For many years the bulk of investor and stakeholder pressure on ESG issues focused on larger companies. Indeed, recent findings by The Conference Board in collaboration with Esguage and Heidrick & Struggles show that most smaller publicly traded firms remain on the sustainability-disclosure sidelines. But with the SEC’s ESG disclosure rules right around the corner, and with evidence that investors expect smaller companies to do more on ESG, that’s no longer a tenable position for firms regardless of size.
CEOs of smaller companies might be tempted to dismiss sustainability reporting as the exclusive province of large multinationals. Yet just last year shareholders voted on 15 resolutions on environmental and social topics at Russell 3000 companies that includes almost all U.S. publicly traded companies with less than $5 billion in revenue. Notably, six of these resolutions passed.
The days of the 100-page phonebook-style sustainability report are over. Instead, effective reports focus on the handful ESG issues where the company can truly move the needle. With stakeholders expecting data on a broad range of issues, some ESG issues have become tablestakes, regardless whether a company sees them as material.
How can companies — especially smaller firms, which may be new to sustainability disclosure — focus their sustainability reporting on needle-moving issues while also satisfying stakeholder requests for broader disclosures as well?
The tiered approach
One way: Take a tiered approach to sustainability disclosure. This entails focusing the company’s sustainability narrative on a few high priority ESG issue, while using supplemental data-heavy communications for the next tier of issues — those which may not be highly material to the company but are still of importance to stakeholders. These supplements can be stand-alone documents, such as data sets or a searchable database. Taking a tiered approach to disclosure allows companies to provide data on a variety of ESG issues while keeping their narrative focused on the issues that matter most to the company.
This is particularly true for the smaller companies that have some catching up to do. Indeed, the analysis by The Conference Board of ESG data reported by US public companies reveals that the larger S&P 500 companies have disclosure rates that are 60 percent higher than S&P MidCap 400 companies, on average, when examining companies’ disclosure across a selection of 10 environmental and social metrics (such as greenhouse gas emissions, water consumption and gender diversity in management). For certain metrics, the gap is far wider.
Catching up on climate disclosures
Take climate data, for example. More than half (54 percent) of S&P 500 companies disclose climate-related risks in their annual reports, and 71 percent report their greenhouse gas emissions. By comparison, just one-third of S&P MidCap 400 companies disclose climate-related risks, and just 28 percent report their emissions. The gap widens when looking at disclosure of Scope 3 emissions — only 13 percent of S&P MidCap 400 companies report these emissions, compared to 43 percent of S&P 500 companies. Smaller firms, in particular, need to step up their climate-related disclosures. In doing so, companies should address both their impact on climate and climate’s impact on them.
On average 16% of water companies withdraw comes from stressed areas.
CEOs should understand the potential impact their company can have on climate, not only through their own operations but also those of their full value chain. Equally important is considering a full range of potential impacts that climate change can have on the company, such as the impact of climate on the company’s operations, costs and revenues; upstream suppliers, business partners and downstream customers; the company’s employees and communities; and the laws and regulations under which the company operates.
Water will be an important ESG disclosure issue
Investors are increasingly interested in understanding a company’s risks when it comes to water, specifically including the amount of water firms withdraw from water-stressed areas. It is not an insignificant amount: Based on the 93 U.S. companies that report this information, on average 16 percent of water they withdraw comes from stressed areas.
As with climate data, larger companies are more likely to disclose these details. In fact, 12 percent of S&P 500 companies report this information, twice the 6 percent of S&P MidCap 400 companies that did the same. Companies large and small should assess their exposure to water risks. The CEO Water Mandate offers a helpful primer for identifying a full range of water-related business risks, including physical, regulatory and reputational risks.
Getting ready for third-party verification
External assurance, such as third party verifications, of ESG data is another important area in which smaller companies have some catching up to do. Six percent of S&P MidCap 400 companies are assuring their ESG data, compared to more than one-third (36 percent) of S&P 500 companies. Going forward, companies need to prepare for increased expectations (and in some cases, requirements) that they externally assure sustainability disclosures.
The assurance process can be resource-intensive, but some preparation and prioritization can help. For example, before getting started with assurance, companies should consider building database systems to prepare their data and seek out partners that can help pressure-test it before it is public. Prioritizing assurance for a selection of a company’s biggest risks (climate-related data) can also make the process more manageable.
To make this all work, smaller companies need to be especially focused on governance: to ensure that from the board on down, they have the clear criteria and processes in place to choose the key issues, set appropriate goals and provide effective communications. They simply don’t have the resources to satisfy multiple reporting frameworks and rating agencies.
The combination of a tiered approach to disclosure, and a highly disciplined approach to concentrating resources, can be especially helpful for smaller companies that have been on the sidelines of ESG disclosure. This approach frees companies to focus their sustainability narratives on the handful of issues that truly make a difference, while still satisfying the deluge of requests for verified data that will soon come their way.
February 22, 2022 at 03:15PM