Examples of environmental negative externalities includes things such as plastic waste in our oceans, deforestation, and carbon released into our atmosphere. In recent years we have begun to see the pricing of some of these negative externalities in the environmental sphere with market mechanisms such as tradable carbon credits and supranational and country level regulatory requirements on emissions. But many costs are still externalised to society rather than being absorbed internally by the company and costs are not limited to the environment there are also social costs. Take for example the obesity crisis in the UK. Although there has been some agreement and proposed regulation around sugar content reductions in food, the outcome of an unhealthier society and the treatment of diseases such as Type 2 diabetes has been absorbed by the health services which is ultimately funded by the taxpayer, these costs in their truest form are not yet on the balance sheet of the companies producing high sugar content food.
Why should investors care?
Besides the obvious of developing healthier ecosystems and societies these costs have potentially huge impacts on the financial performance and in some cases viability of companies and will impact expected investor returns if not included correctly in one’s analysis. For example, the technology sector has a range of argued negative externalities that include topics such as workers’ rights, tax structure, data protection and mental health all of which could have a potential impact on future revenues and valuations if some of these costs were in the future borne by the company rather than society. Research undertaken by Schroders estimated that the earnings listed companies generate for shareholders would fall by 55% if all of the social and environmental impacts identified in their research were crystalised as financial costs and one third of the companies would become loss making (Schroders Research, 2019).
It’s not a trade-off
There is no evidence of a trade-off between generating value for shareholders and value for society. Indeed, those companies doing the right thing presents opportunities for investors. Companies that are actively trying to reduce negative externalities will not only create more sustainable business models as regulation will inevitably catchup with those that don’t, but many of the environmental externalities are ultimately waste products which in turn means there are inefficiencies in the production process. Companies such as Apple are looking at a circular business model that should not only reduce negative externalities and thus the company’s impact on the environment, but it should also, long-term, create cost savings as materials such as rare earth minerals can be reused, rather than purchased. To conclude the increasing movement of these negative externalities from society to business is a theme that will continue to play out in the years ahead as society becomes more aware of some of these costs and governments and regulators take action. It is important investors take note and position accordingly, engaging with those companies that need to make changes and making sure they benefit from those companies that are doing the right thing.
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