Sustainability Reporting & Financial Performance – literature Review
Introduction
Sustainability has become an increasingly important issue as it provides the stakeholders with an understanding of organizations role and its contribution to the society (Shad, et al., 2020). The pace of growth of sustainability reporting requirement emerged when the studies claimed it to be linked with the improved business performance. Many studies indicated both positive and negative impact of sustainability reporting on the firms’ performance. As a result of which, two debates emerged (Herbert, et al., 2020; Buallay, 2019; Gnanaweera & Kunori, 2018; Asuquo, et al., 2018). The first was about the “increased costs associated with disclosures” while the other was the “value creation” (Carp, et al., 2019; Plumlee, et al., 2015). For the purpose of this research, value creation debate will be considered alongside with the reduction in cost of capital.
In the recent past decade, sustainability reports have been recognized as the vehicle through which the firms documents the non-financial issues, from the customer service to climate change that can contribute towards the firm value creation. The way the organizations tend to respond towards the non-financial concerns can lead to firm’s growth through increased reputation, positive innovation and ultimately enhanced profitability (Buallay, 2019). In this context, the question of concern is to analyze sustainability reporting as a business strategy for confirming firm’s growth. This report has been documented in order to analyze the literature review associated with sustainability reporting and its impact on firms’ growth. The literature review will unfold several indicators of sustainability reporting alongside the indicators of firms’ growth including its sales growth, return on assets, net profit margin, gross profit margin and cost of capital.
Literature Review
The efforts of firm towards the sustainable development in recent decades can be accessed by gauging the environmental protection and social actions taken by the entity. Only deeming the social responsibility by the management doesn’t bring its image, but making the actions public via sustainable reporting has recently appeared to be the most crucial strategic decision taken by firms. Several researches (Ahbabi & Nobanee, 2019; Asuquo, et al., 2018; Buallay, 2019; Hahn & Kühnen, 2013) have examined the role of sustainability reporting in generating economic benefits for the companies. It has been documented by several studies that the social and environmental efforts can substantiate in face of streamlined actions of the companies.
Sustainability reporting has so far attracted the attention of several corporations, researchers, regulatory bodies and government. Cui et al. (2018) postulated with growing sustainable development efforts, the companies are facing increasing opportunities and incentives to disclose their sustainability practices. Through sustainability reporting, the firms can indicate their own efforts towards dealing with strategic issues while keeping in view the sustainability concerns. The increased emphasis on the sustainability reporting has led the researcher bodies in analyzing the association between the sustainability disclosure and firms’ financial performance. However, little evidence is present on analyzing the deeper role of sustainability reporting on market value, profitability, cost of capital and overall firms’ growth (measured by sales growth). The performance of firms can be measured in terms of its growth (sales, total assets etc.), profitability (earning per share, net profit margin, gross profit margin, return on assets etc.) and market based proxies (market price per share). Therefore, this research aims at shedding some light on how sustainability reporting can create the firms’ value, reduce cost of capital, increase its sales’ growth and enhance its profitability for selected firms.
Number of social contract theories can be analyzed for explaining the reason behind corporate social and environmental reporting (Uwuigbe, et al., 2018). However, for purpose of this literature review, slack resource theory, signaling theory and legitimacy theory will be assessed.
Firms’ Growth & Sustainability Reporting:
Carp et al. (2019) critically analyzed the overall impact of the sustainability reporting on the firms’ growth. The researcher analyzed the Bucharest Stock Exchange listed company’s annual reports for assessing the its efforts towards sustainable reporting and the overall growth of companies as a result of their economic, social and environmental protection actions. The study found that by voluntarily or forcefully complying with the sustainable reporting practices can improve the public image of company that can then be translated into more customers and increased profitability. However, the negative impact owing to the future costs of compliance is also relevant for the companies.
Bhatia & Tuli (2017) also examined the role of sustainable reporting and the overall firms’ growth. The research indicated that the social responsibility and environmental practices can influence the growth of companies in terms of operational and market value. The voluntary publishing of the environmental and social practices can lead to decreased cost of capital and increased sales. The authors indicated that the sustainability reporting appears as the positive news and can enhance market reputation of the firms that can then be used for avoiding any potential decrease in the share prices.
Bodhanwala & Bodhanwala (2018) gathered the evidence from Indian companies about how do corporate sustainability and the reporting of the actions impact the firms’ profitability. The study identified the positive relationship between sustainability reporting and overall financial performance of the firm by measuring the return on assets, cash flow and earnings per share post sustainable reporting. However, in some studies (Hahn & Lülfs, 2014; Aggarwal, 2013; Bodhanwala & Bodhanwala, 2018; Jones, 2007), a negative link was also apparent between the sustainable reporting and operational performance of the firm. This is because when the firms are more preoccupied with the economic aspects of serving the community and society, their focus on the company’s financial aspects becomes blurred.
The impact of sustainability reporting on the firms’ growth is based on the legitimacy theory. According to Plumlee et al. (2015), the company’s future growth and survival is based on its legitimate status in society that is achieved by aligning its operations with the social norms and expectations. It also means that the company must look at building association with the society in which it operates and must be motivated enough to disclose its environmental and social actions.
