Session:13 Sustainability Reporting
13.1 Describe Sustainability and the Way It Creates Business Value
Principles of Accounting, Volume 2: Managerial Accounting | Leadership Development – Micro-Learning Session
Rice University 2020 | Michael Laverty, Colorado State University Global Chris Littel, North Carolina State University| https://openstax.org/details/books/principles-managerial-accounting
A primary goal of any business is to maximize shareholder or owner wealth and thus continue operating into the future. However, in making decisions to be profitable and to remain in business into the future, companies must think beyond their own organization and consider other stakeholders. This approach is a major goal of sustainability, which is meeting the needs of the present generation without compromising the ability of future generations to meet their own needs.1 Another concept that is sometimes associated with sustainability is corporate social responsibility (CSR), which is the set of actions that firms take to assume responsibility for their impact on the environment and social well-being. CSR can be used to describe the actions of an individual company or in comparing the actions of multiple corporations.
Just as individuals often make conscious decisions to recycle, reuse items and reduce their individual negative effect on the environment, so too do most businesses. Corporations affect the world on many different levels—economic, environmental and social—and many corporations have realized that being good stewards of the world can add value to their business. Companies increase their value, both financial and nonfinancial, in the eyes of consumers and shareholders by heralding their efforts to be good citizens of the globe and the results of those efforts. It is important to note that a corporation’s social and environmental influence is often affected by government policy, both local and federal, and sometimes even internationally through agreements and treaties. The global effort to limit climate change is an example of this influence.
In December 2015, 196 nations adopted the Paris Climate Agreement, a historic plan to work together to limit the increase of global temperatures to 1.5 °C. The Agreement aims to help delay or avoid some of the worst consequences of climate change within a system of transparency and accountability in which each nation can evaluate the progress of the others.
In June 2017, President Trump announced his intention that the United States withdraw from the Agreement. Five months later, Syria ratified the Agreement, leaving the United States as the only non-participating country in the world.
By November 2017, however, a coalition of 20 U.S. states and 50 cities, led by California governor Jerry Brown and former New York City Mayor Michael Bloomberg, had formed (Figure 13.2). During the 23rd UN Climate Change Conference in Germany, the members of this coalition pledged to continue supporting the Agreement. They aim to do this by reducing their carbon output, which is a measure of their carbon dioxide and other greenhouse gas emissions into the atmosphere.
In addition to these commitments at the local, state and national level, many U.S. companies have also committed to reducing their carbon output, including Walmart, Apple, Disney, Tesla, and Facebook.
The fact that these companies and others are run by CEOs whose primary objective is to make a profit does not mean they live in a vacuum, unaware of their effects on the larger world. As mentioned, responsible companies today are concerned not only about their economic performance, but also about their effects on the environment and society. Recall, corporate social responsibility (CSR) is the set of steps that firms take to bear responsibility for their impact on the environment and social well-being. Even if some managers are not personally guided by these motivations, good corporate citizenship makes good business sense.
Historically, companies disclosed financial information in their annual reports to allow investors and creditors to assess how well managers have allocated their economic resources. The public usually learned little about a company’s hiring practices, environmental impact, or safety record unless a violation occurred that was serious enough to make the news. Companies that did not make the news were simply assumed to be doing the right thing.
Today, however, as a consequence of social media platforms such as Facebook and Twitter, the public is more aware of corporate behavior, both good and bad. Investors and consumers alike can make financial decisions about firms that align with their own values and beliefs. Management decisions perceived to be detrimental to society can quickly put companies in a bad light and affect sales and profitability for many years. Thus, users of financial reports increasingly want to know whether businesses are making appropriate decisions not only to increase shareholder wealth, but also to sustain the business, and minimize any future negative effects on the environment and the citizens of the world. This management goal is called business sustainability. The number of companies reporting sustainability outcomes has grown over the last two decades. This growth has made this non-financial component of reporting increasingly important to accountants.
Sustainability Reporting
A sustainability report presents the economic, environmental and social effects that a corporation or organization was responsible for during the course of everyday business. Sustainability reporting aims to respond to the idea that companies can be held accountable for sustainability. In 1987, the former Norwegian Prime Minister, Gro Harlem Brundtland, chaired a World Commission on Environment and Development to both formulate proposals and increase understanding of and commitment to environment and development. The resulting Brundtland Commission Report laid the groundwork for the concept of sustainable development (Figure 13.3). This was defined as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”2
With that in mind, the early adopters of sustainability reporting attempted to construct a framework that could convey the good stewardship of companies, primarily their social and environmental effects. Since then, sustainability reporting has evolved to include the ways in which sustainability practices of the company benefit its profitability and longevity.
