Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
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Environmental Cost Main Page
Introduction
The author begins by comparing the terms economic growth, economic development, and sustainable development. Economic growth is a relatively narrow concept that is measured in monetary terms such as wages per person, gross domestic product and stock market performance. Economic development, on the other hand is a multidimensional concept and includes factors such as access to education, healthcare, leisure time, fresh air, green space and other things that determine the quality of people's lives. Although economic growth can lead to an improvement in the quality of people's lives (trickle-down economics), it can also have the opposite effect if it leads to more air pollution, crowded cities, more expensive housing, less green space, and more homelessness and crime. Economic development takes these externalities into account. The term sustainable development goes even further and according to the Brundtland report refers to "meeting the needs of the present without compromising the ability of future generations to meet their own needs." The United Nations expanded on the Brundtland report and created 17 Sustainable Development Goals that provide a framework for improving the lives of people around the world (See the Busco, Fiori, Frigo, Riccaboni summary below). This framework created a way to measure success on the many sub goals that are needed to achieve sustainable development.
Accountants measure economic growth for business firms in monetary terms like profits, but profit seeking business activity can increase or decrease economic and sustainable development. This leads to the question of whether a company's business model helps or hinders achieving the 17 sustainable development goals mentioned above? Using the sustainable development framework, accountants can broaden their perspective of what is measured when evaluating a company's performance. Accounting research is needed that focuses on the relationship between profits and sustainable development, and provides information related to the UN's sustainable development goals.
Shareholder Primacy and ESG
The acronym ESG refers to Environmental, Social, and Governance and was used in a report published by the United Nations in 2004. The report promotes ESG-related activities (e.g., reducing the firm's carbon footprint) to improve firm performance, improve the firm's reputation, and reduce the firm's ESG-related risks. The focus on ESG has created many research questions including whether investing in firms that are pursuing ESG initiatives leads to better returns on investment? If so, ESG activities do not conflict with the shareholder primacy perspective. In other words, it shows that shareholders care about ESG because other stakeholders care about ESG. However, an important question is whether the effect of ESG activities on return on investment and firm value is the right focus for accounting research?
The Planet's Problems
There are at least two major problems created by human self-interest. These include externalities, and the tragedy of the commons. Externalities are indirect cost to uninvolved third parties that arise as effects of an individual's or firm's activity, e.g., greenhouse gases and air pollution. The tragedy of the commons occurs when each individual acting in his or her self-interest over-consumes a natural resource such as a fishing area, forest, or groundwater. Solving these two problems requires reliable measurements and timely disclosures of these activities.
Who is Going to Save the Planet?
This section includes a discussion of corporate boards, asset managers and pension funds, ESG rating agencies, the government, and finally accountants and standard setters. Corporate boards are unlikely to implement and prioritize sustainability and societal issues given the current state of U.S. corporate governance law. Asset managers and pension funds are constrained by shareholder primacy rules that focus on maximizing returns, so they are probably not going to provide much help in achieving sustainable development. ESG rating agencies also have a shareholder primacy focus and are not going to save the planet. Theoretically the government could change the rules to force corporations to behave responsibly, but due to checks and balances in the political system, weak bureaucracies, the ability of corporations to use the court system to fight legislation, and other constraints it is unlikely that the government will solve the planet's problems mentioned above. That leads us to the question of whether accountants and standard setters can save the planet.
Accountants and Standard Setters
If accountants are to play a role in sustainable development there are some critical questions that need to be answered. Who is the audience for sustainability reporting? What should be measured and reported? Should sustainability reporting be voluntary or mandatory, and who will enforce the rules?
The audience question leads to consideration of the terms financial materiality, impact materiality, double materiality, and dynamic materiality. Financial materiality refers to information that is value relevant to investors. Impact materiality refers to the effects the firm's activities have on the environment, the economy, and society. Double materiality combines financial and impact materiality and refers to sustainability disclosures that are relevant to all stakeholders. Dynamic materiality refers to a situation where something that is not initially financially material becomes financially material over time as people learn and become concerned about an issue.
The question of what to measure depends on the industry. For example, a pharmaceutical company might be measured on product safety and effectiveness, while measures for a manufacturing company might involve supply chain issues and child labor. Sustainability reporting is currently voluntary, but it should be mandatory. There are a number of organizations that are developing standards. Some examples include the following. The Global Reporting Initiative is moving to industry-based standards. The Carbon Disclosure Project produces a survey that companies provide on their carbon footprint. European Sustainability Reporting Standards are being developed and will be enforceable. The ISSB (International Sustainability Standards Board) also intends to deliver a global baseline of sustainability disclosure standards that are potentially enforceable since they fall under International Financial Reporting Standards (IFRS). In addition, the Securities and Exchange Commission (SEC) has proposed carbon disclosure standards and they would be enforceable if these rules are passed. To be relevant, all these standards need to be focused on impact materiality, not financial materiality. The approach described by Kaplan and Ramanna (See that summary below) provides a good example. The point is that sustainability reporting is not focused on money and profits, and accountants need to change their mindsets to different measurement systems that focus on environmental and social impacts.
Conclusion
Accounting educators, practitioners, and auditors have an opportunity to influence sustainability reporting because they have the skills needed to measure, disclose, and provide the assurance required. Clearly accountants need to broaden their focus beyond shareholder interest to include other stakeholders and the company's impact beyond monetary impacts. Accountants have a lot to offer if they embrace sustainability reporting and encourage a stakeholders' perspective. Some examples of research questions include: How do sustainability metrics compare over time, and are they comparable with peers? Are there better ways to evaluate firms on sustainability than ESG ratings? How can sustainability measures be included in incentive compensation? How can we get more comparable metrics on greenhouse gas emissions? How do the characteristics of management influence sustainability reporting? Currently the accountant's role is to determine the value of sales and cost of a company's products and services. A role that they can embrace in the future is to report on the carbon emissions created in producing the products or services, how the raw material used in the products and services impacted biodiversity, how using the product or service impacts the environment or society, as well as information about the disposal or reuse of the components involved. This will help us understand how the company's products and services impact the world and lead to better decision-making for the planet.
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Related summaries:
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