Multiple Capital Accounting: A New Paradigm for Measurement and Reporting

Mark W. McElroy, Ph.D. Executive Director, Center for Sustainable Organizations

Co-Founding Principal, Thomas & McElroy LLC

Multiple Capital Accounting

New Metrics ’15 October 6, 2015 – Cambridge, MA

MultiCapital Accounting (MCA)

Copyright © 2015 by Mark W. McElroy, Ph.D.

What is MCA? •  Arguably the most pervasive principle found in the

100+ year old literature on sustainability –  That the performance of a society or organization is best

understood in terms of what its impacts on vital capitals are, and with specific reference to their limits

–  Vital capitals: natural, human, social, constructed, intellectual and economic

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“Only the second revolution in accounting since double-entry

bookkeeping began” and “of seismic proportions”

Jane Gleeson-White Six Capitals


MCA now also standards-based •  International Integrated Reporting Council (IIRC)

•  Sustainability Accounting Standards Board (SASB)

•  Global Initiative for Sustainability Ratings (GISR)

“Integrated thinking is the active consideration by an organization of the relationships between its various operating and functional units and the capitals that the organization uses or affects.” (12/13)

“Leading reporting initiatives such as IIRC and SASB include references to multiple, or ‘vital,’ capitals. GISR embraces the multiple capitals framework as well.” (12/13)

“Material sustainability issues arise in industries that rely on common capitals as a source of value creation, beyond financial or manufactured capital … Common capitals, as used in this Framework, include natural capital … and human capital.” (10/13)

Copyright © 2015 by Mark W. McElroy, Ph.D. 2

MCA: What does it do for us? •  Provides us with a theory of performance that

addresses the subject in all of its dimensions in an integrated way –  A basis for operationalizing the Triple Bottom Line!

•  Applies common principles to measuring, managing and reporting financial and non-financial performance, both

•  Makes meaningful Integrated Reporting possible (i.e., per the IIRC)

–  A basis for quantifying and monetizing intangible asset elements of market value (now upwards of 80% of market caps)

•  Treats intangibles as capitals •  Interprets externalities as impacts on capitals

•  Also provides a basis for making integrated materiality determinations (stakeholder capitals!)

3 Copyright © 2015 by Mark W. McElroy, Ph.D.

What is capital?

A stock of anything that yields a flow of valuable goods or services

Based upon Fisher, 1906; Boulding, 1949; Hicks, 1974; El Serafy, 1991; Ekins, 1992; Costanza and Daly, 1992; Porritt, 2005; and many others.


What are the capitals? •  In broad strokes, there are six of them:

–  Natural –  Human –  Social (and Relationship) –  Manufactured (or Constructed or Built) –  Economic (or Financial) –  Intellectual

•  Since Intellectual Capital is embedded in many of the others, 5-capital models are also common

•  How we slice and dice capitals is of less importance than that our accounting be capital based in the first instance!


The IIRC’s 6-capital model


Notable 5-capital models

SIGMA (2003) Forum for the Future (2005)


How capitals relate to the TBL


Source: Thomas & McElroy

Available flows of valuable goods

and services (carrying capacity)

Appropriations of stocks and flows by stakeholders who

need them

Resulting levels of stakeholder

well-being

Organizations can, do and/or should have impacts on vital capitals

Stocks of natural capital

Stocks of human capital

Stocks of social capital

Stocks of constructed capital

Stocks of economic capital

What makes MCA relevant?

Organizational impacts on carrying capacities of

capitals affect human well-being!

Organizational Performance Affects Them!


