Can financial directors really feel comfortable signing off on today’s externality-denying financial statements?
Central to the sustainability challenge is that the modern world increasingly directs matter, energy, and human effort in line with what financial statements deem ‘profitable’. Projects that pencil out to a profit get a green light, while businesses that make a loss eventually go bankrupt and stop influencing the world. Such is how we ‘make’ the world today. Yet, the all-important financial statements at the heart of the process exclude large and mounting social and ecological costs.
Just to take carbon as one major external cost, the World Bank estimates less than 4 percent of global carbon emissions are priced at a level consistent with Paris Agreement temperature targets. If so, for this one metric alone, can any corporate financial statement be said to be ‘fully costed’? Including – sobering thought – the statements of solar, wind, battery companies etc, which may be ‘solutions’ and better than alternatives, but which themselves are not paying the full price for their material and energy inputs…?
The de facto decision-making of modern society continues to deny external costs that have become glaringly apparent on this generation’s watch. This has overturned economists’ earlier belief that externalities were negligible residuals of market activity – too small to worry about, or possibly if large too soon remedied by growth to dwell on. Instead, stubborn externalities are becoming the main event of the economy; a growing share of the market’s value consequences are off-balance sheet, not on.
One of the key moments when external costs are denied is when directors sign off on financial statements that represent the aggregation of myriad underlying transactions. Yes, those statements may be ‘generally accepted’, but are they meaningful statements of value? Indeed, what does net income or profit even mean if all costs are not reflected?
In being ‘generally accepted’, financial norms do a lot of difficult psychological work for us as the established shared conventions by which we collectively excuse ourselves from thinking about what the economy as a system is actually doing. Indeed, directors might claim they are just fulfilling a commendable fiduciary duty – yet this increasingly has the disturbing ring of ‘just following orders’ with its connotation of abnegating greater responsibility. Responsibility is just shunted back up the principal-agent chain to who…?
Signing off on financial statements may seem a routine confirmation of ‘the numbers’, but it is a political and cultural act of great significance in that the moment when directors lend their name to a statement is a micro-reinforcement of the legitimacy of what those numbers exclude – and all those micro-reinforcements accumulate up to perpetuate an unsustainable collective system.
This should be a real dilemma for directors.