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The conceptual developments that paved the way for Integrated Reporting

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The International Integrated Reporting Council’s <IR> Framework’s broader view of value creation and its multiple capital concept calls for an enhanced stewardship of the organisations’ capitals; whilst promoting a better understanding of the interdependencies between the capitals (IIRC, 2013, p.8). Relevant theoretical perspectives as well as sound empirical research suggest that the practicing organisations’ underlying motive behind their non-financial disclosures is to maximise their financial capital and profit. This argumentation is synonymous with many conceptual theories in academic literature that seek to justify the rationale for voluntary, integrated reporting (Adams et al., 2016; Idowu et al., 2013; Deegan, 2002, Suchman, 1995; Scott, 1995; Eisenhardt, 1989):

  • The Agency Theory

In the twentieth century, corporations were clearly distinguishing the difference between ownership and control of wealth. The business owners were considered as principals as they employed executives (agents) to manage their firms. The latter executives acted as agents for the principals, and they were morally responsible to maximise their shareholders’ wealth (i.e. the prinicipals’ wealth). The executives have accepted their agents’ status because they perceived the opportunity to maximise their own utility. The agency theory suggests that the company executives and their principals are motivated by opportunities for their own personal gain (Eisenhardt, 1989). Rightly so, the principals may invest their wealth in profitable companies and design governance systems in ways that maximise their investments. On the other hand, agents accept the responsibility of managing their principals’ undertakings to secure their employment prospects.

However, at times, there may be interest divergence between the managers and their principals. There may be situations where the agents may feel constrained by their principals’ imposed structures and controlling mechanisms (Davis et al., 1997). This matter could lead to unproductivity outcomes and will ultimately bring significant losses to the principals themselves. In the event where the agent would have no discretion at all, the firm would be owner-managed. In this case, having a situation where principals are autocratic towards their agents could result in serious repercussions for the businesses’ prospects. The crux of the agency theory is that principals are expected to delegate authority to agents to act on their behalf (Ness & Mirza, 1991). It is this delegation that at times allows agents to opportunistically build their own utility at the expense of the principals’ utility. This happens when there are unaligned objectives; where managers may be motivated by their individualistic, self-serving goals, rather than being stewards for their principals (Eisenhardt, 1989).

  • The Stewardship Theory

The stewardship theory is the collective-serving model of behaviour that is driven by the organisations’ intrinsic values and a genuine desire to do what is best for society and the planet (Donaldson & Davis, 1991). The stewardship behaviours benefit principals through the positive effects of profits on corporate dividends and share prices. Consequently, the stewards place higher value on cooperation than defection (these terms are also found in the game theory), because they perceive greater utility in cooperative behaviours. Stewardship theorists assume that there is a strong relationship between successful organisations and their principals’ satisfaction. The stewards protect and maximise their shareholders’ wealth because by so doing, they maximize their utility functions toward principals.

Stewards who successfully improve their organisational performance will also satisfy other stakeholder groups who have their own vested interests. Therefore, pro-organisational stewards are motivated to maximise organisational performance, whilst satisfying the competing interests of shareholders. The utility that they gain from pro-organisational behaviours is higher than the utility that could be gained through individualistic, self-serving behaviours. This theory suggests that stewards believe that their interests are aligned with those of the corporation that engaged them (Muth & Donaldson, 1998). Ideally, the stewards ought to be committed to improve their organisational performance rather than satisfying their personal motivations. This theory’s ideals are closely aligned with <IR>’s principles for value creation. IIRC’s <IR> Framework emphasises the stewardship of multiple capitals, including; financial, manufactured, intellectual, human, social and natural capital.  In the past, the accountability of social and environmental capitals has often been found to be completely lacking in financial reporting (Adams et al., 2016; Muth & Donaldson, 1998). In addition, some anecdotal evidence suggests that companies are not always presenting a true and fair view of their negative impacts. On the other hand, there are other organisations who may be reluctant to promote their responsible and sustainable behaviours. This may be due to a lack of awareness on the business case for such activities. The motivations for undertaking stewardship behaviours, including; material ESG initiatives (that may be reported within integrated reports) seem to fall into two increasingly converging camps: doing good practices (this is consistent with the predictions of the stewardship theory) or doing well (this is consistent with both institutional and legitimacy theories).

  • The Institutional Theory

Different components of the institutional theory explain how certain processes become established as authoritative guidelines for societal behaviours. Very often, structures and institutions are created, diffused, adopted, and adapted over space and time; and eventually they may also fall into decline and disuse. Unlike the efficiency-based theories which focus on profit maximisation or on the interactions between markets and governments, the institutional theory considers a wider range of variables that could influence the decision-making processes in organisations.

