Rethinking the Cost of Sustainability Reporting

Published : 4 weeks ago, on 12/09/2024

By Dr. Michael Erkens and Dr. Ries Breijer

With new disclosure requirements pushing for enhanced transparency in environmental, social, and governance (ESG) practices, many companies are seeking to reduce expenses for preparing sustainability reports and complying with regulations. Our research, however, indicates that this strategy is ‘penny wise, pound foolish’. Unless companies rethink the cost of sustainability reporting, many may soon face its true costs: market value losses from inadequate reporting.

The most effective strategy for reducing the costs of sustainability reporting, paradoxically, is to invest more in it. Our findings suggest that the market value losses caused by inadequate reporting far exceed what would be considered reasonable expenses to prepare a thorough report. Companies should, therefore, shift their view of sustainability reporting from a compliance obligation to a strategic investment – one where transparency is a competitive advantage.

A paradox

The European Corporate Sustainability Reporting Directive (CSRD), aiming to enhance transparency on sustainability issues, will impact nearly 50,000 European firms over the next three years. Similar regulations are in the making in the United States and other jurisdictions. Many companies consider these regulations a regulatory burden, with significant compliance costs on the horizon.

However, the less you spend on sustainability reporting, the more costly it becomes. This paradox has emerged from our research on the economic consequences of a sustainability reporting mandate (available here).  As the CSRD has yet to take effect, our focus has been on its predecessor, the Non-Financial Reporting Directive (NFRD). Like the CSRD, the goal of the NFRD was to create a standardized, transparent system for disclosing sustainability information, helping stakeholders make informed, sustainable decisions. Yet, our research shows the regulation’s most significant impact has been on companies that might otherwise withhold or obscure sustainability information.

Companies that began disclosing sustainability information long before any reporting mandate, reflecting their genuine commitment to transparency, were already providing meaningful disclosures that reduced information asymmetry and increased investor trust; the Directive has had a minimal additional effect on them.

On the other hand, companies that began reporting only because it was mandated often chose to rely on generic, boilerplate language in their disclosures – a strategy that might lower the cost of preparing the report, but ultimately fails to add real value. The result? Greater information asymmetries and a decline in firm value.

How to get it right

Considering our findings on the negative consequences of inadequate reporting, the question arises: how can companies effectively minimize the true costs of mandated sustainability reporting, or even make it a profitable practice? Through our analysis of the sustainability reporting practices of firms with a genuine commitment to transparency, we have identified the most important strategies to consider.

• Be proactive and forthcoming: Companies that proactively engage in sustainability reporting are better positioned to create meaningful and valuable reports. This approach not only builds trust with stakeholders but also helps avoid the pitfalls of boilerplate disclosures.
• Do not withhold information: Reporting ‘bad news’ is often better than reporting ‘no news’ at all. If you withhold information, investors and other stakeholders may assume the worst and react accordingly, leading to a loss of confidence and a potential drop in firm value.
• Tailor your reporting: Generic reports often fail to address stakeholders’ specific concerns. By tailoring reports to highlight the unique aspects of your business and its impacts, you can provide more relevant information, reducing information asymmetries and enhancing firm value.
• Leverage established frameworks: While some regulations allow flexibility in choosing reporting frameworks, aligning with well-recognized standards developed by the Global Reporting Initiative (GRI) or the International Sustainability Standards Board (ISSB) can lend credibility to your reports and make them more comparable across industries.
• Monitor and adjust continuously: Sustainability reporting is not a one-time task but an ongoing process. Regularly reviewing and adjusting your reporting practices in response to stakeholder feedback helps maintain transparency and relevance, ensuring that your reports continue to add value.

It’s an investment

Although the shift towards enhanced transparency in sustainability is not without its challenges, it doesn’t have to be a financial burden. Companies can shift their perspective on sustainability reporting from a compliance obligation to a strategic investment. After all, in today’s business environment, transparency isn’t just a regulatory requirement – it’s a competitive advantage.

About the Authors

Michael Erkens is a professor at Nyenrode Business University and an associate professor at Erasmus School of Economics. He specializes in financial and sustainability reporting and corporate governance. His research addresses firms’ disclosure practices, executive compensation, and the effect of regulations on firm behavior.

Ries Breijer, an assistant professor at Nyenrode Business University, has a strong interest in financial and sustainability reporting. His research focuses on the regulatory impacts on sustainability reporting, the consequent economic and real effects, and how changes in financial reporting standards can contribute to a more sustainable economy.