How can MCA be done? •  The standards are principles-based only, so we’re

left to our own devices when it comes to methods •  There are arguably two schools of thought or broad

approaches as to how MCA should be done: 1.  Market Value (MV) 2.  Triple Bottom Line (TBL)

•  MV school is about measuring and monetizing intangibles and externalities as a basis for explain-ing market caps and the ability to create $ value

•  TBL school, by contrast, is about assessing impacts on vital capitals as a basis for determining the overall performance of organizations


Are there any MCA methods? •  Market Value School

–  First, this is arguably the IIRC’s school of thought because it stresses measurement, management and reporting of capital impacts primarily for the benefit of shareholders

–  Prominent illustrations of this approach include the EP&L method (pioneered at Puma); the TIMM method (proprietary PwC tool); and Ernst & Young’s approach to Integrated Reporting

–  Forthcoming Natural Capital Protocol may also fit in here

•  Triple Bottom Line School –  So far only one method extant: the MultiCapital Scorecard*

•  A capital-, context-based and open-source TBL system •  Early users include Ben & Jerry’s, New Chapter and Cabot


*Source: Thomas & McElroy LLC

The MultiCapital Scorecard •  A context-based approach to TBL measurement

and reporting (defines company-specific standards of performance on a bottom-up basis)

•  A three-step process: 1.  Scoping and Materiality – Identify duties and

obligations for what an organization’s impacts on vital capitals must be in order to be sustainable; results in identification of related Areas of Impact (AOIs)

2.  AOI Development – Define company-specific goals and standards of performance for each AOI, context-based metrics and associated data collection protocols

3.  Scorecard Implementation – Operationalize Scorecard in order to measure, manage and report performance


Reporting in the MultiCapital Scorecard •  Performance is reported at 3 levels of analysis:

1.  The individual Area of Impact (AOI) level 2.  The Operating Unit level 3.  The Consolidated Operations level

2019 – Company ABC

Bottom Li

ne

Areas o

f Impact/

(Cap

itals)

Progre

ssion Sco

re

Weight

Weighte

d Score

Fully Susta

inable Sco

re

Gap to Fu

lly Susta

inable

Area of I

mpact B

ottom

Line

Triple

Bottom Line

NotesA B C D

A x B B x 3 D - C C / D

Living Wage (H) 3 1 3 3 0 100%

Workplace Safety (H,S,C) 3 5 15 15 0 100%

Innovative Capacity (H,S,C) 1 2 2 6 4 33%

Equity (E:IF) 3 5 15 15 0 100%

Borrowings (E:IF) 2 1 2 3 1 67%

Competitive Practices (E:EF & ENF) 2 1 2 3 1 67%

Water Supplies (N) 3 3 9 9 0 100%

Solid Wastes (N) 2 2 4 6 2 67%

The Climate System (N) 2 5 10 15 5 67%

62 75 13 83%

Economic 90%

Environmental 77%

Overall Performance

Social 83%

Notes

Turnover (millions)

SizingMax Fully Sustainable

Score

Sized Fully Sustainable

ScoreABC 100$ 33.3% 75 25DEF 150$ 50.0% 75 37.5GHI 50$ 16.7% 75 12.5Group 300$ 100% 225 75

Bottom Line CompanyWeighted Score

Fully Sustainable

Score

Bottom line by company

SizingSized

Weighted Score


Score

Consolidated Sized Score

Consolidated Potential Score

Consolidated Bottom Line

ABC 20 24 83% 33.3% 6.7 8.0DEF 14 21 67% 50.0% 7.0 10.5GHI 14 21 67% 16.7% 2.3 3.5ABC 19 21 90% 33.3% 6.3 7.0DEF 16 24 67% 50.0% 8.0 12.0GHI 20 30 67% 16.7% 3.3 5.0ABC 23 30 77% 33.3% 7.7 10.0DEF 20 30 67% 50.0% 10.0 15.0GHI 16 24 67% 16.7% 2.7 4.0

83%67%67%

54.00 75.00 72%

Bottom Line CompanyWeighted Score

Fully Sustainable

Score

Bottom line by company

SizingSized

Weighted Score


Score

Consolidated Sized Score

Consolidated Potential Score

Consolidated Bottom Line

ABC 15 15 100% 33.3% 5.0 5DEF 10 15 67% 50.0% 5.0 7.5GHI 10 15 67% 16.7% 1.7 2.5ABC 10 15 67% 33.3% 3.3 5DEF 10 15 67% 50.0% 5.0 7.5GHI 10 15 67% 16.7% 1.7 2.5