This theory clarifies how firms respond to their institutional environments in which they operate. Stakeholders, including; governments, regulatory authorities, non-governmental organisations (NGOs), and organisations within the supply chain can exert their influence on any business. Scott (1995) held that, in order to survive, organisations must conform to norms and rules that are prevailing in their operating environment. Their compliance with the institutions’ formal regulations and ethos will earn them legitimacy among stakeholders (Beck et al., 2015; Dacin, 1997; Deephouse, 1996; Suchman, 1995). The institutional theory’s applications have expanded even further; as more research is showing how the institutions effect organisational behaviours, particularly on CSR issues. Historically, the notion of CSR has emerged from the institutionalised forms of social solidarity from liberal market economies. The institutional theory offers promising ways of investigating what lies at the heart of the publics’ concern. Therefore, corporations may be influenced by the institutions’ voluntary principles, policies and programmes. Their responsible behaviours have often been triggered by socio-political forces and pressure groups. In this case, CSR practice rests on the dichotomy between the corporations’ voluntary engagement and their socially binding responsibilities (Brammer et al., 2012). The fact that CSR is ‘voluntary’ is a clear reflection of the practicing organisations’ institutional context. Alternatively, CSR may be driven by legal, customary, religious or other defined institutions.

Undoubtedly, numerous institutions have played a dynamic role, both individually and collectively in the development of integrated reporting. While governments have been the primary force for the promotion of financial reporting standards through security exchange commissions; other institutions like IIRC or GRI have facilitated the growth and diffusion of ESG reporting among practicing organisations. For the time being, it may appear that there is a demand for CSR reporting mechanisms by marketplace stakeholders. For this reason, corporations are communicating their ESG credentials (Camilleri, 2015a). This way, they are accountable and transparent about their modus operandi with regulators, industry, and stakeholder groups. Moreover, the corporations continuous engagement with external institutions, particularly multi-governmental organisations, social and environmental NGOs as well as the standard-setting organisations have brought valuable principles and guidelines in the realms of sustainability reporting (Camilleri, 2015a).

Isomorphism has been constructed in conjunction with the applications of the institutional theory (Erlingsdottir & Lindberg 2005; Dacin, 1997; DiMaggio & Powell, 1991). This concept has largely been propagated through global cultural and associational processes. Isomorphic developments arise when ideas or innovations travel and are adopted in different contexts (Harding, 2012; Dacin, 1997; Deephouse, 1996).. For instance, despite all possible configurations of local economic forces, power relationships, and forms of traditional culture it might consist of, a previously-isolated island society that has made contact with the rest of the globe would quickly take on standardised forms that are similar to a hundred other nation-states around the world (Meyer, Boli, Thomas & Ramirez, 1997). Similarly, the notion of isopraxism refers to ideas that are translated and modified by different actors to suit their own needs.

Isomorphism and its related notion, isopraxism are potentially helpful for framing our interpretation of why corporate reporting approaches may converge (or not) over time. For example, the principles-based and non-mandatory <IR> Framework could potentially create explicit and implicit reporting norms that shape the non-financial information of organisations that ought to be communicated through their integrated reporting. In this sense, isomorphism may be useful to understand how and why the disclosures of ESG content can become widely accepted across companies, over time (Adams et al., 2016; Deephouse, 1996). In a similar vein, isopraxism has been used to describe instances where identifiable institutional forces lead to new and different actions within specific organisational and social instances. Therefore, isopraxism suggests that organisations may be intrigued to move toward more integrated approaches to reporting. At times, legitimate organisations may be willing to voluntarily disclose their adapted ESG reports, out of their own volition. However, they may not necessarily label them ‘integrated’, or join the IIRC’s <IR> Framework (Erlingsdottir & Lindberg 2005; Harding 2012).

  • The Legitimacy Theory

Very often, the institutional environments provide regulatory frameworks and may be considered as a considerable breath of narratives pertaining to non-financial disclosures, in different jurisdictions. Hence, there is a possibility that responsible organisations will become legitimate if they comply with relevant societal rules that are found in the countries where they operate (Beck et al., 2015; Deegan, 2002). The stakeholders perceive that organisations are legitimate when “their actions are desirable, proper, or appropriate within some socially-constructed system of norms, values, beliefs, and definitions” (Suchman, 1995, p. 574). This conception suggests that the role of the legitimacy theory is to justify the organisations’ behaviour, particularly when they implement and develop social and environmental initiatives. It goes without saying that the stakeholders will recognise those legitimate organisations that are upholding their social contract in accordance with the expectations of society. Therefore, the drivers of institutional legitimacy may be influenced by the organisations’ external environment; according to the culturally-defined values and beliefs. On the other hand, stakeholders will severely sanction irresponsible organisations when they do not respect social norms and ethical values.

