Since the 1930s, we have looked at things through a financial lens, and I’m afraid that cannot pertain in the changed world of the 21st century. In 1994, I spoke about an inclusive approach to governance—that a board should understand the major stakeholder groupings relevant to the company and try in its strategic decisions to meet the reasonable expectations of stakeholders. The first stakeholder report was, in fact, issued by Ben & Jerry in Vermont in 1995. And in Boston, Bob Massie and Allen White brought up the fact that 80% of value is found in intangible assets not on the balance sheet (see Exhibit 1), and in 1997 they started the Global Reporting Initiative (GRI). I recommended sustainability reporting as a listing requirement, and the Johannesburg Stock Exchange adopted the requirement in 2002. The world’s top body on accounting, IFAC [the International Federation of Accountants], said that financial reporting is critical, but it’s not sufficient. When I was chairman of the GRI, I said that those factors that are critical and relevant and material to the business of the company should be embedded in its short-, medium-, and long-term strategic thinking. If you look at sustainability, it involves three aspects: economic growth, social responsibility, and environmental protection. Any board of directors that develops a strategy and ignores how the company makes its money—and how it impacts on society and the environment—is actually failing in its duty of care to the company.
What we were trying to do was communicate value creation by all these means. As we moved into the 21st century, there are just these unbelievable megatrends. We have the unresolved global financial crises. We have the climate change crises. We have radical transparency. We have greater expectations from stakeholders than ever before. There’s an energetic activism from civil society today that we never had in the 20th century.
A Changing World
We have 7.4 billion people on planet Earth at the moment. In my book, Transient Caretakers, I describe the planet as a hotel. And last night 1.8 billion people went to bed either hungry or without potable water—yet by 2050 we’re going to have another 2 billion people on planet Earth. In that context, if you think you can carry on business as usual, welcome to the edge of stupidity.
Young people think differently. When speaking in Frankfurt to PhD students about the global financial crisis, one student said to me, “You and your generation created for us the GEC—the global environmental crunch.” That’s what we’ve got to deal with. Fiscal is nothing; we can fix it up. But now we’ve got to deal with the environmental issue.
It’s an absolutely changed 21st century. We have to learn to make more, but with less. We have a resource-deprived world—finite assets which have been used faster than nature is regenerating them. Yet we have an increased population with increased demand for product.
Stakeholder relationships have changed completely. The concept of just looking at the shareholder and the company is yesterday’s thinking. It’s a myth that shareholders own a company. They do not. Shareholders have certain rights. They’re important rights: to appoint the board, to get paid the dividend. And yet from the 19th century right through to the 21st century, you will see financial journalists write about the shareholders being the owners of the company. And of course, the board owes its duty of care to the company. But in this decision-making process it must take account of the needs, interests, and expectations of all stakeholders, which of course include the shareholders.
We used to ask how much money has the company made. But how the company makes its money has become a critical issue in the 21st century, because how it makes its money results in positive and negative outcomes on society and the environment. The concept of value has changed completely. We look at the company’s impact on these three critical aspects: the economy, society, and the environment. What are the positive impacts? What are the negative impacts? And we start getting to the concept of total value.
The critical issue is embedding those sustainability issues into the strategy of the business. It’s not these glossy “green-washing” reports. You’ve got ESG [environmental, social, and governance] factors that are critical today in analysis and coming to a judgment call about the investment.
When you think back to our fellow directors of the 19th century, there were a billion people on the Earth. I think they were entitled to look around and say, “This planet has limitless resources. This planet has an infinite capacity to absorb waste.” And so they carried on business on a “take, make, waste” philosophy. None of them could have seen the population explosion of the 20th century. But that’s what happened. Those directors took natural capital, applied human capital, cut down trees and made furniture, sold the furniture, developed systems, brands. What did we report on? The top two capitals—financial and manufactured. As if the others had disappeared. Of course, they hadn’t.
These are the six capitals: financial, manufactured, human, intellectual, natural, and social, which includes relationship capital (see Exhibit 2). Consider one of the world’s great companies, the Coca-Cola Company. If I put a bottle on the table here that had no name on it, you’d all know it’s Coca-Cola. But as you all know, civil society started a legend that one of the causes of obesity in children is Coca-Cola. This resulted in Coca-Cola completely changing its thinking and its strategy. Coca-Cola said, “We will not market to children under the age of 12. We will provide nutritional labeling on our cans and our bottles. We will make our products with as low a calorie count as possible. We will encourage physical activity to children at all our bottling plants around the world.”
Isn’t it extraordinary when people don’t realize that every company has two societies? It has its own society—its suppliers, its customers, its managers, its employees. But if it’s got a business here in New York, it operates in the New York community. It operates according to the mores acceptable to people living in the United States of America. It has to make sure that it’s fulfilling its role as a responsible citizen in those societies. Integrated thinking is understanding, knowing, and then planning how the company makes its money, and how it is going to create value in the long term in a sustainable manner, in a world where the demand for product is going to increase and yet we have less natural assets.