Sizing

2019 -‐ Consolidated

Social 16.0 22.0 73%

Company TotalsABCDEFGHI

Consolidated Total

Economic 17.7 24.0 74%

Environmental 20.3 29.0 70%

Centrally

Determ

ined

Areas

of Im

pact Equity 11.7 15.0 78%

The Climate System

10.0 15.0 67%

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Area of Impact Operating Unit Consolidated Operations


Reporting at the Operating Unit Level: A MultiCapital Scorecard

Capitals: C = Constructed* EE = External Economic* H = Human* IE = Internal Economic* N = Natural S = Social & Relationship* *Usually includes embedded Intellectual Capital

2019 – Company ABC

Bottom Li

ne

Areas o

f Impact/

(Cap

itals)

Progre

ssion Sco

re

Weight

Weighte

d Score

Fully Susta

inable Sco

re

Gap to Fu

lly Susta

inable

Area of I

mpact B

ottom

Line

Triple

Bottom Line

NotesA B C D

A x B B x 3 D - C C / D

Living Wage (H) 3 1 3 3 0 100%

Workplace Safety (H,S,C) 3 5 15 15 0 100%

Innovative Capacity (H,S,C) 1 2 2 6 4 33%

Equity (E:IF) 3 5 15 15 0 100%

Borrowings (E:IF) 2 1 2 3 1 67%

Competitive Practices (E:EF & ENF) 2 1 2 3 1 67%

Water Supplies (N) 3 3 9 9 0 100%

Solid Wastes (N) 2 2 4 6 2 67%

The Climate System (N) 2 5 10 15 5 67%

62 75 13 83%

Economic 90%

Environmental 77%

Overall Performance

Social 83%

Notes

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Note: The Areas of Impact shown here are purely illustrative and are otherwise always company-specific.


The Business Case for MCA (and CSR)


What’s the business case for MCA? •  Two schools of thought:

1.  You genuinely want your organization to be sustainable •  Can’t manage it unless you measure it •  No better way to do that than by measuring and managing

performance relative to impacts on vital capitals! 2.  You want to reap the economic and business benefits of

operating sustainably in more conventional terms 1.  Lower costs, higher revenue, more effective employee

recruiting and retention, lower risk, etc.) … i.e., operating benefits

2.  While also reaping the benefits of CSR performance on market value – a powerful new business case! –  A convergence of the MV and TBL schools –  Whereby strong non-financial performance is material

to, and measurably drives, market capitalization


Thank You!

[email protected]


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The economic case for ‘good citizenship, CSR, ESG, and sustainability’ credentials ... uncovering the tangible side of the intangible

Simon Cole Founding Partner

October 6th, 2015

© Reputation Dividend

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Over the next 40 minutes...

1.  The seeds of the opportunity

2.  Why the economic value of ‘corporate reputation’ matters

3.  How we can measure it

4.  How measurement informs better management...the implications for sustainability credentials

The tangible side of the intangible


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...we are an independent consultancy

...we were founded in 2010

...we support corporate brand owners in their pursuit of more effective messaging

...we work in association with partners in capital markets advisory, consultancy and communications

Some words of introduction


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Walmart aiming to save $3.5bn by reducing supplier packaging

DuPont cutting $2bn costs and reducing greenhouse gas emissions over 10 years by investing in energy efficiency

SRI assets under management c15% of 2015 total1

87% of consumers ‘concerned’ for environment, 54% ‘willing’ to pay a premium to act on it2

76% of CEOs consider that strong sustainability contributes positively to their business in the long term2

1: IFC/World Bank, The Business Case for Sustainability, 2: McKinsey, The business of sustainability (2011)

The business case is getting stronger and stronger


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Top 3 reasons that respondents’ organisations address sustainability

2010 2011 2012 2014

Alignment

Align with company’s business goals, mission, or values

21%

31% 30%

43%

2010 2011 2012 2014

Reputation

Build, maintain, or improve corporate reputation

36% 32%

35% 36%

2010 2011 2012 2014

Cost cutting

Improve operational efficiency and lower costs

19%

33% 36%

26%

Company leaders are rallying to sustainability...it is (increasingly) seen to matter...the dots are connecting

