Corporate social responsibility: many of today's corporate stakeholders are calling for...

IN THE POST-ENRON ERA, THE NUMBER of companies reporting their social and environmental impact on society has increased immeasurably. Indeed, to its many advocates, the emergence of corporate social responsibility (CSR) is not only a blueprint for the future, but a new highway to follow for

Broadly speaking, CSR--also known as sustainable development--involves the increased recognition by publicly held companies that they need to address and heed not only shareholders, but all the multiple stakeholders impacted by the company's behavior. These include employees, customers, suppliers, governments, and nongovernmental organizations. In the new paradigm of social responsibility, stakeholders also could include socially responsible investor organizations, consisting of investors who make investment decisions using various social and ethical screens.

What follows are the major factors behind the emergence of CSR and an outline of key global and U.S. standards that have been put in place, as well as a review of current corporate and social audit reporting and support activities at numerous multinational companies. Several audit practitioners also offer their suggestions on best practices for evaluating, developing, supporting, and reporting on social and audit compliance standards.

EMERGENCE OF CSR

The theory behind CSR is that companies can be profitable while at the same time minimizing their negative impact on stakeholders. As evidence, a recent study by Oekom Research, a German agency that rates environmental and social performance, and securities firm Morgan Stanley indicates that companies with higher sustainability ratings outperform their counterparts who score lower on sustainability practices. The study examined the 602 companies in the Morgan Stanley Capital International World Index that have received Oekom's Corporate Responsibility Ratings and found that, between January 2000 and October 2003, the 186 highest-ranked companies in terms of sustainability outperformed the remaining 416 companies by 23.4 percent. Further, Lynn Sharpe Pains, a Harvard Business School professor, looked at all academic studies conducted on the subject of whether ethics pays (85 studies, total) and found a positive correlation between better financial performance and better social performance in 55--or 65 percent--of the studies.

As recently as five years ago, CSR was seen as an either-or proposition. If a company attempted to address stakeholder concerns, it might be perceived as impacting the company's profitability. More recently, studies and actual practice have shown that critical stakeholders--including customers, employees, and socially responsible investors--are actively looking to do business with socially responsible companies.

The 2004 Cone Corporate Citizenship Study, conducted by strategic marketing and public relations firm Cone Communications, shows that eight in 10 Americans say corporate support of causes wins their trust in that company, a 21 percent increase since 1997. Moreover, the study reveals that Americans stand ready to act against companies that behave illegally or unethically: more than three-fourths of respondents indicated they would respond to a company's negative practices by taking actions such as switching to another firm or speaking out against the company among family and friends. Increasingly, the value of companies long term is seen as dependent upon their ability to meet their expectations of social responsibility.

Furthermore, a significant percentage of many companies' value today is made up of "good will," or benevolence--an asset easy to lose and difficult to regain. In consequence, companies that recognize this fact are increasingly seeing the need to take appropriate steps to minimize their negative impacts on stakeholders and thereby protect their valuable reputations and good will.

PROMOTING RESPONSIBILITY

Failure to pay heed to CSR can dramatically impact a company's reputation and even its value. Multinationals such as Royal Dutch/Shell Group, Dow Corning Corp., Coca-Cola Co., and Nike Inc. have taken hits to their reputations for failing to stay ahead of their stakeholders' expectations. At Wal-Mart Stores Inc., Chief Executive Officer Lee Scott recently apologized publicly for letting the reputation of the company be sullied by questionable hiring practices. "For a bottom-line company like Wal-Mart, that was a significant step," observes Bruce K. Packard, a corporate attorney at Dallas-based law firm Davis Munck P.C. who has advised several boards and audit committees concerning their codes of social responsibility.

As the profile of CSR has increased globally, numerous governmental, nongovernmental, and advocacy groups have joined the dialogue. Several European governments are looking at regulatory approaches to CSR issues. France, for example, has enacted a law requiring listed companies to report annually, not merely on their financial performance, but on their social and environmental performance as well. In addition, the United Kingdom requires pension funds to identify social and environmental criteria relied upon in making investment decisions. Moreover, the IIA-UK and Ireland recently issued a "Professional Issues Bulletin" on the growing importance of CSR in organizations. The bulletin discusses issues and challenges associated with CSR and how internal auditors can help their organization address them.

