From disclosure to insight: Predicting Carbon Management strategies of South African companies from CDP data
By Donald Gibson and Natalie Matthews
The usefulness of sustainability reporting and disclosure information and data extends beyond the analysis of individual companies. Secondary data can be analysed to deepen the knowledge of business-wide and country level strategic management and leadership practices. With multiple carbon management activity options to choose from, companies need to select the most appropriate carbon management strategy to meet the challenges of a carbon constrained future. Because of South Africa’s vulnerability to the impacts of climate change as a developing country and because of business’ pivotal role in addressing this urgent issue, it is important to characterise the corporate responses to climate change.
The contextual factors that influence carbon management strategy decisions need to be understood so that appropriate policy decisions are taken to encourage innovation related to climate change opportunities.
This usefulness of carbon disclosure data is exemplified by this study which analysed responses from 70 large South African listed companies to the Carbon Disclosure Project 2011 questionnaire.
The responses were text-mined to identify five carbon management activities currently practised by the companies. A cluster analysis of these activities revealed four general response strategies to climate change and carbon emission reduction pressures.
The companies were found to have a strong focus on saving energy with less focus on higher-order sustainability activities.While market capitalisation, turnover, sector and carbon commitment were shown to correlate and predict the carbon management strategy chosen by companies, no statistical link was found between carbon management strategy and corporate financial performance.
Broadening the usefulness of reporting information
Academic and practitioner research on the determinants and functions of corporate responsibility reporting is extensively described in the literature (see for example Fifka, 2013).
Indeed, disclosure and reporting on sustainability performance serve numerous functions for corporations. Enhancing credibility and trust in the eyes of stakeholders (for example shareholders, potential investors, customers, activists, governments and communities) is one such function, and is an important objective of transparency and disclosure.
This is particularly the case where concepts like ‘social licence to operate’ or ‘legitimacy’have recently become important factors governing the ability of corporations to create value.
An example is the extractives sector, which, as was evident from numerous presentations made by and discussions held with mining company executives at the 2014 Mining Indaba held in Cape Town, sought to defend its right to exist, as well as articulate its developmental contribution beyond that of the narrow Milton Friedman concept of the purpose of business.
Other functions include, amongst others, using reporting as a standard business management tool to understand risk exposure to global change, convince potential investors of survivability, and potential to profit from new commercial opportunities (KPMG, 2013); set goals and measure performance (GRI, 2013).
against specific metrics and benchmark against industry peers (KPMG, 2011), and importantly to understand and manage material issues that affect the ability of the organization to achieve its goals and its impacts on society (GRI, 2013).
Yvo de Boer believes that the number of detractors of the organizational benefits of reporting is dwindling (KPMG, 2013). However, the usefulness and benefits of sustainability reporting and disclosure extend beyond the organizational boundary and the analysis of individual companies.
Data such as those generated by the Carbon Disclosure Project (CDP) can deepen the knowledge of sectoral and country- level carbon management practices and strategy. This, in turn, can assist companies in adopting appropriate response strategies, informed by a deeper appreciation of the approaches of competitors and peers.
This study therefore used reporting data from the CDP to identify carbon management activities and strategies of South African companies and to investigate the determinants of the type of response strategy adopted.
Carbon management activities, strategies and company characteristics
While there is some research globally on characterizing carbon management strategies of companies, little has been conducted in developing countries (namely Pakistan and South Korea)(Lee, 2011; Jeswani et al, 2008), and none has yet been conducted in South Africa.
Previous research elsewhere has also found that company characteristics, such as size, sector and location, play an important role in the selection of carbon management strategies.
With a dynamic policy landscape on climate change in South Africa and the intention to further price carbon through a carbon tax to be implemented in 2015, implications for company competitiveness and value creation should be leading companies to carefully consider their response strategies.
Research objectives and approach
In this context, the objectives of this research were to:
• Identify the carbon management activities and strategies adopted by South African companies.
• Investigate the relationship between carbon management strategy and company characteristics (sector, size and corporate carbon commitment).
• Investigate the relationship between carbon management strategy and corporate financial performance.
• Determine whether company characteristics can predict carbon management strategies employed by a company.
The study used a similar framework to that suggested by Lee (2011), and similar to Weinhofer & Hoffmann (2010) and Sprengel and Busch (2011), whereby a company’s carbon management strategy is conceptualised by combining (using cluster analysis) the scope and level of the company’s carbon management activities (using automated content analysis).
The study identified five carbon management activities that characterize the response to climate change through analysing 70 company responses to the 2011 CDP questionnaire.
Classification and regression trees were then used to determine whether the combinations of various variables (in this case market capitalization, turnover, CDP disclosure score, CDP performance band, return on assets (ROA) and company sector) could be used to classify the corporate carbon management strategy of a company.
An Analysis of Variance (ANOVA) was performed to investigate the differences between carbon management strategy types in terms of the company characteristics (for example, company size, carbon commitment and financial performance).
Carbon management activities
The foremost corporate carbon management activities used by large South African listed companies are:
- Process improvement – including elements of process improvement such as recycle, efficiency, reduction, energy, store and costs
- Supply improvement – improvement of the supply chain including transport, retail and distribution
- Eco-efficiency and cost reduction – involves energy use, costs, emissions management and efficiency
- Product and new market-development – exploring opportunities outside the current scope, and investing in disruptive technologies
- Governance and regulatory compliance – relates to governance and risk management elements, as well as regulatory compliance
These activities are similar to those conducted elsewhere, with the exception of “emission reduction commitment” and “external relationship development” which did not emerge in this analysis. Further, South African companies focus on “governance and regulatory compliance” activities more than companies elsewhere.
