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This report will ultimately recommend Mr Mackintosh to invest in Royal Dutch Shell Plc (Shell Plc) by means of financial analysis using relevant ratios. A definition of sustainability will be provided along with the theory surrounding the reporting of sustainability. The principles behind investing in sustainable business will be noted and the ways of measuring sustainability judged. Finally, the financial performance and sustainability of Shell plc will be compared to that of American Electric Power (AEP).
Introduction to Sustainability
In the last thirty years, intensive debate has occurred amongst academics, consultants and corporate executives over the various notions of ethical and transparent ways of operating business activities (Marrewijk 2003). One of such notions, 'sustainability', has become a major contemporary issue as a growing acceptance accumulate regarding the need to comprehend, monitor and report the environmental and social effects of business practises.
Definitions of Sustainability
Pezzey (1997) likens the pursuit of a 'single definition' of 'sustainability' to an 'alchemist dream, no more likely to be found than an elixir to prolong life indefinitely' (Pezzey, 1997: 448). The reasons for this 'academic cauldron' of definition, derives from a mixture of the evocative and moralistic nature of the subject matter, and the extent to which individual impetus is given to the various elements that construct it (Warhurst, 2002).
Despite this, there are definitions of sustainability that are commonly cited. Coined from the Brundtland Report, Our Common Future, sustainability is viewed as: 'the development which meets the needs of the present without compromising the ability of future generations to meet their own needs' (WCED, 1987). Warhurst (2002), although pinpointing the origins of sustainability to the 1972 United Nations Stockholm Conference on the Environment, suggests the Brundtland report 'incorporated the connection between development and environmental limits' that ensured the issue widespread acknowledgement amongst modern business. (Warhurst et al, 2002: 13). These notions were subsequently endorsed by national governments at the Rio Earth Summit (UNCED, 1992), paving the way for increased company awareness of their responsibilities to such matters and attracting substantial media attention (Benjits, 2008: 30).
Since these early developments, sustainability 'has become a central part of the language of government and business worldwide' (Deegan and Underman, 2006: 331) with the reporting of environmental and social impact on businesses increasing as public acceptance of the notion increases. Therefore, due to its significant impact in the evolution of 'sustainability', the Brundtland Report's definition of sustainability will be adopted, for the purpose of this report.
1.2 Existing Theories in relation to increased voluntary reporting of sustainability
Friedman (1962) stated there was 'one and only one social responsibility of business: to use its resources to engage in activities designed to increase its profits (Friedman, 1962: 133). Under this 'Stockholder Theory' the reporting of the environmental and social impact of a firm is unjustifiable. However, as previously stated, the voluntarily reporting of such material is increasing. This increase largely stems from the evolving nature of theoretical and philosophical views of an organisation and its responsibilities. Stakeholder Theory, originating from the work of Freeman (1984), assumes that a firm has an obligation to meet the interests of internal and external stakeholders. Under such conditions firms will try to align their stakeholders interests to reduce agency costs, (Agency Theory) (Jensen and Meckling, 1976), attempt to reduce the asymmetry of the information given to them (Signalling Theory) (Akerlof, 1970), justify their existence by proving their adherence to a social contract (Legitimacy Theory) and reduce subsequent costs by increasing transparency to them at the earliest available time (Political Cost Theory) (Jensen and Meckling, 1976). All of these theories can be used to explain why firms are increasingly voluntarily disclosing information such as their environmental and social impact.
1.3 Ethical Investing and Sustainable Investing
This increase in the voluntary reporting of environmental and social issues has also been generated by the increase in the philosophy of investors. Socially Responsible Investing (SRI) or Ethical Investing rose in prominence as a greater public conscience rose to businesses impact on the environment and society. Lewis and Mackenzie (2007) suggest that ethical investment involves the building of an asset portfolio that is not based on non-economic grounds, but the moral commitment of the purchaser.
The difference between this and the subsequent evolution of sustainable investing is that while the primary spur for ethical investment is the internal value system of the investor, the prompt for sustainable investment is the external realities of an economy out of balance. 'Sustainable investors recognise that physical, regulatory, competitive, reputational and social pressures are driving environmental and social issues into the heart of the market place and thus the ability of companies to generate value for investors over the long-term' (Robins, 2008: 6)
1.5 Measuring Sustainability Performance
Despite this evolution of theoretical and ethical perception of the firm and the increase in the reporting of sustainability, the measurement of sustainability performance remains difficult and hindered by a variety of factors.
