Fair Accounting
The movement to monetize corporate externalities is feasible, timely, and necessary.
By T. Robert Zochowski, Katie Panella & Ben Carpenter. Re-posted from Stanford Social Innovation Review.
Last year, Andrew King and Kenneth Pucker argued in SSIR that “new proposals for monetizing corporate planetary impacts are alluring, impossible, and perilous,” and specifically referenced the Impact-Weighted Accounts project at Harvard Business School. Since their statements about our work and its goals also apply to the entire impact valuation community, we have written this response to reiterate our position that impact monetization is the most expedient way for multi-stakeholder impact considerations to be incorporated into management and investor decision-making.
Fundamentally, impact monetization is about translation: converting non-intuitive metrics from a variety of disparate academic fields—from environmental science, public health, human resources management, and public policy—into currency units that can be understood by board members, senior leaders, investors, employees, and customers. Financial accounting and monetized impact accounting are dynamic and evolving processes which provide important context for decision makers. But impact monetization practitioners don’t envision a single static methodology to determine the value of social and environmental externalities. Rather, just as financial accounting continues to adapt, impact accounting will do the same. In contrast to King and Pucker’s interpretation of our goals, our aspiration is to converge on ranges of acceptable monetization factors based on context and science (a concept known as “bounded flexibility”), rather than prescribe rigid interpretations of stakeholders’ preferences.
Impact monetization is not perfect, of course, and there are risks that must be understood and managed. But it represents a substantial step toward more integrated, inclusive, and sustainable decision-making by making inevitable tradeoffs and conflicting needs transparent and comprehensible to a broad set of users. Indeed, our experience working with senior leaders of organizations has shown time and again that monetized impact resonates far more saliently for decision-making than disparate metrics such as Particulate Matter 2.5 or a CEO to Median Salary ratio.
Is Monetization Impossible?
The first argument King and Pucker make against impact monetization is difficulty: “Because different product impact measures are bespoke to each industry, the complexity of determining consumer surplus grows exponentially,” they write, going on to assert that “most economists believe that it is impossible to solve the “economic calculation problem” (i.e. the efficient allocation of production to meet consumer desires) in a centralized way.”
We would suggest that “most economists” is a generous interpretation and that these challenges are not reason enough to throw in the towel. We don’t dispute the difficulty of the undertaking. But the monetization of corporate externalities is already happening: Numerous companies have begun using forms of monetization to better understand their risk, including case studies published by both Impact-Weighted Accounts and the Value Balancing Alliance. Further, this is the direction that impact measurement is moving; the G7 Impact Taskforce in December 2021 formally recommended impact valuation in its report Time to Deliver. We, and our colleagues, choose to add data, rigor, and stakeholder engagement to this existing practice, rather than let impact-washing control the $35 trillion in assets under management that are currently stamped with an ESG or “impact” label and sold at a premium to investors and consumers alike.
To illustrate the difficulty of impact monetization of the value of a product such as airline travel, the authors zero in on a single calculation in one of the Impact-Weighted Accounts framework’s three primary pillars (environmental, product/service, and employment impact). But just as we would not recommend making determinations about a company’s financial health by looking at a single line item on an income statement, we similarly do not suggest that conclusions about the value of a firm’s externalities on society be drawn from a single component of impact accounting statements. To suggest that an airline would change its fundamental business model based on that single component is an extrapolation far beyond the intent and actual practice of impact accounting. It is precisely the point, in fact, that instead of a single bottom line impact number, impact accounting envisions a system where value creation and destruction are broken out by stakeholder and by dimensions of well-being (i.e. human rights vs well-being increases) to provide critical context.
Further, the relevance of King and Pucker’s concerns regarding difficulty has significant range across different components of impact accounting, just as it does in financial accounting. For example, there is significant empirical research to support the convergence around a carbon price, which we would use to monetize a company’s environmental footprint. On the other hand, monetizing the impact of a product or service once it has been purchased by a consumer is a comparatively more recent endeavor, and therefore can easily be explained away as “too hard.” Financial accountants will find this range familiar, as they think about the relative ease of accounting for internal payroll expenses versus tracking revenue from disparate income sources.
