Investor Confidence in Corporate Climate Management and Disclosure
Financial markets process all manner of information about company performance. In the investment research and financial analysis of publicly-traded companies, “financial performance” is often used to refer to the measurement and interpretation of a company’s earnings per share, operating profit, stock price performance and deviation, debt/equity ratio, implied growth rate, dividend yield, or other fundamental indicators of its ability to compete in the marketplace. “Non-financial performance,” on the other hand, is sometimes used to refer to business and management measures such as customer loyalty, product quality, inventory cycles, innovation, employee turnover, and the like. Non-financial performance is also increasingly used to refer to business areas connected with environmental sustainability and other corporate social responsibilities such as stakeholder responsiveness, human rights, labor conditions, and social accountability.
In addition to managing financial performance, businesses also make and manage voluntary commitments beyond legal compliance, for instance, to targets for energy efficiency or air emissions reductions. With the advent of corporate social responsibility and sustainable development, many companies now publish corporate reports outlining business activities or practices that address these important environmental management objectives. Company statements regarding greenhouse gas emissions and reductions, or energy efficiency, may create new performance responsibilities for firms and their managers. Likewise, company statements in the form of non-financial commitments in specific operating functions, like the management of greenhouse gases or energy efficiency, potentially create a reporting responsibility to existing shareholders or interested investors who may rely on this particular type of corporate information in the total mix of their investment decisions.
In the United States, the Securities and Exchange Commission (SEC) regulates and enforces disclosure requirements. To promote truth and transparency in securities markets, and deter the use of false or misleading information, the SEC has promulgated specific rules and the courts have interpreted their application. For instance, the Code of Federal Regulations makes it illegal “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” (17 C.F.R. 230)
The legal threshold or requirement for determining what type of information must necessarily be disclosed for financial securities purposes relies principally on the concept of materiality. “The term material, when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.” (C.F.R.) The courts are frequently asked to determine whether or not the Act’s proscriptions have been violated, whether statements of fact are material, and whether the material facts are misleading.
A material statement is defined as “information that would be important to a reasonable investor in making his or her investment decisions,” the omission of which would have significantly altered the “total mix” of information made available. The leading case on the definition of materiality by the United States Supreme Court adopted an objective standard of materiality “requiring a showing of a substantial likelihood that, under all circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of the information made available.”
Although past performance is no indication or guarantee of future results, and there is no affirmative legal duty to always meet or disclose voluntary environmental and social objectives, there is a sort of due diligence that is necessary to make good on explicit company commitments or at least make some attempt to do so in good faith. There is also an argument to be made that a company’s greenhouse gas emissions and reductions commitments create the expectation for information about its relative performance, information that an investor may justifiably rely upon to make decisions. Although an individual investor may be subjective in a conscientious investment decision, a large institutional investor or a class of socially responsible investors (SRIs) may have a more objective commercial basis for relying on company statements, policies and practices related to climate change and emissions reductions. In other words, once a company states a position on climate change, there is no going backwards in the marketplace without first retracting or re-establishing performance expectations once they are made.
In the competitive, and socially desirable, drive to address and take greater responsibility for external impacts associated with doing business, some companies may overlook the degree to which certain socially responsible investors will rely on company reports and statements designed to demonstrate a voluntary corporate commitment to address climate change. It is reasonable to expect that some investors now consider environmental performance information, and increasingly, greenhouse gas emissions management information, as another set of non-financial performance measures by which a company can be evaluated as a matter of both financial performance and social conscience. Whether or not greenhouse gas emissions statements or reduction commitments are “material” within the current legal interpretation of U.S. securities disclosure laws, or whether such types of environmental or social disclosure should be required, is a growing area of interest for investors as well as an important concern for corporate management.
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David Monsma is assistant professor of law and social responsibility at Loyola College in Maryland and formerly, director of business and environment at Business for Social Responsibility.