Today, worldwide conferences such as the United Nations World Summit on Sustainable Development proliferate. Groups such as Business for Social Responsibility, a global nonprofit organization, help companies identify and manage their social responsibility obligations. The recently published report by retail giant GAP Inc. on its social responsibility activities attracted considerable and favorable media attention worldwide. Indeed, social responsibility reporting by publicly traded corporations has become an expected part of doing business on a global scale.

GUIDELINES FOR BEHAVIOR

There are upwards of 50 global and domestic guidelines by which companies can measure their social responsibility efforts. Most have been issued in the last decade or so. The more prominent categories covered include the environment, supply chain management, hiring practices, community relations, internal management or corporate governance, and charitable donations. Some of the global benchmarks against which companies' CSR performance is being measured include the United Nations Declaration of Human Rights, the International Labor Organization's (ILO's) labor standards, and several globally recognized voluntary standards, such as the Organisation for Economic Co-operation and Development's guidelines for multinationals and the United Nations Global Compact, to name just a few.

Perhaps the most widely accepted reporting guideline, however, is the Global Reporting Initiative (GRI), based in Amsterdam (see "Key Global Standards on Sustainable Development," at right). Launched in 1997 and billed as a common framework for sustainable reporting, the GRI was developed by a group of organizations widely involved with responsible business reporting. Among them were representatives of the Association of Chartered Certified Accountants, the United Nations Environment Programme, and the World Business Council for Sustainable Development. "What the GRI accomplished was to take the best practices in the area of human rights, labor relations, environmental management, and sustainable development, and craft them into guidelines that enable any corporation to produce one comprehensive report," says Jeffrey Hollender, author of What Matters Most: How a Small Group of Pioneers Is Teaching Social Responsibility to Big Business and Why Big Business Is Listening.

Social responsibility also has become more prevalent in the United States. Witness the recent lawsuits against U.S. nonprofit hospitals for charging poor, uninsured patients higher rates than they charge insured patients. "Although the lawsuits seek to attack their tax status, the bigger issue is whether these institutions are behaving in a socially responsible manner," notes attorney Packard.

The U.S. Sarbanes-Oxley Act of 2002 has raised the bar for many corporations with mandates that they conduct business with social responsibility in mind. The legislation includes an expectation that companies build "effective" programs based on adherence to values as opposed to merely laws. Principally through Sarbanes-Oxley Section 302, company executives must now certify that they have effective disclosure controls and procedures in place--and they must continually evaluate them to ensure their ongoing effectiveness.

Other portions of the act--including the whistleblower and code-of-ethics provisions--"combine to make social auditing essential," Packard says. Nonetheless, he believes the jury is still out on whether Sarbanes-Oxley will be an effective locus for corporate social responsibility. "We don't know where the courts are going to go. The litigation is just beginning."

More needs to be done by U.S. companies to incorporate sustainable development issues, agrees author Hollender, who is president of Seventh Generation, a producer of natural household products. "What we need is to develop a parallel to the Generally Acceptable Accounting Principles financial reporting guidelines to make sure the information is complete and independent." Hollender recently accepted the Corporate Stewardship Award for Small Business from the U.S. Chamber of Commerce Center for Corporate Citizenship. The award recognizes Seventh Generation for exemplifying the highest ideals in corporate stewardship.

RESPONSE TO CSR CONCERNS

Thus, the question arises: Are the existing audit inspection measures such as Sarbanes-Oxley and recent CSR initiatives working or not? Perhaps the key determination will be what the public does with this additional information. So far, the signs are encouraging. Many domestic and international companies are taking social issues more seriously and making them an important part of their agendas.

Under fire for years, cigarette manufacturer Brown & Williamson Tobacco Corp. (now merged with R.J. Reynolds Tobacco Co.) began approximately four years ago an unprecedented series of dialogues with various stakeholders across the United States to improve its image. The question was simple: "What would we need to do to meet your concerns?" The company has held more than 25 dialogues with different constituencies including members of the public, legislators, public health officials, employees, retailers, and wholesalers. Both an external auditor and an internal auditor audited the process.

The company's efforts have led to significant change. Brown & Williamson has asked that more of the money U.S. states receive from tobacco settlement funds be spent by the states on education, prevention, and treatment. It has also requested that the Motion Picture Association of America not feature cigarettes in movies. Moreover, the company will no longer put any advertisements on the back of any magazine lest a child see it.

