESSING SECTOR
CATEGORY: BUSINESS ETHICS
Disclosure Topic Sustainability Accounting Metric(s)
Business Ethics & Payments
Transparency EM-EP-51-a.1: Percentage of (1) proved and (2) probable reserves in countries that have the 20 lowest rankings in Transparency International’s Corruption Perceptions Index (CPI)
EM-EP-510a.2:
Description of the management system for prevention of corruption and bribery throughout the value chain

Answer 31

In other words, what conditions might incentivize or disincentivize corruption and bribery… Increased oil prices could, as could greater economic activity due to newly identified reserves or other factors.

Question 32

Interpret the following metric and associated data if you also were given the information that Company A has oil reserves in Libya while most of the oil reserves reported by Company B are located in Iraq.

OIL & GAS—EXPLORATION & PRODUCTION INDUSTRY
EXTRACTIVES & MINERALS PROCESSING SECTOR
CATEGORY: BUSINESS ETHICS
Disclosure Topic Sustainability Accounting Metric(s)
Business Ethics & Payments
Transparency
EM-EP-51-a.1:
Percentage of (1) proved and (2) probable reserves
in countries that have the 20 lowest rankings in
Transparency International’s Corruption Perceptions Index (CPI)
EM-EP-510a.2:
Description of the management system for prevention of corruption and bribery throughout the value chain

COMPANY A COMPANY B
Proved reserves in
countries that have the 20 lowest Corruption
Perceptions Index (CPI)
rankings
Oil (Million barrels of
oil or natural gas liquids [MMbbls])
23% 25%
Gas (Million standard
cubic feet per day
[MMscf])
10% 10%
Probable reserves in
countries that have the 20 lowest CPI rankings
Oil (MMbbls) 28% 26%
Gas (MMscf) 12% 14%

Answer 32

Based on these disclosures, the two companies’ relative risk level looks fairly comparable. However, additional information reveals that most of the oil reserves reported by Company A are located in Libya (which is 173 out of 180 on the Corruption Perceptions Index), while most of the oil reserves reported by Company B are located in Iraq (which is 160 out of 180 on the CPI).37 If Libya increases oil production, the increased economic activity could raise the potential for corrupt practices involving oil companies operating in the country, and consequently heighten the corruption risk exposure for a company with reserves in Libya beyond what might be expected based solely on the amount of its reserves. In this case, a user of the information may conclude that Company A faces a heightened risk relative to Company B despite comparable disclosures. Based on this contextual information, a user may choose to adjust the analysis of risk to account for increased future risk as a result of increased production

Question 33

The financial impacts of more stringent or complex ________ will manifest differently from those of loose ________, as well as the strength of ______ ______ as to the degree of financial impacts.

Answer 33

The financial impacts of more stringent or complex regulation will manifest differently from those of loose regulation, as well as the strength of legal enforcement as to the degree of financial impacts.

Question 34

What does an example where two companies have similar normalized GHG emissions but one operates in the European Union while the other does not exemplify?

Answer 34

The importance of regulatory climate, as they would have different costs of compliance as a result of regional differences in regulation given the EU has a GHG cap-and-trade law while the other company does not.

A user of the SASB standards-aligned data would benefit from an understanding of the operational differences in compliance costs and compulsory operational changes that might result from doing business in a carbon-constrained regulatory environment.

Question 35

Consider and interpret the following disclosure topic and reportings of two companies.

HARDWARE INDUSTRY
TECHNOLOGY & COMMUNICATION SECTOR
GENERAL ISSUE CATEGORY: PRODUCT DESIGN & LIFECYCLE MANAGEMENT
Disclosure Topic Sustainability Accounting Metric(s)
Product Lifecycle Management
TC-HW-410a.4:
Weight of products and e-waste recovered (tons),
percentage recycled
Say that, on a global scale, two electronics hardware manufacturers report the following results:
COMPANY A COMPANY B
Weight of products and e-waste recovered (tons) 150,000 130,000
Percentage recycled 40% 20%

Answer 35

Based on the percentage of recycled materials, a user might conclude that Company A performs at a higher level than Company B. However, the user has yet to fully consider regulatory context. Consider that Company A operates in the United States and Europe, and Company B operates only in the United States. For this example, assume that European laws require higher recycling rates. By comparing only operations in the United States and normalizing for company scale (e.g., units produced), the user of the data could get a better idea of the comparative performance of the two companies when operating under the same regulatory regime. In addition, a comparison of how the two companies manage recovery and recycling programs could provide additional insight and might help project future performance.

