It’s easy sometimes for accountants to imagine (or at least, to pretend they imagine) that the parameters of periodic corporate reporting are largely defined by those of the financial statements, with the MD&A as a tacked-on outgrowth…

Most accountants are presumably aware, at least vaguely, of the conversations about integrated reporting and ESG disclosures and sustainability reporting and so on, but perhaps those conversations are just too sprawling to seem relevant – perpetually circling back to the start to argue the necessity for these other forms of reporting, even while various bodies push the envelope with reports and guidelines on taking them further.

The news page of the Integrated Reporting <IR> website provides an interesting, if sometimes rather chaotic-seeming survey of some of these debates. It tends to read like a collection of propositions and challenges for which an effective guide or curator has yet to be identified, which I suppose might indeed accurately sum things up. One of the recurring themes though might be (and was) summed up as follows:

• With only 20% of companies’ market value found in the tangible assets in the financial statements, it is no wonder companies around the world are increasingly using the International <IR> Framework to support integrated thinking and help understanding of the 80% of their market value that is created by ‘pre-financial’ factors, such as intellectual capital, relationships and human capital.

Put that way, it seems to stamp the accounting profession as a bunch of dolts, endlessly fussing about secondary aspects of that 20% while behaving as if the other 80% were the province of God (this puts a grim perspective on the arguments against recognizing biological assets of marijuana companies at fair value, which in effect amounts to a crusade for financial statements to withdraw from even attempting to represent the market value of those companies, rather than advancing toward it).

Various articles build on the “80%” concept, focusing in effect on how entities might better understand, manage and report on that portion of value. The area of Environmental, Social and Governance information, which I wrote about before, is a key component of this. One report focuses on the Japanese entity Eisai Pharmaceuticals, observing:

• the company is actively promoting intangibles such as diversity of its workforce, improving access to medicines, and preserving the natural environment. For example, in 2015, for the eighth consecutive fiscal year, the Eisai Group in Japan attained zero emissions, which is 1% or less in terms of the ratio of waste sent to landfill against the amount of waste generated.

The Eisai CFO recommends, among other things:

• (placing) importance on intangibles, not only for their social contribution but also as a future source of value creation, with priorities going to each company’s corporate philosophy as well as redefining concrete KPIs for nonfinancial information….
• (explaining) all ESG initiatives by presenting their link to value and the equity story in integrated reports and in tenacious and active engagement with global investors.

We’re told: “The Investor Relations Team led by the CFO conducts about 700 investor meetings per year in the aggregate, thereby pitching the equity story of ROE-ESG integration globally. The team has seen that, by doing this tenaciously and consistently, the market has started to factor it in, and it has led to higher share price or higher price-book value ratio for Eisai.”

This is, no doubt, as much art and advocacy as science: although some of that 80% of non-IFRS-captured market value certainly derives from such factors as intellectual capital, relationships and human capital, we know it may also reflect wild speculation, unsound economic analysis and the like. As with much of IFRS itself, the 20/80 concept certainly works better for large, relatively stable entities (those for which, you might say, the object is to understand the value of an annuity) than for those that are actively and rapidly evolving.

That aside, and going back to ESG, I wrote in the past about some of the reasons why such considerations are becoming more critical to some investors, and about some factors that may stand in the way of broader acceptance. Subsequent to that post, CFA Institute issued an updated report, finding that “nearly three-quarters of investment professionals worldwide (73 percent) take (ESG) factors into consideration in the investment process.” Again though, an article issued in Financial Advisor points to significant constraints, quoting Vincent Papa, the Institute’s director, financial reporting policy as follows:

• “…there is an increasing recognition and validation being done through surveys which shows that there’s a gap between the quality of information that’s provided by companies and the suitability of this information to what investors need. There’s an information gap,” Papa continues, “and the need for initiatives that increase the quality of ESG information.”
• CFA Institute’s 2017 ESG Survey respondents confirmed that the three factors that most limit their organization’s ability to use non-financial information in investment decisions are: a lack of appropriate quantitative ESG information, a lack of comparability across firms and questionable data quality.

I expect I could go on indefinitely citing various studies and reports and surveys, from the <IR> news page and elsewhere, all going to the same key points – not just that it’s desirable for companies to report more clearly and fully and consistently on that other 80% of value, but that it’s absurd it doesn’t already happen. And that spirited and informed advocacy and communication of best practices, although vital to achieving change, can only take us so far in the absence of coordinated regulatory determination…

The opinions expressed are solely those of the author