Suchman (1995) described legitimacy as an operational resource assuming a “high level of managerial control over legitimating processes” (p. 576). Others suggested that legitimacy is strategic as it emanates from recurring conflicts between management and stakeholders (Dacin, Oliver & Roy, 2007; Suchman 1995). Organisational legitimacy could be achieved by forging strong relationships with external stakeholders (Camilleri, 2017). For this reason, organisations may decide to change and adapt their corporate disclosures according to their stakeholders’ expectations to achieve legitimacy. On the other hand, changes in disclosure patterns may be driven by internal decisions on materiality. Corporate reporting could be considered as a mitigating factor that is driven from inside the organisation (Campbell & Beck, 2004). Therefore, the managers’ agenda is to strategically enhance their legitimacy through stakeholder engagement. They may also make financial and ESG disclosures widely available to interested parties to achieve legitimation. This position is consistent with <IR>’s framework. Within this context, the <IR> framework provides significant support to organisations who are willing to disclose their non-financial reports. However, when organisations utilise IIRC’s framework for their very first time, they may inevitably have to adapt their financial and ESG reports as per <IR>’s recommended framework. Hence, <IR>’s reporting guidelines provide a passive avenue for institutional legitimsation. It is through the development of such guiding principles that society and external stakeholders are continuously influencing organisations to restore their ethical and social disclosures (Campbell & Beck, 2004).

The conditions for legitimacy are often constructed by responsible organisational behaviours. For example, relevant research on the legitimacy theory reported that there were organisations who were voluntarily disclosing their non-financial reports. Companies were seeking external legitimation by reporting their environmental performance (Brown & Deegan, 1998). Other corporations who decided to follow GRI’s reporting guidelines or resorted to the <IR>’s framework were increasingly aligning their internal reflections with external outputs (Beck et al., 2015). Initially, the rationale behind their integrated reporting was to improve their organisations’ external legitimation among stakeholders. However, at a later stage they realised that their external reports were informed by their organisation’s strategic positioning, and not constrained by the promulgation of the voluntary guidelines (Beck et al., 2015). Evidently, more organisations are conforming to the prevailing definitions of legitimacy through their disclosures of responsible and sustainable actions. Consequently, these responsible organisations’ leadership sets the agenda for stakeholder engagement and ESG reporting. The underlying objective is to build or enhance reputation (Aerts & Cormier, 2009) that will positively impact on the organisations’ capital flows.

 

This is an excerpt from my latest working paper, “Theoretical Insights on Integrated Reporting: Valuing the Financial, Social and Sustainability Disclosures”.

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Leveraging Organisational Performance through ‘Shared Value’ Propositions

Many successful businesses are forging strategic alliances in their value chain in order to run their businesses profitably. They also promote the right conditions of employment, where they can. Arguably, several businesses are doing well by doing good as they create shared value opportunities in their supply chain. At the same time, they are instrumental in improving the lives of their suppliers. They do this as they want to enhance the quality and attributes of their products, which are ultimately delivered to customers and end consumers.

Nestlé, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart are some of the multinational organisations who have somewhat embraced the ‘shared value’ approach. These successful global businesses have shown that they are capable of creating value for shareholders as well as for society in general. In many cases they are building partnership and collaborative agreements with external stakeholders (including suppliers) hailing from different markets. Evidently, these businesses are reconceiving their products as they are taking a broad view of their purchasing and procurement and on production activities. Several multi-national organisations are looking beyond their short-term profits for shareholders. They are also looking after their other marketplace stakeholders. Many multinational organisations are redefining productivity in the value chain and enabling local cluster developments to mitigate risks, boost productivity and competitiveness.

