Isomorphism in ESG and Sustainability reporting14 min read
In recent times, the term greenwashing has often been used to represent sustainable practices which, however, do not translate into real actions. Therefore, actions are “painted” green, when they are not green at all.
More rarely, the concept of isomorphism in ESG and Sustainability reporting has been discussed.
This approach does not necessarily have to be linked to greenwashing. But in specific cases, isomorphism and greenwashing could coincide.
But let’s do it in an orderly fashion.
For now, let’s start by defining what isomorphism means. And why this phenomenon is occurring in the area of Sustainability and ESG.
What is isomorphism?
According to Douglas Hofstadter, the word isomorphism applies “when two complex structures can be mapped onto each other, in such a way that to each part of one structure there is a corresponding part in the other structure, where corresponding means that the two parts play similar roles in the respective structures” [Hofstadter (1979). Gödel, Escher, Bach: an Eternal Golden Braid].
In sociology, an isomorphism is a similarity of the processes or structure of one organization to those of another, be it the result of imitation or independent development under similar constraints. There are three main types of institutional isomorphism: normative, coercive, and mimetic. The development that these three types of isomorphism can also create isomorphic paradoxes that hinder such development. Specifically, these isomorphic paradoxes are related to an organization’s remit, resources, accountability, and professionalization [Caemmerer, Barbara, and Marck, Michael (2009). The Impact of Isomorphic Pressures on the Development of Organisational Service Orientation in Public Services].
More simply, we can define isomorphism as follows. That is to say the tendency of people (individuals or groups) or systems belonging to a specific field to resemble each other in some basic requirements of practices and styles of thought, by virtue of mimetic, coercive, and regulatory mechanisms.
Effects of isomorphism in ESG and Sustainability reporting
You may have noticed a certain convergence of content when reading the various ESG and Sustainability reports.
Let us distinguish and immediately eliminate the cases of the so-called “coercive isomorphism” (convergence of contents that are dictated and required by law.)
In this case, more than ever, similarity is required. If it comes to regulatory requests, zero tolerance is the approach to be adopted (compliance alike). Therefore the phenomenon should not surprise at all.
It is not surprising that regulators are demanding ever more robust ESG and Sustainability disclosure. This obviously leads to common elements.
On the one hand, this convergence also facilitates the users of these reports, who are thus able to find all the elements exactly where they expect.
On the other hand, however, this limits the development of innovative practices to be implemented in reporting.
This incredible convergence means that all players are adopting common practices, without trying to differentiate or do anything original.
The results below are taken from a Teneo study that analyzed 200 reports from S&P 500 companies published between January 1 – June 30, 2022 (generally called “Sustainability Reports”). From these documents, convergence elements such as common content and design elements of 2022 Sustainability Reports, along with useful examples and recommendations are deduced.
Let’s start from the base.
Most of the 2022 Sustainability Reports included the term “Sustainability” (31%) or “Environmental, Social, Governance” / “ESG” (33%) in the title of the document. Other titles less used and common included “Corporate Responsibility” (14%) and “Corporate Social Responsibility” (7%). Both of these terms can evoke corporate philanthropy and/or community initiatives, which are certainly important but can reflect a somewhat dated and limited view of a company’s sustainability strategy.
Sustainability reports ranged from 11 pages to 273 pages, with an average length of 77 pages. This is slightly longer than the average length of 70 pages in 2021. Most reports (53%) had between 50 and 100 pages. 2022 Sustainability Reports of over 100 pages were more common among companies with a market capitalization of $ 20 billion or more.
More than two-thirds of the 2022 Sustainability Reports (70%) included a table with key ESG data.
Data tables can help investors and other interested parties easily find the information that is most relevant to them. Additionally, companies may want to consider providing three-year trend data in a downloadable Microsoft Excel format to make it even easier for investors to capture the company’s ESG data.
More than half of the companies surveyed (62%) issued a press release announcing their 2022 Sustainability Report. Press releases can provide stakeholders with an outline of the report’s key points, including new initiatives or progress updates on ESG goals.
Most companies released their 2022 Sustainability Report within 4-6 months of the end of the fiscal year, with April being the most popular month (39%), followed by March (18%) and June (17%).
About 27% of companies included interactive ESG microsites within the company website. While interactive websites can be a creative way to communicate the company’s ESG strategy, companies should also ensure that a PDF version of the report is readily available. 93% of the 2022 Sustainability Report has been made available in PDF format.
Adhering to a correct reporting format is increasingly important to ensure that stakeholders have a clear picture of your sustainability efforts. For example, the Corporate Sustainability Reporting Directive (CSRD) proposal to change Europe’s Non-Financial Reporting Directive (NFRD) requirements to digitally label information stems from difficulties in finding relevant ESG data and could substantially change reporting requirements for US companies. This will be a key development in support of wider standardization and dissemination of ESG data, with requirements for automatic reading and “flagged” information supporting EU plans for a central “repository” of all financial data and non-corporate financials. For businesses, this requires careful consideration of IT and infrastructure requirements and integration.
