Evaluations of key impacts vital for setting strategy, bringing substantive changes

By Sandra E. Taylor 

Materiality is a concept within the auditing and accounting fields relating to the importance of an amount, transaction or discrepancy. The objective of an audit of financial statements is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in conformity with Generally Accepted Accounting Principles (GAAP). The assessment of what is material is a professional judgment.

Information is material, according to international accounting standards, if its omission or misstatement could influence the economic decision of users—investors, regulators and suppliers—taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances and whether a reasonable person, relying on this information, would have been influenced by the omission or misstatement.

Thus, materiality provides a threshold or cut-off point to guide companies in making decisions about what information to disclose. Despite many years of financial accounting practice, opinions can still vary radically on what is or is not influential.  

What does this mean in the context of corporate social responsibility (CSR)? The main driver for discussing materiality in the CSR context is the increasing importance of sustainability reports.  Moreover, a materiality assessment is equally critical in setting a company’s CSR strategic direction.

Sustainability Reporting: The growing numbers of issues companies are asked to include in their annual CSR reports cause them to question which ones should be the main focus and which ones are less seminal. At the same time, reporting principles—such as the indicators recommended in the Global Reporting Initiative guidelines—are gaining more credibility and use. Companies must be able to prioritize issues they will manage, and materiality is a foundation for making those decisions.

CSR Strategy: An essential first step in CSR strategic planning is to identify the material issues that senior management must consider in order to minimize CSR risks and maximize opportunities. A first-rate CSR strategy provides a structure for managing all sustainability challenges and impacts, and puts responsible practices at the core of a company’s business planning. This includes supply chain accountability, environmental impact assessment, governance, policy, stakeholder engagement, social community commitments and transparency.

The heart of this strategy should focus on a company’s supply chain:

• what the company buys
• whom it buys from
• what it manufactures
• who makes the product(s)
• the social and environmental practices throughout the chain.

Most businesses understand they must keep track of the changing economic and consumer trends that affect their industries, as these can greatly impact their financial success. Yet they are less adept when it comes to identifying emerging social and environmental issues. Many U.S. companies are not at all clear, beyond traditional or regulated areas, which social and environmental issues are likely to be material to their business. The solutions lie in stakeholder engagement.

To assist in determining materiality, Nike recruits people who have expertise in labor, human rights, environmental, social, economic and diversity issues, and share a commitment to transparency and multistakeholder engagement, for a report review committee. Members share an interest in supporting innovative efforts by corporations to address these challenging issues. Appreciating Nike’s decision to continue a corporate responsibility (CR) reporting process that includes intensive and inclusive stakeholder engagement, committee members serve voluntarily and review information provided by Nike about its past years’ performance and future plans.

At Starbucks, the assessment of what is material involves a review of topics and indicators to be included in its annual CSR report; issues that reflect the company’s significant economic, environmental and social impacts, or substantively influence the assessments and decisions of stakeholders. In this process, Starbucks consults a variety of sources—both internal and external—as part of the materiality assessment. These sources include:

• company objectives, strategies, policies, programs and risk factors
• employee surveys and input gathered through various other feedback mechanisms
• customer-contact feedback
• shareholder resolutions and anecdotal feedback
• input gathered through stakeholder dialogues
• informal input from coffee suppliers
• media coverage and blog discussions of company issues
• stakeholder feedback about the company’s past CSR reports
• GRI-recommended topics and data for inclusion

After reviewing these sources, a list of the most material issues is compiled and prioritized for inclusion in the report, based on:

• the importance of the issue to—and potential impact on—Starbucks
• the importance of the issue to—and potential impact on—external stakeholders
• the amount of reasonable control Starbucks has over a particular issue.

Of course, reporting is not an end in itself. It is only useful if it discloses publicly and formally a company’s CSR strategy, follows corporate action and facilitates change.

Yet, businesses still mainly concentrate on materiality in terms of how it can reflect commercial developments in their sustainability reporting rather than how it can direct strategy, decision making, performance and change. With the increasing focus on standardized reporting methodologies, companies often miss the opportunity to learn from stakeholder engagement. This engagement is key to deciding what is material—that is, what sustainability issues matter most to the business and how they matter.  

Studies indicate that publicly reporting social and environmental performance issues keeps a business on its toes. Indeed, some evidence suggests that the process of building a public report is the single most important driver of change in how these issues are managed since it increases organizational knowledge, facilitates reflection and transforms policies and practices. Under the annual deadline for submitting metrics and numbers for the CSR report, the business manager focuses on the commitments made the year before and the pending public disclosure of how things have improved—or not.

However, transparency and the communication of material information are not confined to an annual CSR report. Increasingly, companies utilize other methods to inform stakeholders about its progress or performance on material issues. In the end, transparency is enhanced when companies use reliable indicators of CSR progress and communicate honestly with various stakeholders about CSR policies and practices.

Timberland, which manufactures biodegradable boots and shoes, uses a “Green Index Label” to list a product’s carbon footprint—or how much fossil fuel it took to create each pair of footwear—on every shoebox. Starbucks establishes key performance indicators in CSR areas, measures progress internally as part of its quarterly business reviews, and reports publicly on progress in its annual CSR report.

Whatever the format or process used, a viable CSR strategy requires that you define what CSR means for your company. This includes:

• key issues, stakeholders and spheres of influence relevant to corporate citizenship in your company and industry
• materiality, based on products, lines of business and geography
• input from key stakeholders regarding what they see as material for your business
• internal performance, communication, incentive and measurement systems

Your challenge is to understand the impact that your operations and sourcing decisions have on local communities, workers and the environment, and to then take action to ensure this impact is positive. And finally, to report to all stakeholders the progress you are making in these areas.

Sandra E. Taylor is President and CEO of Sustainable Business International.