W3: Lecture 6 Flashcards
"Mandatory & Voluntary reporting" (22 cards)
When should a company report? (diagram)
- Mandatory reporting
Importance to stakeholders: H
Burden to Company: L - Voluntary reporting
Importance to stakeholders: L
Burden to Company: L - Case-by-Case Evaluation
Importance to stakeholders: H
Burden to Company: H - No Reporting
Importance to stakeholders: L
Burden to Company: H
Reporting development over time
- Shift in balance of information interests of public vs. private firms
—> greater interest in public firms
Catalyst: Corporate scandals, financial crisis, sustainability focus - Shift in definition of stakeholders
From shareholders to—> broader, including all stakeholders - Data collecting, processing, and reporting made easier by digitalisation.
SEC CD&A disclosure reform (US)
July 2006
CD&A–> compensation disclosure and analysis.
WHY? Reaction to corporate scandals (ex., Enron) and the CEO pay surge
HOW? extend disclosure of executive and director compensation
*Company policies
*Pay level and composition
*Performance measures
*Quant and narrative disclosure
Dodd-Frank Act (US)
July 2010
WHY? Reaction to the financial crisis, again CEO pay issue
HOW? Imposes far-reaching rules of corporate governance
*more details on pay-performance link
* “golden parachutes”
–>packages CEO received when they leave the company
*CEO pay ratio
The CEO pay ratio is a metric that compares the compensation of a company’s chief executive officer (CEO) to that of its median employee.
CEO Pay Ratio=Total CEO Compensation /Median Employee Compensation
EU Shareholders’ Rights Directive 2 (SRD2)
WHY?
Strengthen shareholder engagement and transparency
Improve corporate governance in EU
HOW?
*Say on pay:
Shareholders vote on the executive remuneration policy
*Transparency:
Detailed disclosure of individual director pay
*Long-term engagement:
Focus on sustainable value creation
*Identification of shareholders:
Better communication with investors
EU Shareholders’ Rights Directive 2 (SRD2): What is executive remuneration?
*Clear disclosure of fixed vs. variable pay components
*Explanation of how pay aligns with performance
*Annual remuneration report for shareholder view.
EU Shareholders’ Rights Directive 2 (SRD2): What are shareholder rights?
Shareholder rights under SRD2:
*Right to vote on pay policy (binding or advisory)
*Right to vote on actual pay outcomes (in some EU member states)
*Greater oversight of related party transactions
Supervisory board pay
Only based on short-term incentives.
—> No share-based payment for being a supervisory board member. If the members get them, it must be as a basis for additional work as an employee, for example.
EU Directive of Non-Financial Reporting (NFRD)
Adapted in 2014 but in effect in 2018
*Guidance rather than requirement!
*Applies to “public interest entities”
> 500 employees
publicly traded and/or financial institutions
*Mandates reporting on:
environmental matters
social and employee matters
respect to human rights
anti-corruption and bribery matters
Recommended framework –> GRI, IR, SASB
Sustainability reporting frameworks
- GRI- Global Reporting Initiative
1997
AIM:
Empower decisions that create social, environmental, and economic benefits for everyone.
MAIN USERS:
mostly stakeholders
KEY CONCEPTS:
materiality and accountability - IR- Internationally Integrated Reporting Council
2010
AIM:
Establish integrated reporting and mainstream business practices as a norm in public & private sectors
MAIN USERS:
mainly investors + others
KEY CONCEPTS:
Integrated thinking and value creation - Sustainability Accounting
Standards Board
2011
AIM:
Establish industry-specific disclosure standards across ESG topics
–> to communicate information between companies and investors about financially material and useful information
MAIN USERS:
Financial markets, investors
KEY CONCEPTS:
Financial materiality, decision usefulness, and value relevance.
Challenges in non-financial reporting
- Assessment of Materiality
Firms are given substantial discretion, so there is a need for extensive involvement from different stakeholders. - Assurance of the reports
Audit is not mandatory for most non-financial reporting
Standards of assurance are not clear –> even if firms report, they do not necessarily comply - Comparability of reporting
Big international difference in legislation
Differences across industries
Different interpretations of guidelines - Strategically important reporting
Non-financial leading indicators are often sensitive information, and customers, suppliers, and competitors will evaluate them.
So often, firms do not report (because of privacy concerns) despite their high relevance.
Trade-offs in non-financial reporting
*Costs vs. benefits
What are the benefits or costs of reporting everything?