Question 36

While differences in regulations across regions can have an impact on sustainability performance, the ______ of ______ can often determine how important regulations are. Explain an example related to environmental laws.

Answer 36

While differences in regulations across regions can have an impact on sustainability performance, the strength of enforcement can often determine how important regulations are. Doing business in a region with a history of strict enforcement of environmental laws might have a greater impact on company performance than doing business in another region with tougher laws but a reputation for very lax enforcement.

Question 37

A company’s operations significantly influences the materiality of ESG issues. What are the four aspects determined by a company location?

Answer 37

• resource access and physical climate, as well as the economic and regulatory boundaries within which a company operates;
• exposure to environmental changes;
• availability of natural resources; and
• local ecosystem changes

Question 38

Within the examples of external operating conditions, you may notice that an additional form of evidance can help a user understand a company’s performance. What is it?

Answer 38

Management and Governance decisions, i.e. the company’s decisions

Question 39

It is the _______ ________ makes to control performance within a company’s unique context that can play a crucial role in determining whether a sustainability factor will cause growth or decline, or represent a risk or opportunity.

Answer 39

It is the decisions management makes to control performance

Question 40

What are four general practices that demonstrate a company decision-making for sustainability begins at the top of the hierarchy with governance which then informs risk management practices and strategic direction?

Answer 40

For example:
* Is compensation linked to sustainability KPIs?
* Is sustainability information included in reports certified by the board?
* Do enterprise risk management systems include sustainability KPIs?
* Are corporate strategies linked to sustainability-related value drivers?

Question 41

When management effectively _________ a company’s sustainability initiatives and goals, stakeholders and shareholders can better evaluate its performance data.

Answer 41

When management effectively communicates a company’s sustainability initiatives and goals

Question 42

Consider the following disclosure topic and explain why this is a disclosure topic for this industry.

IRON & STEEL PRODUCERS INDUSTRY EXTRACTIVES & MINERALS PROCESSING SECTOR
CATEGORY: ENERGY MANAGEMENT
Disclosure Topic Sustainability Accounting Metric(s)
Energy Management
EM-IS-130a.1: Total energy consumed, (2) percentage grid electricity, (3) percentage renewable

Answer 42

The steel industry is among the most energy-intensive industries in the sector. Coking coal and natural gas are primary energy sources, and companies purchase a significant amount of grid electricity as well. For some steelmaking processes, electricity is the primary energy input.

Question 43

Consider the following disclosure topic and data for Steelmaker A, with the additional information that they took their largest electric arc furnace offline at the end of Year 1, and explain the company’s performance.

IRON & STEEL PRODUCERS INDUSTRY EXTRACTIVES & MINERALS PROCESSING SECTOR
CATEGORY: ENERGY MANAGEMENT
Disclosure Topic Sustainability Accounting Metric(s)
Energy Management
EM-IS-130a.1: Total energy consumed, (2) percentage grid electricity, (3) percentage renewable

STEELMAKER A YEAR 1 YEAR 2
Total energy consumed (GJ) 1,142 997
Percent grid electricity 41.2% 32.3%

Answer 43

The absolute value of the disclosed data represents a year-over-year decrease in energy consumption of 12.7 percent:
(997 GJ - 1,142 GJ) / 1,142 GJ = -0.127 or –12.7%

A user could interpret this result as an improvement in the company’s management of energy consumption. Similarly, the company’s percentage of energy consumed from grid electricity declined by 21.6 percent:
(32.3% - 41.2%) / 41.2% = -0.216 or -21.6%
This result suggests that the company managed to significantly reduce its
dependence on grid electricity. These improvements in total energy consumption and share of grid electricity could be seen as reducing energy costs or mitigating regulatory impacts from the internalization of carbon emissions by electric utilities, a potential positive for the company’s future financial performance. However, the disclosed totals, when taken alone, fail to capture the context of the company’s actions that may have affected its total energy and electricity use.
Importantly, at the end of Year 1, the company took offline for repairs one of its largest electric arc furnace (EAF) facilities, which consumed approximately 10 percent of the company’s total energy and represents a large share of its electricity consumption during normal operational years. Since EAF facilities use only electricity to produce steel, the company’s significant reduction in purchased electricity consumption can largely be explained by the fact that its largest EAF
plant was offline. When the plant comes back online, consumption of electricity will presumably rise back to near the level it was in Year 1, suggesting that the company is as reliant on grid power as it was previously.

