The search for value among the numbersSeptember 2012
We will continue to consume and trade as the climate changes. But in a world where production and supply chains come under increasing strain, how far down the path is it right to exploit profit-making opportunities posed by extreme weather? And, if profit is not enough, what measure of value should we use as an alternative?
So, the searing drought afflicting two thirds of the US is good for business. Or, at least, good for commodities trader Glencore, whose director of agricultural products Chris Mahoney described in a conference call how he believes soaring food prices have created a highly profitable business environment. “High prices, lots of volatility, a lot of dislocation, tightness, a lot of arbitrage opportunities [the purchase and sale of an asset in order to profit from price differences in alternative markets],” he said.
“I think we will both be able to provide the world with solutions, getting stuff to where it’s needed quickly and timely, and that should be good for Glencore,” he added. The company reported net profits of $2.3bn (£1.5bn, €1.8bn) for the six months to June.
Of course, that’s not how the world’s hungry or the US agricultural sector will see it. The blistering heatwave that has turned vast swathes of US farmland to dust has destroyed nearly half of the States’ corn and a third of its soya bean crop.
Though the US agricultural sector has received much of the attention for its troubles, there are similar droughts in India and Russia, with the latter’s grain crop also depleted. This means the price of food commodities is reaching record highs: global food prices jumped 6% in July, according to the UN.
Some commentators see the drought as a watershed moment for the climate change debate in the US following, as it does, a series of dry summers and a particularly damaging tornado season earlier this year. If Mother Nature has a mischievous sense of irony, it can’t be any more visible than in the arrival of ‘near-hurricane’ Isaac over New Orleans exactly seven years after Katrina ravaged that city – and, as if to remind everyone of George W Bush’s handling of that crisis, during the Republican Party’s national convention to nominate Mitt Romney as presidential candidate.
US opinion polls show a trend of increasing US public acceptance of climate science and concern for the future, despite the strong influence of ‘climate denial’ there.
Meanwhile, to some, Glencore’s position reflects all that is bad about modern corporate culture. Jodie Thorpe, speaking for Oxfam’s Grow Campaign, put the case for the prosecution: “These mega companies are profiting from the misery and suffering of poor people worst hit by high and volatile food prices. They use their privileged market position and access to information to exploit high and volatile prices, and their political muscle to oppose tougher regulation of their activities on commodity markets. If we are going to fix the ailing food system, traders must help curb food price volatility by supporting better regulation and transparency of commodity markets.”
According to Milton Friedman’s model of business, Glencore is merely maximising its profits, a company’s only responsibility. For decades, a company could deliver its goods and services, publish an annual report and distribute a dividend ... and that would be pretty much that. But this model faces a legitimacy deficit that has been steadily widening over the last two decades. During that time, alternative ways of doing business have been promoted by economists and from within the corporate sector itself.
Prof Michael Porter, at Harvard University, for instance, last year promoted a mindset change within business in which it would commit to ‘creating shared value’ (CSV) which is, by implication, a more enlightened and long-term method of defining value. In an article last year for the Harvard Business Review – subtitled “how to reinvent capitalism and unleash a wave of innovation and growth” and co-written with Mark Kramer – he said the corporate world had lost its way, by continuing “to view value creation narrowly, optimising short-term financial performance in a bubble”.
Porter positioned CSV as an alternative to a definition of CSR that appeared to consist of supporting charities or volunteering while the company continued to plough its short-term furrow. Instead, he saw self interest as driving companies to meet real societal needs, without overlooking customers’ wellbeing, contributing to their communities’ economic and environmental distress or depleting natural resources.
Speaking to promote the article, he said: “Profit is not inconsistent with society’s needs. What’s good for society is actually good for business. It’s really quite a profound change in perspective. Creating societal benefit is a powerful way of creating economic benefit.”
Though CSV was promoted as a successor to CSR – or, at least, the US definition of CSR – the concept contained little that was new. There were similar ideas in currency which covered very much the same ground, such as Jed Emerson’s ‘blended value’.
