By Martin Kelly FCCA, associate professor, accounting at Waikato Management School, New Zealand
Corporations sometimes pollute rivers, destroy forests and generate dangerous gases without reporting any of the costs that such errant behaviour may ultimately incur. The UN has explained why business managers should consider the effects of their decisions not only on finance, but also on social systems and natural capital.
Business decision models must recognise how those decisions will affect natural capital, despite the effects not being material on reported profits. ACCA’s recent report, Is natural capital a material issue? is welcome because it highlights concerns about current business decision making practices.
However, attempting to make companies put value on natural capital in their financial reports may not be the best way forward.
Society is structured so that any organisations cannot exist unless they make profits. Managers are aware of this, but most managers might agree that it is wrong to:
- Pollute streams and the sea;
- Pollute arable land so that little will grow on it
- Pollute the air and in so doing affect people’s health
- Add to the world’s carbon emissions
- Add to global warming
- Add to ozone depletion
- Destroy forests
- Destroy fish and other natural food stocks
- Drive species of plants and animals to extinction
- Pass onto the next generation a degraded natural environment.
Depleting or destroying natural capital in these ways usually results from business activities undertaken to increase profits. While the ACCA report suggests that in accounting terms ‘a material issue is largely defined as one that has a significant financial impact on corporate activities’, the natural capital destruction listed above typically never appears in financial reports; it is invisible to people who are trained to view the world financially.
It is interesting to examine the efficacy of financial reports in discharging their more traditional role. The 2011 working paper of the International Integrated Reporting Committee, referring to financial reports observed: ‘The small percentage of market value now explained….down to 19 per cent in 2009 (for the S&P 500) from 83 per cent in 1975. The remainder represents intangible factors…’
Do we wish to introduce further estimates and complications to financial reports? It would be difficult to provide comparable natural capital figures for all financial reports that all interested parties would agree were fair. The ACCA report itself declares: ‘Studies undertaken….showed that corporate reporting on biodiversity is largely qualitative in nature…’
The argument that what cannot be quantified cannot have influence is an absurd one. A fishing company could decide not to fish within the habitat of an endangered species. Would it be worth estimating how much the company’s total fish catch declines in value as a result, or what the value of public relations benefits are? Would everyone agree?
Most managers are aware of such disastrous outcomes as those listed above. Surely they will avoid such outcomes, even without valuations, because it is the right thing to do. Or should managers do the right thing only when it can be justified financially? If we cannot trust senior managers to behave responsible, we must re-educate them away from the hegemony of the current market model or suffer the consequences.
ACCA’s report is welcome because it challenges its readers to address an issue that everyone, for the time being, can choose to ignore. The longer the issue is ignored, the more difficult it will become to sustain natural capital. It is undeniable that natural capital is a material issue in our world. It must be recognised as such, and the related problems are quantified and appear in financial reports.
This post first appeared in Accounting and business, February 2013