Question 44

What are two questions for analysis for Management and Governance decisions?

Answer 44

Questions for Analysis:
* Are material sustainability issues integrated into governance practices and risk management systems?
* Are changes in a company’s performance due to one-time circumstantial events, or are they a direct result of long-term management decisions?

Question 45

What are the common contextual considerations for Sustainability Dimension: Environment?

Answer 45

*Environmental regulation in operating areas and trends (air, water, and waste regulations from the EPA and states)
*Environmental chemical safety regulation (e.g., a ban on CFCs)
*Climate change trends and projections
*Environmental attributes of company operations
(e.g., operations in sensitive areas, scope of heavy manufacturing relative to peers, energy mix)
*Mergers or divestments that could significantly affect absolute or normalized environmental performance

Question 46

What are the common contextual considerations for Sustainability Dimension: Social Capital?

Answer 46

*Shifts in consumer safety, protection, or health regulations
*Shifts in social preferences or consumer concerns (e.g., preference for low-calorie foods, efficient vehicles)
*Human rights and Indigenous peoples regulations

Question 47

What are the common contextual considerations for Sustainability Dimension: Human Capital?

Answer 47

*Changes in workforce size or composition
*Nature of operations (e.g., physical hazards)
*Employee health and safety regulations or standards

Question 48

What are the common contextual considerations for Sustainability Dimension: Business Model & Innovation?

Answer 48

*Regulatory developments that could affect demand for products (e.g., engine emissions regulation)
*Environmental and social regulations
*Sustainability performance and the functionality of existing products
*Development or acquisition of new products
*Developments in extended producer-responsibility laws

Question 49

What are the common contextual considerations for Sustainability Dimension: Leadership & Governance?

Answer 49

*Competitive nature of a company’s market
*Developments in process safety regulation
*Changes to governance and financial regulation
*Changes to supply chain standards or regulation

Question 50

To fully evaluate a company’s _____ performance, users can benefit from a strong understanding of the ______ a company operates in.

Answer 50

To fully evaluate a company’s relative performance, users can benefit from a strong understanding of the context a company operates in.

Question 51

Indeed, a holistic understanding of a company’s _______ _____, ______ ________, _________ ________, and _________ _________ is essential in evaluating current performance and estimating future performance.

Answer 51

Indeed, a holistic understanding of a company’s business climate, economic climate, regulatory climate, and operating location(s) is essential in evaluating current performance and estimating future performance.

Question 52

Furthermore, the decisions of _______ and quality of ________ can directly influence the strategic actions and _____
____________ decisions that ultimately determine company performance.

Answer 52

Furthermore, the decisions of management and quality of governance can directly influence the strategic actions and risk management decisions that ultimately determine company performance.

Question 53

[CHECK FOR UNDERSTANDING] What factors related to a company’s operating location might influence a user’s interpretation of its sustainability performance?

Answer 53

There are several factors related to operating location that can influence a company’s performance on key ESG issues, however they can broadly be categorized as:
a. The economic and regulatory boundaries within which a company operates; and
b. The physical environment in which the company operates, which determines access and availability of natural resources and exposure to changes in the natural environment.
Regarding the former, a company’s exposure to emerging market growth,
commodity prices in a given location, inflation rates in a given location, the presence of regulation, the stringency of regulatory enforcement, and other factors can incentivize or disincentivize performance on a sustainability issue. For example, consider two companies that operate in the Processed Foods industry in two different jurisdictions. Consumers in one jurisdiction may have relatively high levels of disposable income and demonstrate a high willingness to pay for products labeled with certain health and nutritional attributes while consumers in the other jurisdiction demonstrate no or low willingness to pay for similar products related to overall lower levels of disposable income. A user may conclude that the first
company is better positioned to capture revenue from healthy products based on these locational differences in consumer spending capacity.
Related to the latter, changes in a company’s physical environment can influence exposure to physical risks based on a company’s location. For example, companies in water-stressed regions may be perceived as facing higher risk than a peer
company with the same level of water use located in a region with very low levels of water stress (see Section 6.1.4.)

