This article was first published on Thomson Reuters on 12 June 2018 and has been reproduced in full below.
For more than half a Millennium – since Franciscan friar Luca Pacioli’s publication of the first full account of double-entry bookkeeping in 1494 – business and investment have calculated value by focusing predominantly on a sole capital: financial. With such single-minded thinking, one could call this the era of mono-capitalism.
Precisely 500 years later, John Elkington’s 1994 coining of the term “Triple Bottom Line” expanded attention to environmental and social impact of the business, spurring the emergence of sustainability reporting, which focused thinking predominantly on non-financial performance of companies.
The 2013 release of the International Integrated Reporting Framework, addressing the full spectrum of the different resources and relationships companies use to create value.
From the tradition and strictures of financial reporting, we termed them ‘capitals’, recognising their stocks could both be measured, added to and depleted – in exactly the same way as financial capital.
From the sustainability perspective, we recognised the integral impact of the inter-relationship between the company and the context in which it operates, in a world of complex supply chains and business relationships, profound technological change, and in recognition of societal ‘mega-trends’ and planetary boundaries.
Whilst drawing on and involving the practice of sustainability reporting, we turned it on its head. The focus now was not only the wider impact of the company in the world, but of the wider impact of the world on the company.
So, we entered a new era of ‘multiple capitals,’ moving beyond the financial and manufactured capitals which were integral to financial reporting as it has developed over decades and centuries.
The Framework now encompassed six capitals to also cover people – human capital; society – social and relationship capital; ideas – intellectual capital; and the environment – natural capital.
That difference from what has been colloquially termed ‘ESG’ (environment, social, governance) is not just a definitional one.
Whilst it is an important change of mindset to look at the wider context in which the company operates, that perspective still focuses on the external impact of the company, treating environmental and social impact as externalities. This expanded focus also encompasses internalities, among other things.
Furthermore, the rise of new business models (including the service industries becoming the principal value-drivers in many developed economies) and of the technology age has led to the increasing need to understand the value of intangibles – in which human and intellectual capital are critical to business strategy and success.
The analysis that intangibles have moved from 20 to 80 per cent of the value of companies over the last thirty years is now widely understood, now reaching a ‘high’ of 87% according to recent Ocean Tomo research.
So ‘new capitals’ have been firmly established and, as has been suggested, the era of multi-capitalism is emerging.
Crucial to the IIRC’s own role in contributing to this shift in thinking, has been the central role played by investors right from the beginning. The impetus for our formation was as much the financial crisis and issues of financial stability, as those of sustainable development.
Each of the six capitals presents risks and opportunities to the business.
Business and investors – and society at large – benefit by broadening the palette of value generation opportunities, to enable a more holistic understanding of how organizations can and will create value.
On the risk side, multi-capitalist thinking also opens decision-makers’ eyes to often overlooked inter-capital impacts, whereby appreciation of some capitals involves depreciation of other capitals. Ignoring such depreciation of capitals upon which business models rely can only last for so long, as a recent Oxford report suggests.
This concept of ‘connectivity’ is crucial to integrated reporting, providing a tool which enables the trade-offs, mutual dependencies and integration of the multiple strands to value-creation to be analysed, measured, and put into business model design and strategy.
This is a bold and transformational change, in that it challenges all of us on what is ‘intrinsic’ to what we do.
Multi-capitalist thinking envisions a world in which businesses understand how they create value in the context of six capitals, each of which has intrinsic value – value within the company as well as outside of it.
This may seem controversial in a world where value is often defined as concerning assets that are owned or controlled by the organization. But as a paper on the capitalspublished by the IIRC makes clear, a wider view is essential to understanding value creation:
“Whether or not the capitals an organization uses or affects are owned by that organization, their availability, quality and affordability can affect the long-term viability of an organization’s business model and, therefore, its ability to create value over time. This is particularly the case with respect to capitals that are in limited supply and are non-renewable.”
We are unapologetic multi-capitalists.
We believe this is how businesses best thinks about value creation and how they can best communicate to investors and other stakeholders how that value will be maintained over time. Our report continues:
“Using the term ‘capitals’ emphasizes the role of the various capitals as stores of value that can be built up or run down over time, but which must be maintained if they are to continue to produce a flow of benefits in the future.”
In this way, multi-capitalist thinking brings benefits to business in terms of better understanding of value creation.
This includes value creation from natural capital, and its relationship to environmental goals. By providing a way of thinking that ensures impacts (both positive and negative) are understood in the context of value creation by the company, these material issues will be better embraced by business and investors. The coalition driving integrated reporting will succeed by assisting organizations to make direct connections precisely to the concepts of sustainable development and long-term horizons – in a way which can be ‘owned’ and implemented by CEOs, CFOs, and Boards.
The highest demonstration of this argument is shown at the heart of the UN Sustainable Development Goals, whose preamble underlines this thinking that each SDG is ‘integral’ to the other and whose Target 12.6 specifically calls for integration in reporting.
The integration of the goals of sustainability and economic development was a key turning point for the world, and that integration provides the same transformational opportunity for business.
But will this transformation really succeed in having an impact back on the world?