I love going into companies as a consultant. Just give me 48 hours; you can feel if that company is operating well. There is what I call the tone at the top. But there’s a tune in the middle, and there’s the beat of the feet at the bottom. If you get your strategy right and you get the buy-in from the top to the bottom, you can get ordinary people to achieve the most extraordinary things. But if you don’t get that buy-in, you can have PhDs from the top to the bottom, but you won’t even achieve ordinary things.
And those people at those three levels today include the millennials. They don’t buy into a strategy in which you’re just complying with what’s mandated, just doing your financial statements and not applying your mind to the other critical aspects that we’ve spoken about already. Do you think doing your financial statements according to FASB over and over again, and not applying your mind to what is critical or relevant or material to your business from an ESG point of view, is going to lead to a different result? And that you’re going to actually create value in the 21st century? The answer is in the negative.
The critical issue is embedding those sustainability issues into the strategy of the business.
The second stage of integrated thinking is to appreciate that we have this challenge and we’ve got to change our mindset at the board. We’ve got to change the corporate toolbox. We can’t with the same tools think we’re going to create something different. Corporate social responsibility and corporate social investment—these are yesterday’s thinking. You need to embed these issues into your business strategy.
The third stage is to think about the six capitals. How does the company make its money? If management understands the legitimate and reasonable needs, interests, and expectations of the company’s stakeholders, they can develop strategy on a more informed basis.
We have moved from share value to shared value. We direct through the board the company’s operations to generate longterm value for its business and society. Success depends on internal financial returns. This is what a lot of people don’t understand about integrated thinking and integrated reporting. If you look at our definition of outcomes, it’s internal and external. You need that internal outcome of profit, of making money—if you don’t, you’re going to have corporate failure. But you have an external outcome as well, with that product impacting on society and the environment.
I believe ACCA, the Association of Certified Chartered Accountants, got it right: “Over the past few decades, sustainability issues have slowly become mainstream, and there is a shift from the creation of share value to a generation of shared value. Through shared value creation, a company links its operations to generating long-term value both for its business and for society as a whole, and defines its success in terms of internal financial returns and external social and economic results. Ultimately, creating shared value acknowledges both the work that corporations need to do to reduce negative impacts on society as well as, and more fundamentally, how they can be part of progress on global challenges, such as climate change and the enforcement of human rights. Following this shift, there is a new trend of corporate reporting: the integration of financial and nonfinancial concerns into one accounting tool, known as integrated reporting.”
We have moved from share value to shared value.
Deciding What’s Relevant
I use the metaphor of an octopus. In the U.S., you have to do financial statements according to FASB and have to have them audited. That’s the one arm of the octopus. You might need to do carbon disclosures. That’s another arm. You have this mass of data we spoke about earlier. The board has to spend more time applying its collective mind to this mass of information because if it doesn’t, who else is going to extract what is pertinent and relevant?
Research has shown that up to 20% of directors don’t understand the financial statements. And up to 80% of directors don’t even read the sustainability issues—and out goes an annual report. The other incredible thing is that the accountants in the room will know that the financial statements today are incomprehensible to 99 out of 100 people. But we would apply our minds to these statements and take out the information in clear, concise, and understandable language and put it in the head of the octopus: the integrated report. Show how it’s interconnected and imbedded into strategy.
Can you discharge your duty of accountability as directors if that which you report is not understandable? The answer must be in the negative. That’s what we have to do as directors: take out from this mass of data the knowledge which people really need. Investors need to make investment decisions. Trustees need for pension funds to discharge their duty of care to those ultimate beneficiaries.
Reporting Is Not What It Used to Be
How is IR different? It’s integrated. It’s all forms of capital, short-, medium- and long-term. It’s got greater transparency. It’s concise and material. It’s technology-enabled. You’re entitled to say on your website: “You want more information? Drill down. It’s all there.”
There are two interrelated aspects of value: value created for the organization itself, which enables the financial return to the providers of financial capital, and stakeholders and society at large. The ability of an organization to create value for itself is linked to the value it creates for other stakeholders.
We’ve got to change that corporate toolbox. We just can’t carry on as before. And we need to see that the world is not what it used to be. Reporting is not what it used to be. Strategy is not what it used to be. Taxation is not what it used to be. Transparency is not what it used to be. Value is not what it used to be. And raising capital is not what it used to be. So we need that mindset to change.
In the 19th century, the concept of limited liability was developed, and the limited liability company has become the chosen medium in which business is conducted. And I believe integrated thinking and reporting is a concept whose time has come.