Question 54

[CHECK FOR UNDERSTANDING] When a user is evaluating operating and performance context, how might additional context alter the perception of disclosed data?

Answer 54

Information about a company’s operating environment, strategy, historical performance, or other characteristics nearly always improve the accuracy and completeness of analysis. Additional context can add information to analysis that improves the accuracy of a users’ conclusions. For instance, it can inform the level of performance considered to be bad or good, significantly influence understanding
of what future performance will look like, and explain major differences or changes in performance from company to company. Recall that a company’s operating environment is defined by its business climate, economic climate, regulatory climate, and operating location(s).
Generally, contextual information related to business climate and peer behavior can lend insight into unique factors that drive competition and influence market power. Information related to economic climate and regulatory climate can lend insight into unique circumstances that influence market-wide or systemic risks and opportunities. Information related to operating location(s) can lend insight into unique levels of physical risk exposure and natural resource constraints.
Finally, information about a company’s managerial strategy and risk management decisions adds an additional layer of rationale that can make the difference between positive or negative future performance expectations. Indeed, without context, no user’s analysis is complete (see Section 6.1.).

Question 55

[Part2 TEST YOUR UNDERSTANDING]

Read the following case study and answer the question:
1. What two activity metrics provide insight into the two companies’ normalized fertilizer use over time? (Choose two.)
a. Production by principal crop
b. Revenue
c. Total land area under active production
d. Number of processing facilities

PRACTICE CASE 2: Agricultural Products Industry
The Agricultural Products industry is engaged in growing, processing, trading, and distributing vegetables and fruits; and producing and milling agricultural commodities, including grains, sugar, consumable oils, maize, soybeans, and animal feed. Agricultural products are sold directly to consumers and to businesses for use in consumer and industrial products. The industry is global, and companies may source a substantial part of agricultural commodities from thousands of third-party growers in various countries. Vertically integrated agricultural products companies operate farms, crop-processing facilities, and storage and distribution networks. The industry produces low-cost agricultural commodities and competes largely on prices.
To meet the challenges of scale, modern agricultural developed the practice of monoculture cultivation—growing the same crop over large areas each year—which decreases production costs. However, the practice involves significant trade-offs, including plants that are more susceptible to insects, diseases, and variations in growing conditions, which can lower yields and increase the risk of widespread crop failure. It also depletes the soil of key nutrients required for high yields. To manage these risks, agricultural products companies are increasingly dependent on agrochemicals, such as fertilizers and pesticides, which carry regulatory risks of their own, as runoff may contaminate water sources. Agrochemical use is especially intensive when crops are cultivated in regions outside their natural ecological range.
Meanwhile, consumer preference for organically grown crops—which typically use crop rotation to replenish the soil, reducing the need for fertilizers and pesticides—is driving growth in the industry worldwide. Financial impacts related to land-use and ecological impacts can therefore occur through a variety of channels including contingent liabilities, operating expenses, asset impairment, market share, and access to new markets. As the global population continues to grow, the Agricultural Products industry will be faced with the challenge of balancing two key factors: maintaining high yields to satisfy increasing demand over the long term, and
reducing environmental externalities associated with fertilizer and pesticide use.
Company A and Company B operate in the Agricultural Products industry, grow the same principal crop using monoculture cultivation practices, own land, and have direct control over their farmer suppliers.
Company A is rapidly increasing in size, including through the Year 2 acquisition of 25,000 hectares on which it grows its principal crop outside its natural range.
In Year 2, Company A’s management decided to undertake an effort to improve the efficiency of its fertilizer consumption by precisely calculating the required loads needed to meet the requirements of its crops.
Company B did not undertake any significant operational changes from Year 1 to Year 2, but made the decision to adopt new higher-density farming techniques to produce higher yields from the same area of land.
COMPANY A COMPANY B
Year 1 Year 2 Year 1 Year 2
Revenue ($ in millions) $35,000 $45,000 $50,000 $55,000
Production by principal crop (metric tons) 200,000 275,000 375,000 400,000
Total land area under active production (hectares) 35,000 60,000 50,000 50,000
Number of processing facilities 275 375 400 400
Amount of fertilizer consumption (metric tons)*
(1) N 4,150 5,750 4,750 4,825
(2) P2O5 1,000 1,400 1,250 1,325
(3) K2O 2,100 2,850 2,500 2,600
Total 7,250 10,000 8,500 8,750
Amount of pesticide consumption (metric tons)**
(Ia) Extremely hazardous 300 500 450 500
(Ib) Highly hazardous 750 1,000 1,100 1,000
(II) Moderately
hazardous 2,500 3,250 3,000 3,000
(III) Slightly hazardous 2,250 2,750 3,000 2,750
(U) Unlikely to present
acute hazard 450 750 450 1,000
Total 6,250 8,250 8,000 8,250
* refers to fertilizer type. N: Nitrogen, P2O5: Pentel 0.5mm, K2O: Potassium oxide
**refers to hazard code. Ia: extremely hazardous, lb: highly hazardous, etc

