Americans and Climate Change: Incentives: Business and financial leaders
"Americans and Climate Change: Closing the Gap Between Science and Action" (PDF) is a report synthesizing the insights of 110 leading thinkers on how to educate and motivate the American public on the subject of global warming. Background on the report here. I’ll be posting a series of excerpts (citations have been removed; see original report). If you’d like to be involved in implementing the report’s recommendations, or learn more, visit the Yale Project on Climate Change website.
Why aren’t people in the business world — corporate leaders, financial analysts, etc. — more hip to climate change? Find out below!
Business and Finance Incentives: Profit and Fiduciary Responsibility
Business and financial professionals, for their part, face incentive structures that, on their surface, are remarkably clear-cut. They are measured on their profit-making success. Unless and until a particular business leader sees either a profit-generating opportunity or a probable cost or risk associated with climate change, their fiduciary responsibility will typically dictate that they ignore the issue, even if a values-based appeal has succeeded in pricking their conscience about the societal risks.
Within many business organizations, moreover, there are employees (usually in the government relations department) whose incentives are sharply defined to minimize regulatory burdens on the firm by lobbying diligently against climate change policies. So even if a smattering of executives in a corporation grows concerned about climate change, their organization’s course as a whole may still proceed on auto-pilot in opposition to climate change action.
A similar type of organizational behavior can cause disconnects within trade associations. One member business may grow more receptive to climate change action, while its trade association leadership remains wedded to the least common denominator position of the most recalcitrant members. Even apart from this membership influence, trade associations face a fundamental incentive to demonstrate how their unique ability to aggregate and exert the membership’s collective strength delivers a measurable return by minimizing regulatory burdens.
The business community is, of course, not monolithic. Some businesses are large emitters of greenhouse gases and determined to avoid regulation of any kind, even by funding disinformation campaigns on climate change science. Some are large emitters who have explicitly acknowledged the inevitability of regulation and are working to shape it to their advantage by seeking a predictable price-signal for carbon, equitability across sectors, and the flexibility to minimize costs (and avoid stranding their assets) through market-based emissions trading. Still others are providers of low-carbon technology and assets like renewable energy or efficiency enhancements, and see a profitable upside from climate change regulation.
So business’ incentive structures, while tied to the profit-making motive at the highest level of analysis, can and do cause very different behaviors depending on how the business is situated and how it calculates risks and opportunities over various time horizons. These calculations are fundamentally driven by information inputs, and this is where the Conference identified a key target of opportunity. Simply put, participants noted that there is room to do much better in making businesses aware of the profitable opportunities associated with buying or selling low-carbon or no-carbon products and services.
Achieving this awareness requires not high-minded exhortations, but an increasingly tailored approach that begins with the realities of each business’ capital budgeting and operational framework and proceeds to supply the analytic and decision-support tools needed to help them evaluate carbon mitigation technologies on a basis that is commensurable to other opportunities.
At the Conference, some touted the emissions-reducing efficiency gains immediately available to businesses at a cost-savings, and expressed puzzlement about why these have not been adopted already. But others underscored all the variables that complicate adoption of new technologies — from first-cost obstacles and other financing gaps to a range of other intangible behavioral frictions such as the inertia that comes from comfort with using the "tried-and-true." There are, after all, many positive Net Present Value (NPV) investments that businesses knowingly do not make — due to limited execution capacity, competition from other, higher-NPV projects, choices about which activities are more strategic to the firm, and many other reasons.
How carbon mitigation fits into all this quickly becomes a complex picture of the kind that few business leaders have the time to sort out on the fly, especially in the face of other short-term pressures like quarterly earnings reports and near-term competitive threats. Accordingly, the Business & Finance group recommended the creation of an outside information intermediary to help businesses perform these calculations, and a set of eight principles to guide them in developing their internal capacity with respect to carbon-related risks and opportunities.
The first of these recommendations calls for the creation and funding of an R&D-type organization to undertake and disseminate credible and independent studies of the economic impacts of climate change on a sector-by-sector basis, as well as of the appropriate solutions (Recommendation #34). This would be an independent provider of reliable information free of any advocacy taint, and it would likely do not only original work but would also aggregate, vet and translate the many good studies already being done on this subject by academics and, as available, by private consulting firms. The envisioned mandate could also extend to provision of funds to overcome financing gaps impeding adoption of low carbon technologies, including grants to deploy pilot- scale technologies for testing and demonstration purposes.
As for the eight principles described in Recommendation #33, these would help business leaders reduce the enormity of the climate change issue to a manageable, if still ambitious, to-do list. The principles range from analyzing the firm’s carbon profile (including facilities, products, suppliers) under multiple scenarios and in standardized reporting formats (i.e., pro forma P&Ls) to developing a company-wide plan to address the carbon risks and opportunities identified. To be actionable, the recommendation would need to be supplemented by detailed implementation guidance.
Among other benefits, adopting these eight principles would help American businesses close a growing shortfall with European businesses in understanding how to measure their potential carbon liability. American businesses have so far operated without a price on carbon emissions, while European companies (and American multinationals operating there) are now subject to carbon regulation through the European Union’s Emissions Trading Scheme (the first phase of which runs from 2005-2007). But there are other increasing pressures on American companies that are starting to affect the way executives and fiduciaries interpret the climate change issue, from the risk of shareholder lawsuits to future U.S. regulation that could emerge well within the life-cycle of investments being made today. Energy price increases and volatility are already prompting a reexamination of exposures and trends in the U.S., a process that could usefully be expanded to include related factors like future carbon liabilities.
The eight-principle framework also calls for education of the CEO and board members on climate change and its implications. Some may object that this issue can be handled by a firm’s risk managers or government relations department and need not rise to an executive or governance level. That will remain a valid point of debate as the principles are promoted and considered for adoption. But consistent with an overarching Conference theme, the lack of action on climate change stems partly from the fact that it has often been kept in a silo. Integrating the issue more fully at the strategic level, at least in businesses where it is potentially material, should help create a more robust private sector discourse on, and eventually response to, the climate change issue. Moreover, executives who are informed may be more likely to adopt another of the eight principles, which calls for businesses to engage externally in policy dialogue and to dissociate from scientific disinformation campaigns.
One of the most compelling and comprehensible cases for scaling up the adoption of low-carbon and no-carbon technologies by businesses across the world comes from S. Pacala and R. Socolow of the Carbon Mitigation Initiative at Princeton University. Rather than acting as enthusiasts for any particular technology, they categorize a range of proven technologies in relation to the overall reductions needed to stabilize greenhouse gas emissions in the atmosphere. Others have noted the disconnect between their somewhat cheerful admonitions that this can be done and the dauntingly heroic technological scale-up they prescribe. Nonetheless, their assertion in the journal Science bears quotation:
Humanity already possesses the fundamental scientific, technical, and industrial know-how to solve the carbon and climate problem for the next half-century. A portfolio of technologies now exists to meet the world’s energy needs over the next 50 years and limit atmospheric CO2 to a trajectory that avoids a doubling of the pre-industrial concentration. Every element in this portfolio has passed beyond the laboratory bench and demonstration project; many are already implemented somewhere at full industrial scale . . . . It is important not to become beguiled by the possibility of revolutionary technology. Humanity can solve the carbon and climate problem in the first half of this century simply by scaling up what we already know how to do (Science Vol. 305, No. 5686: 968).