Performance and value

Published in Environmental Finance, in October 2005.

A constellation of factors have led to environmental and social performance becoming an increasingly important factor in shaping a company’s value. This places the issue of how to assess that performance much higher on the corporate agenda.

The first of those factors is simply the success of modern economies. More affluent, better educated and highly connected populations have higher expectations. Delivering high  quality goods and services competitively priced is no longer enough. Customers also want their goods and services to be produced in an environmentally and socially responsible manner.

Another is the emergence of a single global information space. The vast, and practically costless, flow of information made possible by modern telecommunications capacity, the Internet and cheap computers underpins globalisation. But it also means that anything a company does anywhere is instantly visible everywhere.

A third factor has been the steady growth of socially responsible investment funds. The emergence of a generation of investors with real disposable capital in another consequence of increasing affluence. A significant proportion of that generation are keen to invest in their values as well as for value. Hence the emergence of a set if indices – most with obscure analytical foundations – to guide investors towards companies with better environmental and social performance.

Finally, those same more affluent, better educated and more connected customers are also citizens. As such, they have increasingly demanded the right to know how the activities of companies affect them personally and the world as a whole. The result has been a consistent drive for more transparent corporate reporting and a huge increase in the volume of data about corporate behaviour in the public realm.

In response to these diverse and accelerating pressures a growing number of companies issue now claim to report on their environmental and social performance. Actually, that is not what they do. What they actually do is to issue their environmental and social results, just as they issue their financial and operating results. This is no mere wordplay.

Of course when a company publishes its financial and operating results it also comments on what it think of those results. In other words, it passes its judgment on what those results mean in terms of performance. Understandably, it will put the best possible face on them. But many other people – predominantly investors and analysts –  take those same results and come to different judgements as to what they mean in terms of performance. If they did not do so there would not be a market in the company’s shares.

The intricacies of judging a company’s financial performance on the basis of its published results are now the subject of a vast literature dealing with the different metrics and methodologies. It has taken about a hundred and fifty years for the current cluster of broadly recognised key performance indicators to emerge as market standards. Even so, there remain plenty of unresolved issues over the right way to compare the performance of different companies in the same sector let alone comparing that of companies in different sectors.

But comparing financial and operating performance as a basis for judging the value of a company is straightforward compared to judging its environmental and social performance. At least with financial performance all the dollars or pounds of revenue are fungible and outputs add up to outcomes. Each pound of revenue generated is exactly the same as every other pound wherever it might come from. The value of a company is a function of its ability to generate more dollars or pounds for its shareholders.
This is not true of environmental outcomes and even less true of social outcomes. Here outputs do not simply aggregate into outcomes. This is because environmental outcomes are rarely fungible. Sulphur dioxide emitted in one part of the world does not do the same damage to health or the environment as sulphur dioxide emitted elsewhere.

So you cannot simply add up all of a company’s emissions of sulphur dioxide to arrive at a meaningful measure of its environmental performance. Furthermore, reducing emissions of one pollutant may lead inevitably to increasing another – reducing sulphur emissions often involves increasing carbon emissions. Which term of this trade off is best for the environment will vary from place to place so simply aggregating the carbon and sulphur emissions and seeing which has gone up and which down does not tell you very much about the company’s environmental performance.

Social performance is even more difficult to compare. Not only do you have all of the same difficulties of turning outputs into outcomes as with environmental performance but even if you have exactly identical outcomes different communities may place a different value on them. This means that assessing a company’s social performance means finding out what affected communities think not just what the company has done. The only way to do that is to ask them.

The corporate world has rarely taken the opportunity to understand, let alone explain,  these complexities to investors, analysts, governments, the media or the public. The result is a widely held perception that measuring a company’s environmental  and social performance is mainly a matter of adding up the outputs. There have been plenty of NGOs and consultancies willing to do just that.

In the absence of any more informed and systematic information flows from the corporate sector itself these efforts have filled the need for some ranking of corporate environmental and social performance. For companies, this means that there may be no good link between their value and their actual environmental and social performance. For the environment, this might mean that we are rewarding and punishing the wrong companies.

About tomburke

Tom Burke is the Chairman of E3G, Third Generation Environmentalism, and an Environmental Policy Adviser (part time) to Rio Tinto plc. He is a Visiting Professor at both Imperial and University Colleges, London. He is a member of the External Review Committee of Shell and the Sustainable Sourcing Advisory Board of Unilever and a Trustee of the Black-E Community Arts Project, Liverpool.
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