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David Hess
  David Hess

Ensuring the Success of Information-Based Regulation

9/18/2006 --

Mandatory disclosure requiring firms to report their social and environmental performance is needed for true corporate accountability.

ANN ARBOR, Mich.—A system of mandatory corporate environmental and social reporting is necessary to achieve true corporate accountability, according to a new study by the University of Michigan's Stephen M. Ross School of Business.

Although more firms now issue social reports and the methodology is improving (a new version of the widely used Global Reporting Initiative's standards will be released in October), social reporting appears to be failing as a mechanism that improves the behavior of a significant number of firms, says David Hess, assistant professor of business law at the Ross School, in a forthcoming study in Business Ethics Quarterly.

"The current voluntary system of social reporting has failed to achieve the goals of organizational transparency and stakeholder engagement, and may actually work against those goals," Hess said. "Many corporations have been able to co-opt a process designed for stakeholder accountability and turn it into a means of stakeholder management. Firms also have engaged in strategic disclosure for the purpose of protecting their legitimacy rather than painting a complete picture of the company's environmental and social performance."

Supporters of social reporting consider it an important tool for increasing stakeholder democracy in corporate governance, Hess says. This is consistent with the collaborative, participatory and decentralized approach advocated by the "New Governance" model of regulation, which presents an alternative to the conventional command-and-control, deterrence approach to regulating corporate behavior.

"The best way to achieve regulatory goals in this area is not by assuring that certain policies are in place, but by providing stakeholders with actual power through information," Hess said. "Only through true accountability to stakeholders will corporations engage in the necessary self-reflection and organizational learning."

However, in order for social reporting to be an effective New Governance regulation and, at the same time, be politically sustainable over the long term, Hess says two key factors must be considered.

First, he says, it is important to increase the ratio of benefits to costs for both the disclosers and the users of the social and environmental information provided by companies. For disclosers, costs arise from producing the required information as well as from any negative consequences, such as lost good will, resulting from the disclosure of unfavorable information.

Some disclosers, however, can receive benefits from making disclosures. These beneficiaries may include firms wishing to demonstrate their strong performance or improvement on a certain social indicator compared to their competitors. This favorable comparison may lead to an improved corporate reputation, which, in turn, can have a positive impact in consumer markets as well as on treatment in the regulatory environment.

"If there is a subset of disclosers that have sufficiently high benefits-to-costs ratios from their disclosures, then they will push for improvements in the law, or their voluntary actions will increase pressures on other disclosers to do the same," Hess said.

This may lead to "rolling best-practices rule-making," or a ratcheting process where the minimum acceptable standard continually rises based on past learning, he says.

Similarly, the benefits-to-costs ratio for users of the information also will impact the success of social reporting. If the information is not accessible in a timely, user-friendly manner, or if too much information is conveyed, then the costs for users will likely exceed the benefits. To improve the potential benefits, standardized and comparable data must be provided so users can compare firm performance and focus on laggards. In addition, the social and environmental information users receive must be interpreted correctly.

Consequently, Hess says, the second key factor needed for ensuring long-term success and continuous improvement of social reporting is the presence of third-party intermediaries who can process the information and pass it on to the ultimate users in an easy-to-understand format that significantly reduces the costs of use. These "infomediaries" include socially responsible mutual funds, public-interest groups, unions, public pension funds and the media.

"With this information and the required participation of all firms, stakeholders will be empowered to demand real change in corporate behavior," Hess said. "Such a process does not need to be a substitute for voluntary initiatives, but it can serve to reinforce those efforts."

Written by Claudia Capos

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847