(Strategically important reporting ) vs. (Assurance of the reports)
* Comparability vs. specificity
So, should everyone follow set standards and measures, or should it be firm-specific based on the industry and business model they have?
(Comparability of reporting) vs. (Assessment of Materiality)
*Different ESG rating agencies use different measures, and they do not match
EU Corporate Sustainability Reporting Directive (CSRD)
Passed 2023 and the first mandatory reporting in 2025 for FY2024
Basically, updated NFRD:
*extends scope to all public and large firms.
*requires all information to be audited
*more detailed reporting requirements: DOUBLE MATERIALITY
*mandates info to be digitally available
European Sustainability Reporting Standards are divided into…
- Cross-cutting standards
*General Requirements
*General Disclosures - Topical standards
E: climate change, pollution, water/marine resources, biodiversity/ecosystems, circular economy
S: own workforce, workers in the value chain, affected communities, end users
G: business conduct
Double Materiality
- Impact Materiality
–> environmental and social materiality
–> impact-based perspective
How does the company’s business impact the environment and society?
Impact on people and the environment in the upstream and downstream value chain. - Sustainability-related financial materiality
–> financial focus
–> traditional investor perspective
How do sustainability issues affect the company’s value?
Sustainability risks and opportunities might impact firm financially.
Significance of double materiality reporting
*Comprehensive view of sustainability’s impacts, risks, and opportunities.
*Acknowledges that organisations impact outside factors and are being impacted by outside factors.
*effective risk management
*caters to diverse stakeholder needs
*enhances credibility.
–> embedded in ESRS
Theories regarding voluntary disclosure
- Agency Theory
*Managers (agents) have more information than shareholders (principals) (information asymmetry).
*Voluntary disclosure reduces information asymmetry and agency costs –> reducing the agency costs of debt and equity.
*Monitoring also reduces these costs.
*Firms with high leverage provide more voluntary disclosure - Signaling Theory
*Information asymmetry between firm and stakeholders
*“Good” (and “neutral”) firms have an incentive to disclose
*“Bad” firms have an incentive to delay/not disclose - Political economy theory
*Political, social, and economic activities are interconnected
*Business cannot be run without considering economic, political, and social elements
*Firms disclose to seek support from stakeholders
*Firms disclose to respond to pressure from stakeholders - Stakeholder theory
*Corporate decisions must be taken considering stakeholders’ interest
*Firms disclose information to convince stakeholders of compliance - Proprietary cost theory
*Disclosure varies regarding proprietary nature of information
*Firms will disclose if expected benefits outweigh proprietary costs - Legitimacy theory
*Organizations have a “legitimacy” derived from contract with society
*Organizations must operate within norms/standards identified in this “social contract”
*If legitimacy is threatened, organization tries to regain it
*Disclosure is one strategy to regain legitimacy
*“Bad” firms will voluntarily disclose
Regulation for Fair Disclosure
Firms disclose through many channels:
*Regular public reports
*Conference calls
*Meeting with individual investors
Main concern: level playing field
No selective disclosure, but if done accidentally, file the K-8 form with the SEC.
Voluntary disclosure metrics: operational metrics
Nonfinancial leading and lagging indicators
*Firms provide more voluntary disclosure if:
–>They are larger firms
–>They have a stronger global focus
*More disclosure of leading indicator information associated with:
–>Lower dispersion of analyst forecasts
–>Higher accuracy of analyst forecasts
Voluntary disclosure metrics: ESG
- CSR
*Firms with high cost of equity capital more likely to initiate voluntary CSR reporting
*Firms with high reported performance:
–>See decrease in cost of capital
–>Attract dedicated institutional investors
–>Attract analyst coverage
–>Analyst achieve lower forecast errors and dispersion
–>Exploit benefits raising equity - Carbon reduction targets
*Firms setting more difficult targets show higher achievement
*Effect negatively moderated by monetary incentives - Gender diversity
*Job applicants pay attention to information on gender diversity
Click-through rate is higher for high-diversity firms
Employees are willing to pay $1.463 for a 10% increase in diversity score
*Firms in industries with higher job-seeker responsiveness more likely to disclose in 10K
Proprietary vs. Publicly available metrics
Publicly available metrics:
*employee satisfaction
Proprietary:
*ESG score, ratings by agencies
*geospatial info (satellite imaging, data on locations of individuals and objects: supply streams, customers, etc.)
Why report voluntarily on sustainability matters?
Assurance of the reports
–> Companies are more likely to gain assurance from auditors or other institutions.
need to comply with:
*Rule of law
*Country-specific factors
*Industry-specific factors