Carbon management strategies
Four key types of carbon management strategy are employed by large South African listed companies:
• Governance, risk and compliance (GRC) reducers
• Vertical reducers
• Internal efficiency seekers • Cautious reducers
*The characteristics of the four strategies are provided in Table 1.
These strategies are similar to those employed elsewhere, with the exception of “GRC reducers”. This strategy strongly incorporates “governance and regulatory compliance” activities, which as mentioned above, does not strongly appear in companies elsewhere.
It is interesting to note that “Vertical Reducers” have the highest CDP disclosure and performance scores, while “Cautious Reducers” have the lowest.
Predicting carbon management strategies
Company size, sector and carbon commitment individually influence to some degree the type of strategy adopted, while return on assets (ROA) was not found to do this.
However, different combinations of variables were tested to provide the best prediction of carbon management strategy, with the following results:
• All variables (market capitalisation, revenue, ROA, company sector, carbon disclosure score and performance band) – provided 77 % prediction accuracy
- Company variables (market capitalisation, revenue, ROA and company sector) – provided 66 % prediction accuracy
CDP-related variables as a proxy for company commitment (carbon disclosure score and performance band, as well as whether a company has emission reduction targets) – provided 66 % prediction accuracy.
Therefore, the proportion of companies’ corporate carbon strategies correctly classified based on company size, carbon commitment, company sector and corporate financial performance is greater than the proportion that would be obtained by chance (that is, 25%). Corporate carbon management strategies employed by companies can be classified based on the variables used. As combinations of variables does not seem to have been assessed previously, the findings from the current research add new information to the body of knowledge available on carbon management strategies and the contextual factors that influence the choice of management strategy.
This study provides an empirical examination of the carbon management activities and strategies employed by the South African listed companies in the sample.
It would appear that, because of their focus on lower-order activities (that is, incremental changes to existing products and processes and not transformative strategy), managers in South African listed companies are not yet focusing on activities which could better prepare their businesses for future change and shocks (Kurapatskie & Darnall, 2012; Hart & Milstein, 2003).
As anticipated, the findings of the study verify the relationship between a company’s carbon management strategy and its size,
particularly for the largest and smallest companies in the sample; however this link was not clear for companies sitting between these extremes. A company’s level of carbon commitment, as proxied by disclosure score andperformancebandallocatedbytheCDP, was shown to have a bearing on the type of carbon management strategy employed, as was the company’s sector.
The analysis did not find a significant relationship between carbon management strategy and corporate financial performance, and there are many reasons that this could be the case. The combination of company variables was shown to predict the carbon management strategy chosen by a company.
Implications for companies, policymakers, and investors
The results of this study have a number of important implications for companies, policymakers, investors and also for the CDP. Firstly, carbon management strategies employed by companies in developing countries (like South Africa and Pakistan for example) are in initial stages of responding to climate change (Jeswani et al., 2008).
Most companies in this context are likely to take a relatively reactive approach to climate change (Lee, 2011) as evidenced by the fact that none of the companies in this sample have a comprehensive carbon management activity focus.
Climate change issues present business risk as well as opportunities which could “completely transform existing competitive environments” (Lee, 2011, p. 44) thus companies can choose from various strategic options that are available to address the “market components related to climate change” (Lee, 2011, p. 44). Companies should therefore consider market activities, as well as political and non-market responses, while integrating climate change issues into their strategic management processes (Kolk and Pinkse, 2005). Secondly, policymakers can use the results of this study to understand the actual corporate responses to climate change. This understanding can help to shape policy and legal decisions. Companies in more regulated industries were found to have reduction initiatives and targets in place (for example, the materials sector) while those in less regulated industries were less structured in terms of a carbon response (for example, media).
Therefore legislation is important and is required to encourage action. However, the structure of policies should remain such that flexibility in how companies respond is available (Kolk & Pinkse, 2005).
The pending carbon tax (Clarke, 2012) is something that has started to make companies pay attention to their emissions. The government can play a role in inducing innovation by providing incentives, increasing awareness and creating an environment which enables and fosters innovation in the area of climate change responses (Jeswani et al., 2008).
However, the success of any policies will “largely depend on the proactive response from industries” (Jeswani et al., 2008, p. 58). Therefore, policies need to address “barriers faced by industries, which hinder adoption of low-carbon strategies” (Jeswani et al., 2008, p. 58). This study has concentrated on the largest South African listed companies which are likely to have far greater resources available that many of the companies that exist in the country.
It could be assumed that smaller companies’ level of response to climate change would be less evolved than that of the respondents implying that much needs to be done to ensure that more businesses are working towards addressing climate change. Policy makers need to consider how to improve the general response to climate change and could consider government awareness and assistance programmes.
Third, investors can use these results, and this type of analysis, to better understand the actual responses to climate change that companies are engaged in as they have been derived from the companies’ own responses to the CDP survey, in conjunction with company sustainability reports and marketing collateral which may contain a degree of “green washing” (Delamus & Burbano, 2011).
A greater understanding will allow better informed decisions with regards to financing and investments and may advise the types of conditions which may be imposed on financing arrangements.
This article is a summary of research conducted at the Gordon Institute of Business Science, University of Pretoria in 2012. The authors are thankful for the support provided by the Carbon Disclosure Project and the National Business Initiative, who supplied the CDP 2011 database to GIBS for research purposes. Thanks are also due to Merle Werbeloff, for her input on statistical analysis.
Source: Sustainability and Integrated Reporting Handbook Volume 1
Contribute an article to the SR & IR Handbook Volume 2
Book your seat here.
Join the discussion here.
Follow Alive2Green on Social Media