Measure What Really Matters: Accounting for Company ESG Impacts
A Conversation with Harvard Business School Professor George Serafeim
Professor George Serafeim is the Charles M. Williams Professor of Business Administration at Harvard Business School (HBS) and author of “Profit + Purpose: How Business Can Lift Up the World,” about the genesis of the HBS Impact-Weighted Accounts Project and the pathway for corporations and governments to account for social and environmental externalities of their activities as well as financial performance. An initiative that can mark a critical turning point for capitalism as we know it. Restoring Milton Friedman’s ‘fair rules of the game’ by fixing one of the most significant deficiencies of modern-day capitalism: externalities.
“The mission of the HBS Impact-Weighted Accounts Project is to drive the creation of financial accounts that reflect a company’s financial, social, and environmental performance. Our ambition is to create accounting statements that transparently capture external impacts in a way that drives investor and managerial decision-making. We need to be able to factor into our decision-making the consequences of our actions not only for financial and physical capital, but also for human, social and natural capital.”
Doris Honold/Joe Azrack: Professor Serafeim, thank you for joining us to discuss the innovative Impact-Weighted Accounts Project. How did you become interested in having businesses and government measure the consequences of their actions in human, social, and environmental terms in addition to traditional financial metrics?
George Serafeim: I grew up in Athens, Greece. At that time, the absence of established transparent accountability systems to measure the allocation of national economic resources and financial performance resulted in a high degree of corruption, the destruction of a meritocratic system, and detrimental effects on the country’s prosperity. So, I realized at an early age that there could not be any accountability if there is no transparent accounting system.
New Zealand was the first government to develop credible accounting for national assets and liabilities in the 1990s. Many other countries, such as the United States and the United Kingdom, have followed over the years. Unfortunately, the absence of credible measurement and accounting systems still plagues some countries today where corruption and cronyism persist and result in suboptimal economic development and growth.
As I became more involved in researching how corporate performance and governance could be expanded to include all stakeholders, I observed similar ESG accountability and measurement challenges. How do we compare the environmental and social impact of companies? How do we ascertain if Coca Cola or PepsiCo is doing a better job at addressing their social constituents and environmental issues? Twenty years ago, we had no idea, and the answer is very fuzzy even today. But we are making a serious effort to answer these questions. The data is beginning to accumulate, and we are starting to get a better idea for some companies about how to quantify their respective human, social, and environmental impacts. This progress has been helped by many independent organizations such as the Carbon Disclosure Standards Board, the Global Reporting Initiative, and the Sustainability Accounting Standards Board.
Honold/Azrack: Please tell us about some of the challenges you have encountered in working with the corporate world on this project.
Serafeim: Most of the metrics companies report are input metrics. Companies have a set of principles, policies, targets, disclosures, all excellent things, but they don’t necessarily result in a positive change for environmental and social outcomes. A company must use these metrics to impact its strategy, resource allocation and culture. If not, there is the risk of “Goodwashing”, which is when a company reports positive company practices, but these practices do not improve its ESG outcomes. Disclosing your carbon footprint is not equal to reducing your carbon footprint. The other issue is what I call an “interpretation problem”. This happens when a company is trying to improve racial diversity by 10% or reduce its water consumption by 300,000 cubic meters. These are not traditional economic metrics, and they are hard to translate into meaningful financial metrics to impact companies’ priorities and behavior.
Honold/Azrack: Sir Ronald Cohen is on your Advisory Council and Chairs the Global Steering Committee for Impact Investments. He stated that if companies accurately account for their externalities, for example, the environmental damage they are creating, it would cause a substantial hit to their financials. More precisely he states that hundreds of companies out there create more environmental damage than annual profits. How have companies with big carbon footprints responded to this?
Serafeim: Imagine you have overindulged at meals over the holiday period and are not feeling great about your weight. You can react in several ways. You could avoid going on the scale and ignore the problem, which might not be the best decision for your health. Alternatively, you could be honest with yourself and be courageous, and get on the scale to see how overweight you are and how much weight you need to reduce to feel better. Companies are like this. Some ignore the problem. Others want to know how much “weight” they must take off. And some not only want to know the facts but also figure out how to change to become a healthier company in the future.
There is no single answer, but more companies are calibrating their negative impacts each year and joining the second and third categories. All companies can improve their ESG footprints and create value for all stakeholders. The question becomes, “Does the company have the management and governance toolkit to mitigate the negative externalities of their business?”
Honold/Azrack: Thank you for those perceptive comments and the apropos metaphor. At this time of year, that strikes home! Sir Ronald also characterized the Impact-Weighted Accounts Project as a “Race to the Top” in that once you have the data and metrics, and companies from different industries begin to report, the data can create a virtuous process as companies learn from others’ experience as well as their own. Can you share your experience in this area?
