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Mark McElroy

Mark McElroy

We need Multiple Capital Accounting and Integrated Materiality

September 2015 User View by Mark W. McElroy, Ph.D., Executive Director, Center for Sustainable Organizations, and Co-Founding Partner, Thomas & McElroy LLC, United States

EARLIER this year, Doug Park, Director of Legal Policy and Outreach at the Sustainability Accounting Standards Board (SASB), published a short article in which he said, “More than ever before, investors want nonfinancial information from companies in making investment decisions.” If this is true – and I believe it is – it effectively renders the conflicts between financial and non-financial materiality moot. How so?

First, to state the obvious, materiality in the case of financial reporting is mainly about the needs of investors. As Park explains, “what is material depends on what the reasonable investor would find important in his or her investment decisions.”

Shades of this investor-centric interpretation – which I fully understand is variously dictated by law – can also be found in the International Integrated Reporting Council’s (IIRC) Framework for integrated reporting (section 3D, 3.24, Materiality):

Not all relevant matters will be considered material. To be included in an integrated report, a matter also needs to be sufficiently important in terms of its known or potential effect on value creation.

On the non-financial side, the Global Reporting Initiative (GRI) is similarly emblematic. In the latest version of its Guidance (G4; section 4.1, Materiality), it says:

The report should cover Aspects that:

  • Reflect the organization’s significant economic, environmental and social impacts; or
  • Substantively influence the assessments and decisions of stakeholders

Here it should be clear that what GRI is calling for is anything but investor-centric disclosure, and that it is the “significant … impacts” of firms and/or the “assessments and decisions of stakeholders” (of all types) that matter most. That said, the problem arises, of course, of what to do when the determinations made under one policy happen to conflict with those of the other.

Thankfully, this is a problem I honestly think is fading away for precisely the reason Doug Park provides above. Increasingly, investors not only want non-financial information, but are entitled to have it, because it simply is no longer possible to separate the financial health of organizations and their risks from their own social and environmental performance.

To be clear, information about non-financial performance is demonstrably material to financial investment decisions, even under SEC/IIRC-type criteria. Listen to how Eccles et al put it in their very fine book, The Integrated Reporting Movement (pp. 121-122):

Although providers of financial capital form the “direct audience” – that is, the “users” – of an integrated report, the “indirect audience” of stakeholders also exerts pressure on the firm’s selection of material issues. Firms are driven to engage with stakeholders because stakeholders wield varying degrees of influence on the providers of capital, and the implications of that influence are often too great to ignore. Consequently, when the firm decides what information is material, it must, for its own good, take into account the perspectives of stakeholders beyond those who provide financial capital.

And let us not forget – God forbid – that firms actually have other, non-shareholder stakeholders to whom non-financial duties and obligations are owed, for reasons that have nothing to do with shareholder value. How firms perform relative to those responsibilities, too, matters greatly to the interests of shareholders.

Indeed, strong evidence now confirms, thanks to the pioneering efforts of UK-based Reputation Dividend, that the CSR performance of listed firms directly contributes to their market values. The non-financial performance of listed firms, that is, is just as material to the interests of investors as their financial performance is, because both have direct, measurable impacts on shareholder value. The jury is now in on that.

Why, then, do mainstream materiality determinations consistently fall short of the mark by depriving investors of the non-financial information they need? Is it because investors haven’t complained? I don’t think so. In a study conducted by PwC last year, 61 percent of investors reported their dissatisfaction with corporate disclosures of social and environmental information. In that regard, mainstream reports (financial and non-financial alike) have simply not been effective. Evidently, stovepipe thinking dies hard.

For their part, investors could do no better than to insist that financial materiality determinations formally recognize CSR performance for what it is: a tangible, causal and measurable factor in shareholder value. And the best way to do that, in my view, is to embrace Multiple Capital Accounting, an evolution in the field that Australian scholar Jane Gleeson-White describes in her book, Six Capitals, or Can Accountants Save the Planet?, as only “the second revolution in accounting since double-entry bookkeeping” and “of seismic proportions”. If integrated materiality is where we need to go – and I think it is – Multiple Capital Accounting can show us the way.

Take the MultiCapital Scorecard (MCS), for example, a new (and open-source), integrated, context- and capital-based measurement and reporting system developed by Thomas & McElroy LLC in Vermont. The first step when using the MCS is to perform a materiality analysis, which consists of identifying stakeholders to whom duties and obligations are owed for managing one’s impacts on vital capitals. This ensures that the focus of a CSR or sustainability program is appropriately geared towards the needs of stakeholders, not just shareholders, while also mitigating the risks of not attending to them. This, in turn, helps build reputation and market value as a result. Indeed, how a firm performs relative to its duties and obligations to stakeholders now verifiably affects market value, the materiality of which tools like the MCS can help identify and flesh out for measurement, management and reporting.

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