Will ESG Information Suffer the Same Fate as Financial Information?

The importance of Environmental, Social, and Governance (ESG) Analytics for companies is growing rapidly. Apart from a public interest focus around the world, investors are interested, it has become a factor is mergers and acquisitions, and the accounting profession and regulators is moving rapidly to set reporting and audit standards.

ESG performance is primarily about results and impact – improving society and the environment, but the effort, resources, and costs applied to achieve those objectives can quickly become relevant for both internal decision making and external evaluation. Many ESG activities are project oriented initially and grow to be ongoing staff functions managing multiple short and long-term projects. Some activities are regulatory requirements; and hopefully most are discretionary, innovative initiatives done for the right reasons. Environmental initiatives and innovations can become new products, new services, or are built into existing products or services as standard features, options, or enhancements. Sometimes these changes raise costs, sometimes they lower costs, sometimes they increase sales, and sometimes they decrease sales. The question of increasing importance is: How should ESG effort, impact, results, benefits, and costs be captured for decision making for internal managers and employees, external investors, other external stakeholders, and the public? Should it be different for external reporting/presentation vs. internal decision making?

I don’t have the answers to all these questions, but I have one important perspective to share. Profitability Analytics and managerial costing have come into existence to develop causal, operationally reflective, and economically relevant information for internal decision support. Because all too often that involves “undistorting” information collected for external financial reporting standards. As ESG reporting becomes more prominent, and as a result more structured, we should all advocate for an approach that clearly reflects reality, is highly actionable, and doesn’t require “undistorting”. ESG information is critical to everyone’s long-term survival and well-being. ESG results should be clear, highly visible, identifiable, and actionable down to the organizational elements, resources, and processes that cause the result and can make improvements.

Keep in mind this phrase from FASB Statement of Financial Accounting Concepts No. 1 (which is now superseded, but I think this statement still applies).

“The information should be comprehensible to those who have a reasonable

understanding of business and economic activities and are willing to study the information with

reasonable diligence.”

This is who external financial reporting standards are designed for…and the word “reasonable” has escalated in its level of complexity by many magnitudes since this was written. If we go down the same road with ESG Standards, they won’t achieve much more than large fees for consulting and audit firms. The bottom-line test for any ESG reported performance metric is that it can be causally traced and tracked as a performance metric in an actionable way to the very specific components, resources, and processes of the organization that create the result and can be changed to improve the result. If that insight isn’t crystal clear and immediately available, the information isn’t meaningful and should not be accepted by any stakeholder, investor, manager, or auditor.