In general terms, this approach is also supported by the International Integrated Reporting Council (IIRC), whose mission it is to “create a globally accepted, integrated reporting framework which brings together financial, environmental, social and governance information in a clear, concise, consistent and comparable format”.
By contrast, says the IIRC, “the majority of the information available to investors is historic. They are required to navigate a course around the next corner with reference only to the financial picture presented in the rear view mirror.”
But the issue of how to define and measure value and reflect it in company accounting procedures is unlikely to go away, and has been given more urgency with last November’s COP 17 Conference in Durban.
The parties to the conference agreed to adopt much tighter emissions targets, which could become legally enforceable by 2020. This could also lead to an increasing role for carbon trading, as well as more sophisticated offset, corporate risk management and carbon disclosure initiatives.
Writing of the business implications in The Guardian, Paul Toyne, head of sustainability at design consultancy WSP Group, said: “All UN countries will need to [set reduction targets] by 2020, including the new big emitters such as China and India. This sets the whole world on a course for a low-carbon economy for the first time.”
“Companies that can sell services and goods that help realise this roadmap process will prosper. This should also stimulate investment in low-carbon technology and encourage the carbon offset markets.”
This drive will inevitably push businesses into using a wider definition of value. But is the company accounting regime up to the task? Jeremy Nicholls, of the Social Return on Investment (SROI) Network, believes the whole accountancy regime needs to be reviewed, to include the impact of externalities on the balance sheet. And his organisation is looking to stimulate debate among accountants on how this can be taken forward. He said: “Most of us think that accounting is about money, [but] it is firstly about people carrying out activities and preparing an account to those who have an interest in those activities.
“All the products and services we use are the result of investment decisions that were based on information arising from these principles. Accounting is one of the great social innovations, an approach that allows us to make decisions based on a reasonable, and audited, application of a set of principles. Yet we should remember that they are principles rather than truths. [They] did not arrive on tablets of stone, nor were they discovered by an eminent scientist. Most of us will never read a set of accounts – but they are the ghost in a machine on which our lives depend.”
As things stand, many of an organisation’s impacts, both in terms of sustainability but also social elements, such as human rights, are treated as externalities and are therefore omitted from a company’s financial accounts.
Accountancy regimes, says Nicholls, tend to develop through minor revolutions, the last of which occurred during and after the First World War when the US and British governments used cost-accounting to underpin the production of commodities for military use.
With climate change and sustainability now forming a backdrop to much of our long-term planning, says Nicholls, we are on the cusp of a new accountancy revolution, which could include new definitions of the ‘accounting entity’, the ‘unit of measure’ and the ‘historic cost convention’.
The accounting entity – the company – is treated as separate from its owners and other firms and is the basis for deciding what should be included in an account. These decisions “could be based on known and probable liabilities”, says Nicholls. “But the accounts could be expanded to consider the effects of the company’s activities on all those whose access to resources is affected. Not necessarily to recognise a legal liability but to make provision for the effect, to be accountable for them.
“In some situations, such issues are already being considered. For example, mining companies are required to provide for the costs of closing mining operations that may not be incurred for many years. However, if there were a broader definition of what should be included in the accounts, this would affect company profitability. It would also result in changes in strategy and business models as businesses sought to maintain profitability.”
As money is the standard, comparable unit of measure, accounts are restricted to transactions that can be expressed using monetary units.
But Nicholls adds: “The historical costs convention is the basis for how items are valued. This has always been difficult since significant areas of financial accounting are not based on historical costs. Many require an assessment of cost (or value) based on a forecast of the future where costs have not yet been incurred.”
You can bet this is where the insurance industry’s economic interest and expertise in risk and trend analysis will step in. Even if companies are not doing this predictive work themselves, they are likely, through insurance premiums and related risk management, to be furthering this agenda by proxy.
Exactly what the costs of climate change or resource depletion will be for corporations such as Glencore remains to be seen. The company has at least introduced a corporate sustainability framework ‘to balance social, environmental, ethical and commercial interests at every level’. Getting a handle on long-term net value is still some way off.
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