Standardizing ESG Reporting Is ‘Impractical,’ But Canada’s Public Pensions Want It: Think Tank

ESG stands for environmental, social, and governance. Deemerwha studio/Shutterstock

Companies face pressure to adhere to standardized frameworks for environmental, social, and governance (ESG) reporting, similar to those for financial reporting to stakeholders.

But the subjective nature of ESG reporting makes it “impractical” and “extremely costly” for companies to do in a standardized way when compared to the more objective financial reporting, say experts at the Fraser Institute.

The heads of Canada’s eight leading pension plan investment managers, representing some $1.6 trillion in assets, called for companies to adhere to the Task Force on Climate-related Financial Disclosures framework in 2020.

Such frameworks, among more than 600 available to companies, don’t represent the varied opinions and interests of stakeholders, said Elmira Aliakbari, director of the Fraser Institute’s Centre for Natural Resource Studies, and Steven Globerman, a senior fellow at the Fraser Institute, in an essay published April 21.

Importance to Stakeholders

In financial reporting, what is important or “material” to stakeholders is easier to define, Aliakbari and Globerman said. It is defined as material “if the omission or misstatement of that information would affect the judgment of a reasonable person in making a financial decision.”

When evaluating what is material to ESG—that is, what must be included in the reporting for stakeholders to make investment decisions—big differences in opinion exist among stakeholders. For example, they may have different views on diversity requirements in employee hiring, or on the importance of reducing emissions.

“They may even have conflicting views on specific critical ESG issues such as the causes and consequences of climate change,” the essay authors said. “Given the likely divergence of viewpoints on the importance of specific ESG issues, standardizing ESG disclosure across public companies will inevitably involve value judgments thereby making the process political and costly.”

Scope

Aliakbari and Globerman said that the costs of ESG reporting are “orders of magnitude greater” when frameworks are applied uniformly across broad segments of a national economy.

They gave the example of clothing manufacturers and the banking sector both having to provide the same kind of reporting on labour standards. It’s a more relevant issue for the clothing manufacturers, but the banks would still have to pay to collect and report the same data.

If the scope of the framework is too broad, it becomes pointless because companies can more easily leave out unfavorable information and the benefits ESG is supposed to provide stakeholders would be lost,  Aliakbari and Globerman said. Yet a cost is still associated with collecting, processing, and disseminating the required information. The costs would thus exceed any benefits.

However, if the framework is too specific, it doesn’t fit a broad set of companies and circumstances and it can also make companies reveal proprietary information to competitors.

Monetary Value

Another argument the authors make against standardized ESG reporting is that it’s hard to put a monetary, quantifiable, value on the outcomes.

“For example, we can measure the number of minority group board members for a company, but there is no practical way of assigning a monetary value to the racial or gender composition of board membership.”

They said research that has evaluated attempts to put a dollar value to human resources have always failed. “Employee valuations are either arbitrary or unverifiable,” Aliakbari and Globerman said.

ESG reporting standards proposed by the U.S. Securities and Exchange Commission would have companies estimate how much financial loss they could suffer due to the physical impacts of climate change. “Predicting the future impact of climate change relies on several assumptions fraught with uncertainties,” the authors said, citing research to that effect.

Enforcement is another problem, they said. In financial reporting, price data or industry benchmarks are helpful for verification, but ESG reporting relies heavily on internal information and the criteria are more subjective.

In conclusion, they said, “implementing and enforcing a standardized ESG reporting framework that is applied to all public companies is economically impractical, if not technically impossible, owing to the distinctive features of ESG reporting, which differentiate it from financial reporting.”