Week 2 - Voluntary ESG disclosures & ESG ratings Flashcards
Sustainability
ESG - technically reporting for investors
CSR - less common than ESG nowadays
triple bottom line (people, planet, profits)
Corporate obligation to meet the needs of the present without compromising the resources available for future generations
> > both of the planet but mainly for the ENTITY ITSELF
Materiality
in traditional accounting sense vs in ESG: single vs double materiality
IASB
- an element included in the reporting which AFFECTS DECISION-MAKING by INVESTORS
in ESG
1. SINGLE materiality
- an item is relevant to INVESTORS’ interests (entity focus)
2. DOUBLE materiality
- an action is relevant due to its impacts on BOTH the ENTITY and OTHER STAKEHOLDERS
Negative externalities + why is valuation difficult?
- also NEGOTIATION ISSUES
- Economists: Financial costs generated by one entity but borne by another
- Unerman et al. part of the ongoing dialogue between business and society about the nature of business responsibilities and allied duties of accountability
» implies that society is also shaping biz - valuation of externalities is very difficult
eg. valuing cleanup costs
Difficult to value when there is NO MARKET EXCHANGE; diff. interest groups may also disagree on the value
Negative externalities
Coase theorem + Pigou (internalising externalities)
Coase theorem
- he argued that MARKET INEFFICIENCIES due to externalities can be MITIGATED by BARGAINING between those affected & those producing them
- only feasible if low bargaining costs, well-defined property rights, & information is symmetrical
- MEASUREMENT is necessary but challenging, esp. for NON-MARKET GOODS such as pollution
Pigou
- producers are required to PAY TAX = -VE EXTERNALITY
- incentivise behaviour change which reduces externalities
- crucial to MEASURE the COST of the externality
eg. carbon emissions tax, tax on plastic bags
4 issues discussed regarding Voluntary disclosures
- It may just be telling us about the co’s POLICIES, NOT OUTCOMES
- putting happy photographs is simply PR trying to distract stakeholders; ppl feel cheated - Lack of information
eg. %employee engagement may just be employees taking a survey
eg. new colleagues with disabilities but we don’t know what roles given, could be sth unpleasant at minimal wage - Is it really benefitting the society or the entity itself?
- No BENCHMARKING against other companies in the same industry
- COMPARABILITY issues
Why are accounting representations of ESG activities important? (ref. to high quality/useful acct. info + neutral representation)
- diff. interests being reflected by DIFF. DISCLOSURES
- not taking into account diff. interests might lead to INEFFICIENT RESOURCE ALLOCATION…
- …or perpetuate BAD BEHAVIOUR
- TRANSPARENCY leads to BEHAVIOUR CHANGE
So, we need to have diff. sets of disclosures to capture DIFF. INTERESTS, not only INVESTORS’ interests
Why do firms make Voluntary financial acct. disclosures?
Note:
- ESG disclosures are on the rise over past 2 decades
- through CSR reports, statements included within main annual report, social media disclosures, affiliation with particular orgs like B-corp
- different from financial reporting in terms of subjectivity, shifting concepts…
Disclose if BENEFITS > COSTS
eg. improved access to capital markets, lower cost of capital, higher firm value, greater analyst following (Leuz and Wysocki, 2016)
Environmental externalities - GHG emissions: For a bank, what item is mainly relevant in describing its GHG emissions?
Financed emissions (scope 3)
What are the challenges and limitations of GHG emissions measurement and reporting? 4 points
- UNRELIABLE, just relying on information by suppliers, employees etc.
- hard to check if correct or not - a lot of MANUAL INPUT & RESOURCES required
- PRONE TO ERRORS
- a lot of SOURCES of evidence, hard to be sure that is is fact-checked
Scope 1, 2, 3 GHG emissions
Scope 1
- direct emissions produced by the company, within their control
Scope 2
- indirect emissions PURCHASED by the co.
eg. purchased goods & services, purchased electricity
Scope 3
- indirect emissions produced by entities NOT within direct control of co.
eg. suppliers, employees’ commute, customers & packaging from goods bought -> all very DIFFICULT to estimate!
4 limitations of ESG data
Note:
- ESG ratings (independent evaluations of a co’s ESG performance and risks based on a range of ESG issues) focus on SHAREHOLDER INTERESTS
- models specific to each rating agency offers opportunities for CHERRY-PICKING
» investors choose the ratings that are more relevant to the diff. particular issues they are interested in
» rating agencies differentiate themselves by having their own bespoke models
- Data inconsistency
» there can be many ALTERNATIVES to measuring the same thing
eg. for health & safety, such as % of lost hours, no. of incidents reported/hospital admissions, litigation, payouts by insurers…
» all diff. inputs which can be weighted differently - Distortions due to BENCHMARKING
» used when the co. has missing information, so benchmark against industry peers/competitors
eg. can record 0 or maximum value, or minimise bc smaller company - Varied methodologies of ESG models
» {diff. rating agencies each have their own bespoke ESG rating model -> not comparable} - Disagreement between ESG data providers (even for public information)
4 frameworks for standardising disclosures
Focusing on DOUBLE MATERIALITY (investors’ + society interests)
1. GRI
2. CDP
Focusing on SINGLE MATERIALITY (shareholders’ interests)
3. SASB
4. TCFD
JetBlue case - How important are the issues identified in the SASB standards for airlines for JetBlue? How do these specific issues impact JB’s financial performance?
Note:
- pressure to disclose stems from regulatory mandates or investor pressure, and they are likely to be interdependent
- Fuel use
- disclosure would generate INTERNAL PRESSURE to reduce reliance on fossil fuels, and hence…
- reduce fuel costs and price volatility (from geopolitical tensions), which have an impact on PROFITABILITY
- airlines especially spend a massive amt of their costs on fuel -> huge impact on profits, very important factor
- Voluntary disclosures may merely look like Advertising, but this branding might DIFFERENTIATE them from COMPETITORS; selling point for customers
- also a SIGNAL TO INVESTORS that they are proactive & already mitigating financial risks; getting ahead of the game - Labour relations
- expensive labour market, so want to RETAIN EMPLOYEES
- JetBlue’s differentiating factor/strategy is having a CUSTOMER FOCUS (hence employees are important)
-> disclosing will be good for their bottom line and investors - Accidents & safety management
eg. Boeing recently
- impact on revenues and profit
- grounded planes cannot be sold & cannot be flown -> share price falls - Competitive behaviour
- disclosing is an OPPORTUNITY for JetBlue, can benefit from it, win-win
JetBlue case - Concerns related to the adoption of the (SASB) disclosure standard - 3 cons, 3 pros
ie. Disclosure and adoption of a new voluntary standard comes with both potential costs and benefits
- PROPRIETARY COSTS, disclosing info to COMPETITORS that might have given them their competitive advantage
- possible LITIGATION if found to be publishing misleading info
» cannot just bank on the assumption that they will always be disclosing good news
- the decision to disclose incurs the risk of having to reveal negative news, so must be accompanied by a focus on improving performance - Difficult and costly to “trace costs” and report information
Pros
4. SIGNAL to INVESTORS that the co. is getting AHEAD of the game and take into account the LONG-TERM STRATEGY
5. SIGNAL to investors that the co. is MITIGATING their risks and is well-managed, not risky
6. Currently mostly have short-term investors. A BENEFIT from voluntary disclosures: can attract LONG-TERM INVESTORS who care about long-term risk mitigation strategy
- resulting in LOWER COST OF CAPITAL