Letter from the CEO or Board
Most of the 2022 Sustainability Reports (89%) included a letter from the CEO, of which 10% also included a letter from the Board. In some cases, the letter from the CEO was written together with the Board or the Chief Sustainability Officer of the company.
Letters from the CEO offer companies the opportunity to appropriately signal to stakeholders that ESG is a priority for senior leadership. A newly appointed CEO can use the CEO’s letter to communicate his or her renewed vision for the company and its sustainability strategy. Likewise, the Board’s letters may also signal its focus on ESG oversight, an issue of growing importance for institutional investors.
Consistent with results in 2021, the vast majority of the 2022 Sustainability Reports described how ESG is supervised internally. While most companies have stated that they adopt a cross-functional team approach to managing sustainability initiatives, approximately 72% of 2022 Sustainability Reports also identified the executive with primary responsibility for sustainability.
21% of the 2022 Sustainability Reports found that the Chief Sustainability Officer or another ESG-focused executive was responsible for delivering the company’s sustainability strategy, while 10% found that the CEO held that responsibility. Generally speaking, companies have taken a variety of approaches to this problem.
The board’s oversight of ESG issues is also described in the vast majority of the company’s 2022 sustainability reports. Sustainability was most commonly overseen by nomination and governance committees (46%), while 14% of companies noted that sustainability monitoring was done by multiple board committees. Although the eligibility criteria are not well defined, 26% of the 2022 Sustainability Reports mention a Board member with “ESG” credentials and/or experience.
Half of the 2022 Sustainability Reports indicated that a formal materiality assessment was conducted to help determine ESG priorities. Just under half of the 2022 Sustainability Report (40.5%) also included an actual materiality matrix, while one-third (34%) included a disclaimer or qualifier on the use of the term “materiality” to avoid any confusion with other definitions of materiality, such as the SEC definition.
Materiality Matrices can be a very useful tool for stakeholders to gain insight into how the company determines its sustainability strategy.
Stakeholder engagement, another common component of the 2022 Sustainability Report, is generally the main mechanism for informing the company’s materiality assessment.
Diversity, Equity, and Inclusion (“DEI”) have become a common component of the 2022 Sustainability Report.
In response to increasing pressure from stakeholders to disclose details of DEI programs, progress, and metrics, companies have also started publishing separate DEI reports, allowing them to further articulate the evolution of their strategy and approach. In 2022, 47% of sustainability reports published diversity targets, 4% less than in 2021.
These numbers do not necessarily represent a decline in the number of companies that have publicly set diversity targets nor a decline in reporting on DEI measures. The decline is likely to indicate that these data are contained in a DEI report separate from the Sustainability Report. Companies are advised to include the DEI objectives within the Sustainability Report, even if a separate DEI report is produced.
Employee Demographic Data
91% of 2022 Sustainability Reports disclosed employee demographics, with 85% of diversity data at the executive / senior level. Although the vast majority of companies share this data and continue to disaggregate information on workforce diversity, there is a lack of uniformity in how companies define classifications as executive or race/ethnicity, making it difficult for shareholders to track and compare data between companies.
Promotion, Retention, and Hiring Disclosure
Due to investor pressure, companies are also reporting more and more recruitment, promotion, and retention rates for different employees. Quite often, companies reported new hires by gender (35%) and race/ethnicity (26%).
Promotion and turnover rates were reported less frequently (10-13%), possibly signaling ongoing challenges in talent development efforts in the current “war for talent” environment.
Companies continue to report purposefully on qualitative measures such as new programs, partnerships, and initiatives that add context and demonstrate a path to achieving previously defined goals.
Pay Gap Analyses
Just under one-third of the 2022 Sustainability Reports included information on employee pay gaps, a decrease of 6% from 2021. This does not mean that pay gap analyzes are falling out of favor, as audits continue to grow in popularity. The 2022 data suggests that transparency on the topic has probably stalled, or the data has shifted from Sustainability Reports to DEI reports.
In general, 32% of companies shared their adjusted pay gap, measuring the difference in median total pay across demographic groups by adjusting to factors such as role, seniority, education, experience, and position. Companies have often noted a commitment to “equal pay for the same job”. 16% of companies reported unadjusted or raw pay gaps, which tends to be a less lenient figure as it doesn’t take any of the above factors into consideration.
Unsurprisingly, all companies that shared raw pay gaps also revealed adequate pay gaps. 16% of the 2022 Sustainability Reports found that their pay gap analyzes were assured.
Use of Third-Party ESG Disclosure Frameworks
The use of third-party ESG disclosure frameworks in the 2022 Sustainability Reports continued to grow, with SASB and TCFD as the primary focus for institutional investors. This is a result of many large institutional shareholders essentially requiring companies to report to these reporting frameworks or risk losing their support for certain directors in office at the next annual shareholder meeting. As in the case of 2021, not all SASB or TCFD disclosures looked the same, as some companies did not disclose all components within the frameworks.