Multi-capitals and integrated reporting
We think the shift to multi-capitalist thinking, the emphasis on integration in business models and strategy, and the requirement for measurement to standards required by investors and in the world of financial reporting, all suggest real impact on the capitals at an aggregate level as well as for the business.
This has been termed the ‘context.’
We see in this approach the potential to bring about new thinking on thresholds and allocations – how to ensure the sustainable use of capitals that are in limited supply or are non-renewable or need to be continually regenerated – in more technical terms, within the “carrying capacities” of the capitals themselves.
Indeed, Reporting 3.0 is already considering this in the context of ecological ceilings and social foundations through the Global Allocations and Thresholds Council (GTAC).
This is consistent with the <IR> Framework, which says: “The overall stock of capitals is not fixed over time. There is a constant flow between and within the capitals as they are increased, decreased or transformed.” As a thought paper on value creation, published by the IIRC, noted: “Ultimately value is to be interpreted by reference to thresholds and parameters established through stakeholder engagement and evidence about the carrying capacity and limits of resources on which stakeholders and companies rely for wellbeing and profit, as well as evidence about societal expectations.”
A world in which businesses, investors and other actors in our capital markets embrace a multi-capital world would lead to more inclusive outcomes, including broad-based prosperity. It would maximize the value creating potential of the resources and relationships used by business. It would give investors a holistic understanding of how the business creates value, bringing into focus the financial implications of what have previously been called non-financial factors.
Multi-capitalist thinking reveals how ongoing value creation requires managing both horizontal and vertical dependencies:
This expanded scope synthesizes broader societal factors that are integral to holistic management and decision-making.
This has been characterised by some as a shift from the concept of ‘shareholder value’ to one of ‘shared value’.
There is much merit in this approach, but also a necessary caution in understanding that unless information has investor confidence, it will never be fully embraced by capital markets.
That’s where the concept of multi-capitalism may provide even sharper focus and why the concept of integrated reporting retains the investor as the ultimate audience for integrated reports.
We aim to make integrated reporting the global norm for mainstream corporate reporting, which again requires us to put it in the context of ‘systems thinking’ – not just for individual businesses but for global markets.
Once again, it is multi-capitalism that fulfils the application of ‘systems thinking’ to capital markets.
It shifts the focus onto the ultimate purpose of business and finance to system value creation – which harmonizes financial value creation with the maintenance and enhancement of social and ecological systems in which the business and the economy operates.
The shift from mono-capitalism to multi-capitalism heralds the maturation to an economic doctrine that is fit for managing 21st century risks and opportunities.
It is a new approach to enterprise risk, rolling up portfolio risk with systemic risk.
It aggregates endogenous and exogenous risks, that in the 21st century are amassing in to existential risk.
Equally, it is commensurate with the step-change in business opportunities that exist by managing capitals within their carrying capacities, to generate positive value at the enterprise, portfolio, systemic, and existential levels.
Multi-capitalist thinking in practice
Businesses across the world are making this new way of thinking a reality. Sri Lankan industrial business DIMO uses its integrated report to illustrate how the company’s performance has depended not only upon financial capital, but also on human, relationship, and natural capitals.
Through the use of fully integrated performance indicators (KPIs) and narrative, the report sets out the underlying logic and activities undertaken in relation to each capital in order to achieve its strategic objective.
The European utilities company Iberdrola describes how its resources have been managed in order to create value. Information is provided for each of the capitals through narrative and quantitative forms, explaining the outcomes of the business in terms of effects on the capitals.
In its report, Italian consumer goods business, De Spar Nordest, sets out the interdependencies and trade-offs between the capitals, embedding the concept of connectivity of information.
Governments are embedding multi-capital thinking as well, with the New Zealand Treasury introducing a Living Standards Framework, as it recognizes that higher living standards requires growing the country’s human, social, natural, and financial/physical capitals which together represent New Zealand’s economic capital.
Moving from examples to system change
These examples, and hundreds of others just like them, already demonstrate that it is possible for business both to articulate and to live a multi-capital reality.
Businesses have stated that this multi-capitalist approach is leading to real behavioural change, integrated thinking, better corporate governance, and greater resilience.
It is building levels of trust and enabling investors to invest with more confidence and over longer time horizons due to an enhanced investment appraisal that is based on a multi-capital outlook.
However, it will require a conscious effort to universally realign our capital market system towards multi-capitalism. The question is, how do we move this new way of thinking – this new form of capitalism – from individual examples into a permanent shift in how we assess the components of value creation for a modern economy?
This is a challenge that all of the organizations that participate in the coalition of the International Integrated Reporting Council, including Reporting 3.0, are committed to taking on.
This week, we are announcing that the IIRC and Reporting 3.0 are beginning collaboration on a new ‘White Paper’ on multi-capitalism, which we believe can be an important next step in developing a deeper understanding of the implications of a multi-capitalist approach, as well as helping embed integrated, multi-capital thinking more widely in business.
The two organizations will set out a pathway for a transition to system change and to articulate the role of multi-capitalism in sustainable development.
There are many in the world today who question whether capitalism is capable of reform to meet the scale of the challenges before it.
There are some in the world who would also prefer to see it fail.
Multi-capitalism may be the key to proving them wrong.