Barron’s, By Leslie P. Norton,
At the age of 26, in the early 1970s, Ronald Cohen co-founded Apax Partners, one of the world’s oldest venture-capital firms. It was around the same time that Milton Friedman famously wrote that the social responsibility of a business is to increase profits. That was a premise Cohen rejected even as he built his fortune; he felt, instead, that capital could produce solutions to pressing problems. “Without him, we wouldn’t have impact investing at all,” says Fiona Reynolds, CEO of Principles for Responsible Investment. “He has worked tirelessly to make sure that government understands the benefits.” With inflows into sustainable investments jumping, Cohen, who just published a book on impact investing, sat down with Barron’s to talk about impact-weighted accounting and other subjects. Read the following edited excerpts for more.
Barron’s: How did a big venture capitalist become the father of impact investing?
Ronald Cohen: We’ve seen a period of very high growth and great technological change, which most of us expected would reduce gaps in society but actually led to the biggest gaps we’ve ever seen between rich and poor. As globalization has advanced, the degree of environmental damage created by our companies has become untenable. Over the past 50 years, while traditional Milton Friedman capitalism has innovated and delivered economic growth, the single-minded pursuit of profit without concern for the damage created has turned capitalism into a self-defeating system.
That increasing economic and social inequality led me and others to consider how to bring investment capital to improve lives and the planet, instead of just relying on government spending and philanthropy. The first social-impact bonds, the Peterborough bonds, showed you could reduce recidivism and get rewarded. It can also enable us to deliver superior returns. The reason for this is the changing norms around which [products] you purchase, which company you would work for, and which company you invest in. The advantage now is to companies that achieve a proper balance between risk, return, and impact. It puts fossil-fuel companies at a disadvantage relative to new disruptive companies like Tesla [ticker: TSLA], for example, which aims to optimize risk, return, and impact by reducing emissions from cars.
Does Joe Biden’s victory change the U.S. landscape for sustainable investing?
Biden has run his campaign on the basis of social and economic equality, and reduction of environmental damage. It is better for him to adopt and encourage impact investment—and, like Franklin D. Roosevelt, to introduce transparency. We’re at a historic crossroads. After the crash of 1929, there was no transparency about the profits companies made. In 1933, the Roosevelt administration introduced securities legislation that brought about generally accepted accounting principles and the use of auditors. We’re at exactly the same crossroads with impact. Transparency on the impact that companies create will take us to the next frontier for society and capitalism.
You’re an advocate of impact-weighted accounting. Tell us about it.
Impact-weighted accounts reflect in dollar terms the impact [positive and negative] that a company creates through its products, its operations, and its employment. They enable us to measure this impact on both people and planet. We are, therefore, able to add and subtract from a profit-and-loss statement the impacts that companies have created. We begin to look at companies in a different way.
I chaired an effort at Harvard Business School that published the environmental damage, in dollar terms, created by 1,800 companies. We discovered that 252 of these 1,800 companies created more environmental damage a year than profit. In a world with impact-weighted accounts, these companies would become loss-making. We found that 543 of them deliver environmental damage equivalent to 25% or more of their profits. These 1,800 companies delivered environmental damage of $3 trillion a year. Impact-weighted accounts would enable companies and investors to [look] at performance on two dimensions, profit and impact. This becomes significant when you look at the ability it provides for companies to disrupt their industries. Investors [will be] prepared to adjust [portfolios] more favorably toward companies that optimize risk/return/impact, like Tesla, say, than to companies that simply try to optimize risk/return. Transparency can affect the company’s valuation as much as its profitability.
After this effort, did companies begin reporting the effect of impact on profit?
About 56 companies now use some type of impact measurement. In July, Danone [BN.France] published earnings per share weighted for environmental impact. It’s the way of the future. Look at Procter & Gamble’s [PG] annual meeting in October: Two-thirds of shareholders voted against Procter management because of deforestation. That is a harbinger of things to come.
Regulators have become aware that this information is quite sensitive: The Harvard data show correlation between lower stock-market valuations and higher damage environmentally. Regulators are concerned with maintaining markets in which investors all have access to the same information, because they’re concerned about this information being reliable. They will soon have no choice but to step in. The International Organization of Securities Commissions, or Iosco, has already said it’s looking at this issue of impact transparency.
Did your study get pushback?
So far, no. Stakeholder capitalism has dawned on the consciousness of most companies. I am finding a lot of interest from companies in understanding how this transparency will help them focus on ways to improve impact and how it will affect performance of their shares.
Companies complain about having to make extra disclosures and, with some justification, about all of the competing reporting frameworks.
The metrics of environmental impact are in place. The metrics of social impact, too, are more or less in place. Computing and Big Data enable us to put this data together and attach monetary value to it. The Harvard effort shows we can do that. What’s missing is that all of this information in the public domain hasn’t been prepared according to the same principles. It makes comparability very difficult, which is why we have all of these accusations about greenwashing. So, it’s necessary to do what we did in 1933.
It’s no coincidence that in the past few months, apart from Iosco, you had International Financial Reporting Standards, the International Federation of Accountants, and the World Economic Forum all focus on impact transparency. It’s being driven by consumers, employees, and investors. When investors channel more than a third of professionally managed money to achieve impact, the goal posts have moved for investment flows. If governments mandated that starting in two years, companies should begin to publish impact-weighted accounts, alongside their traditional ones, companies would be able to do that, in my view.
Still, that’s a big ask.
Coronavirus has created an impossible position for governments today. Across the world, they will emerge from coronavirus heavily laden with debt and facing much greater social challenges, on top of the mounting environmental ones that they already face. We are likely to face many years of sustained high unemployment, which will lead to poverty and all of the issues that flow from it, including homelessness. The only way that governments can really ensure a quick recovery, a fairer recovery, and a more sustainable one, is to bring companies and investors alongside to provide solutions to the problems we face, rather than aggravating them as we’re currently doing. The big question is, do our international institutions and groupings, like the G-7 and the G20, achieve consensus on the fact that we have to do this? Or will it be individual governments that will have to lead out of necessity?
If governments take too long to do it, we’ll live in an intermediate world where information is disparate and exists in the public domain but isn’t audited, and some investors suffer because they don’t know where to look for the information and the information is itself unreliable. This will delay a response to the massive issues threatening the stability of our society and our planet.
In the past, ESG has meant a kind of risk measurement and investment opportunity. Impact has focused on achieving social and environmental outcomes. Will they become one?
ESG is a precursor to impact. It’s the big wave that shows the change of values. But because ESG doesn’t have the tools and measurements, the organizations investing in ESG haven’t got the tools to measure. Chief investment officers will tell you that they would like to go in the direction of measuring ESG impact, but the tools aren’t available. This is what impact-weighted accounts are designed to provide. When we have those tools, it will all become impact investment, and ESG, the new normal.
How has Covid-19 changed the corporate discourse and the landscape for impact investing?
Corporations are aware now because of the rebellion, the social inequality, the protests about environmental damage. They have begun to realize that it will affect their sales and their profits. Many companies that didn’t embrace technology were left behind by nimbler competitors who designed more disruptive, more effective business models. The same will happen to companies that don’t manage their impact properly, that don’t address the conflicts their business models pose between profits and impact. The market capitalization of [oil producers] has fallen sharply. Companies are beginning to realize that ignoring the arrival of impact will hold the same risks as ignoring the arrival of technology.