Answer 55

1. This question evaluates Learning Objective 5.
   A. This is CORRECT. Normalizing by “production by principal crop” would allow the analyst to better understand how efficiently each company uses fertilizer and to make more meaningful comparisons between firms — especially those that vary in size (see
   Section 4.3.2.) and change over time (see Section 4.3.1.). This activity metric reflects the company’s operational scale and output. When normalized, one calculates metric tons of fertilizer consumed per metric ton of crop produced. See Section 4.2.
   B. This is incorrect. Although revenue is a product of a company’s output, it has a less direct relationship to fertilizer use than do production and land area. See Section 4.2.
   C. This is CORRECT. Normalizing by “total land area under active production” would also allow the analyst to take operating scale into account to make more meaningful comparisons between firms. This activity metric reflects the company’s operating scale. When normalized, one calculates metric tons of fertilizer consumed per hectare of land under active production. See Section 4.2.
   D. This is incorrect. the number of processing facilities a company owns has no direct relationship with its fertilizer use. See Section 4.2.

Question 56

[Part2 TEST YOUR UNDERSTANDING]

Read the following case study and answer the question:
2. On a normalized basis, Company A’s total fertilizer use in Year 2 was below that of Company B based on which factor?
a. Production by principal crop
b. Total land area under active production
c. Revenue
d. Number of processing facilities

PRACTICE CASE 2: Agricultural Products Industry
The Agricultural Products industry is engaged in growing, processing, trading, and distributing vegetables and fruits; and producing and milling agricultural commodities, including grains, sugar, consumable oils, maize, soybeans, and animal feed. Agricultural products are sold directly to consumers and to businesses for use in consumer and industrial products. The industry is global, and companies may source a substantial part of agricultural commodities from thousands of third-party growers in various countries. Vertically integrated agricultural products companies operate farms, crop-processing facilities, and storage and distribution networks. The industry produces low-cost agricultural commodities and competes largely on prices.
To meet the challenges of scale, modern agricultural developed the practice of monoculture cultivation—growing the same crop over large areas each year—which decreases production costs. However, the practice involves significant trade-offs, including plants that are more susceptible to insects, diseases, and variations in growing conditions, which can lower yields and increase the risk of widespread crop failure. It also depletes the soil of key nutrients required for high yields. To manage these risks, agricultural products companies are increasingly dependent on agrochemicals, such as fertilizers and pesticides, which carry regulatory risks of their own, as runoff may contaminate water sources. Agrochemical use is especially intensive when crops are cultivated in regions outside their natural ecological range.
Meanwhile, consumer preference for organically grown crops—which typically use crop rotation to replenish the soil, reducing the need for fertilizers and pesticides—is driving growth in the industry worldwide. Financial impacts related to land-use and ecological impacts can therefore occur through a variety of channels including contingent liabilities, operating expenses, asset impairment, market share, and access to new markets. As the global population continues to grow, the Agricultural Products industry will be faced with the challenge of balancing two key factors: maintaining high yields to satisfy increasing demand over the long term, and
reducing environmental externalities associated with fertilizer and pesticide use.
Company A and Company B operate in the Agricultural Products industry, grow the same principal crop using monoculture cultivation practices, own land, and have direct control over their farmer suppliers.
Company A is rapidly increasing in size, including through the Year 2 acquisition of 25,000 hectares on which it grows its principal crop outside its natural range.
In Year 2, Company A’s management decided to undertake an effort to improve the efficiency of its fertilizer consumption by precisely calculating the required loads needed to meet the requirements of its crops.
Company B did not undertake any significant operational changes from Year 1 to Year 2, but made the decision to adopt new higher-density farming techniques to produce higher yields from the same area of land.
COMPANY A COMPANY B
Year 1 Year 2 Year 1 Year 2
Revenue ($ in millions) $35,000 $45,000 $50,000 $55,000
Production by principal crop (metric tons) 200,000 275,000 375,000 400,000
Total land area under active production (hectares) 35,000 60,000 50,000 50,000
Number of processing
facilities 275 375 400 400
Amount of fertilizer
consumption (metric tons)*
(1) N 4,150 5,750 4,750 4,825
(2) P2O5 1,000 1,400 1,250 1,325
(3) K2O 2,100 2,850 2,500 2,600
Total 7,250 10,000 8,500 8,750
Amount of pesticide consumption (metric tons)**
(Ia) Extremely hazardous 300 500 450 500
(Ib) Highly hazardous 750 1,000 1,100 1,000
(II) Moderately
hazardous 2,500 3,250 3,000 3,000
(III) Slightly hazardous 2,250 2,750 3,000 2,750
(U) Unlikely to present
acute hazard 450 750 450 1,000
Total 6,250 8,250 8,000 8,250
* refers to fertilizer type. N: Nitrogen, P2O5: Pentel 0.5mm, K2O: Potassium oxide
**refers to hazard code. Ia: extremely hazardous, lb: highly hazardous, etc

