In recent years, most major international airlines have reported healthy profitability. But our calculations show this to be a mirage. In the case of Lufthansa and American Airlines, for example, accounting for their environmental costs of $2.3 and $4.8 billion respectively would make both companies unprofitable.
What explains this discrepancy? To date, there has been no way for companies to account for their benefits and costs to society and the environment. We have been working to change that.
Accounting for impact took a major step forward in July with our publication of the cost of the environmental impact of 1,800 companies by the Impact-Weighted Accounts Initiative (IWAI) at Harvard Business School. Next year, the IWAI will publish the cost of product and employment impacts too, providing a complete picture of the impact companies create.
The era of impact transparency has begun, and it is moving the goal posts for businesses and investors. Technology and Big Data have combined with longstanding efforts by many individuals and organizations to make the measurement and valuation of corporate impact a reality. With the arrival of impact transparency, impact and profit set the new rules of the game.
Analyzing the IWAI’s extensive dataset for 2018 through an impact lens brings a new perspective on the true profitability of companies. It becomes apparent that many companies are creating environmental costs that exceed their total profit (EBITDA). Of the 1,694 companies which had positive EBITDA in 2018, 252 firms (15%) would see their profit more than wiped out by the environmental damage they caused, while 543 firms (32%) would see their EBITDA reduced by 25% or more.
For certain industries, including airlines, paper and forest products, electric utilities, construction materials, containers and packaging, almost all firms would see more than a quarter of their EBITDA eliminated, according to our group’s calculations.
Within other industries, huge variation is revealed in the environmental damage companies create. In food products, for example, environmental costs range from 5% of EBITDA (Nestle, $1.6 billion) to 62% (Associated British Foods, $1.8 billion). In the challenged oil and gas industry, where 75% of companies would see more than a 25% reduction in EBITDA, a few best performers have overtaken their competitors. And in semi-conductors, industrial conglomerates, food and staples retailing, and beverages, significant variation is similarly found between leaders and laggards.
It is not all negative though. Companies also create positive impacts through their products and employment, which do not show up in their bottom line. Take Intel’s employment impact as an example. In 2018, it created approximately $3.6 billion of positive impact in the U.S. through the wages it paid and the jobs it provided in areas of high unemployment. Intel can increase this impact by improving its level of diversity and offering more equal opportunity for racial minorities and women to advance within the company.
Impact transparency will have far-reaching consequences. First, instead of taxing all of us to remedy negative impacts such as pollution, pay below the minimum wage, and products that cause obesity and ill health, governments will be able to tax companies directly for the harm they create. They will also be able to provide direct incentives — in the form of reduced taxes, subsidies or preferential procurement — for companies to deliver positive impact through their products, operations and employment practices.
Second, investors will price the environmental and social impacts of companies into their investment analysis. More than $30 trillion flowing today in ESG and impact investments, equivalent to more than a third of the world’s professionally-managed assets, are already doing their best — despite the absence of all the relevant data — to integrate climate change, employee diversity and customer health into their investment decisions.
Firms with greater negative impact generate less investor interest, which reduces their stock market valuation and raises their cost of capital. Impact transparency will, therefore, motivate management to improve corporate impact, in order to increase stock market value and, sometimes, their own compensation too.
Read the rest of Ronald Cohen and George Serafeim’s article here at Harvard Business Review
