value insights

Corporate Social Responsibility Benefits- Valutrics

Although regulation on environmental practices and corporate stewardship already existed, until recently Corporate Social Responsibility (CSR) has been widely regarded as a costly waste of resources.
Enron’s failure succeeded in focusing the attentions of the regulators, the financial sector and the stakeholders not only on corporate governance standards, but also on internal controls and risk management policies. As a result, public limited companies across the world’s capital markets are now having their CSR policies, or lack of them, thoroughly scrutinised. CSR has therefore become the latest ‘value-added platform’ for many an executive board. CSR agenda moved from being consumer-driven to investor-driven.
But good CSR is not just about joining up environmental and social policies. Although the moral reasons for practising CSR lend themselves to easily identifiable ‘ethical’ benchmarks such as the environment, employee opportunities and human rights, the financial benefits are asymmetric; in other words, a company will not just benefit from CSR practice, but will improve its performance by being better at it.
Yet, to fully reap the benefits of this essential business discipline, organisations must be prepared to fully embrace it as corporate culture. Companies must ensure that this essential business discipline is present in all parts of the business, including board operation. Although CSR should not be considered a performance guarantee in its own right, having the right checks and balances in place can help facilitate a soft landing rather than a crash when scandal or failed strategy strikes.

Key Influences behind CSR
. Technology – investors and consumers can now access vast amounts of information 24/7.
. Transparency – stakeholders can now choose who they buy from, invest in, and work for using measurable benchmarks such as environmental and community impact.
. Sustainability – organisations are facing increasing pressure to adopt sustainable development strategies.
. Globalisation – as global corporate expansion increases, particularly in developing nations, so too have the calls for the export of human rights and environmental policies.
. Borderless governance – reflected by the creation of global governance approaches such as the Global Reporting Initiative, the UN Global Compact, the Sullivan Principles, and the Kyoto Protocols.
. Stakeholder pressure – poor governance, including accounting irregularities and excessive remuneration, has led to a demand for greater corporate transparency.
. Mega-risk – organisations now face increasingly complex and potentially dramatic risks such as product tampering, terrorist action, human rights violation, genetic modification, climate change, pollution, and nutritional care surrounding rising obesity levels.

The cost of ‘getting it wrong’ is high. Not only does a company face damage to its financial position, image and reputation, legislation is upping the ethical stakes. Under Sarbanes–Oxley, for example, shareholders can now prosecute directors for neglecting their interests. The increased significance of intangible assets including brand, combined with the implications of globalisation and government requirements for disclosure is having enormous effects on directors’ duties and accountability and the trend is not going to quietly fade away; if anything, it is more likely to grow in prominence. Companies must now show that they are acting responsibly towards the environment, the community they operate in, and society at large in order to appease their stakeholders.

Improved Risk Management
CSR enables an organisation to improve its risk management and risk assessment. Even in today’s enlightened times, many senior executives still associate the word ‘risk’ with business failure, fraud, and ultimately the destruction of shareholder value. Yet there is substantial evidence to suggest that if CEOs understand their organisation’s risk profile, and put in place strategies and mechanisms to deal with them accordingly, such as CR, they will generate superior shareholder returns year on year. In order to gain the necessary operational control to avoid confrontation with stakeholders, directors need an integrated, automated platform that delivers a single point of control, as well as enforcing business rules and compliance with policies, across the organisation. Combined corporate performance management (CPM) and risk management corporate control (RMCC) systems should ensure that important data travels more quickly to the right people, and that it is what they need to hear instead of just what they want to hear.

Ensuring Compliance
The global corporate governance environment is currently undergoing a dramatic evolution. Compliance is now a measurement of responsibility to the stakeholder, the environment and the community. Business leaders must be prepared to demonstrate and explain their societal contribution on training, employment, income generation, wealth creation, innovation, and supply chain development. Failure to do so incurs a high price. As such, CSR is intrinsically linked to corporate governance – and financial reporting.

In the USA, the Sarbanes–Oxley Act has increased social responsibility commitments, despite the existence of relatively tough regulation governing business ethics including the SEC and Environmental Protection Agency (EPA) regulations on corporate disclosure on environmental liabilities, and the Foreign Corrupt Practices Act, which legislates ethical company behaviour. A number of initiatives to encourage adoption, and ensure compliance, have been launched. Among these is the
United States–Asia Environmental Partnership (US-AEP), which aims to improve Asia’s many social, environmental, and industrial problems, and help US-based private and public companies to implement CSR policies through overseas contracts.
The European Union is also encouraging companies within its member states to adopt CSR policies, with the vague suggestion of making it a mandatory reporting requirement. the European Commission’s European Multi Stakeholder Forum aims to create dialogue between businesses, trade unions, NGOs and the EU.