Indeed, adopting sustainable business practices may benefit business in many ways. Companies can:
- save money by using less water and energy and reducing or recycling business waste
- reduce insurance costs by limiting their exposure to environmental risks
- attract investors who prefer to work with businesses that are environmentally and socially responsible
- reduce social risks, such as racial or gender discrimination
- improve customer sales and loyalty by enhancing reputation and brand value
- reduce the possibility of potentially costly regulation by proactively undertaking sustainability initiatives
- attract and retain employees who share similar values
- strengthen their relationship with the community
- contribute to improving environmental sustainability
In short, sustainability reporting has evolved to describe both how the company’s practices contribute to the social good and how they add value to the company, which ultimately provides better returns to its investors.
The need for improved reporting by corporations on sustainability developed over time. The Union Carbide, Nestlé, and Johnson and Johnson cases are examples of corporate crises that contributed to the development of better sustainability reporting. And though each of these cases involved a negative public response toward the company, this led to a broader shift in business practices, changing how other corporations handle similar challenges.
Historical Drivers of Contemporary Sustainability Reporting
Much of the drive to adopt sustainability reporting has resulted from the publicity surrounding corporate responses to specific crises. The three featured cases, on Union Carbide, Nestlé, and Johnson & Johnson, look at events that had such an impact on communities and the social conscience that they have contributed to shaping modern sustainability reporting and what society’s expectations of corporations are today. We first look at Union Carbide, whose actions, or lack of action, resulted in the deaths of thousands of impoverished Indians who lived in the shanty communities next to a facility of the U.S.-owned conglomerate. This case highlighted the power disparity between corporations and poor individuals and became a stark emblem of corporate disregard for the human toll of the quest for profit. We then consider the long running campaign against Nestlé Corporation, ongoing since the early 1980s. We will examine what Nestlé has attempted to do to mitigate the perception of exploitation which, some activists argue, is still a superficial response. Finally, we look at the reaction by Johnson & Johnson to the Tylenol poisoning crisis, which, while not of their making, is seen as a rapid and responsible response to ensure the well-being of the community, even if it initially came at considerable financial cost to the company.
Union Carbide
A few hours before midnight on December 2, 1984, at the Union Carbide pesticide plant in Bhopal India, pressure and heat built up in a tank that stored methyl isocyanate (MIC). Within two hours, approximately 27 tons3,4 of MIC had escaped into the surrounding community, exposing more than 600,0005 people to the deadly gas cloud. By the next day, 1,700 people were dead. The official toll eventually rose to 3,598 dead6 and another 42,000 injured, although some accounts estimate that the incident was responsible for 16,000–20,000 deaths.7
Though the plant had ceased production a couple of years earlier, the plant still contained vast quantities of dangerous chemicals. There was still 60 tons of deadly MIC in tanks at the plant, and proper maintenance of the tanks and the containment systems was necessary. It was later discovered that all the safety systems put into place failed due to lack of maintenance after the plant closed.8
Within days of the explosion, Warren Anderson, the CEO of Union Carbide, arrived in India, was arrested and released, and then immediately flew out of the country. Although he was subsequently charged with manslaughter, he never returned to India to face trial.9 Some of the criticisms of Union Carbide’s handling of matters, both before and after the disaster, are:
- A safety audit two years before had noted numerous problems at the plant, including several implicated in the accident.10
- Before the incident, staff were routinely ordered to deviate from safety regulations and fined if they refused to do so.11
- Employees discovered the leak around 11:30pm on December 2. However, they then decided to take a tea break and did not deal with the leak until two hours later.12
- Two of the plant’s main safety systems were out of action at the time of the accident; one of them had been inoperable for several weeks.13
- Staffing had been cut from 12 operators a shift to six. Kamal K. Pareek, a chemical engineer employed by the plant later argued that it was not possible to safely run the closed plant with only six people.14
- There were no public education programs to inform the surrounding community about what to do in an emergency,15 and on the night of the leak, there was no public warning of the disaster. An external alarm was turned on at 12:50am but ran for only a minute before it was turned off.
