Blog: Monday, 16 November 2020
How do you know if a company creates value? Dr Willem Schramade completed his PhD in corporate finance at Rotterdam School of Management, Erasmus University (RSM) in 2006. He is now an independent sustainable finance consultant and researcher and shares his perspectives in this article.
During my business studies in the 1990s, I learned the narrow answer to that question: the return on invested capital needs to exceed the cost of capital. But that answer is problematic, as by that definition tobacco companies are among the best in the world – even though they destroy tens of billions of social value (health) every year in the Netherlands alone. Ecological costs are also not included in the narrow financial definition. This makes us largely blind, and we continue to overexploit our planet and society. How, then, can we ensure that companies operate within social and planetary boundaries?
Such a sustainable form of capitalism is certainly possible, if we focus on broad value. That means that enterprise value includes not only the financial value, but also the social and ecological value that the company creates or destroys. Such value is barely mapped out yet, but is ideally measured and reported as thoroughly as financial value. If companies do that, they can steer for and achieve better social outcomes, often with better financial results too. Governments can then finetune their taxes and regulations so that fairer prices are charged for products – prices that also include the hidden costs of issues like pollution and health damage. This requires change not just in businesses, nut also in the financial sector, governments, and education. This change can be illustrated by the contrast between Air France-KLM and Novo Nordisk.
It is tragic that Air France-KLM is being bailed out by the government. Because this is just the kind of company that scores poorly on broad value. Our RSM case study concludes that the company destroys financial, ecological and possibly social value on balance. The negative financial value is evidenced by years of low or negative profit levels, despite the lack of both tax on kerosene and VAT on airline tickets (taxpayer subsidy). The strongly negative ecological value is visible in emissions of 32 million tonnes of CO2 per year, which at a shadow price of € 100 per ton amounts to € 3.2 billion hidden (the CO2 requirement price will only increase as long as real action is not taken) ecological costs per year (160 per cent of profits in 2018). And that’s even without the cost of the degradation of the other planetary boundaries, such as biodiversity and nitrogen. These cannot be quantified in the absence of data but are also negative. Social value is a big question mark. On the one hand, the group creates positive social value by providing workers with jobs and enabling people to travel. On the other hand, flying causes nuisance to people who live near the airport, seems to negatively affect health, is too cheap (due to the lack of kerosine and/or environmental taxes), and a subsidy from poor (barely flying) citizens to wealthy (often flying) citizens and businesses. And what about the very high salaries of pilots when the workload seems to be increasing for the other staff? In short, even before the Covid-19 crisis, Air France-KLM was a company that effectively survived through subsidies, and most likely destroyed value for society on a structural basis.
Meanwhile, Air France-KLM's annual report is mainly about the growth strategy – whereas growth is exactly what you don't want when a company destroys value. There is little indication of thinking in broad value at Air France-KLM. Its annual reports say little about the mission, and how it should be reflected in strategy, revenue models and relationships with stakeholders. There is no serious estimate of the negative externalities (costs that they do cause but do not bear), nor do they indicate how such costs can be brought to zero. At least the group's enormous CO2 emissions can be found in the report, but hardly anything is said about the deterioration of the other planetary boundaries, although flight movements, for example, cause a lot of nitrogen and aerosol. Sustainability initiatives are mentioned, of course, but are limited to drops in the ocean, such as the use of biofuel on flights to Oslo. The emissions reduction targets are so unambitious that they are far from the 2-degree-scenario of the Paris agreement.
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