The Business Case for Non-Financial Reporting

With an EU directive on non-financial disclosure now being translated into national legislature, social and environmental reporting seems to become a reality for an increasing number of organizations. Although it still isn’t mandatory for all companies to disclose non-financial information, the trend is clearly towards greater disclosure. In this month’s piece, I argue that your organization should start reporting on social and environmental topics even if regulators aren’t (yet) requiring this.

What’s the current status on non-financial reporting? The EU directive states that listed companies, banks and insurance firms will all have to disclose non-financial information on environmental and social topics. My guess is that it won’t stop there: the Netherlands is already opting to extend the scope to other public-interest entities such as pension funds, housing associations and utility firms.

Beyond the group of organizations already mentioned, other firms are also experiencing increasing pressure from stakeholders to disclose more information on their operations and supply chains. Whatever the reason (e.g. regulation, pressure from stakeholders, or maybe even new worldviews such as radical transparency or the purpose economy), companies are faced with mounting pressures to report beyond mere financial statements. We could see this as an increased attention to the distribution of “goods” and “bads” as Garrett Hardin already pointed out in his 1985 classic Filters Against Folly:

Every human activity produces both things that we want – “goods” – and things we don’t want – “bads”. How should society distribute these goods and bads?

Hardin goes on to argue that:

.. most people living today would say that even if it is historically true that the widespread externalizing of business costs was causatively responsible for the rise of modern civilization, we cannot, from here on out, tolerate the practice. Regardless of the past, future policy must insist on internalizing the cost of production.

It seems that with recently implemented policies like the EU directive on non-financial disclosure, the future that Harden writes about in 1985 is becoming a reality.

Two concepts that Hardin introduced in Filters Against Folly show that you can use non-financial reporting as an opportunity to boost the competitive advantage of your organization.

Non-financial reporting to update your business strategy

A useful mental model in analyzing the business world is what Hardin calls the “Double C–Double P Game”, which stands for commonize costs and privatize profits. (Commonizing here means the spreading of the cost of an activity over a population no matter who profits from the cost. Privatizing means the profit from activities accrues to the company, and the company alone.) This model seems to be under attack with the increased attention of stakeholders to disclose which costs are commonized (e.g. land and water use, CO2 emissions, etc.) and which profits are privatized (see the discussion on the relationship between tax evasion and corporate social responsibility in The Economist).

Although the increased scrutiny of stakeholders can seem troublesome to many an organization in terms of increased effort to dig up information from every nook and cranny of operations, I see opportunities to actually use it for a renewed look at the company’s strategy and perceived competitive advantage.

There are numerous frameworks available to help an organization structure its non-financial reporting, these include ISO 26000, the United Nations Global Compact and the Global Reporting Initiative. Rather than just use these as reporting guidelines, a company can actually use these frameworks to understand where it may be losing ground in the “Double C–Double P Game”. You may ask yourself which topics need more attention because costs are becoming increasingly internalized, or how you can continue privatizing the profits of the operations you undertake. Social and environmental analysis might prove indispensable in effectively adjusting your business strategy to accommodate  a new business environment where your current business’s specific and carefully crafted “Double C-Double P Game” is losing ground.

Non-financial reporting to build better stakeholder relations

In addition to the benefit of building a strategy matched to the new business environment, there is a second opportunity in reporting on non-financial performance. If done well, a company might actually improve the relationship with all stakeholders by melding together what Hardin calls numeracy, literacy and ecolacy filters. Companies might be under attack from differing interest groups that are biased toward using one filter only. Literacy, for example, can do much harm if it is not accompanied by numeracy to put statements into perspective. Hardin explains:

There is no royal road to rationality. Whatever means we are tempted to use, we must be wary of the poetic approach. Rhetoric (..) may give one a wonderful “oceanic feeling” (to use Freud’s term), but this feeling is more likely to prevent than to facilitate advances in understanding. It is when ecological rhetoric is most beautiful that we must be most on our guard.

And, again about abusing literacy:

.. the wish to escape debate disguises itself under a multitude of verbal forms: infinity, non-negotiable, never, forever, irresistible, immovable, indubitable, and the recent variant “not meaningfully finite.” All these words have the effect of moving discussion out of the numerate realm, where it belongs, and into a wasteland of pure literacy, where counting and measuring are repudiated.

Of course, the company itself should also avoid vague words and terminology. One of the techniques proposed by Hardin to make clear what is actually meant, is operationalism:

Faced with conflicting views, the critical analyst asks, “What operations are implied by these statements?” Once the operations are made clear, difficulties usually evaporate.

After answering the question ‘What do thew words actually mean’ (i.e. literacy), Hardin further proposes to go beyond mere numbers to numeracy:

In spite of its name, numeracy is concerned with more than numbers. The relative size of quantifiable factors is often more important than their exact measures. The importance of scale effects can be appreciated with little actual measurement.

He gives an example where the numerate filter is a useful addition to the literate filter:

Dichotomies are favored over quantities. It is so comforting to divide polluting substances sharply into the categories of “safe” and “unsafe”. (..) Nature is silent. Nature does not tell us when “safe” slips over into “unsafe”; men and women, reasoning together, must legally define “unsafe”. (..)“Safe” and “unsafe” are literate distinctions; nature is numerate. Everything is dangerous at some level. Even molecular oxygen, essential to human life, becomes lethal as the concentration approaches 100 percent.

Finally, Hardin proposes to combine literacy and numeracy with ecolacy ‘to ferret out at least the major interconnections’. With ecolacy we ask the basic question “And then what?” to sort out what the unwanted consequences are ‘to grant a modicum of justification for the position of society’s nay-sayers’:

Excessive ecolacy can lead to conservatism of the most stultifying sort. For prudence’s sake, ecolacy must be combined with numeracy. Any action that we take – and inaction is a form of action – leads to some unwanted consequences. Prudence dictates that we compare the advantages and disadvantages of all proposed courses of action, choosing the one that, on balance, is quantitatively best.

By using non-financial reporting not as ‘just another report’, but as an actual effort to communicate through multiple lenses (i.e. literate, numerate and ecolate), I see huge opportunities in creating a more effective strategy, and better stakeholder relationships with fewer controversies.

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