To address climate change, companies need to measure carbon emissions accurately and be accountable for commitments.
This article is part of a 2-part series exploring the benefits and the shortcomings of corporate carbon reporting. In this article, Dr. Patrick Callery reveals that companies don’t always report their carbon performance accurately, why this happens and how to fix it.
In a companion article, Dr. Christian Blanco describes how even an imperfect carbon reporting system can improve a company’s carbon-related innovation and investment.
Companies are important actors on climate change
Climate change is already a problem, as anyone who follows the headlines can see. Flooding, property damage, human displacement, agricultural loss – all follow from changing weather patterns.
In the battle against climate change, companies are important actors. For example, in the United States, industry and agriculture directly produce a third of all carbon emissions.
Investors and others increasingly call for reduced carbon emissions by business. Up to one third of all investments in the United States now factor in sustainability, including corporate carbon performance.
Unfortunately, investors don’t have accurate information on corporate carbon performance. This article describes the current state of corporate carbon reporting – and how it can be improved.
What is carbon reporting?
Carbon reporting is a voluntary process by which companies publicly share their carbon emissions and targets, as well as carbon-related policies and practices.
Sometimes, companies publish their own carbon performance data, guided by a framework from an organization like the Task Force on Climate-related Financial Disclosures (TCFD).
Other times, companies choose to report directly to an outside agency such as the global non-profit, CDP. The agency then compiles data from many companies and shares the data with stakeholders, including investors.
Corporate carbon reporting is inaccurate
Researcher Patrick Callery of the University of Vermont and his colleagues have studied the carbon-related information that companies share with CDP. They are interested in CDP data because the organization has huge global influence.
Data collected by CDP are the most widely used carbon-related data in the global investment community. In 2021, more than 13,000 companies completed CDP’s annual questionnaire; collectively, these companies represent 64% of global market capitalization.
Callery and his colleague, Jessica Vieira, found the data may be giving investors a false sense of security, as it contains inaccuracies.
These findings could be a warning signal. “If we’re having a hard time getting accurate data on greenhouse gas emissions, for which formal measurement and accounting mechanisms exist, it seems fair to assume that there’s even more ambiguity when reporting on intangible issues, like lobbying on carbon regulatory policy,” Callery told NBS.
Companies don’t act in a vacuum. Inaccurate reporting happens because of broader dynamics, explained Callery. Companies face pressure to report on their carbon performance, but the ratings agencies – and therefore investors – can reward the wrong behaviors. With little oversight and few penalties in place, companies may be tempted to game the system.
Callery identifies four key problems with today’s carbon reporting.
1. Financial incentives create pressure to rate well
Low-carbon investing is a major trend right now and investors rely heavily on CDP data to guide their decisions. For example, an asset manager might use carbon performance data to decide which companies to include in a low-carbon investment fund. This gives companies huge incentive to improve their ratings. Unfortunately, past research shows that when companies are publicly rated, they tend to focus more on improving ratings than improving actual performance.
Callery and Vieira have seen the same pattern in carbon reporting.
Analyzing corporate reporting to CDP across multiple years, the researchers found that as many as 10% of firms claim to have reduced their emissions relative to a prior year, when their emissions had actually increased.
“We know that companies often engage in financial earnings management, where accounting rules leave room to fudge the numbers,” says Callery. “It’s the same with carbon emission standards.” CDP tries to bring rigour to carbon emissions reporting by encouraging companies to use recognized global standards to calculate their emissions. But those standards still allow companies flexibility in areas like:
How they account for important factors like emissions from electricity usage (Scope 2), or suppliers and end users (Scope 3).
Where they draw their corporate boundaries (e.g., which subsidiaries or facilities) for the purpose of calculating emissions footprints.
How they account for the purchase of carbon offset mechanisms.
2. Over-emphasis on future targets
CDP and other sustainability rating organizations give companies credit for setting ambitious goals for future performance. For example, the CDP questionnaire asks companies to report detailed information on their carbon emissions reduction targets.
In many ways, long-term thinking is good. It can help companies think big and plan strategically. However, evaluating companies on their long-term goals must be coupled with holding them accountable for short-term progress, Callery emphasized.
Otherwise, companies are incentivized to set ambitious goals for the future and defer short-term action and investment. This can be a “set and forget” approach to carbon target management.
Indeed, Callery and his colleague Eun-Hee Kim (Fordham University) are seeing that companies are pushing out the time frame on their carbon management targets while failing to make substantial near-term progress against those targets.
3. Over-emphasis on corporate policy
In the annual questionnaire for CDP, as with most other ratings agencies, companies report not only their emissions but many other aspects of their carbon-related policies and practices. That might include how climate change is baked into strategy, whether companies have a systematic process for identifying climate risks and opportunities, and whether boards have oversight of the company’s climate-change response.
The challenging thing about ranking companies on policy proclamations is that meaningful implementation is hard to measure. Companies can line up policy-based responses with factors rewarded by CDP’s scoring methodology without substantively implementing those policies and driving meaningful emissions reductions.
4. Inadequate verification and consequences
Carbon reporting’s most important shortcoming may be the lack of adequate auditing, which leads to few consequences for poor carbon performance or inaccurate reporting. While companies often obtain third-party verification of their reports, prior research has found such verification processes to be riddled with conflict of interest and poor quality.
“We know from financial reporting that in order to keep companies reporting honestly, the cost of misrepresenting their performance has to be higher than the benefit they get from misrepresenting,” says Callery. “This is not the case in the current carbon reporting system.”
Investors don’t even seem to look at whether firms make good on their targets from previous years. With financial reporting, companies that fail to meet financial performance targets often end up with a lower market valuation. But ongoing research by Callery and Kim shows no effect on market value for firms that have failed to meet previously set carbon targets.
How to improve carbon reporting
OK, so we know that carbon reporting has room for improvement. Where do we go from here?
Here are Callery’s recommendations for CDP and other reporting agencies.
Focus on what’s measurable. Metrics for corporate policies are too ambiguous, said Callery. Base rankings on actual emissions and ensure those data are accurate.
Make the long-term meaningful. Callery would like to see progress against longer-term emissions targets tracked over time. For example, when companies report on their carbon emissions, they would share:
A current year emissions figure.
An assessment of their progress toward a long-term target.
A detailed plan showing a clear path to their target. This would include specific initiatives and annual milestones.
Reinforce accountability. That means more rigorous verification to improve data accuracy and penalties for false reporting. (Early action in this direction is already underway by the U.S. Securities and Exchange Commission.)
“I am advocating for a tighter focus on the most measurable aspects that organizations like CDP already request,” says Callery. “It’s OK to ask companies to report on carbon policies and strategies. That can help stakeholders assess future performance and risk. But at the end of the day, if managers fail to translate their plans into reduced carbon emissions, they should be held to account. It’s the actual emissions that matter.”
Don’t forget to check out part 2 of this series (coming soon). Dr. Christian Blanco describes how even an imperfect carbon reporting system can help improve a company’s carbon-related innovation and investment.
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