We must avoid building a false binary between financial accounting and impact accounting, presenting the former as a science, while the latter as an art. Reality lies in between the two, both are necessary for a dynamic and effective system, and it is crucial to stay humble, and to evolve. Thus, when King and Pucker write that “The problem of measuring the value of possible changes is further aggravated by the dynamism of modern economies: Economic conditions are always changing, so impacts would need to be updated constantly,” we would observe that this same dynamism permeates any financial measurement (ask anyone who has been keeping up with the continuously evolving changes to accounting treatment of operating leases or revenue recognition). In finance, no less than in impact, evolution is part of the fundamental DNA of the system and is critical to ensuring the relevance of financial accounts to current economic contexts. This evolution is a tool to combat what the authors present as a risk inherent in impact accounting: that a far-removed, static, and elite group will make the rules that the rest of the economy needs to follow.
Is Monetization Un-Democratic?
A second primary theme of King and Pucker’s article is the disintermediation of customers’ needs and preferences by a select (meaning elite) group of experts, citing Arrow’s Impossibility Theorem and the challenges of calculating consumer surplus (which they argue proponents of monetization have not considered). This seems to us to be a scare tactic, envisioning a “single mainframe computer to calculate the true value of each exchange to sellers and buyers, third parties and planet as a whole,” which would transfer the valuation role from consumers to experts; “In an impact accounting system,” they write, “these experts would decide how much consumers benefit from flying to various destinations, or from drinking a glass of water or buying a handbag… [leading] to waste and the further accumulation of decision-making power” analogous to that of the communist economies of the mid-twentieth century.
To put it mildly, central planning is not what has been envisioned by the Impact-Weighted Accounts team nor by other experts in the impact-monetization field. Social Value International, the membership network that has overseen the “Social Return on Investment” since the early 2000s, defines “stakeholder involvement” as its first core principle, despite common misconceptions. (The following statement from SVI’s Standard for applying Principle 3: “Value the Things that Matters,” illustrates the importance placed on stakeholder involvement in the valuation process: “Value is subjective in its very nature. Therefore, it is critical that Principle #3 “Value what matters” is applied in conjunction with Principle #1 “Involve stakeholders” so that we value outcomes from their perspective.”
The Impact Management Project (IMP) facilitated a discussion on this point between IMP Practitioner Experts on impact valuation and monetization, whose key findings (and contradictory view-points) are summarized extensively in a public document. On the topic of whether agreement could be reached on the relative priority or worth of different impacts, the consensus was that less than or about half could be:
“Even if an enterprise or investor were to be wholly altruistic and subordinate in its interests to those of its stakeholders (including the environment), there does not appear to be one “correct” way of doing so. It appears inevitable that enterprises and investors will have to rely at some point on their own preferences and values to make decisions. In these situations, organizations leading on this topic traditionally encourage practitioners to engage with stakeholders if they haven’t already, to codify (and question) their assumptions, and to be internally and externally transparent about what data and methodologies were used to prioritize impacts.”
The vision for what might be agreed upon in impact monetization is best described as bounded flexibility, or choice within limits. There is no single value for each impact that will stand across time, stakeholders, cultural, and geographic contexts, but that there are limits, based on stakeholder engagement, science, and other price/preference discovery methodologies that can inform the upper and lower bounds of acceptable valuations and provide guidance on confidence intervals. In “Mutually Compatible Yet Different,” Nichols and Zochowski acknowledged Arrow’s Theorem, postulating that “bounded flexibility places consensus-based boundaries on the limits of the expected deviation in an impact valuation within a framework. This maintains a level of comparability whilst allowing for context…[acknowledging] that preferences can be dynamic in nature and may require adjustment.” The strawman of a hegemonic dystopian selection of preferences by an elite group of experts doesn’t do justice to the complexity of views held by the impact monetization movement.