Answer 56

2. This question evaluates Learning Objective 5.
   A. This is incorrect. When normalized, one finds that Company A uses more fertilizer per metric ton of principal crop produced than Company B.
   B. This is CORRECT. When normalized by “total land area under active production,”
   Company A’s fertilizer use is lower than Company B’s in Year 2:
   Company A:
   10,000 mt ÷ 60,000 hectares = 0.167 mt/hectare
   Company B:
   8,750 mt ÷ 50,000 hectares = 0.175 mt/hectare
   For more information on normalizing to enhance peer-to-peer comparisons, see Section
   4.3.2.
   C. This is incorrect. When normalized, one finds that Company A uses more fertilizer per dollar of revenue generated than Company B. See Section 4.2.1.
   D. This is incorrect. “Number of processing facilities” is not the best metric for use in normalization (see Section 4.2.). Even so, when calculated one finds that Company A consumes more fertilizer per processing facility than Company B.

Question 57

[Part2 TEST YOUR UNDERSTANDING]

Read the following case study and answer the question:
3. When normalized by total land area under active production, Company A reduced its total fertilizer use by 19.5 percent from Year 1 to Year 2. Suppose that an investment analyst notices this short-term trend and infers that the company seems to be improving its management of that sustainability issue. What two contextual factors would inform the analyst’s long-term outlook for Company A?
(Choose two.)
a. Business climate
b. Operating location(s)
c. Operating scale
d. Management and governance decisions

