The corporation used to be considered by economists as a profit-maximizing “black box.” The development of industrial organization and business management theories has challenged this traditional view, unveiling the complex structures of transaction costs and decision-making processes that form a company. However, nearly a century after Ronald Coase challenged the black box theory, there are still new aspects and impacts of corporate management and performance that we discover, try to understand and improve.

From the Black Box to a Corporate Ecosystem

The complex links between corporations and their environmental and social context are an example of what draws the attention of both social scientists and investors. For instance, some impacts of companies’ activities are material to our health and well-being. The increased awareness of such relationships explains the rising pressure on corporations by their stockowners and stakeholders to disclose more information about such impacts.

Three different channels accelerate this trend:

  • Regulations: Changing SEC rules, the Dodd-Frank act, mandatory extra-financial reporting in the European Union, etc.
  • Competitive pressure: When the best performing companies start disclosing certain information, others follow up as it becomes best practice (ex. integrated reporting, ESG ratings and indexes).
  • Social media: Semi-private information, known by a limited number of stakeholders, becomes easily available to all. 

As a result, companies are held accountable to an intensifying information stream of environmental, social and governance-related (ESG) topics. Their brand and reputation are increasingly subjected to their capability to accurately respond to the “ultra-transparency” challenge. Companies are expected to manage relationships that go beyond their traditional boundaries, thus transforming the black box into a much wider corporate ecosystem.

The Impacts of Ultra-Transparency

“Ultra-transparency,” or the unprecedented levels of transparency expected from companies, has been identified by the Forum of the Future as one of the defining trends that will affect business in the coming years and that can deeply transform supply chains[1]. Starbucks has acknowledged that the race towards transparency has changed the way it operates and develops, and the coffee giant has taken a proactive stance to turn it to an advantage[2]. Involving customers in product design, or publishing operational targets related to environmental impacts are two examples of this strategy. But how has this trend affected business practices and models in general? The consequences across sectors are more or less apparent, but they have occurred in almost every industry, and are affecting the way the whole economy functions.

The drive for more transparency stemmed initially from internal and legal issues: How does a company conduct its business? How compliant are its factories with prevailing laws, etc.? Today, these concerns extend towards the increasingly important (but not always legally binding) environmental, social and governance factors, both within corporations and in their operating context. There is a growing consensus among investors that many of these “extra-financial” factors do contribute, positively or negatively, to corporate profit. Thus, a better understanding of the social and environmental externalities of business activities and how they affect our welfare in general, reinforce the legitimacy of this growing request for information[3].

The drive towards more transparency affects various aspects of business models:

  • Supply chains: The exposure of how a company operates in the economic value chain has had significant impacts on industries with very poor environmental or social performance, and has led to closer scrutiny of supply chains.
  • Life cycle of products: The awareness of the total footprint of some products has also driven companies to integrate externalities, which is changing the cost structure of many sectors, and has even added new business lines.
  • Stakeholders’ relationships: Information on how a company manages its employees, its customers, and its external stakeholders, has had deep impacts on companies’ social strategies and practices.

We have compiled examples from different industries and markets, analyzed which transparency factors have been instrumental, and what change this has incurred in corporate business models and practices (see Figure 1 ). Often, transparency impacts supply chains, product design and stakeholders’ relationships at the same time, and stems from both social and environmental issues.

JSFB_Jan15_PirovskaFig1Revised

Transparency, Materiality and Trust

The impacts of increased transparency can often be substantial and drive a long-term change, with profound impacts on industry structure. And companies are not giving up information lightly. Many have argued that they already provide too much data, and that it is not really being used—either by stockowners or stakeholders. Data users would argue on the contrary, that the data quality, especially related to ESG issues, is still not satisfactory. But despite this corporate resistance, we expect companies will move proactively to increase transparency and more decision-useful data will become the norm, as it offers benefits beyond stakeholder management.

Indeed, by monitoring, measuring and reporting ESG data and related information, companies can learn a lot about their own operations and the challenges experienced throughout the corporate space. They can use this knowledge to improve their internal processes, better manage risks, increase management quality, and gain a clearer view on material issues that previously haven’t been included in their strategic and operational oversight.

Increased transparency also deeply affects the relationship between a company and its customers. Trust is much harder to gain in the age of hyper-transparency,[15] as business models are questioned by increasingly aware customers and business partners. Therefore, it is important for companies to take ownership of this dialogue and prudently address the most material ESG issues, for stockowners and for stakeholders – and to address gaps efficiently. Overall, it will help companies regain trust and confidence, reduce social and environmental risks, and reap the long-term benefits of stronger customer relationships.

Michael Geraghty, Global Markets Strategist at Cornerstone Capital Group, contributed to this article.

Margarita Pirovska, PhD is the Policy & Sustainability Analyst at Cornerstone Capital Inc.

 

[1] http://www.forumforthefuture.org/sites/default/files/Sustainable%20Business%20Trends%202015_0.pdf
[2] Welcoming hyper-transparency is part of building the “pre-competitive trust”, and a special relation with customers. http://www.theguardian.com/sustainable-business/starbucks-toyota-transparency-social-media
[3] On the rising importance of ESG factors in investment decisions, see our new report “ESG Essentials: a Guide for Investors
[4]Unilever has reached that objective.
[5]http://www.theguardian.com/sustainable-business/2014/dec/12/eu-labelling-changes-palm-oil-consumer-change?CMP=new_1194
[6]http://www.theguardian.com/sustainable-business/sustainable-fashion-blog/2014/oct/01/cotton-production-linked-to-images-of-the-dried-up-aral-sea-basin
[7]http://www.npr.org/blogs/thesalt/2014/02/14/276976353/americans-want-antibiotic-free-chicken-and-the-industry-is-listening
[8]http://www.pepsico.com/Purpose/Human-Sustainability/Product-Choices
http://www.pepsico.com/Purpose/Human-Sustainability/Product-Choices
[9]http://www.investors.annies.com/phoenix.zhtml?c=251112&p=irol-newsArticle&ID=1964964
[10]http://www.step-initiative.org/
[11]http://www.greenbiz.com/blog/2014/09/19/best-buy-hits-billion-pound-recycling-goal
[12]http://www.bloomberg.com/news/2013-06-19/h-m-wants-your-fashion-discards-by-offering-discounts.html
[13]http://www.riotinto.com/ourcommitment/taxes-paid-in-2013-4757.aspx
[14]http://www.riotinto.com/ourcommitment/communities-4796.aspx
[15]https://hbr.org/2012/07/trust-in-the-age-of-transparency