The Greening of Profits

Want to really attack the climate crisis? Make firms account for the environmental costs of their operations

By Bertrand Malsch and Pavlo Kalyta 

 

World leaders negotiating in Paris tried to approach the climate crisis in a way that’s compatible with the promises they have made to electorates: more growth. Think of pyromaniac firefighters trying to stop the fire they started and you will get a sense of the conflict in the task.

There are some important questions we need to consider. First, how can we pursue economic development without destroying the planet? More specifically, is there a way we can align corporate decisions while reducing our carbon footprint?

Let’s start with a basic refresher. A corporation is an entity owned by shareholders, who invest to make more money. The bottom-line objective of every corporation is to maximize profit for shareholders. If Corporation A has a different objective, shareholders will invest elsewhere and Corporation A will simply cease to exist.

Under this view, corporate social responsibility (CSR) is only in the “best interests” of shareholders as long as it generates more profit. For example, turning off the lights in the building at night will save on energy and electricity costs, but such low-hanging CSR fruits produce marginal profit increases and marginal social or environmental benefit. Real CSR, which goes beyond mere charity and the protection of reputation but does not provide business opportunities, is generally too costly for the corporation. Sadly, nothing has really changed since Milton Friedman’s provocative argument that “the social responsibility of business is to increase its profits.”

Then we arrive at the next critical question: Is it possible to somehow create incentives for a corporation to engage in real CSR without affecting its objective to maximize profit?

Corporations will change the way they make profit when they change the way they calculate and report profit to shareholders

One recent development in Canada in this respect was the announcement that Ontario will join Quebec in the emissions-trading market. But market mechanisms alone won’t address the challenge that we face collectively.

Aligning social and environmental responsibility measures with market rationality will only result in putting a price tag on environmental degradation and trading it as a commodity. As for for-profit corporations, the self-interested criteria of stock value and reputation – insofar as it affects the bottom line – trumps socio-environmental responsibility.

Fundamentally, we believe that corporations will change the way they make profit when they change the way they calculate and report profit to shareholders. Broadly speaking, a financial benefit is realized when revenue exceeds operational expenses, costs, and taxes. Thus, as long as the calculation of costs exclude environmental and social damages caused by the corporation’s activities, shareholders’ interest of maximizing profit won’t align with the public interest of minimizing greenhouse gas emissions.

Without denying the difficulties of quantifying the full external costs of environmental impacts, the burning reality is that these costs are still accumulating. Corporations should be required to take whatever limited measures they can to account for the environmental costs of their operations. Accounting standards should be modified to force corporate disclosure of conventionally measured environmental costs, and use them in their calculation of profit in their financial statements.

Whether we like it or not, capitalism has proven its extraordinary capacity for resilience over the centuries and its capacity to absorb criticisms. Arguably, real changes to the system are most likely to come about from within, by changing the way profit is measured and reported. This will shift the game in corporate practices. Accounting, more than any other technology, can make this shift happen.

 

Bertrand Malsch is associate professor and distinguished research fellow in accounting at the Smith School of Business, Queen’s University. Pavlo Kalyta will be joining the Smith School as an assistant professor in April 2016. This essay is adapted from an article that originally appeared in the Globe and Mail.

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