In part one, Mark McElroy examined three types of integrated report structures, as identified by the Global Reporting Initiative (GRI), along with their limitations. Here, he explores a new methodology that puts stakeholder primacy front and center in integrated reporting.
Shareholder Primacy
This brings us to the present moment and to the content of the <IR> framework released by the IIRC this past December. What can we say about the prevailing theory of performance in most of what passes for mainstream practice in integrated reporting and in the <IR> framework itself?
First, in the <IR> framework the story is a mixed one. On the positive side, the IIRC has taken a very strong and important stand on the question of how integrated reports should be prepared. Performance should be interpreted, they say, in terms of what an organization’s impacts on vital capitals are, insofar as such capitals are important to both organizations themselves and others whose well-being depends on them. This is the capital-based theory of sustainability and the scholarship behind it is strong.
Now while under most circumstances, an embrace of capital theory would signal a co-commitment to stakeholder primacy, in the case of the IIRC it does not. How so? Where is the smoking gun, if any, in the <IR> framework that might suggest otherwise — that the <IR> framework holds to the shareholder primacy doctrine instead? The answer is here (section 2.7):
When these interactions, activities, and relationships [that affect the value of non-financial capitals for non-shareholders] are material to the organization’s ability to create value for itself, they are included in the integrated report. This includes taking account of the extent to which effects on the capitals have been externalized (i.e., the costs or other effects on capitals that are not owned by the organization).
Translation? When impacts on non-financial vital capitals of importance to the well-being of others affect the value of the organization’s own financial capital, they should be regarded as material for integrated reporting purposes. No other non-financial impacts need be considered. Pay no attention, in other words, to the effects organizations’ activities may have on the well-being of non-shareholders, independent of their effects on shareholder value.
What this effectively does is transfer the materiality criterion for financial reporting (a shareholder primacy principle of the highest order) to integrated reporting, as if the latter necessarily shares the narrow doctrine of the former. If a social or environmental impact has no effect on shareholder value or the financial performance of the organization, it need not be considered. So says the new <IR> standard.
Consider the implications of this. Today’s perfectly legal, and yet utterly unsustainable, practices of, say, emitting greenhouse gases or consuming water in excessive quantities need not be included in an integrated report. Why not? Because despite the fact that externalized costs may be involved, such externalized costs may not, and very often don’t, affect shareholder value or financial performance. The first part of the IIRC criterion trumps the second part in many if not most cases.
The MultiCapital Scorecard™
My own view is that organizations should: a) follow the IIRC’s guidance on reporting performance relative to impacts on vital capitals, while at the same time b) ignoring its guidance to do so only for impacts that affect shareholder value. Organizations have impacts on vital capitals of importance to non-shareholder well-being too, and to suggest that they be ignored in integrated reporting is a non-starter.
Still, even if one were to embrace the idea of measuring and reporting performance relative to impacts on vital capitals (as the <IR> framework advises), while at the same time rejecting the shareholder-centric view as I have suggested, can that in fact be done? Are there any methodologies that actually put the stakeholder primacy theory of performance into action in integrated measurement and reporting?
The answer, I’m pleased to report, is yes. Earlier this year, a UK colleague of mine, Martin Thomas, and I completed development of a context-based integrated measurement and reporting system called the MultiCapital Scorecard™ (MCS). It is already finding its way into leading corporate sustainability programs, including at Ben & Jerry’s, a wholly owned subsidiary of Unilever in the US.
The MCS is grounded in the stakeholder primacy theory of performance and therefore measures and reports performance in terms of impacts on all capitals. This includes impacts on financial capital for the sake of shareholders, but not in any sort of superordinate way in which the value of financial capital necessarily supersedes the value of all other capitals. The MCS puts impacts on all capitals on a level playing field.
In practice, the MCS starts out by defining organization-specific duties and obligations to have, not have or manage impacts on vital capitals in ways that can, do or should affect stakeholder well-being. The sustainability performance of an organization can then be determined by simply comparing its actual impacts on vital capitals to performance norms so defined. Performance norms, in turn, are context-based in the sense that they reflect whom an organization’s stakeholders are, the vital capitals it either is or should be having impact on in particular ways, and what its impacts therefore would have to be in order to be sustainable.
The MCS is also structured in accordance with the Triple Bottom Line. We do this by correlating impacts on vital capitals with each of the three bottom lines as follows:
- Social Bottom Line: Expresses performance relative to context-based assessments of impacts on human, social and constructed, or built, capitals
- Economic Bottom Line: Expresses performance relative to context-based assessments of impacts on internal and external economic capitals
- Environmental Bottom Line: Expresses performance relative to context-based assessments of impacts on natural capitals
By assessing impacts on vital capitals of importance to all stakeholders, and in a non-hierarchical way, the MCS makes it possible for organizations to avail themselves of true, Triple Bottom Line, integrated measurement and reporting and not just enhanced financial reporting. Indeed, at this point in time, the MultiCapital Scorecard™ is the only such method that does.