VSAsh-rich companies need an excuse to do better on the environment: impact-weighted accounting can give them the hedge they need.
At first glance, there may be few things that seem exciting about a large consumer products company like Proctor & Gamble. Dishwasher soap. Toothpaste. Laundry. But beneath the surface, P&G is brimming with cash at such remarkable levels that it’s a wonder the company doesn’t win more accolades for being one of America’s Best Managed Companies. A quick look at the company’s cash flow statement confirms this. Its operations generated nearly $17 billion in cash while achieving just over $3 billion in capital expenditures.
And P&G is not alone. Apple’s operations generated $104 billion in cash, and its cash flow statement shows just $11 billion in capital expenditures. At Pfizer, operations generated nearly $33 billion in cash, while the company made just $2.7 billion in capital expenditures. In fact, there are plenty of companies like this among the S&P 500.
What are these companies doing with all this money? There’s no one answer, but they all pay a lot of dividends and buy back a lot of their own stock. Apple paid out more than $100 billion in dividends and stock buybacks last year. P&G spent $19 billion on buybacks and dividends. Pfizer paid $9 billion in dividends.
These are not unsustainable uses of cash. Dividends and buyouts enrich hedge funds and institutions, but also cops and teachers through their pension funds. And no one is saying these companies are badly run. Quite the contrary. Freeing up so much money with such low levels of capital expenditure is a mark of excellence. Moreover, no one is saying that these companies are shirking their responsibilities to environmental, social or governance standards, in the conventional sense of the word.
Still, the amount of money they generate suggests they could do more. Maybe a lot more. For example, P&G could figure out how to rid the planet of all the hard plastic containers they populate the earth with. Pfizer could raise pay standards for all of its low-level employees. And Apple could manufacture its products in the United States where there is a stronger environmental program.
Even if these companies wanted to do it, they couldn’t. Why? Because the pillar on which capitalism rests, profit maximization, means that large expenditures that are not mandatory, such as those above, decrease profits, and that capital and talent will go to companies that are maximize profits.
It is not a theoretical construction. Profit maximization is supported by powerful enforcement mechanisms. Remember, in 2017, P&G got into a heated proxy battle with activist investor Nelson Peltz. Peltz, who called P&G a “suffering bureaucracy,” eventually won a seat on the board. So in this case, the validity of the leadership team was called into question simply because they weren’t working fast enough.
In an environment like this, how does a company divert resources to, say, wholesale re-engineering of its products to eliminate pollution, or to improve its pay structure when there isn’t doesn’t have a warrant and she’ll eat away at her profits? Why smother the goose with the golden eggs?
One way to do this is to incorporate what is known as impact-weighted accounting. Impact-weighted accounting is a simple concept with far-reaching implications. In particular, he overhauls the financial statements taking into account the costs borne by everything of a company’s stakeholders. Net, net, it shows who pays and how much for a company to earn its shareholder’s profits.
Here are some examples :
The Harvard Impact-Weighted Accounts Project shows that a group of nine major global oil and gas companies with a positive margin for earnings before interest, taxes, depreciation and amortization over multiple reporting periods grew to a 329% negative margin when considering environmental impacts.
For a set of 13 packaged food companies, research from the Harvard Project showed that operating profits dropped to -103% when accounting for externalized costs. The distribution of foods high in sodium and sugar is profitable for these companies, but the resulting health costs, as well as the environmental impacts, analyzed with impressive precision, are losses that the public bears.
It’s important to note that this is not a Big Brother proposal where the feds tell companies like Proctor & Gamble what they can do. Quite the contrary. They can do whatever they want without government interference. However, weighted accounting gives them some cover to make tough decisions.
The proposition here is that if investors and boards knew the magnitude of the expense the public bears in pursuit of corporate profit, they might make different decisions. The board could redesign the company to reduce the impact on constituencies other than shareholders. Investors, with a full accounting of the cost of doing business, might decide to deploy their capital elsewhere.
The quality that promises impact-weighted accounting is also its greatest weakness: honesty. Because if company managers are honest with themselves and with shareholders, they know that they are outsourcing their costs, sometimes a lot. And if they know it, they know or at least recognize that the absence of a mandate to do better is not necessarily a good reason not to do better. But capitalism is a badass, and it can still prove insensitive to what the facts and analyzes present in black and white.
But the information is available and companies can look to themselves to calculate these costs. At the moment, we can only rely on the best angels to do so.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.