Improved Financial Performance
Although the wider ethical business case for CSR is fairly self- evident, the financial motives have always been a little more difficult to measure. However, a number of reports linking improved financial performance with CSR have been published, as have comparative reports between ethical indices and mainstream money markets:

. A review of the Dow-Jones Sustainability Index suggested that between 2002 and 2003, the index outperformed the mainstream market. At the same time the DJSI World increased by 23.1 per cent, while the Dow-Jones World Index went up by 22.7 per cent.
. A study of ‘stakeholder superstars’ including Procter and Gamble, Johnson & Johnson showed that companies who consistently try to take into account stakeholder opinions outperformed the S&P 500 by more than twice the average over the past 15 years. Total shareholder return was 43 per cent over the past 15 years, while the total shareholder return from the S&P 500 was 19 per cent.
. According to the London Business School, out of 100 studies carried out over the past 30 years, 68 per cent demonstrated positive correlation between CSR and shareholder value.
. An Institute of Business Ethics report showed companies that had adopted CSR into their strategy performed better on three out of four financial measures. The companies studied also had 18 per cent higher profits on average. Another study focusing on FTSE 250 companies showed that organisations with an ethical code in place for more than five years outperformed the average on economic and market value-added.
. In 2000, Harvard University produced a report showing that stakeholder-balanced companies showed four times the growth rate and eight times the employment growth when compared to companies that were shareholder-only focused.

While it is true that many business leaders view legislation as merely suppressive, embracing regulation within the corporate responsibility agenda can in fact stimulate creativity. According to the Business in the Community Fast Forward report, 80 per cent of European CEOs believe that responsible business practice allows companies to be creative. As CSR affords an enterprise- wide view, organisations are able to put better risk management policies in place, not only equipping them with the appropriate strategies to cope with the unexpected, but allowing them to take advantage of market opportunities . Instead of seeing a problem, innovators see a business or market opportunity or a means of improving efficiency or maintaining competitiveness. Organisations should also be willing to pursue ‘parasitic’ partnerships or joint ventures in which all parties benefit. Nike, for example, has programmes in place with six of its material suppliers to collect 100 per cent of their scrap and recycle it into the next round of products, thereby reducing production costs and waste.
Another example is Hewlett-Packard, which after discovering a demand for wedding and identity photos in India developed technology to enable low-cost picture taking and development, the HP Photoshop Store, where basic image development was licensed locally and a high quality solar-powered camera was used. The initiative sparked a cottage industry made possible through micro-lending. HP benefited as most of its margins are made through selling paper and providing replacement cartridges.

Institutional Investment
A decade ago, ethical investment simply meant avoiding arms manufacturers, tobacco companies, pharmaceuticals, petrochemicals and nuclear power generators. Today, it has a whole new meaning, and the commitment of a once cynical financial services community. Following Enron et al., ‘ethical’ can now be measured in terms of corporate governance and CSR practice, as well as industry sector. As such, ethical investment funds have grown considerably. According to US-based group the Social Investment Forum, CSR screening measures have been used on more than $2 trillion in managed assets. A similar report by Russell Reynolds Associates showed that 50 per cent of European investors and 61 per cent of US investors had decided to reduce their portfolio or not to invest in a company because of poor governance.

Despite this steady growth, the bulk of the investments are still almost entirely in retail mutual funds. The capital markets have tried to redress this balance as part of their efforts to restore investor confidence. In 2001, the FTSE4GOOD index was launched and includes FTSE companies that have adopted CSR policies. Since then, other initiatives designed to promote the benefits of good corporate governance and CSR have appeared, including the
Business in the Community Corporate Responsibility Index, which allows firms to compare their adoption of CSR into core business operations against other companies in the same sector.

