American business and politics are divided by many issues, perhaps none as much as climate and the push by some investors and business leaders for aggressive environmental, social and governance (ESG) changes. One side sees the dynamic as critical to saving the planet and increasing value for shareholders by addressing risks and opportunities. The other calls it a sham.
Given the vast flow of capital into ESG strategies, scrutiny is understandable. The push to realign major industries and capital markets makes it imperative to develop better measures of value. The process of putting a dollar value on ESG impact is coming.
The reality is the most ambitious companies already are making sustainability part of their brand and business model. Auto manufacturers are retooling to become all-electric by 2035. Financial institutions have pledged a whopping $130 trillion to fund the transition to a net-zero carbon economy. But there continues to be a disconnect between financial performance, stated in dollars, and ESG performance, stated in non-monetary units such as greenhouse gas emissions.
To bridge the disconnect, efforts are underway to translate hard-to-compare ESG metrics into monetary terms that executives, corporate supply chain partners and investors can use to drive business decisions and capital allocation. This will create a radically transparent marketplace where financial and ESG impact calculations redefine the value of brands and businesses, and enable comparisons of how industry competitors stack up. Dollar values could also inform the conversation between critics who look on ESG as "non-financial" and at odds with a focus on shareholder returns, and the three-quarters of CEOs and investment professionals who are adopting ESG as a value driver.
Here are three market trends that will play a role in dollarizing ESG impact:
Carbon footprints hit the bottom line: Greenhouse gas emissions impose a real cost on companies. European carbon prices briefly hit $106 per metric ton this year due to Russia’s war on Ukraine. S&P Global projects that long-term supply and demand trends will result in high carbon prices around the globe — and create competitive advantages for companies that lower their emissions more successfully than peers. A CDP report found 2,000 companies used carbon pricing or plan to in order to drive low-carbon investments and change internal behavior. A record 156 million carbon credits were purchased by companies, governments and individuals last year, and McKinsey predicts annual demand could exceed 2 billion carbon credits within the next decade.
Impact accounting quantifies company sustainability: The Impact Weighted Accounts work of Harvard Business School aims to create accounting statements that reflect a company’s financial, social and environmental performance, and enable investor and corporate decisions to drive down costs and free up capital. According to a CFA Institute study, one well-known global company’s net profit would fall by 28 percent if negative environmental factors were an accounting item, and Harvard Business School makes similar calculations for major companies and industries. Similarly, New York University embeds Return on Sustainability Investment calculations into companies’ customer-facing, operational and financial drivers to find ways to generate billions of dollars of additional value through increased cashflows and reductions in the negative financial impact of their environmental footprint.
Net-zero portfolios and environmental P&Ls bend the spend: Embedding ESG risks into financial frameworks changes how capital is allocated and what gets funded. Some companies will inevitably be seen as riskier and more likely to be charged a higher cost of capital, borrowing rates and insurance premiums. Fund managers with $60 trillion in assets have pledged to align their portfolios with net-zero carbon goals, using new financial tools and metrics for profitable decarbonization. A handful of companies use environmental profit & loss accounts that calculate the monetary value of their environmental footprint. This makes it easier for executives who are used to thinking in dollars or euros to analyze the business, drive decision-making and report to shareholders on how they are growing sales while bending the environmental cost curve.
Policy tailwinds could accelerate these trends. The European Union’s proposed Corporate Sustainability Due Diligence Directive would require both EU and non-EU companies to anchor environmental and human rights considerations into their operations and management systems. The U.S. Securities and Exchange Commission’s proposed rules would require climate risk disclosure. These developments would be a sea-change for companies and boards akin to earlier corporate governance reforms such as Sarbanes-Oxley.
ESG momentum feeds a backlash, but critics who charge that "non-pecuniary" considerations have no place in investment decisions must contend with studies that generally find positive financial effects. They should also ponder whether it’s a good idea to create blind spots for investors. We don’t say, "You can only look at revenues, you can’t look at profits." Investors want to see the whole picture of company value — and ESG data and dollar values can deliver a richer picture.