Headline: Reporting and Accounting: Regulatory Bedfellows?

Reflections on a conversation with Christian Heller at the Summer of Purpose in Munich.

The neoclassical approach that currently prevails in economics does not factor in the damages caused to health and the lives of people, animals, plants and ecosystems in capitalist economies. Instead, they are regarded as unforeseen side effects and treated as “externalities”.

The spectrum of political strategies for dealing with such externalities ranges from

1. Appealing to the better instincts of business leaders to engage in corporate social responsibility (CSR);
2. Creating incentives, for example by taxing greenhouse gas emissions;
3. Taking the regulatory path, for example in legislating for the nuclear phaseout or a ban on pesticides or single-use plastic packaging.

But there are also two further, less obvious strategies: reporting and accounting. They have common roots and are both becoming increasingly important. Accounting refers to the statutory obligation to disclose financial figures. The procedures for doing so are standardised in the profit and loss account and financial statement. Reporting ist broader; apart from the disclosure of financial information, it can also refer to the disclosure of non-financial information (NFI). The latter can cover a multitude, from human and employment rights, to environmental and climate protection, social cohesion, distributive justice, diversity, and anticorruption. Up to now the disclosure of such information has been largely voluntary, with a mixed bag of standards for sustainability or NFI reporting.

At the Summer of Purpose, a gathering of thought leaders for a better world organised by the Grameen Creative Lab this July in Munich, I took part in a discussion of both approaches with Christian Heller, CEO of the Value Balancing Alliance (VBA) initiated by BASF. The VBA is helping to refine the accounting approach by expressing non-financial risks in financial terms. By contrast, the Economy for the Common Good (ECG) tries to systematically capture externalities in reports based on a points system that is tied to legal incentives.

There are important methodological differences between the two approaches: the VBA seeks to monetise non-financial risks, for example environmental damages, based on the assumption that in today’s business world it’s the language of hard figures that’s most readily understood. Many decision-makers only begin to take notice of an environmental or health risk when it has a negative impact on the (financial) balance sheet.

The problem with this approach, however, is that it demands that a monetary price is attached to intangible values like the health or dignity of a species or the stability of an ecosystem. This is no easy task – how do we go about deciding what a ton of carbon emissions should cost? But it also presents us with a fundamental ethical dilemma: does it even make sense to put a price on the violation of human rights, ocean acidification, or the extinction of an entire species?

Apart from the “sacrilege” of treating living things as commodities, this approach would force us to weigh up financial costs instead of ethical considerations. Thus we might have to ask ourselves whether it was profitable to destroy some more of the environment or disregard employment rights.

The Common Good reporting approach resolves such ethical dilemmas in a different way. Externalities are registered, described, evaluated and given points – both positive and negative. The total score, which can range from minus 3600 to plus 1000, is shown at the end of the Common Good Balance Sheet. This score can then be tied to incentives in the form of taxes, interest, customs duties, or higher or lower priority in public procurement processes and business development schemes. In this way, the externalisation of costs is rendered unprofitable, because it puts companies at a competitive disadvantage. Conversely, the externalisation of benefits, as reflected in a high score on the Common Good Balance Sheet and corresponding incentives, is rewarded with lower relative prices and greater company success.

During the workshop, Christian Heller and I talked about whether the two approaches are complementary. We agreed that both have the same ultimate goal. Regardless of whether carbon emissions are included as a cost factor in a company’s financial statements or presented transparently in an NFI report that brings higher taxes and other incentives in its wake, ideally, the effect would be the same.

Policymakers can choose either to incorporate carbon emissions into the financial accounting system at a fixed price or to control them via incentive-based NFI reporting. They can also outlaw certain practices, business models, technologies or products through appropriate regulation. In a systematic approach, new externalities – for example, hitherto unknown adverse psychological or physical effects of products – could first be registered in the NFI report. At this stage it would still be possible to choose between simply reporting or sanctioning by way of incentives. Depending on whether emerging scientific evidence justifies a clear cost allocation or recognition as a threat to health, life, or ecosystems, policymakers would have the option of moving the externality in question into the accounting system or taking the regulatory path. And there is always the possibility of creating incentives to deal with individual cases, for example in the form of a tobacco or carbon tax. So all in all, policymakers have a wide range of specialised reporting instruments at their disposal, which they can use as levers to promote greater corporate responsibility.

Christian Felber was a Senior Fellow at the IASS in 2018 and has been an Affiliate Scholar since 2019. He is currently leading a project that explores options for putting financial and non-financial reporting on an equal footing. He is the initiator of the international Economy for the Common Good Movement and has written 15 books, most recently This is not economy. Aufruf zur Revolution der Wirtschaftswissenschaft.