Disclosure of Long-Term Business Value: What Matters?

Abstract

Sustained and superior performance depends, in part, on effective measurement, management and disclosure of traditional financial metrics. There are many other metrics such as those used to evaluate environmental, social and governance (ESG) performance; resource efficiency; business model resilience; innovative capacity; brand strength and corporate culture that can be just as informative on how a business is creating value. There is a lot to be said for building a business that outperforms on these metrics — especially when competitors miss, ignore or simply misunderstand how they can drive business value and growth opportunities. CFOs, with their unique, cross-functional vantage point, need to consider more than their results for the next quarter and a wider range of stakeholders — customers, suppliers, consumers, employees, non-governmental organizations and communities — that play an important role in an organization’s success. This research takes an in-depth look at how companies determine materiality in the ESG context, and discusses the challenges managers face and how these impact what type of data is disclosed. Today, most companies who measure these nontraditional metrics disclose most of the information in a separate sustainability report — yet this is likely to change. The challenge faced by all public and private companies is how to determine what information to disclose. Many companies are trying to apply the principle of materiality from traditional financial reporting to this new set of performance metrics, but this remains difficult terrain because there is little hands-on guidance about precisely what to do. Simply put, managers have neither the tools nor the approach to make these decisions efficiently and rigorously. The result is data that is difficult to use for making business decisions, both inside a company and externally. Materiality determination is one of the most complicated ESG-related decisions for senior management, which faces considerable uncertainty related to ESG topics. With limited resources at hand, managers should choose a small set of material performance indicators that inform on valuation impacts and consistently report data and should focus less on trying to satisfy every one of the company’s stakeholders. Furthermore, ESG materiality determination need not be a qualitative “finger to the wind” exercise. We believe that decision science methods have the potential to put corporate leaders and CFOs in a stronger position to use the intelligence that is gained from all key stakeholders using a structured approach to stakeholder engagement; and make strategic choices, including capital budgeting decisions. More importantly, the result is quantitative and based upon fundamental insights into how complex decisions are made.