Firstly, a lack of conceptual framework and regulation in the area of social and environmental reporting ensures much variation on how firms report such matters. (Deegan and Underman, 2006: 353). This makes comparisons of performance hard to make between firms.
Furthermore, the inability to assign particular costs to the measurable areas of economic and social impact (e.g. water, air, future benefits etc.) is a further hindrance.
However, one broad mechanism commonly used by firms to report their social and environmental impact is through 'triple bottom line reporting', that is, where a balance is sought between 'economic', 'social' and 'environmental' sustainability. The term, first coined by Elkington (1997), is now extremely common amongst firms, but does have its limitations, most notable, again, the inability to factor in and assign immeasurable costs. Furthermore, the triple bottom line fails to reflect the interrelated nature of the three areas.
Internationally developed in 2002, the Global Reporting Initiative's Sustainable Reporting Guidelines (GRI) are accepted as representing 'best practices reporting' and comprise 97 separate indicators of performance. The key categories of disclosure include 'types and quantity of materials', 'energy consumption', 'water consumption', 'biodiversity issues' 'emissions', 'wastes', 'legal compliances' (Global Reporting Initiative, 2002)
Measuring the Sustainability Performance of Shell Plc and American Electrical Power (AEP)
Both Shell and AEP have produced their environmental and social reports in accordance to Triple Bottom Line Reporting. Both have worked alongside 'SustainAbility', a company founded by Elkington, who originally constructed the idea. Therefore, both companies' performance will be measured from an 'economic', 'social' and 'environmental' perspective. However, both adhere to the GRI sustainable reporting guideline and because of which the key performance indicators will be identified and compared.
2.1 Financial Analysis: Shell vs. AEP
The financial performance of Shell and AEP will be conducted through the use of financial ratios relating to efficiency, gearing, liquidity and profitability.
2.2 Financial Analysis and Recommendations
From the table above, particularly the 'comparison' column, it is recommended to Mr Mackintosh that Shell provides a better financial option than AEP. A more competitive ROCE, Current and Acid Test Ratios, asset turnover and the company being less dependent on lenders outweighs its lower profit margin. However, Mr Macintosh is concerned not only with making a reasonable return, but whether the firm involves itself in sustainability engagement.
2.3 Sustainability Performance: Shell vs. AEP
Table 2.2: Analysis and comparison of sustainability performance Shell and AEP
2.4 Sustainability Performance Analysis and Recommendations
The table above shows the difficulties in accurately comparing and evaluating sustainability performance, with information available inconsistent between the two companies. However, overall, it is recommended to Mr Mackintosh that Shell performs more effectively in all three areas of the triple bottom line definition of sustainability.
Economically, Shell offers greater return to shareholders (22%) and their 'contributions to local development' far outweigh AEP's. Socially, their fatalities and rates of injury are decreasing year on year, whereas AEP's are rising and the benefits they offer their workforce is impressive. Environmentally, their Greenhouse Gas Emissions have reduced to 35% since 1980 and their investment portfolio in new environmental technology is impressive.
Shell's most impressive element of their sustainability is that $132m was spent on social performance, with most being spent of community development projects. This includes prominent work in Africa, particularly Nigeria, and India. Furthermore, 90% of Shell's workforce is local.
Finally, both reports are transparent in their reporting of social, economic and environmental issues. This may reflect their close association with 'SustainAbility', the company founded by John Ecklington, the pioneer of Triple Bottom Line reporting.
The recommendation of Shell further highlights the distinct differences between ethical investing and investing in sustainable business. One would assume that ethical investors may be wary of engaging with a company like Shell, who profit from the world's natural resources. However, an investor in sustainability may accept their line of work, focusing on their engagement to limit their impact both socially and environmentally whilst continuing to generate considerable returns on their investment.
Conclusions and Recommendations
This report recommends Mr Mackintosh to invest in Royal Dutch Shell Plc (Shell Plc). The definition of sustainability, derived from the 1987 Brundtland Report, has been put forward, and the different theories that have encouraged the reporting of sustainability have also been stated. The moralistic differences between ethical investment and investing in sustainable business have been outlined. The ways in which sustainability performance is measured have been judged and finally, Shell Plc has been compared to American Electrical Power, and the former has come out favourably through the use of financial ratios from an economic, social and environmental viewpoint in reaching this decision.