Source: 2014 global survey on reputation risk


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Increased efficiency of waste reduction •  88% of sustainability reporters reported

‘enhanced management decision making’1

Improved access to capital •  Sustainability reporting linked to fewer capital

constraints2

Meeting employee expectations •  30%+ reported increased employee

loyalty...with implications for higher retention, lower turnover, recruitment costs etc3

Better reputation •  50%+ of sustainability reporters cited

‘improved corporate reputations’4

And the value of reporting is being recognised

1:BlackSun (2012), 2:Social Science Research Network (2011), 3:EY/Green Biz (2011), 4:Boston College Center for Corporate Citizenship/EY (2013)


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“The sum of all the thoughts, feelings, associations and impressions that come to mind when thinking of the corporate entity”

Many and various


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Leading

Profitable Trus

twor

thy

Innovative

Over bearing

Car

ing

Ethical...or not

Mea

sure

d

Cynical

Nim

ble Aggressive

Uncaring Nurturing

Fast

Ada

ptab

le

Une

xcitin

g

Domineering Considerate

Me-too

Led well

Clinical

Err??

...demanding measurement to underpin management


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Tangible asset value as a % of market

capitalization across the S&P 500

0%

20%

40%

60%

80%

100%

1975 1985 1995 2005 2015

Intangible value Tangible value

17%

80% 68%

32%

83%

Why reputation measurement matters

Source: Ocean Tomo/Standard & Poor’s

1)  The relentless rise in the value of intangibles…


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2)  The rise of the referential consumer


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... of executives rate reputation risk as more important than other strategic risks.

87% ... of companies that experienced a negative reputation event reported loss ... of revenue.

41% Reputation risk is a board and C-Suite issue... the responsibility of: The CEO – 36% The CRO – 21% The board – 12% The CFO – 11%




3)  The c-suite is recognizing the downside

Source: 2014 global survey on reputation risk


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“ ...reputation is now one of the most important factors in any assessment of a company’s value.

A good or bad reputation will be reflected in any share forecast we make

Reputation sits at the core of our investment principles. ”





4)  Investors are appreciating the upside

Source: ‘How the people who value companies value reputation’


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4)  Investors are appreciating the upside

5)  Traditional metrics have come up short

‘Reputation value’ ...market confidence in expected economic returns

‘Brand value’... turning customer support into economic profit

‘Employee brand value’ ...leveraging employee engagement for economic advantage



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Underpinning investor confidence

Supporting and elevating share price –

the Reputation Contribution

REPUTATION BELIEF

EXPECTATIONS OF FUTURE BEHAVIORS BASED ON PAST PERFORMANCE

THE AGGREGATE “ANALYSIS” OF PAST BEHAVIOUR

Reputation builds ‘trust’…and, ultimately, tangible economic value


"We can afford to lose money — even a lot of money. But we can't

afford to lose reputation — even a shred of

reputation.”

15 © Reputation Dividend

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So how do we measure it?


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Profitability

Macro forces

Market perceptions

Product brand experience

News flow

Creating shareholder value

Underpinning

confidence in the ability to deliver economic return

Allocation of capital

Commercials e.g. marketing

Industry dynamics and networking

Perceptions of the management

‘reputation’

Investor behavior provides the foundation for understanding the impact of reputation


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Ø Proprietary research Ø What is being said about the company Ø Mainstream business press

Media

Ø Sourced among ‘professional’ stakeholders Ø Collected ‘thoughts and feelings’ Ø Raw measures from Most Admired

Companies reports

Reputation

Ø Reported performance Ø Analysts consensus forecasts Ø Company and third-party sources

Financial

Three inputs…hard data


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Stage 1 – The ‘general model’ of investor behaviour: o  Inputs from three sources – news media, Fortune and Management Today’s

