Monetizing Externalities as Uncounted Liabilities

November 25, 2001
Jim Fournier

If we examine the state of capital markets from a systems perspective it becomes obvious that a tremendous amount of the real costs of many allegedly profitable activities are not currently being counted. These are the costs of all the "externalities" that businesses are presently allowed to ignore under the social political arrangement we call economics. The question is how long this will remain the case. We have but to look at the current state of the tobacco industry to see that what was a perfectly acceptable source of profits yesterday, is cause for civil, if not criminal, prosecutions today. And we have but to look at the consequences of today's "externalities" to recognize that these must sooner or latter become the source of major liabilities.

Thus, the question becomes one of how to begin to estimate, tabulate, and publicly disclose the magnitude of those future liabilities now, so that investors, and especially pension fund trustees, wishing to take a fully informed position might make better decisions about the actual long term liabilities of firms which are not currently making full disclosure with respect to the environmental and social costs of their activities. This might most easily be estimated by industry sector, as that is the form in which the data is most likely to be available.

Paradoxically, this might actually create positive incentives for managers of those firms which do take steps to improve their performance by providing a baseline against which they might distinguish themselves and justify their expenditures. Indeed these costs should ultimately be seen as offsetting insurance costs, which might actually prove to be higher than the cost of simply eliminating the risk of the future liability through better business practices. For those firms which attempted to ignore their potential fiscal responsibility by refusing to correct the underlying problem, or to buy insurance, the capital markets might ultimately address the problem by adjusting their share prices downward to reflect their potential liability exposure.

This might be hastened if pension fund trustees, who have now been given the mandate to consider the true costs and opportunities of their long term investments, began to take the lead in considering this data, as indeed their true fiduciary responsibility would require. If the vast investments controlled by pension fund trustees began to be repositioned based on this data, then other financial analysts would be compelled to follow suit, as the pension fund activity by itself would affect share prices so profoundly that other financial analysts would begin to use the data preemptively to protect themselves in the market.