When economic bubbles burst, the results can be devastating. Consider the recent housing bubble or the previous high-tech bubble. While the high-tech industry has recovered, millions of homeowners and former homeowners have not. Several years later, global markets today are still feeling the effects of the housing market implosion. Clearly, preventing economic bubbles is a worthwhile enterprise.
By definition, a bubble occurs when prices are inflated above their "real" value. For stocks and other investments, value is related to their anticipated future performance. If there is some risk that might prevent a company or investment from doing well in the future, that risk should be figured into the "real" value. When such risks are hidden, prices become inflated and a bubble grows.
In recent years, climate change and natural resources have begun moving into the realm of financial risk that companies need to understand and appropriately value. For traditional financial accounting, this represents a significant shift, but the foundation is sound: The risk of climate change is real and therefore should be factored into the "real" value of companies' stock and investment portfolios. The same is true of threatened natural resources, such as clean water. The risk of depleted natural resources is real. Hiding that risk will contribute to an economic bubble.
Because natural resources and climate touch of all of us, a bubble that encompasses them would be destructive in ways that are hard to imagine.
Organizations such as GreenBiz, The Investor Responsibility Research Center Institute (IRRC) and Ernst & Young have been working to both determine and track what companies should do and are doing to manage their risk.
The Global Reporting Initiative and integrated reporting are two of many proposed tools to help companies navigate the complexity and accurately value risks that, until recently, have been taken for granted.
Admittedly, the proper valuation of natural resources -- and access to them -- is an extremely complex task. Recent advancement in scenario analysis programs and techniques have, possibly for the first time, made it possible to do so. Other information resources such as Aqueduct are also coming online to help companies and analysts see risks they may not have seen before.
Next page: Shareholder pressure