Most Admired Companies research, Factset/Bloomberg etc

o  Regression analysis to test combinations of financial and reputational drivers of market cap

o  Re-calibrated annually using 700+ of the world’s largest listed companies

o  Trending and modelling data over eight years

…informing a two stage modeling process


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Stage 1 – The ‘general model’ of investor behaviour: o  Inputs from three sources – news media, Fortune and Management Today’s

Most Admired Companies research, Factset/Bloomberg etc

o  Regression analysis to test combinations of financial and reputational drivers of market cap

o  Re-calibrated annually using 700+ of the world’s largest listed companies

o  Trending and modelling data over eight years

Stage 2 – Analysing company performance through the lens of the general model

o  Isolate the economic contribution of company reputation assets ... as a whole and for individual components

o  Calculate stock price implications of changes to the reputation profile

•  Value lost through reputation degradation

•  Value gained through reputation enhancement

o  Identify implications for corporate communications and messaging

…informing a two stage modeling process


Statistical analysis of hard data

Informed by financial metrics and empirical reputation research data

Repeatable and stable

Objective...

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…to make the link between corporate reputation and share price


/

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Company DomicileReputation Contribution

Reputation Value (Dec 14/Jan 15)

UK 49.7% $61.3bn

US 49.5% $323.4bn

US 49.4% $78.4bn

US 48.6% $187.7bn

UK 48.4% $35.3bn

UK 48.2% $7.7bn

UK 47.3% $50.4bn

UK 47.3% $5.1bn

US 47.2% $166.9bn

UK 46.3% $4.8bn

Ten of the most potent reputations – US and UK – $921bn of shareholder value


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Why measurement informs better management...the implications for sustainability credentials


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Reputation Driver Interest The Return on Reputation Investment

Rel

ativ

e va

lue

impa

ct 1.6X

0.8X

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1. Because investor side interest in reputational characteristics varies from factor to factor


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Reputation Driver Interest The Return on Reputation Investment

Rel

ativ

e va

lue

impa

ct 1.6X

0.8X

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1. Because investor side interest in reputational characteristics varies from factor to factor


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Global competitiveness

Use of corporate assets

Financial soundness

Quality of management

Long term investment potential

People management 16%

14%

13%

13%

11%

1%

$3,329bn of shareholder value at Jan 2015 (17% of the combined market capitalization)

11%

10%

13%

Social responsibility

Innovation

Quality of products/services

2. Because ‘CSR’ credentials are already accounting for a substantial proportion of reputation value


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Global competitiveness


Financial soundness


Long term investment potential

People management 16%

14%

13%

13%

11%

1%

$3,329bn of shareholder value at Jan 2015 (17% of the combined market capitalization)

10.7%

10%

ð$356bn

13%

Social responsibility

Innovation

Quality of products/services

2. Because ‘CSR’ credentials are already accounting for a substantial proportion of reputation value


-‐6%

-‐4%

-‐2%

0%

2%

4%

6%

8%

10%

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8.9%

8.1%

6.9%

6.7%

6.5%

-5.9%

-5.6%

-5.3%

-4.0%

-5.9%

3. Because generalizations fall short, the average hides a wide range of winners and losers


-‐

0.04

0.08

0.12

0.16

0% 5% 10% 15% 20%

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Factor Contribu-on

Rela-ve Va

lue Grow

th Poten

-al

Value as a long term

investment



Corporate & social

responsibility

Global compe::veness

Quality of products & services

People management

Innova:on

Value Growth Poten-al

Value Security

Financial soundness

4. Because companies need a compass for messaging …and behavior, to plan for value management


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1.  There is solid, objective evidence to be had as to the economic benefit of reputation credentials for sustainability

2.  The implications for corporate strategy are clear and profound

3.  The challenge is to integrate the case into the communications strategy

4.  The benefits in terms of RoI can be substantial

In sum...the business case for sustainability credentials has just become even stronger


Multiple Capital Accounting: A New Paradigm for Measurement and Reporting

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Transcript of Multiple Capital Accounting: A New Paradigm for Measurement and Reporting