The flaws in sustainability reporting

The number of ESG disclosures does not always determine quality. There should also be greater scrutiny of how companies pick topics “material” to them.

Victoria Peak_Hong Kong
Victoria Peak, Hong Kong. In addition to being major financial centres, Hong Kong and Singapore are both aiming to be the top sustainability hub for APAC investors. Image:  Ryan Mac via Unsplash

Sustainability reporting standards aim to establish a common language for measuring and disclosing environmental, social, and governance (ESG) data.

The idea of using standardised metrics is to make it easier for users to compare the ESG performance of different companies. Some academic researchers use these standards to assess report quality, specifically based on the number of disclosures.

The assessment, called Sustainability Reporting Quality (SRQ), generally relies on a content analysis and quantitative method. Researchers then established a set of measurement criteria and a scoring mechanism for each criterion based on the reporting principles of Global Reporting Initiative GRI), the most commonly used sustainability reporting framework.

The scoring mechanism is then developed using a Linkert scale to assign a particular score to the extent of the information presented in each criterion. For example, the scoring of the balance criteria might range from the lowest score of 1 (if the information only highlights positive events) to the highest score of 5 (if it describes both positive and negative events and impacts).

Another illustration comes from the report’s accuracy aspect. According to GRI, accuracy refers to the organisation’s efforts to disclose correct and sufficient information to allow an assessment of the impacts.

Since companies may use varying methods to measure impacts, GRI suggests reporters disclose evidence-based qualitative information and measurement methods for quantitative data. Then, the Linkert scale is also set forth to evaluate whether companies comply with this principle and compare them with their peers; for instance, it consists of the lowest score of 1 assigned to companies which only disclose qualitative information to the highest score of 5 for disclosures of comprehensive details with evidence.

In the next stage, researchers may quantify the number of disclosures on economic, environmental, and social topics. Further, in some cases, an index score can be tabulated to compare SRQ across different companies or industrial sectors. The above approach might be helpful for statistical analysis (e.g., testing the relationship between SRQ and other indicators like board diversity).

However, some limitations of this approach might hinder us from a more meaningful, thorough analysis of what lay behind and buried within those disclosures.

First, the number of ESG disclosures reported does not always determine quality. Material topics vary depending on the industrial sector and the companies’ context. It is even possible for companies from different sectors to have other material topics and, hence, different disclosures selected. As such, the broader contexts in which companies operate need to be considered to understand their decisions on specific material topics and disclosures.

Second, a deeper analysis of the companies’ contexts would help examine how they determine and arrive at their current material topics. It should not be too difficult to see that the number of material issues or ESG disclosures do not provide meaningful information if a robust materiality assessment does not justify them.

Third, a content analysis approach looking just at the completeness of the information reported (e.g., whether it covers both positive and negative impacts) fails to analyse further whether such information is consistent, meaningful, reasonable, and solidly connected to the quantitative data presented. For example, if a company adopt a particular measurement methodology—like Social Return on Investment (SROI)—to support its evidence, a deeper look at the method and its underlying assumption is also critical in assessing the report quality, ensuring the trustworthiness of the information presented. In short, the quality of information cannot be evaluated at the sentence level.

Fourth, sustainability reports are about more than just what has happened. They are also a form of companies’ commitment to and actions for the future. As suggested by GRI Standards, each ESG disclosure should be accompanied by descriptions of the policies and actions taken to manage the respective topic. Thus, it is necessary to assess the extent to which the companies’ existing and forthcoming policies, strategies, and actions can adequately address the current negative impacts and magnitudes.

Meanwhile, to address these limitations, researchers and practitioners need to return to the underlying principle of sustainability reporting: it is not just simply about “reporting”.

Understanding how and in what ways ESG topics are measured and disclosed offers a starting point for assessing how “serious” a company’s commitment to sustainability is. It also helps to show to what extent it is willing to manage the impacts.

It is important to uphold the adage “sustainability is a journey”. But, faced with the real and urgent climate crisis, any journey must have clear, justifiable destinations and pathways.

Hendri Yulius Wijaya is a writer and corporate ESG practitioner. He formerly served as the Indonesia Country Program Manager for the Global Reporting Initiative (GRI), which developed a set of international sustainability reporting standards. Currently, he is pursuing a PhD in School of Social and Political Science (joint supervision with Faculty of Business and Economics) at Melbourne University, Australia.

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