Annual reports should inform society – not just shareholders – about vital issues such as the financial health and environmental impact of organisations, says Professor Alan Jagolinzer of Cambridge Judge Business School.
By Professor Alan Jagolinzer
Corporate financial reports aren’t usually considered ‘page-turners’, and the people who typically read them – stockholders, analysts and the media – normally focus on the business performance narrative, which might include growth in revenue, profit and dividends. This limited focus is unfortunate, however, since I tell students that financial reporting is a public policy initiative.
Financial reports can and should serve as a tool to inform society–not just people with a direct financial stake in a company–about how the organisation is, or is not, addressing crucial human-impact issues such as providing life-enriching services or affecting climate change.
One of my favourite examples I discuss with students is the 2014 annual report of Switzerland-based pharmaceutical company Novartis. On its cover, Novartis depicts a patient and medical professional walking arm in arm, dressed in blue hospital gowns. This cover photo hints that Novartis’ financial health affects patients and caregivers who rely on Novartis’ life-enhancing technology.
The annual report was compiled as the Ebola virus threatened to become a global pandemic. Inside the report, Novartis declared: “We are actively searching our compound library and evaluating any molecules that may be effective as a potential future Ebola treatment.” It’s obvious that investors and financial stakeholders would care about the financial viability of Novartis’s drug research programme. However, as is evident in today’s environment, global society should care as well. Right now, I believe everyone should be paying very close attention to the financial health of companies like Pfizer, Moderna, and AstraZeneca, because any misutilisation of financial resources, whether intended or unintended, might impede these organisations’ ability to service society with much-needed vaccine technology and distribution.
Likewise, I believe that society needs to pay more attention to the financial viability of other enterprises that directly impact human need, such as companies that build infrastructure like roads, railways and hospitals, and airlines, currently in deep financial distress, which transport people and cargo including mail, prescriptions, repatriated remains of the deceased, and humanitarian food aid.
The societal danger of not recognising, anticipating, and intervening on financial malfeasance is reflected in the January 2018 collapse of UK government contractor Carillion, which was building schools, hospitals and roads, and providing critical services ranging from cleaning to school lunches. Financial shareholders lost a significant amount of capital in the company’s insolvency. Society lost as well because cities and towns didn’t get their hospitals and other projects built on time or on budget as more than 400 contracts were suddenly disrupted. A scathing UK parliamentary report cited “recklessness, hubris and greed” among directors.
A company’s obligation to its pensioners is another area where credible financial reporting serves a vital societal issue – and this is an area where poor pension-obligation performance also impacts shareholder performance. A report last summer by Morgan Stanley looked at 50 companies with the largest shortfalls in their pension funds, and found that those companies with pensions underfunded by more than 5% of market capitalisation “significantly underperform” both broader equity markets and their sector peers.
Like underfunded pension liability, I am increasingly concerned that environmental issues – ranging from toxic clean-up obligations to stranded asset write-downs – are being severely underreported in annual reports. I believe that firms are not allocating enough money to cover these potential environmental liabilities. If companies can’t pay for these obligations, then the costs will fall to taxpayers, or the clean-ups simply won’t be performed.
Finally, I think that more people should understand what United Nations accounting experts said more than two decades ago, that conventional financial reporting “routinely ignores environmental issues unless they have a financial impact of sufficient materiality.” There are two facets of environmental and social impact that are not yet fully accounted for in traditional financial reports: the effect of social and environmental climate change on the financial viability of the enterprise and the effects of the enterprise business operations on social and environmental climate change.
Thankfully, multiple agencies including Accounting for Sustainability (A4S), the International Accounting Standards Board (IASB), the Task Force for Climate-related Financial Disclosures (TCFD) and the Climate Disclosures Standards Board (CDSB) are engaged in developing better reporting on these issues. Each agency actively solicits stakeholder feedback to inform their proposed solutions. Since these problems affect humanity beyond those who merely hold financial interests in certain companies, it would be helpful if more people – from broader society – would learn about these initiatives and help support their development.
Alan Jagolinzer is Professor of Financial Accounting and Co-Director of the Centre for Financial Reporting & Accountability at Cambridge Judge Business School. He teaches on the Cambridge Master of Accounting (MAcc) and other programmes at the School.