Bill White, director of audit for Brown & Williamson, said, "We were impressed by the openness and directness displayed during the dialogue sessions and by the integrity and willingness of management to address the key issues. Our conclusion was that the CSR annual report accurately reflected the issues and management's response to them."

Likewise, Baxter International, a manufacturer of pharmaceutical and biomedical products, has a viable sustainability program in place. The external verification aspect of Baxter's program got its start in the mid 1990s in response to a stockholder group wanting assurance that environmental data presented to the public was accurate. Initially, Baxter only used its internal personnel at the division and corporate levels to verify environmental data. External auditors were drawn into the verification process as a result of the stockholder group's concerns. Over time, the external report evolved to incorporate the reporting of health and safety data as well as environmental data. Currently, an external consultant, ERM Certification and Verification Services (CVS), and Baxter have an arrangement in which they jointly verify selected data at every facility they audit. ERM CVS maintains overall quality control of the process through recently created verification protocols for use by all their auditors assessing Baxter's facilities.

"Besides improving the accuracy of the data, the verification process has also assisted Baxter in improving the efficiencies of collecting, combining, and publicly reporting the data," says Mike Cycyota, Baxter's director of corporate environmental health and safety audits. Because Baxter has manufacturing facilities in almost 30 countries, the cultural differences between auditors were an additional concern. Cycyota adds, however, that the verification protocols used by ERM CVS will help minimize these inevitable auditor differences when working in different geographic areas.

Another company that is paying more than lip service to sustainable development is French telecommunications giant Alcatel. Having emerged from a major reorganization in 2003, Alcatel, which operates in 130 countries with 60,000 employees, has a comprehensive sustainable development program. Its strategy is based on strict guidelines published in policies and charters, as well as social, environmental, and economic objectives, defined by the company's executive management.

Alcatel's sites around the world have benefited from an environmental management system; and through its "Digital Bridge" initiative, Alcatel technologies serve development in scores of countries. In 2003, the company joined the UN Global Compact, reinforced its corporate governance practices, updated its "Statement on Business Practices," and elaborated on its Social Charter, which emphasizes Alcatel's commitment to socially responsible practices.

In a country with a substantial natural resource sector, Canadian investors, businesses, and taxpayers have been sensitive to social and environmental concerns for some time. Rio Algom Ltd., which before a takeover in 2000 was one of Canada's leading diversified mining and metals distribution companies, developed and operated mines in North and South America.

"The company believed a strong corporate social awareness went beyond a matter of being a good corporate citizen to being good business," recalls Archie Thomas, chairman of IIA's International Relations Committee and a former chief audit executive of Rio Algom. "The company also believed that the responsible reputation it was building was key to gaining a competitive advantage when it came to getting local acceptance and regulatory permits for new projects."

Thomas speculates that Rio Algom's CSR program was one factor that made the company an attractive takeover candidate. He adds: "I think in any corporation that sets out measurable goals for operating at a high level of corporate social responsibility, internal auditors can play an important role in assessing the risks and controls associated with these goals and the strategies and tactics put in place to attain them, as well as the integrity of the resulting performance reporting."

THE RISK OF IRRESPONSIBILITY

In an address on matters related to CSR at The IIA's International Conference in Sydney in June 2004, Charles Macek, chairman of the Australian Financial Reporting Council and the Sustainable Investment Research Institute (SIRIS), said companies should regard their social responsibilities at least on a par with their financial obligations. Too often, he said, financial analysis of companies ignores other risks and resources beyond purely financial matters. "These are regarded as 'soft' or nonfinancial issues," Macek said. "Yet a failure to meet environmental, labor market, or even social obligations can have a substantial impact in the longer term. Names such as Shell, Exxon, Nike, Philip Morris, and Coca-Cola come to mind."

According to Macek, directors are appointed by shareholders as fiduciaries, and have an obligation to the company, which should include its multiple stakeholders. "The shareholder perspective focuses on the short term and only on items that are readily measured," Macek said. "The stakeholder view considers the long-term view and recognizes that so-called soft issues can involve considerable financial costs that are ultimately borne by shareholders."