But what of the authors’ faith in the efficiency of markets and consumers’ ability to influence prices? The efficient markets hypothesis relies upon the assumption of perfect information. Not only is this clearly not the case for most products that we consume, but the role of monetization is to make the true cost of such decisions more transparent, arguably increasing market efficiency. For many products, especially staples, consumers are price takers as can be seen in energy, gasoline, and food markets with substantial forces beyond simple supply and demand driving prices. Critically, the value created or destroyed for other stakeholders—like the environment, community, or workforce—are not readily priced into the interaction between a firm and its customers. A single focus on supply and demand forces, with the hope that government regulation will intervene on behalf of other stakeholders, simply has not worked. Climate change and growing social inequality can speak to this truth.
It could be argued that all monetary valuations are inherently biased, even when derived through accepted price-discovery methodologies: Many of them rely upon asking the population, or one of similar properties, about their preferences or valuations. However, the very process of seeking out valuations for the impacts from affected populations is a notable improvement beyond investors and corporations imposing their values upon others. Where impact monetization directly incorporates stakeholder voices this can only democratize valuation and increase the accountability of impact measurement.
Ironically, the alternative proposed by the authors of “Heroic Accounting” is closer to the centralized dystopian system that they envision resulting from monetization, by proposing that government regulation be the most important driver of impact management. When the authors propose a one-sided system of regulation of impacts and the disclosure of impact metrics on consumer packaging, they do not explain how stakeholder’s needs, preferences, or rights would be incorporated into those governmental regulations nor how consumers or government officials would manage to understand the magnitude of impacts represented. How could a carbon price that actually reflects the true social cost (rather than the politically convenient cost) be determined absent monetization? One cannot have a tax on environmental impact without measuring that impact, nor can you incentivize job quality without valuing the cost to employees and society from poor employment practices (and just as importantly, the positive impact created from good employers). Monetized impact is not only a tool to ease analysis, but the transparency of the approach makes it possible to back out of calculations for regulatory use. It also helps to prepare companies for the internalization of impacts by translating risk and opportunities into financial figures.
Impact monetization proponents are in support of an ecosystem of actors; investors, corporations, employees, consumers, and government regulation all have transparency and agency with which to advocate for their preferences and needs. There is no need to assume that impact-weighted accounts and government intervention must be mutually exclusive; in fact, we argue that they should be complementary.
The Potential of Impact Monetization
The language of currency allows the broadest audience to understand and act upon social, environmental, and financial information. After all, would you buy a product if all you knew was that its price was “medium” or expressed in a different currency than the one in your pocket? Or, would an investor put capital into a company with “strong” returns without any actual numbers? That’s essentially what we are asking in the absence of impact valuation. There is tremendous appetite from investors, employees, and consumers to engage with “responsible” companies, but very little consensus on how to assess a firm’s commitment to social and environmental performance.
Impact monetization gives all stakeholders a clear understanding of the social and environmental cost of their decisions. Furthermore, monetization also helps businesses to understand the true costs of production when accounting for total value derived from other capital types, which are referred to as dependencies. Proposals for displaying impact monetization results also call for the clear disclosure of all assumptions made as well as separate “balance sheets” and “income statements” for each stakeholder group, in terms that are easily understood by non-experts. By publishing their assumptions, other market players could check whether the valuations were reasonable, i.e., within the range of “bounded flexibility,” or whether the organization was somehow manipulating the numbers (just as happens today with financial information assurance).
For many, it feels uncomfortable to put a monetary value on something of intrinsic or sublime value, as governments do with cost-benefit analyses to aid decision-making for the public good, or life insurance companies have been doing since their inception. We are all making choices every day that impact these intrinsic or invaluable goods and aspects of well-being, whether we put an explicit price on them or not. In our view, choices made with more transparent and comprehensive data that is informed by those experiencing the impacts are better than those made with less (as long as the assumptions which underlie that information are valid). By making decision makers accountable for all of their organization’s externalities, rather than just financial results, we move in the right direction.