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New Bottom Line Volume 2.2 – Actions and Consequences: Where the Free Market Lies

October 28, 1993

Executives and managers are caught in a dilemma: A society used to throwing things “away” is starting to realize that there is no “away,” but our decision-making tools and structures haven’t caught up.

The cost of environmental protection or cleanup is borne by the individual firm, while the cost of the environmental impact is borne by society. Faced with capital and operating costs that impact profits and balance sheet, weighed against risks you may never have to pay for or benefits you may never see (at least in financial terms), a “reasonable person” with fiduciary responsibility to shareholders will minimize “non-essential” investment. The result: oil spills, toxic dumps, Chernobyl… and the air outside your window.

Reasonable people produce sub-optimal solutions when locked in too narrow a view. A free market depends upon accurate information, and a tight coupling of actions & consequences. When either–or both–of these is lacking, as is the case with environmental management, the “free market” tells lies, and the economy suffers.

The uncoupling of actions and consequences is pervasive in our society, and at the root of many of our business and social challenges. The examples are numerous, andWWWW familiar.

– School boards, observes author Michael Parenti, are run by people whose kids don’t go to public schools, and transit districts run by people who never ride a bus. Would they make the same decisions if their own kids were on the line?

– Pennsylvania ratepayers, rather than utility shareholders, will bear the costs of decommissioning costs of Three Mile Island nuclear plant. Would TMI shareholders–and management–have acted any differently if they knew decommissioning costs would be charged against profit?

– CEO pay is not only widely viewed as excessive, but is not even necessarily tied to performance. (Who hasn’t growled at the phenomenon of company laying off workers or cutting their pay while paying bonuses to the leaders whose failed?)

– GM built pickup trucks with gas tanks outside the frame rails, and silenced its own engineers when they objected to the practice. The weighted analysis of cost and risk produced a ‘rational economic decision’ that has left people dead, the company embarassed… and an expensive liability in shareholders’ laps.

What do these all have in common? When decision makers–whether executives, managers, employees or consumers–don’t feel either the personal or financial impact of their decisions, reasonable people make reasonable decisions that in the big picture don’t make common sense.

What can be done to build a larger rationality into the system? Clearly, inspired leadership can cut through the logjam. Xerox CEO Paul Allaire was so shocked by Bhopal disaster that Xerox environmental policy now declares: “Environmental health and safety concerns take priority over economic considerations.”

But such commitment must be also built into decision and compensation structures. Since what gets measured gets managed, many companies are developing “environmental information systems” to provide accurate and timely environmental information from the executive suite down to the production line. Since what gets rewarded gets done, some are tying environmental performance into compensation systems.

In addition, the principles of accounting are likely to change to better reflect new ways of balancing short term and long term issues including potential future liabilities from environmental hazards, and to build environmental costs and benefits more tightly into balance sheet. The EPA, for example, is encouraging firms to allocate “indirect” environmental and overhead costs directly to specific products and divisions. The SEC is exploring ways to represent potential future environmental liabilities. The insurance industry recently cosponsored a conference with Greenpeace to explore their common interest in understanding and mitigating risks from global warming.

Where the market fails to reconcile itself to biological reality, government will likely try to level the market, both by monetizing externalities through taxes and fees (such as energy taxes and tradable pollution rights), and by ending market-skewing programs like subsidized forest and mineral leases.

Expect more of these changes in coming years. Companies can wait for them to be imposed from the outside, whether by government fiat or by competitive or consumer pressure. Or they can adopt tools now to line up their actions with the standards that will be expected of the “reasonable person” ten years from now.

The good news: Companies that approach environmental quality systemically–through Negawatt financing, Pollution Prevention, Design for Environment and Industrial Ecology–are finding that improvements can boost, not drain, their bottom line. Pollution, after all, is waste, and the last thing a good manager wants to do is pour shareholders’ money down the drain.

(c) 1993 Gil Friend. All rights reserved.

New Bottom Line is published periodically by Natural Logic, offering decision support software and strategic consulting that help companies and communities prosper by embedding the laws of nature at the heart of enterprise.

Gil Friend, systems ecologist and business strategist, is President and CEO of Natural Logic, Inc.

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