The Socially Responsible Investment (SRI) index, which is the first of its kind, tracks the performance of smaller companies operating in Europe. Maintained by HSBC Bank, the index is made up of more than 70 companies from 14 countries. Europe now has around 300 SRI funds attracting investment from international pension funds.
The Dow-Jones Sustainability Group Index benchmarks the performance of investments in companies that have adopted SRI policies. Around 200 companies representing the top 10 per cent of firms that have already committed to CSR are included in the index. Qualification includes an industry-related sustainability assessment, which looks at the integration of economic, environmental and social factors into strategy. Corporate governance and transparency are also given high priority. Regulation governing business ethics already exists, including the SEC and EPA regulations on corporate disclosure on environmental liabilities, and the Foreign Corrupt Practices Act, which legislates ethical company behaviour. Since
Enron’s collapse in 2001, however, the focus on CSR has increased dramatically, as reflected in the number of new CR initiatives. These include the United States–Asia Environmental Partnership (US-AEP), which aims to improve Asia’s many social, environmental, and industrial problems and encourage US companies to adopt CSR policies as part of international operations. Although the USA and Europe can be seen as SRI fund trailblazers, other countries are quickly following suit.
Europe and the USA are not alone in trying to realign their respective capital markets. Thailand, India and Korea are all in active debate on how to best improve transparency in their home capital markets, amid drastic changes to their respective economies. The South African government has introduced tougher financial reporting regulations with heavy emphasis on HIV/AIDS-related CSR and corporate governance compliance as the country’s HIV/AIDS pandemic continues to accelerate.
However, in 2003 Japan emerged as the leading market to adopt the international CSR framework as devised by the Global Reporting Initiative. According to research by the Fujitsu Research Institute, more than half of the companies listed on the Tokyo Stock Exchange publicly disclosed information on their environmental performance.

In today’s highly competitive market, brand is undoubtedly king, therefore protecting the reputation of intangible assets is paramount. Recent research by advertising group Interbrand showed that 96 per cent of Coca-Cola’s value is now in intangibles; in the case of Kellog’s, 97 per cent; for American Express, 84 per cent. Reputation management experts have long agreed that it is easier to build a reputation from scratch than to improve one damaged by scandal. One such example is mineral water giant Perrier, which never fully recovered its loyal customer base following the benzene contamination disaster in 1990. Despite accounting for 60 per cent of all mineral water sold in the UK, the scandal saw Perrier’s market share plummet to 9 per cent. Much of this can be attributed to the emotional way in which the public responds to corporate failure.

Although the media plays a significant role in highlighting corporate foul-ups, the Internet has become an even bigger threat to corporate and brand reputation. From self-starter rogue websites, to shareholder action groups, the Internet can have a significant effect on an organisation’s reputation and accountability. Only by enhancing relationships with its stakeholders can a company truly create value. According to Jane Nelson, business leadership and strategy director at the International Business Forum, CSR innovators have quickly recognised the need to ‘integrate’ CSR principles and values into core business structures and strategies. Accountability is then clearly traced to the executive management team and board, with some companies even integrating performance targets to SRI into management appraisals. Nelson adds that companies such as Shell, Procter & Gamble, Nokia and 3M have already introduced internal venture capital funds, competitions and other incentives to encourage a ‘culture of innovation’. These companies are also working with government and voluntary agencies and NGOs to generate debate and accepted institutional frameworks. Such voluntary initiatives include the UN Global Compact, the Ethical Trading Initiative and the Global Alliance for Workers and Communities.

Employee Attraction and Retention
According to a study by US human capital consultants Aon, workers are now more concerned over control of their working time, intellectual challenge and working for an organisation with a clear vision and values than pay. This, coupled with an ever- evolving employment landscape that has seen decline in manufacturing and growth in the services sector, has led to a greater awareness of corporate impact than perhaps experienced by the previous generation. Many organisations have acknowledged this fundamental shift in priorities; viewing their workforce not as a cost, but as an asset that needs serious investment. Attracting talent has therefore become like a male peacock’s display – boastful and beautiful. Societal, environmental and workplace achievements and programmes have become a familiar element of job adverts, reflecting the high priority given to the triple-bottom line by potential applicants, and the recognition by corporations that successful CSR is a commitment to all stakeholders.
As a result, benchmarking workplace indices, similar to those created by Sunday Times and Fortune Magazine, are increasingly hotbeds of competition, with companies desperate to publicly demonstrate full, equal and diverse commitment to their workforce. Companies such as Xerox, still recovering from its own painful accounting irregularities scandal, are now proud to be recognised for their support of ethnic and gender diversity.