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Two Case Studies:

#1 Nestlé

Nestlé’s business principles incorporate the 10 United Nations Global Compact Principles on human rights, labour, the environment and corruption. It transpires that Nestlé is an active member of the Compact’s Working Groups and Initiatives. ‘Creating shared value’ has become an integral strategy of how Nestlé does its business. In a nutshell, this approach is focusing on stakeholder engagement as well as environmental sustainability. Nestlé maintains that it complies with international regulatory laws and acceptable codes of conduct, as it improves its company’s operations. Yet, at the same time it is nurturing its suppliers’ (the farmers’ in the developing countries) talents. Nestlé has revisited its numerous processes and its value chain activities. Each stage of the production process, from the supply chain to transforming resources adds value to the overall end product, for the benefit of the company itself. Nestlé sources its materials from thousands of farms; many of them are situated in poorer rural regions of the world. Nestlé provide training to their supplies  in order to encourage sustainable production whilst protecting their procurement, standards and quality of their raw materials. This brings positive, long-term impacts on the local economy. At the same time, the suppliers are running profitable farms, as they are offering their children a better education. Moreover, both Nestlé and the suppliers are committed to protecting their natural environmental resources for their long term sustainability. In their corporate site, Nestlé indicate that their key performance indicators for responsible sourcing include;

  • 89.5% of Nestlé‘s suppliers comply with the brand’s Supplier Code.
  • Nestlé’s sources 11% of its cocoa through the Nestlé Cocoa Plan, where they have trained more than 27,000 farmers and distributed more than 1,000,000 high-yield, disease-resistant cocoa plantlets.
  • Nestlé helped 14 cocoa cooperatives achieve UTZ or Fair Trade certification.
  • Nestlé purchased 133,000 tonnes of green coffee through Farmer Connect, trained more than 48,000 farmers and distributed 12 million coffee plantlets in 2012.
  • 80% of the palm oil that Nestlé purchased this year was RSPO compliant, out of which about 13% was traceable RSPO certified oil and 67% had GreenPalm certificates.
  • More than 8,000 farmers joined the Nespresso AAA Sustainable Quality™ Program in 2012 and we’ve sourced 68% of Nespresso coffee through the AAA Sustainable Quality™ Program.

#2 The Intercontinental Hotel Group

The Intercontinental Hotel Group (IHG) reaffirm that they are successful in identifying innovative opportunities within the environment as they foster closer collaboration with the community. IHG have aligned their CSR report with the Global Reporting Initiative Scorecard. The hotel chain claims that it is envisaging reductions in energy consumption of up to 10% over the next three years. IHG plans to achieve this target by using an online sustainability tool named, ‘Green Engage. IHG suggests that this tool has helped them in measuring and monitoring energy, water and waste management. The international hospitality chain prides itself of a dedicated web page entitled Corporate Responsibility Report which outlines innovation, collaboration, environmental sustainability and sustainable communities. These laudable initiatives deliver education programs to employees, diversity initiatives, and environmental protection among others issues.  According to IHG, their key ‘Green Engage’ achievements in 2012 were the following;

  • Exceeded their three-year target (2010-2012) to reduce energy per available room by between 6 and 10% in our managed and owned estate with a reduction of 11.7%
  • 50% of IHGs’ hotels (2,250 based on January 2012 hotel figures) have used Green Engage as at 14 January 2013.
  • Reduced their carbon footprint in IHG owned and managed hotels by 19% per occupied room in a year
  • Achieved an absolute reduction in global carbon footprint in IHG hotels and corporate offices by 76,000 metric tonnes in a year
  • Launched a carbon calculator within IHG Green Engage using the industry approved carbon measurement methodology
  • Launched a Green Meeting checklist for IHG hotels
  • Developed further new features within IHG Green Engage such as multi-unit reporting and a water benchmark.

Evidently, many multinational organisations have taken on board Porter and Kramer’s latest notion, “creating shared value” as they work hard to ensure a sustainable and high quality supply of their raw materials. Some of these latest corporate responsibility developments are focusing on training of suppliers, improving social conditions, buying from cooperatives and paying premiums, and working with certification programmes (such as FairTradeEcolabels et cetera). Of course, all these initiatives create value through the supply chain, particularly for the smaller businesses and sole traders. Effective communication with stakeholders is a very important element of responsible business behaviour. This contribution suggests that through stakeholder engagement, businesses are identifying emerging issues, shape their responses and continue to drive improvements in their financial performance.

This contribution was published in the TimesofMalta.com:

http://www.timesofmalta.com/articles/view/20130523/business-comment/Leveraging-organisational-performance-through-shared-value-propositions.470940

Similar contributions:

http://www.timesofmalta.com/articles/view/20130124/business-comment/Creating-shared-value-for-long-term-sustainability.454548

Additional Links:

Blogs about ‘Shared Value’

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