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GAO Finds ESG Information Inconsistent in Both Reporting and Usefulness

By:
Chris Gaetano
Published Date:
Jul 7, 2020

A Government Accountability Office review of public company disclosures on environmental, social and governance-related issues (ESG) has found that such information varies widely from firm to firm in terms of both its content and its usefulness to investors.

The GAO looked at the annual reports, 10-K filings, proxy statements, and voluntary sustainability reports for 32 companies. Overall, the report said that companies disclose many different ESG topics, but it found wide variability on specifically which ones they'd discuss. For instance, everyone was eager to talk about board governance and management, such as avoiding conflicts of interest and maintaining independent board members, which the GAO said is likely because the SEC required companies to report governance information in their proxy statements. Another popular topic of discussion in this space was data security, with nearly all companies examined holding forth on how they identify and address such risks. Climate change was another common topic in ESG disclosures, particularly for those in the airline and fossil fuel industries, as was workplace diversity.

Conversely, almost no one wanted to talk about human rights violations. Of the 32 companies that the GAO looked at, only 22 reported on the topic: Only six identified company operations that might endanger human rights, only four provided specific metrics for human rights reviews performed by the company, and only two disclosed metrics on the number of identified human rights infringements.

Additionally, while almost everyone talked about cybersecurity risks, only two provided quantified data on the number of data security incidents.

The GAO said that companies generally choose which ESG factors to disclose based on a combination of legal and regulatory requirements, stakeholder outreach and risk assessment. As such, the report said, some factors may not be germane to a particular firm, thus explaining at least some of this unevenness. For instance, very few internet media companies chose to talk about climate change risk, compared to utility companies, which focused particularly hard on it.

The report also noted that while investors generally crave company-specific information over generic narratives, the degree to which companies provide it varies based topic. On some, like those related to adding new directors to the board or promoting diversity and inclusion, most reports contained detailed, company-specific information. On others, not so much. For instance, while 26 of the 32 firms examined discussed "obstacles that might limit the company's ability to hire the talent it needs," only seven provided company-specific information, with the rest going with more generic language.

The GAO said that companies may choose not to disclose more detailed information for a particular ESG topic for several reasons, including concerns that such disclosures would put the company at a competitive disadvantage or expose it to legal liability.

However, even when companies were specific about their ESG information, the GAO noted that there were inconsistencies in how they went about quantifying it, as the review found instances when companies defined terms differently or calculated similar information in different ways. For example, when discussing workforce diversity, some companies used broad groupings such as "minority" or "ethnically diverse" while other companies broke this information down into specific racial or ethnic groups. This seemed to happen even when companies were using the same sustainability reporting framework, such as the Global Reporting Initiative (GRI). Among four different companies reporting ESG information using the GRI framework, the GAO identified four different methods for calculating workplace diversity (although the report noted that the GRI framework does not have a set method for such reporting).

These issues, said the GAO, mean that the usefulness of such disclosures to investors is limited, as 11 of the 14 institutional investors they interviewed for the study said that they directly ask companies for further ESG information in order to address gaps and inconsistencies. While there are a wide range of policy options to address these issued, the report noted that each one has different trade-offs, meaning none stand out as the clear choice.

Regulation or legislation, for example, would provide a clear consensus on what needs to be reported and how but that risks increasing compliance costs on companies, as well as puts a burden on regulators to update and administer the rules. Another possibility is for the government to endorse a single framework, which would enhance comparability, though the GAO said that there's the risk that under such a plan some companies will just plain stop reporting, which actually hurts comparability. Also, the GAO noted that there is currently no universally accepted framework and so choosing a single one might prove challenging.

The GAO also raised the possibility of leaving the matter up to the private sector, which would minimize compliance costs, but the disadvantage would be that some industries are very diverse and won't be able to reach a consensus on standards, and that, furthermore, company and trade association interests may conflict with those of investors and other stakeholders. Another way for the private sector to manage the issue is through having the exchanges impose requirements before allowing a stock to be listed there. But, said the GAO, this risks competition between exchanges offering different terms. Stock exchanges are aware of this and so are hesitant to impose listing requirements out of concern that firms will just go to another exchange.

Those wanting a deeper dive into the lack of clarity and consistency in ESG reporting can read The Trusted Professional's in-depth three-part series on the issue. Part 1 concerns the myriad frameworks and the difficulties in reconciling them; part 2 examines how unusual incentives in sustainability frameworks can lead to perverse results; and part 3 is about how ESG factors are becoming increasingly important to investors in determining long term value.