But the motives go beyond philanthropic idealism. According to a report by professional services firm PricewaterhouseCoopers (PwC) of more than 1,000 organisations in 47 countries, companies that had good human resources strategies boasted higher revenues of up to 35 per cent. Other studies have shown that good CSR also helps to reduce high staff turnover as traditionally associated with the catering industry, increases organisational effectiveness through departmental co-operation, and enhances brand awareness and protection. In fact, many experts believe that a talented, motivated workforce is now essential in creating a competitive advantage, especially within the service sector where employees have direct contact with customers. According to an Institute of Employment Studies report on a leading British retailer, a one- point increase in an employee commitment score represented a 9 per cent increase in monthly sales. Health care group BUPA claims that since launching their ‘Taking care of lives in our hands’ initiative, it has boosted employee satisfaction by 20 per cent, and turnover by 39 per cent over three years. CSR in the workplace, however, is by definition a complex discipline. Multinationals such as Shell, which publishes an annual CSR report, work hard to ensure that such standards are kept across all operations, using key performance indicators to measure success – and failure. Such intense data mining, while helping to achieve long-term shareholder value, not only safeguards reputation and improves risk management policies, but also demonstrates social accountability; an important factor when governments of developing countries are considering foreign investment that they know will create substantial social and environmental impact.

Measuring and Reporting CSR
Despite a growing willingness by the corporate community to adopt CSR or sustainable development, its measurement and how to report it remain a highly contentious issue. Furthermore, the growth of CSR has led to an explosion of ethical league tables and benchmarks, all offering a different perspective of the discipline. This growth, in line with the information demanded by institutional investors from Socially Responsible Investment rating agencies, has led to an increased number of questionnaires being sent out to participating organisations, and confusion over the purpose. The SRI community has also been accused of failing to deliver realistic ‘insights into quality of management’ and not limiting enquiries to issues that have a ‘significant effect’ on value.

The confusion surrounding SRI reporting is worsened by the lack of a single standardised reporting framework, which has led to the creation of numerous initiatives, codes, and guidelines. All the while, stakeholder pressure to produce these reports is increasing. Bad news, including environmental fines or health and safety figures, was being hidden deep within reports as throwaway facts bearing no relation to the glowing successes accompanied by glossy photography of happy smiling faces.
There are other dilemmas. Defining stakeholder priorities, matching expectations set by early innovators, and ultimately financial cost. Because the discipline is a relatively new dimension in corporate undertaking, CSR is in constant development. Until now, organisations have been in control of what and how they report. However, it is likely that the same legislative influence exerted by stakeholders on financial reporting will further influence CSR reporting before long. The largest obstacle organisations face is that no formal framework yet exists to enable them to carry out a comprehensive cost–benefit analysis.
Despite all these problems, and the obvious need for better dialogue between the investment community, rating agencies, and the organisations themselves, CSR reporting can substantially add value . Organisations that readily embrace Enterprise Governance will find that they not only have much of

Materiality Explained
Defining materiality has so far proved problematic, both for legislators and professional organisations. Technically, material issues are those which have a non-financial risk at an operational level, or an impact on business performance; and which are relevant to stakeholder interests. However, organisations not only face common risks, such as those shared by the business community or industry sector as a whole, but unique risks or opportunities. As a consequence, legislative bodies have been reluctant to define materiality through law, even though there are a number of legal cases in the USA for alleged misrepresentation of non-financial performance by US companies. Organisations therefore need not only to identify material issues, but also to demonstrate transparent governance to avoid legal action and secure professional indemnity assurance; if premiums have not risen beyond reach that is.

AccountAbility, an international non-profit membership based institute created to promote accountability for sustainable development, has worked extensively with governments and legislators on redefining materiality. The group has developed a ‘materiality approach’, which involves a five-stage test in determining what should be publicly disclosed.
1 The traditional direct short-term financial impacts of sustainability performance, i.e. where they appear as significant items on profit and loss or balance sheets.
2 Aspects of policy-based performance where agreed policy positions of a strategic nature exist, irrespective of short- term financial consequences.
3 Peer-based norms, which can be determined where a company’s peers are deeming and disclosing issues and aspects of performance to be material.
4 Stakeholder behaviour and concerns, which are relevant to organisations where this is reasonable evidence that their stakeholders’ perspectives on the company are likely to impact decisions and behaviour. Stakeholder views are not sufficient to be deemed as material alone – behavioural change makes it material.
5 The consideration of societal norms. Beyond regulation, the test would include aspects of performance that are likely to become regulated in the future.

CSR in the future will have considerable impact on the ‘true and fair view’ of a company’s financial performance. Stakeholder focus will be on where an organisation is heading, not where it has been.