Internal auditors, he said, should take the lead in managing risk in these areas beyond their traditional role in financial reporting. Macek took to task cynics and others who say corporate social responsibility is of little value except to "do-gooders." This is a "narrow and erroneous view dangerous to shareholders' wealth," Macek said. "The issue of CSR is best considered by answering the following question: Does reputation matter? When a company that rated in the top 25 global brands with 120,000 employees [Arthur Anderson] can literally disappear within a matter of weeks, the answer is self-evident."

INTERNAL AUDITING'S ROLE

There is broad agreement that for the future, chief audit executives need to ensure that social responsibility is on the board's agenda of corporate governance issues. They should be aware of existing standards and global initiatives as they relate to CSR and use them as yardsticks against which to measure their organization's performance. Additionally, auditors should advise the board on identified best practices and determine whether their organization's core values and code of conduct still reflect the desired position of the enterprise in today's and tomorrow's world.

Finally, internal auditors should use the international standards and practices designed by independent organizations or competitors as benchmarks against which to measure their organization's CSR performance. Summing up the role internal auditors need to play in the future, Phillip H. Rudolph, an attorney involved in Foley Hoag LLP's corporate responsibility practice, says, "CSR issues are increasingly touching upon subjects of material relevance to corporations and their boards, and internal auditors need to be correspondingly vigilant in making sure their companies are not falling short of what shareholders and management should reasonably expect."

The IIA maintains a CSR repository in the Guidance section of its Web site. Visit www.theiia.org and search for "sustainable development."

To comment on this article, e-mail the author at bfraser@theiia.org.

RELATED ARTICLE: Key Global Standards on Sustainable Development

Several organizations have made global efforts to standardize corporate social behavior. Their initiatives include:

* Global Reporting Initiative (GRI). The GRI is an international, multi-stakeholder process and independent institution whose mission is to develop and disseminate global sustainability reporting guidelines. Started in 1997 by the Coalition for Environmentally Responsible Economies (CERES), the GRI became independent in 2002 and is an official collaborating center of the United Nations Environment Programme (UNEP), working in cooperation with UN Secretary-General Kofi Annan's Global Compact. (www.globalreporting.org)

* United Nations Global Compact. Launched in 2000 as a direct initiative of UN Secretary-General Kofi Annan, the Global Compact seeks to advance responsible corporate citizenship worldwide in the areas of human rights, labor, and the environment through the support of 10 principles. The Global Compact involves all relevant governments, companies, labor organizations, and civil social organizations. It also engages five UN agencies: the Office of the High Commissioner for Human Rights, the UN Environment Programme, the International Labor Organization, the UN Development Programme, and the UN Industrial Development Organization. (www.unglobalcompact.org)

* Dow Jones Sustainability World Index (DJSI). The world's first global index to track the performance of leading sustainability-driven companies, DJSI uses a best-in-class approach that identifies the top sustainability performer in all sectors, regardless of any given sector's social or environmental impact. Other indexes that track socially responsible companies are the Morningstar Socially Responsible Investment Index, the Financial Times' FTSE4 Good Global Index, the FTSE4 Good Global 100 Index, and the Ethical Sustainability Global Index. (www.sustainability-indexes.com)

* International Labor Organization (ILO). A pro-worker, pro-labor UN agency that seeks to protect the labor rights of children and adults around the world, the ILO sets minimum standards involving basic labor rights, freedom of association, the right to organize and bargain collectively, the abolition of forced labor, and other standards. It promotes the development of independent employers and workers organizations and provides training and advisory services to those organizations. (www.ilo.org)

* Social Accountability International (SAI). The SAI is a U.S.-based human rights organization dedicated to improving workplace standards by developing and implementing social accountability standards. Its first fully operational standard, Social Accountability 8000 (SA 8000), is a workplace standard covering all key labor rights and certifies compliance through independent, accredited auditors. SA 8000 is based on workplace norms promulgated by ILO conventions and other human rights organizations. (www.sa-intl.org)

* The Rainforest Alliance. The alliance is an international, conservation organization based in New York, organized to protect the world's threatened tropical rain forests and promote economically viable and socially desirable alternatives. Companies, cooperatives, and landowners that participate in the alliance's programs must meet rigorous standards for protecting the environment, wildlife, workers, and local communities. (www.rainforest-alliance.org)

BY BRUCE W. FRASER

FREELANCE FINANCIAL WRITER

ILLUSTRATION BY RICHARD TUSCHMAN