13.2 Identify User Needs for Information

Shareholders

Many consider the company’s shareholders to be its primary information user group. These equity investors may be small single investors or they may be part of an institutional investment fund charged with investing on behalf of its members. As shareholders they concern themselves with the future viability of the company and want profits to be sustained or increased over the long term. Shareholders often use financial ratios, such as earnings per share (EPS), return on investment (ROI), and the price/earnings ratio to evaluate the financial health and the sustainability of financial growth of the company. Shareholders not only evaluate whether there is current value in owning stock of the company but also whether there will continue to be value in owning that company’s stock. Otherwise the shareholder is likely to divest of their ownership interest.

One ratio that shareholders often use to measure the value of the company’s stock relative to the company’s earnings is the price-earnings ratio, or P/E ratio. In the P/E ratio, the market price of the stock is divided by the earnings per share of the company’s stock. This ratio indicates the amount an investor is willing to pay for one dollar of the company’s earnings. For example, if a stock is trading at a P/E of 30, then this indicates investors are willing to pay $30 for $1 of current earnings. A high P/E ratio indicates investors expect high future earnings. A low P/E ratio has several interpretations but could indicate a company is undervalued. Many investors use the P/E ratio as a measure of whether or not a stock should be purchased, but no single metric should be used alone. In addition, the P/E ratio is only useful when comparing changes across time for a single company to see trends or lack of trends. The P/E ratio is most useful if compared across companies within a given industry sector. Most often, growth will vary widely between different sectors but will be more similar within a particular sector. Investors buy and sell stock for many reasons, both financial and non-financial. They can sell a stock due to lack of current growth in value or an expected drop in future earnings. They can also buy a stock because the company participates in activities that the shareholder values, such as fair wages and greenhouse emission reductions even if the company has a low P/E ratio. Let’s look at an example of an investment driven by more than just the company’s current financial situation.

In 2008, Warren Buffett’s MidAmerican Energy Company, a subsidiary of Berkshire Hathaway, bought a $230m stake in BYD, a Chinese battery maker about to begin auto production.⁵² Although the auto industry initially ridiculed Buffet’s investment in such a little- known company, he may well have the last laugh. Since 2008, the company has evolved into the world’s leading producer of electric cars, and its shares now trade at almost 10 times what MidAmerican paid for them. This increase in value reflects the market’s optimism about the future of the company based on the Chinese government’s commitment to speeding up the phasing out of fossil fuels.

The new ethical investing movement focuses on eliminating investments that conflict with shareholders’ values, such as dependence on environmentally damaging fossil fuels. The movement is growing each year. In 2016, ethical investments topped $8.7 trillion, up 33% from 2014, and they now account for 20% of all investment under professional management.⁵³ Ethical investors are increasingly avoiding polluters, weapon manufacturers, and tobacco companies as well as companies with a poor track record on human rights or philosophies that do not align with a fund’s religious tenets. Pension funds, such as the New York City Pension Fund⁵⁴ have announced a move away from investing in companies in the fossil fuel industry, a move that will put substantial pressure on these companies to seek out alternatives to the non-renewables business model. On the opposite side of the country, the California Public Employees’ Retirement System announced that it had divested from most of its holdings in thermal coal stock.⁵⁵

Investors are also increasingly looking to the future to evaluate whether a firm’s stock price is sustainable. Consider that, as the cost of renewable energy alternatives become cheaper, non-renewable resources become less able to compete. That is, the price of the non-renewable commodity falls to a point where the costs of extraction become greater than the price that can be obtained for the asset, and so the non-renewable resource remains in the ground.⁵⁶ At this point, the value of the asset, the mine, is impaired, which leads to a reduced share price.

For example, in mid-2017, Coal India, the largest coal-mining company in the world, announced that it would close 96⁵⁷ of its 394 mines⁵⁸ by March 2018 because they would be no longer economically viable after the Indian Government announced it would cut its commitments to purchase coal after 2022.⁵⁹

Investors, including ethical investors, must look to the future of their investments, buying shares that are sustainable for the long term to provide better returns. A recent Harvard Business Review study showed that socially responsible companies post higher profits and stock performance than those that were not focused on social responsibility.⁶⁰ This result is supported by a Deutsche Bank analysis of more than 2,000 studies dating back to the 1970’s, 90% of which suggested that socially responsible investing gives better returns than passive investing.⁶¹

Lenders

Sustainability reports provide useful information for lenders. Lenders want to know that the company borrowing from them does not have any going-concern risks that could affect its ability to repay the loan (Figure 13.8). They want to know the company will not be sued for human rights violations at home or abroad, be unable to repay its loans because consumer boycotts have hurt its cash flow, or that they maintain valuable property assets in high-risk areas. For example, after the 2017 Houston floods, a number of Houston-based banks were examined to find that they had a high level of exposure in commercial real estate in Houston.⁶⁴ This type of investment concentration in a single geographic area can be risky for lenders as a single disaster can have a more damaging effect than on a portfolio spread over a broader geographical area.

Figure 13.8 Sustainable Investment. Lenders appreciate sustainable investment because it gives them assurance that their loans will be repaid. (credit: modification of “Money Coin Investment” by “nattanan23”/Pixabay, CC0)

Employees

Employees and potential employees want to know that the company they work for is concerned about their safety and is an ethical organization. They want assurance that they will be fairly compensated and that all employees have equal rights and opportunities, regardless of gender, race, religion, or sexual orientation.

Recent studies show that employees increasingly want to work for companies that align with their own values and will be more loyal to those organizations. In 2016, 76% of millennials said that a company’s social and environmental commitments were considerations in employment, with 64% of millennials indicating that they would not work for a company that did not have strong corporate social responsibility practices.⁶⁵

Employees also report higher levels of satisfaction when their employers engage in corporate giving programs that are aligned with employee values or are chosen by employees.⁶⁶ For example, Intel will donate $10 to an educational institution, environmental program, or other community organization for every hour an employee volunteers there. More than 40% of Intel’s U.S. employees have donated time that totals hundreds of thousands of volunteer hours.⁶⁷ Other firms have corporate giving programs that match employee’s charitable donations dollar for dollar.

Customers

Customers often have many choices about where to spend their hard-earned dollars. They want to know the companies to which they give that money reflect their own values and beliefs. If a company is seen to be uncaring about an issue, then customers may arrange campaigns to boycott the company (see the Nestlé story for an example of such consumer activism).

A 2016 study by Unilever showed that 33% of consumers buy from brands they believe are doing social or environmental good and that this presents a €966 billion (over 1.1 trillion $USD) opportunity for brands. As such, it is important for a company to demonstrate their commitment to CSR, and sustainability reporting offers a medium to do this.⁶⁸

Governments and Regulators

Governments and regulators want to be able to see that a company is behaving responsibly. If they are confident that it is, there is less need to design laws and regulations that might restrict the company even more than if it undertook best-practice measures on its own. Many companies form industry alliance groups that aim to implement best practices in trade, social responsibility, or environmental initiatives.

Community

The community at large also wants to know that the organization is behaving at the level of society’s expectations. This reflects the existence of a social contract, the expectation that companies will hold to an unwritten contract with society as a whole. If a firm is undertaking actions that might harm society or that reject its general values, community backlash may cost the firm dearly.

In summary, a company’s accountability to a wider group of users is an element of stakeholder theory. This theory presents a view that asserts a corporation has an obligation to groups beyond just its shareholders.