Serafeim: Excellent question. This idea of “Race to the Top” is intentional and by design. We did not want the Project to be just about writing research papers. We wanted a very active involvement and debate with companies and therefore shared our results publicly for everybody to use and to do their own analysis and comparisons. Getting quality impact data underlying the company’s operations is a real challenge but as more companies report, the data gets better, and it becomes easier to identify inconsistent results. When we release the data publicly, it can be a little uncomfortable because the transparency shines a bright light on what companies are doing relative to their competitors, making them more accountable for their actions or lack thereof. But it also creates a race to the top, because if competitors in your industry can run their operation with significantly better environmental, employment or product impact, so can you.
I would add that the way we think about the Impact-Weighted Accounts Project is that we are on a journey that is focused on measuring outcomes. We begin by asking companies to be accountable for ESG impacts and financial results. Then we create the metrics that measure and account for impacts in the capital budgeting processes. Finally, we measure the outcomes associated with actions improving social and environmental results. This is a long journey that will take more than a few years to produce the impact accountability that will transform corporate culture, strategy, and policies.
Panella, Katie and Serafeim, George (2021). “Measuring Employment Impact: Applications and Cases.” HBS Impact-Weighted Accounts Project, Working Paper 21-082.
Freiberg, David and Park, DG and Serafeim, George and Zochowski, Rob (2020). “Corporate Environmental Impact: Measurement, Data and Information.” HBS Impact-Weighted Accounts Project, Working Paper 20-098. Data available at: “Corporate Environmental Impact: Data Supplement.”
Honold/Azrack: Do you receive extreme reactions to the information the Project publishes from companies or activists?
Serafeim: Whenever you release data, it is beyond your control how it is used and how different parties react. We strive for radical transparency - no black box - and our methodology is very clear and traceable. Secondly, we don’t point fingers or attribute blame. If you are an oil and gas company, it is no secret that your environmental footprint is carbon-heavy. Everyone knows that. However, by quantifying the emissions and the social cost of carbon on health, global warming, and biodiversity, we can make the cost explicit and establish benchmarks from which industry and individual companies can plan and evaluate alternative pathways to reduce their impact footprint.
The important thing is that we are offering a transparent accountability methodology with verifiable metrics that companies can use to quantify and evaluate their current policies and the potential to improve their impact performance. We always invite companies to create their own impact-weighted accounts; they have a lot better data about their operations than we have and are best placed to do this. This helps us to grow our impact movement.
Honold/Azrack: What other players can be agents of change in impact accounting?
Serafeim: There is a massive role for policymakers. This is why the G7 report of its Impact Taskforce that goes to policymakers is so important. Policymakers have a huge role to play in establishing the right institutional structures, such as an International Valuation Standards Council. A Standards Board that will be solely focusing on the valuation of non-financial metrics. Of course, private sector companies have a huge role because they are in the market experimenting, disseminating information and learning. Investors are also critical by demanding impact transparency of the companies they invest in. We have also found many organizations thinking in similar terms to us, and one of those is Banking for Impact. Many institutions recognize that environmental, social, and governance outcomes need to be measured in financial terms. Finally, customers are also interested in their suppliers’ social and environmental impacts and their role in the product value chain.
Honold/Azrack: One way to think about the impact accountability movement you are leading is that it quantifies externalities and, with it, the implicit transfer of wealth from society to shareholders. Re-balancing this could create more equity in the world. Could you comment on this perspective?
Serafeim: I would agree with that completely. We need to get this right. We need transparency on who is paying for these externalities, which may be negative or positive. Sometimes the price of these externalities associated with a product or service is too high, but at other times, it may be a reasonable price to pay or even beneficial to society.
Honold/Azrack: Professor Serafeim, this has been an excellent exposition of your work on the Impact-Weighted Accounts Project. You and your team have accomplished a great deal in less than three years. Where do you think things will be five years from now?
Serafeim: When we started the Project, it was with the support of HBS Dean Nitin Nohria. Without his support, nothing would have happened. He had the vision that this could be a revolutionary management and governance innovation. In the last year we have continued with the support and visionary leadership of Dean Srikant Datar. We hope that companies will measure and analyze their environmental and societal impacts and integrate them into corporate and investment decision-making. We anticipate established formal guidelines for valuation methodologies and have thousands of entities applying the impact accounts in practice. We hope it will become a useful tool for all of us to consider not only risk and return, but risk, return and impact.
Honold/Azrack: Thank you very much for your time.
About the Authors:
Doris Honold is a 2021 Harvard Advanced Leadership Initiative (ALI) Senior Fellow. Before ALI, Doris’ executive career has spanned more than 25 years in financial services across Chief Risk Officer and Chief Operating Officer roles in Frankfurt, Tokyo, Singapore and London. Doris’ interest lies in finding solutions for global problems that are pragmatic, business-driven and economically viable.
Joe Azrack is a 2021 Harvard Advanced Leadership Initiative (ALI) Senior Fellow. Before ALI, Joe spent more than 30 years in senior leadership roles in real estate investment management and was appointed by the Governor of Rhode Island to chair a partnership that revitalized and drove economic growth in Providence.
This interview has been edited for length and clarity.