Cost of Capital & Sustainability Reporting:
Aras & Crowther (2009) analyzed the impact of sustainable reporting on the firms’ performance from the capital angle. The study revealed that the sustainable activity and its reporting can reduce the cost of capital. The negative association between sustainable reporting and the cost of capital was confirmed as the firms with high level of financial opacity tend to improve responsible relations with employees and the investors. The costs of capital are reduced by inducing the investors in believing that the risk associated with the investment in the companies with transparent social responsibility and environmental policies is low.
The study by Clarksone et al. (2008) revealed that the sustainable reporting can significantly reduce the costs of capital by influencing investors’ perception favorably. This is done by reducing uncertainty in business operations that in the end increases the overall financial value of the firm. The researchers affirmed that sustainable reporting reduces the future compliance costs and increases the overall value of firm. Cormier & Magnan (2013) conducted the research on sustainable reporting and its impact on the firms’ growth. The study highlighted that by reporting the environmental policies and having transparent sustainable reporting can increase the entity reputation and enhance the economic benefits for firms that in result increases overall share prices.
Sustainable reporting is many times considered as the major tool for attracting capital sources for achieving the corporate sustainability goals. Mocan et al. (2015) reflected that investors tend to prefer investing in the firms that have more transparency regarding social and environmental disclosures because there is increased level of trust between the managers and the shareholders at back-end. It was also pointed out by Mocan et al. (2015) that the disclosure of sustainable data including the social and environmental efforts made by the firm, can positively affect the operational cash flows and the returns on assets while reducing the cost of capital.
Bauer & Hann (2010) examined the role of sustainability reporting in lowering the cost of capital. The authors contended that the solvency of borrowing firms is hugely affected by its social and environmental practices. The financial institutions tend to gauge the exposure of firms to potentially costly legal and regulatory risks if the firms do not consistently believe in sustainability reporting. The authors indicated that the sustainability reporting allows the financial institutions in providing the debts at lower cost of capital due to higher trust level and high credit ratings.
Financial Performance & Sustainability Reporting:
The relationship between the corporate financial performance and the transparent sustainability reporting isn’t that much straightforward. As, on one hand, it can cost several dollars for the companies to take the social initiatives that is usually deemed as the deviation of management from the goal of shareholders’ wealth maximization. While, on the other hand it has proven out to be a major player in risk mitigation as it tends to prevent negative externalities of the firms harming society that can flow back to the entities in terms of explicit costs. Qiu et al. (2016) analyzed the impact of social and environmental disclosure on the corporate financial performance and indicated that the firms that have higher profitability and market value tend to publish more enriched and detailed environmental and social information that provides them overall positive economic benefits.
Oncioiu et al. (2020) discussed how sustainable reporting can impact the overall financial performance of the company in the research. The authors claimed that the corporate social reporting is vital for the entities and is an important tool of generating positive public image that can quickly be translated into more revenues and financial growth. It can also pose positive impact on the productivity of employees that can reduce the operational costs for the firm and result in improved profits. According to Chen et al. (2015), sustainability reporting contributes to the increased firms’ financial performance and enhanced environmental sustainability.
Cui et al. (2018) also conducted the research on analyzing the impact of corporate social responsibility reporting on the corporate financial performance. The results indicated that the companies implement the social responsibility reporting as regular practice for yielding maximum benefits out of the business and for making certain profits. Reddy & Gordon (2010) also confirmed that sustainability reporting influences the financial performance of Australian and New Zealand’s’ firms positively.
Uwuigbe et al. (2013) used the signaling theory for explaining the sustainability reporting as the major determinant of the firm’s performance. The author confirmed a positive link between the firms’ financial performance and the sustainability reporting. The study also shed light on slack resource theory as another major component of firms’ financial performance. According to the study, the companies with better financial performance tend to have slack resources that can be used for corporate social activities. Reem & Ahbabi (2019) assessed the link between sustainable financial growth and sustainability reporting. The research confirmed the fruitful and positive link between sustainability reporting and the profitability. Hahn & Kuhnen (2013) stated that the sustainability reporting can increase the competitive advantage of firms and enable it to get ahead of the competitors. The authors claimed that the sustainability reporting enables the firms in increasing their revenues and reducing their costs.
Firms’ Market Value & Sustainability Reporting:
Sustainability reporting has proven out to be providing the companies with enhanced possibility of strengthening their social and public image. According to Reverte (2009), by publicly exposing the social and environmental actions, the firms can achieve better public image and strong market value. Bachoo et al. (2013) also pointed out that the sustainable reporting tends to improve company’s performance and its overall value in the market. It has been affirmed on basis of signaling theory, that there tends to be a positive relationship between sustainability reporting and increased firms value. The reason is that when the firm appears out to be more transparent, the devaluation of the share price can be halted as per the signaling theory of finance. According to Uwuigbe et al. (2013), the signaling theory indicates that the firms report the positive information for public in order to improve their reputation in the market that attracts different members of the society. Hence, the attraction can stimulate influx of investors and customers leading to better image and performance of the firm.
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