- Beginning at 1:15am, workers denied to local police that they were aware of any problems. They restarted the public warning siren at 2:15am and then contacted police to report the leak.16
Union Carbide asserts that a disgruntled employee sabotaged the plant by mixing water with the methyl isocyanate to create a reaction. Some employees claimed that a worker lacking proper training was ordered by a novice supervisor to wash out a pipe that had not been properly sealed. Although it was against plant rules, this action may have started the reaction.17
Union Carbide’s disgruntled-employee theory appeared to many to be an effort to deflect blame and deny responsibility. Ultimately, the company agreed to pay the Indian Government $470 million in compensation to be distributed to Bhopal residents,18 and seven former employees were jailed for two years. In 2001, the company was bought by Dow Chemical Company. Though Dow Chemical obtained the financial liabilities of Union Carbide, Dow maintains that it did not assume legal responsibility for the prior actions of Union Carbide.19 More than thirty years later, many victims are still awaiting the compensation they were promised, after having paid doctors and lawyers to prove their injuries. “In a way, they were fighting their own government for adequate compensation, whereas the state should have fought with them against Union Carbide,” says a representative of the one of the groups fighting for the victims’ rights.20
Nestlé
Nestlé is the target of one of the longest-running consumer boycotts in modern history. Founded and headquartered in Switzerland, the company recently became the largest food company in the world. While there have been boycotts against a number of its products over the years, none has lasted as long as the baby formula boycott.
The origins of the boycott go back to the mid-1970s, when consumer concerns arose about Nestlé’s use of aggressive marketing tactics to sell its baby formula in developing countries in Asia, Africa, and Latin America. Initially new mothers were provided with free samples of formula to feed their babies, a common practice in many hospitals throughout the world. But in developing countries, this led to two negative consequences for mothers and their babies. First, once bottle feeding begins, the demand on the mother’s body is reduced and breast milk begins to dry up. Mothers in developing countries were often living in poverty and unable to afford the cost of artificial infant food. Action groups argued that, in Nigeria, the cost of bottle feeding a three-month-old infant was approximately 30% of the minimum wage, and by the time the child reached six months old, the cost was 47%.21
A second consequence arose from the fact that preparation of infant formula required sterilized equipment and clean water. Both clean water and sterilization were difficult to guarantee in developing nations where mothers may not have understood the requirements for sterilization or may have lacked the fuel or electricity to boil water. Lapses in preparing the formula led to increased risks of infections, including vomiting and diarrhea that, in some cases, proved fatal. UNICEF estimated that formula-fed infants were 14 times more likely22 to die of diarrhea and four times more likely to die of pneumonia than breast-fed children. Advocacy groups also argued that dehydration could result if mothers used too much formula and malnutrition could occur if they used too little in an effort to save money.23
An active campaign against Nestlé ensued, and the company endures a backlash even today. One group distributed a report, Nestlé Toten Babies (“Nestlé Kills Babies”), which a Swiss court found to be libelous. Nonetheless, the judge warned Nestlé that perhaps it should change the way it did business if it did not want to face such accusations.24
The boycott and negative publicity precipitated a long-running campaign by Nestlé to improve its image. The company now explicitly states on its packaging that breastfeeding is best for babies and supports the World Health Organization’s recommendation that babies should be breastfed exclusively for at least the first six months of life. It distributes educational materials for healthcare professionals and parents on the benefits of breastfeeding and holds seminars on breastfeeding for the medical community. Nestlé established a global Maternity Protection Policy that provides its own employees with extended maternity leave (up to six months) and flexible work arrangements. It opened 945 breastfeeding rooms in India and another 1,500 in China in a partnership with several public and private organizations, and it developed a breastfeeding room locator app for mothers.25 In those countries considered to be at higher risk for infant mortality and malnutrition, Nestlé applies its own stringent policies, which they believe are stricter than national code and which were derived from the World Health Organization’s International Code of Marketing of Breast-Milk Substitutes.26 Meanwhile, debate about whether Nestlé is a good corporate citizen continues.
Johnson & Johnson
At 6:30 in the morning on Wednesday, September 29, 1982, twelve-year-old Mary Kellerman woke up feeling sick. Her parents gave her some Tylenol and decided to keep her home from school. Within an hour Mary had collapsed, and she was pronounced dead at 9:24. Within 24 hours another six people were dead, poisoned, like Mary, by cyanide capsules in Tylenol bottles.
In the early 1980s, Tylenol was the leader in over-the-counter pain relief, and during the first three quarters of 1982 the product was responsible for 19% of Johnson & Johnson’s profits. Then an unknown person replaced Tylenol Extra-Strength capsules with cyanide-laced capsules and deposited the bottles on the shelves of at least a half-dozen stores across Chicago.