And while it is common to cross-reference SASB and TCFD indices in other corporate disclosures, investors and other interested parties may prefer the substance of the SASB and TCFD disclosures to be included directly in the indices. As in the case of companies that produce a DEI report separate from a Sustainability Report, companies that report to the SASB and/or TCFD indices separate from the Sustainability Report run the risk that investors cannot find such indices and conclude that the company is not divulging the information at all.
Use of External Assurance
Just over half (54%) of companies said the data for the report was externally assured. Of these, 51% provided only environmental data, while nearly 43% assured both environmental and social data. 5% of companies assured only social data, while less than 4% did not specify which ESG data was assured. Of the companies that indicated the third-party providing the external assurance, only one external assurance provider was used by almost 16% of the companies, while the second most common was used by 9% of the companies.
Sustainability Disclosure Developments Outside the U.S.
Mandatory reporting on ESG issues will become more prevalent across Asia-Pacific as regulators and exchanges seek to align with global best practices. However, there is still significant fragmentation between the markets.
In Australia, climate reporting is not yet mandatory but is expected to emerge under a new federal government that promises more climate action. Both securities and prudential regulators recommend TCFD reporting.
In New Zealand, climate information is mandatory for some companies starting in 2023.
Singapore also has new requirements coming into effect in 2023, including mandatory climate reporting for certain sectors, diversity disclosures, and sustainability training for directors. The SGX has indicated that the International Sustainability Standards Board (ISSB) standards will be incorporated into the mandatory disclosures once published.
In the Hong Kong SAR, mandatory climate disclosure for certain sectors is expected by 2025. Meanwhile, HKEX focuses on improving data transparency on issues such as board diversity with the launch of an information repository. Support was expressed for the ISSB framework.
In China, domestic entities are now required to disclose environmental information every year starting in 2022, while the securities regulator also requires listed companies to disclose any environmental sanctions.
These and other Asia-Pacific markets will also closely follow international developments in sustainability reporting, which are likely to impact the regional landscape. Investors’ expectations will also increasingly push companies to exceed local requirements to align with standards set in other markets.
The European Financial Reporting Advisory Group (EFRAG) has launched a consultation on the draft corporate sustainability reporting standards, offering a look at what companies will need to report according to the CSRD.
The new standards include the use of the dual materiality concept and consideration of the sustainability factors of the value chain. For example, the climate change exposure draft requires disclosure of “gross indirect emissions of GHG Scope 3 in tonnes of CO2 equivalent”, which includes emissions beyond the direct control of companies, including purchases and upstream travel.
In June 2022 the EU Council and the European Parliament announced that they had reached an agreement on the rules of the CSRD, reaching an important milestone toward the official adoption of the law.
In the UK, ESG reporting and disclosure expectations continue to rise for both listed and private companies. As of January 1, 2022, many UK companies are required to publish their first TCFD report according to the Financial Conduct Authority (FCA), a requirement already in place for larger companies.
Even the largest listed companies and some financial sector companies will need to publish a net zero transition plan under the TCFD framework, detailing how to decarbonize to achieve the 2050 targets. This will encourage more widespread adoption of published plans and the need for standards that allow for consistency and comparability will increase.
Finally, many UK and overseas issuers will need to include a statement in their annual financial report for financial years starting April 1, 2022, or after April 1, 2022, indicating whether they have achieved specific diversity targets.
The Future of U.S. Sustainability Reports
Global regulation will certainly shape the ESG reporting landscape in the coming years. The SEC’s final rules on climate disclosure and draft rules on human capital management disclosure are expected in autumn 2022. The ISSB is also expected to publish its final framework for reporting on climate and ESG criteria by the end of 2022. Final rules are expected from the European Union’s CSRD in 2023. While there is optimism that there will be some consistency across all three outreach initiatives, companies are likely to encounter substantial differences.
As regulators also step up policing for so-called “greenwashing,” it is imperative that companies not only continue to disclose material ESG issues but also ensure that disclosures are verifiable.
The situation in the Sustainability / ESG Reporting arena so far is one of incredible convergence.
All actors, including leaders and trendsetters, are tacitly aligned and adopt common practices, without trying to differentiate themselves or do anything original. For example:
- degree of employee involvement in corporate matters
- any connection or involvement with risk functions
- amount or overview of objectives not achieved in previous periods
- areas for improvement
- clear distinction between corporate objectives that do not concern and/or include the sustainability
Most likely, based on sociological differentiation, what is happening in Sustainability / ESG Reporting is a mimetic isomorphism. There is no innovation, ambition, or competitive advantage to bring best practices to advance further and further. They are peer benchmarks with the minimal ambition to take risks.
Let’s see what the future brings us.
Featured image by Reed Mok on Unsplash
Source: “What’s ESG Got To Do With It? The Current State of U.S. Sustainability Reporting”, September 26, 2022 (Teneo)