Jed Emerson, the Generation Foundation

If a growing band of free-thinkers wins the day, corporate balance sheets everywhere will display a more earthy tone of green. Initially at least, that could turn the cozy world of accounting upside down.

The first engagement will take place in intangible assets. And it will be involve the age-old debate over cost versus value. Accountants are comfortable dealing with cost because they can examine receipts. And failing that, they can bring in professional valuators to make the proper assessments.

But like most other financial professionals they are not so adept at estimating value, especially when there are no platforms for establishing market-clearing prices. And according to one of the free-thinkers, Sara Olsen, the San Francisco-based founding partner of the Social Venture Technology Group, that exercise is being further hampered since companies have traditionally ignored the intrinsic worth of a clean environment and the health and well-being of people.

“These issues have usually been referred to as intangible items,” she says, “because their value cannot be measured by traditional financial and accounting methods.

“What we need is a systematic way for companies to measure opportunities that drive business creation and create a clearer understanding of how these can become opportunities for generating business revenue and profit.”

Olsen and others are introducing outside-the-box thinking on how to establish methods for monetizing such potential value. These include designing and marketing products and services that will contribute to a cleaner environment and healthier people.

She has mapped out a road to link idealistic environmentalism and practical commerce. The mileposts along the route include: visualize, measure, validate, commercialize and trade. “The process behind all this is first to identify and recognize what’s of value that previous systems overlooked,” she says. “The second step is to measure the volumes and verify that activities took place. Finally, market mechanisms will emerge to bring buyers and sellers together to undertake transactions.” 

Such winds of change have yet to ruffle most of the accounting world in Canada. “I have not heard very much about such concepts,” says Rick Robertson, an accounting professor at the Ivey School of Business in London, Ont. “But whenever those activities result in transactions, accountants will certainly know what to do.”

Even before that, accountants will play a role. “They can help develop standardized methods for describing such activities and calculating their results,” says Jed Emerson, a Denver-based senior fellow at the Generation Foundation, a sustainable development investment firm. “We need to develop new ways of handling intangible assets that can be placed in a financial analyst’s toolbox.”

All these new age financial ideas could be simply dismissed as so much tree-hugging propaganda were it not for the pedigree of some of its early adherents. The first one is more symbolic yet highly authoritative.

It’s the U.K.-based, Accounting for Sustainability program established by Prince Charles in June 2006. He brought together a small cross-sectional team to build sustainability considerations into decision-making, resource allocation and accounting as a prerequisite to embedding sustainability into everyday organizational processes.

The group’s initial plans call for expanding existing ‘cap and trade’ schemes for carbon and other emissions to cover other resources. In addition, for companies voluntarily adopting better accounting for sustainability practices, the team is considering the introduction of a ‘kite marking’ system.

Currently, the kite mark indicates certification by the British Standards Institute (BSI), applicable to safety and quality management standards.

Such certification would help shareholders and consumers identify organizations that follow emerging best practices. This designation might be considered comparable to a royal warrant emblematic of a corporation’s proven level of environmental sustainability.

But it is not just royalty that is going green. There is General Electric, number 11 on the Fortune 2007 Global 500 list with 2006 revenues of $168.3 billion US. Its entry in the green sweepstakes is Ecoimagination. According to Olsen, CEO Jeffrey Immelt expects that in 2007, GE’s so-called clean technology products and services such as solar panels, hybrid engines and other new materials could generate $20 billion US in revenue that could later rise to $50 billion US.

Another early follower is the reinsurance firm Swiss Re, with $32.1 billion US in 2006 revenues that was good enough for 209th spot on the Fortune list. Besides recently signing up for the United Nations’ Principle for Responsible Investment, a voluntary program that encourages best practices in environmental, social and corroborate issues in investments, the firm has also put some of its own assets in the game.

Last January, Swiss Re offered a 5,000 Swiss franc ($4,283 Cdn) incentive to all of its employees who commit to reducing their personal carbon footprint. Earlier in 2003, it declared that it would make its own operations carbon neutral by 2013.

What is the rationale for global insurers to act in this way? “Markets can set a value on a company’s reputation,” says Nir Kossovsky, Pittsburgh-based chief executive of reinsurance firm Steel City Re and executive secretary of the Intangible Assets Finance Society. “And the intangible value behind its reputation is based on its policies and practices related to concerns such as security, safety and innovativeness. Companies need to manage those assets properly and communicate to their stakeholders what they are doing to build and protect their reputation.

“It’s similar to managing the brand for a product, only reputation relates to the entire enterprise.”
Kossovsky is starting to notice some firms very quietly taking out insurance to protect their company’s reputation against random risk. And on the supply side, many insurers believe that there are still many corporate assets that are not being insured, so they are constantly looking for new products and services to address that need. And when it comes to such intangible assets, how do they price that risk?

“For conventional life and property risks,” says Kossovsky, “insurers start with actuarial models. But for intangible asset risks, they may not have a great deal of historical data or insurance experience. Each insurer may need to develop its own database and quantify risk based on its own assumptions. But the first rule of insurance is never to underprice risk.

“And since various insurers might use different assumptions, the rates they quote are likely to vary. So that is where competition kicks in.”

Another approach to sustainability accounting is called blended value. “It goes beyond earlier systems such as the triple bottom line that encompasses the separate calculation of financial, environmental and social aspects of an organization’s activities,” says the Generation Foundation’s Emerson “Those elements must be integrated into one entity because they form an interactive and dynamic whole and their impact has to measured together.”

Many off balance sheet items include potential environmental and social liabilities. These become critical when executives allocate capital. Today to do it effectively, they increasingly need to consider a broader set of demands beyond those of finance and economics.

Emerson compares the road ahead to the evolutionary development of econometrics, which combines economic theory with statistics to analyze and test economic relationships. “It took close to 30 years for those principles to catch on as a mainstream discipline. For blended value and the others, it should be less.”