PRACTICE CASE 2: Agricultural Products Industry
The Agricultural Products industry is engaged in growing, processing, trading, and distributing vegetables and fruits; and producing and milling agricultural commodities, including grains, sugar, consumable oils, maize, soybeans, and animal feed. Agricultural products are sold directly to consumers and to businesses for use in consumer and industrial products. The industry is global, and companies may source a substantial part of agricultural commodities from thousands of third-party growers in various countries. Vertically integrated agricultural products companies operate farms, crop-processing facilities, and storage and distribution networks. The industry produces low-cost agricultural commodities and competes largely on prices.
To meet the challenges of scale, modern agricultural developed the practice of monoculture cultivation—growing the same crop over large areas each year—which decreases production costs. However, the practice involves significant trade-offs, including plants that are more susceptible to insects, diseases, and variations in growing conditions, which can lower yields and increase the risk of widespread crop failure. It also depletes the soil of key nutrients required for high yields. To manage these risks, agricultural products companies are increasingly dependent on agrochemicals, such as fertilizers and pesticides, which carry regulatory risks of their own, as runoff may contaminate water sources. Agrochemical use is especially intensive when crops are cultivated in regions outside their natural ecological range.
Meanwhile, consumer preference for organically grown crops—which typically use crop rotation to replenish the soil, reducing the need for fertilizers and pesticides—is driving growth in the industry worldwide. Financial impacts related to land-use and ecological impacts can therefore occur through a variety of channels including contingent liabilities, operating expenses, asset impairment, market share, and access to new markets. As the global population continues to grow, the Agricultural Products industry will be faced with the challenge of balancing two key factors: maintaining high yields to satisfy increasing demand over the long term, and
reducing environmental externalities associated with fertilizer and pesticide use.
Company A and Company B operate in the Agricultural Products industry, grow the same principal crop using monoculture cultivation practices, own land, and have direct control over their farmer suppliers.
Company A is rapidly increasing in size, including through the Year 2 acquisition of 25,000 hectares on which it grows its principal crop outside its natural range.
In Year 2, Company A’s management decided to undertake an effort to improve the efficiency of its fertilizer consumption by precisely calculating the required loads needed to meet the requirements of its crops.
Company B did not undertake any significant operational changes from Year 1 to Year 2, but made the decision to adopt new higher-density farming techniques to produce higher yields from the same area of land.
COMPANY A COMPANY B
Year 1 Year 2 Year 1 Year 2
Revenue ($ in millions) $35,000 $45,000 $50,000 $55,000
Production by principal crop (metric tons) 200,000 275,000 375,000 400,000
Total land area under active production (hectares) 35,000 60,000 50,000 50,000
Number of processing
facilities 275 375 400 400
Amount of fertilizer
consumption (metric tons)*
(1) N 4,150 5,750 4,750 4,825
(2) P2O5 1,000 1,400 1,250 1,325
(3) K2O 2,100 2,850 2,500 2,600
Total 7,250 10,000 8,500 8,750
Amount of pesticide consumption (metric tons)**
(Ia) Extremely hazardous 300 500 450 500
(Ib) Highly hazardous 750 1,000 1,100 1,000
(II) Moderately
hazardous 2,500 3,250 3,000 3,000
(III) Slightly hazardous 2,250 2,750 3,000 2,750
(U) Unlikely to present
acute hazard 450 750 450 1,000
Total 6,250 8,250 8,000 8,250
* refers to fertilizer type. N: Nitrogen, P2O5: Pentel 0.5mm, K2O: Potassium oxide
**refers to hazard code. Ia: extremely hazardous, lb: highly hazardous, etc

Answer 57

3. This question evaluates Learning Objective 7.
   A. This is incorrect. Although consumer demand for organics – a characteristic of the company’s business climate – is a contextual factor relevant to the industry, the case presents no evidence to support the assumption that this consumer trend will exist in the long term. This business climate characteristic is also unrelated to an analyst’s ability to assess efficiency gains. For more information on business climate, see Section 1.2.2.1.
   B. This is CORRECT. An analyst will want to consider the region of cultivation (operating location(s)) because when crops are grown outside their natural ecological range, they are more agrochemical-intensive, as described at the end of paragraph two in the case (see Section 6.1.4.). Although Company A has made strides in using fertilizer more efficiently, the location of its operations limits its ability to reduce fertilizer use. Company B, on the other hand, which grows the same crop only where it is native, has the potential to reduce its fertilizer use more significantly over the long term by undertaking a similar initiative. For example, although Company A’s output has grown significantly from Year 1 to Year 2, its crop production per hectare of land has decreased, indicating that Company A’s “more efficient” use of fertilizer may be misleading. For more information on operating location(s), see Section 1.2.2.4.
   C. This is incorrect. While scale of operations can sometimes be directly linked to efficiency of operations, this factor is not a primary focal point of ESG analysis in this instance, as it likewise sheds no light on the ability of Company A to sustain its efficiency gains over the long term.
   D. This is CORRECT. This outcome reflects the company’s managerial decisions to improve performance through better land-use efficiency. Operational changes reflect strategic decisions likely aimed to capture opportunities related to customer demand for organic and more “sustainable” products, as well as risk mitigation techniques in the face of potential long-term production declines as a result of declining soil health and/or fertilizer-focused regulation. Insight into management’s decisions can help inform future performance expectations for the company. For more information, see Section 1.3.