On learning of the deaths, Johnson & Johnson reacted swiftly. CEO James Burke formed a seven-member strategy team charged with answering two questions: “How do we protect the people?” and “How do we save the product?” The first step was to immediately warn consumers through a national announcement not to consume any type of Tylenol product until the extent of the tampering could be determined. All Tylenol capsules in Chicago were withdrawn, and upon discovering two more compromised bottles, Johnson & Johnson ordered a nationwide withdrawal of all Tylenol products. Less than a week had passed.
At the same time, the company established a toll-free number for consumers and another one for news organizations that provided daily recorded updates about the crisis. Within two months, Tylenol was re-launched with three-way tamper-proof packaging (Figure 13.4). The carton was securely glued, the cap was wrapped with a plastic seal, and the bottle carried a foil seal. The company also began an extensive media campaign emphasizing trust. In addition, other companies, not only in the pharmaceutical industry but in other industries such as food production and packaging, began to implement the use of tamper proof or double sealed packaging after the Tylenol incident.
Since the crisis, the company’s response has been lauded in business case studies and has formed the basis of crisis communications strategies developed by researchers.27 Ultimately, Johnson & Johnson spent more than $100 million on the recall, an amount that might cripple some companies. Yet its share price returned to its previous high within six weeks.28 In fact, if you had invested $1,000 in Johnson & Johnson in September 1982, it would have been worth almost $50,000 by late 2017. Today, the company ranks 35th in the Fortune 500, with revenues of almost $76 million.29
These are three early examples of the impact on businesses of decisions made by management that had unintended consequences or circumstances brought about by others that the company did not foresee happening. Each of these instances weakened the sustainability of the corporation, at least temporarily. These examples, as well as others, helped contribute to the CSR movement. Companies are concerned about the effects of their products and practices on all stakeholders from a moral and ethical standpoint and want to be socially responsible in addition to maintaining sustainability of their business. Certainly, there have been many more examples of company responses to social and environmental impacts that have been either positively or negatively received by stakeholders or those who have an interest or concern in the business. Nonetheless, the cases examined demonstrate a range of the types of events and company responses that can affect both the company’s reputation and the society in which they operate in, sometimes for decades.
Initial Sustainability Reports
Following the Brundtland Report, financial statement preparers began to ask how they might communicate not just the financial status of a company’s operations but the social and environmental status as well. The concept of a triple bottom line, also known as TBL or 3BL, was first proposed in 1997 by John Elkington to expand the traditional financial reporting framework so as to capture a firm’s social and environmental performance. Elkington also used the phrase People, Planet, Profit to explain the three focuses of triple bottom line reporting. By the late 1990s, companies were becoming more aware of triple bottom line reporting and were preparing sustainability reports on their own social, environmental, and economic impact. Another innovation was life-cycle or full-cost accounting. This reporting method took a “cradle to grave” approach to costing that put a price on the disposal of products at the end of their lives and then considered ways to minimize these costs by making adjustments in the design phase. This method also incorporated potential social, environmental, and economic costs (externalities in the language of economics) to attempt to identify all of the costs involved in production. For example, one early adopter of life-cycle accounting, Chrysler Corporation, considered all costs associated with each design phase and then made adjustments to the design. When its engineers developed an oil filter for a new vehicle, they estimated the material costs and hidden manufacturing expenses and also looked at liabilities associated with disposal of the filter. They found that the option with the lowest direct costs had hidden disposal costs that meant it was not the cheapest alternative.30
Much of the early sustainability reporting movement was driven by stakeholder concerns and protests. For example, throughout the 1990s, Nike drew accusations from consumers that its employees and subcontractors’ employees in developing countries were being subjected to inhumane working conditions. The “sweatshop” charge has since been made against many companies that use off-shore manufacturing, and some now pre-emptively respond by producing sustainability reports to assure stakeholders that they are maintaining a good track record in human rights.
One of the earliest adopters of social reporting was The Body Shop, which released its first social report in 1995 based on surveys of stakeholders. BP (formerly British Petroleum) took a different approach, with a series of case studies in social impact assessment and releasing its social report in 1997.
Early study into the hows of sustainability reporting led researchers31 to suggest that some performance indicators could be quantified. Figure 13.5 shows the sustainable product indicators identified by Fiskel and colleagues with suggestions on how each element of economic output might also be measured from an environmental or societal stance.
Fiskel’s research suggests that different elements can be categorized as economic, environmental, or societal. The study demonstrates how each element may have quantifiable costs or indicators that can be measured and reported so that users will be able to consider how those inputs and outputs contribute to the entire life cycle of a product. Although Fiskel’s model is rarely reported today, the creation of quantifiable and measurable social and environmental standards is the basis of the Sustainability Accounting Standards Board, which uses an approach similar to Fiskel’s model.