Q&A with Governance Expert Bob Monks (Part 1, on Social Costs and ESG Research)

(The following interview appeared as part of GovernanceMetrics International’sFounders’ Forum. GMI is the leading independent provider of global corporate governance and ESG ratings and research. Corporate stakeholders – including leading investors, insurers, auditors, regulators and others – use GovernanceMetrics services to identify and monitor risks related to non-financial measures covering key environmental, social, governance and accounting risk factors.)

GMI Director Bob Monks is the co-founder of The Corporate Library (now part of the new GovernanceMetrics International). Last week Research Associate Michelle Lamb talked with Bob about environmental accounting, the social costs of our energy economy, and what it all means for the future of ESG research.

You’re known as a governance expert, but here we are at the new GMI having recently expanded to include the E and the S in the broader field of ESG research. How do you see the new attention to environmental and social concerns tying back to the governance issues that you've worked on for decades?

When I first began working on corporate governance, I described it as having two facets: the internal functioning of a company and the company’s impact on society. It took most of the last 30 years to explore the first aspect—to understand how different elements in the corporate constellation related to each other and to whom they were accountable. Very recently, in the last 10 years, we’ve turned to the second aspect of corporate governance, looking at the company’s impact on the environment, on the government, on suppliers, on customers… and all of these are beginning to be reflected in a whole variety of ways in the work that we’re now doing on what is called ESG. So what’s happened really is we’ve simply advanced to a second level of concern with governance issues, one that was always anticipated by our conception of the field.

I understand that your estate in Cape Elizabeth uses a lot of solar power, is that right?

We still don’t use as much as we should, but yes, we’ve been very, very conscious of an effort to ultimately become self-supporting in energy. I’ve had a lot to do with this over the years, since I was Maine Commissioner of Energy about 30 years ago. We knew we needed to develop local energy resources, but the technology for, say, wind power was very frustrating. Even today we really don’t have a technology that offers an attractive rate of return for investors. What we’ve seen in the past is that every time there seems to be some progress in alternate energy, the price of oil goes down and the alternate energy all of a sudden isn’t attractive to utilities and it isn’t attractive to homeowners. But the development of renewables may now be facilitated by the unhappy fact that the costs of traditional power are going to continue to rise. If energy costs are high, and people believe they’re going to stay that way, then you have an environment within which it’s possible for serious investment to be made in alternate energy. So in a way, the bad news (of high energy costs) is the good news (in terms of faster progress on alternate energy).

How has your awareness of this and other environmental issues shaped your views as a businessperson?

I think the key issue for businesspeople is that the accounting system we use cannot adequately reflect the real impact of a corporation on the society in which it lives. We have a whole set of conventions about which aspects of corporate impact will be registered as an expense chargeable to that company, and which will simply be ignored and eventually paid for by the public. Let me give you an example. Many, many years ago when I’d get up in the morning here in Cape Elizabeth I’d open my door, and I’d look out at the ocean, and I’d say “It’s wonderful to be alive” and take a deep breath of air, and what I’d get was this God-awful smell of the sulfate paper process from the paper mill in Westbrook. And the people who ran that mill weren’t bad people – they weren’t attempting to do anything that everybody else didn’t do – but the presence of that odor indicated that the company was comfortable passing on the costs of having clean air to the public. The company did not have a business responsibility for doing it. So I think the great advances which I’m looking for are, prosaically enough, in the field of accounting. That’s one of the reasons I view our recent combination with Audit Integrity as so powerful. I think accounting expertise will be essential to our field as we strive to understand the materiality of environmental factors for our assessment of companies.

But isn’t it very hard to figure out how to quantify things like pollution in a financial statement?

It’s true that we don’t have an exact basis on which to make these calculations. But as our Audit Integrity colleagues will tell you, that’s a problem with a lot of aspects of accounting. We assign numbers to things and we don’t have any great confidence about whether they’re actually always going to be literally true. The point is that if all companies were forced to account for their external costs in the same way, those who damage society would not be at a competitive advantage. And that’s always been the thing that has been inhibiting to the vast preponderance of people who run companies who want to do the right thing. Because they say “well, we want to do the right thing but we can’t afford to take on costs that our competitors don’t.” So the only way that a higher level of concern for impact on the society can be implemented is through having a changed accounting system, and I’m pleased to say there seems to be a lot of progress in this direction. I’m attending a conference next month on the creation of a “unitary financial statement” which will include the external costs that have traditionally just been ignored. This gives us a real source of optimism about the ability of companies to coexist in a constructive way with civil society.

What risks and opportunities in business do you see emerging related to climate change?

I think the biggest risk is that we continue to have a lack of humility about what we know and what we don’t know. The various dialogues about global warming, for example, appear to have reached a level of incivility based on taking data and arriving at opposite conclusions, and people feel very strongly either one way or the other. What has been clear to me, a rather strange conclusion, is that whenever everybody is certain about something, they are usually wrong. The reality is that what we know, actually know, is a great deal less than we think we know. So the way I look at it is this: “suppose there is human impact; then we certainly ought to reduce it. Suppose there’s not human impact; what do we lose by trying to reduce it anyway?” So that’s part of my approach of humility; if you can proceed in a way that covers both of your bases, that’s far preferable to standing on either side of an argument and shouting at each other.

I understand that you yourself have been the CEO of a business in the extractive industries, in mining in particular. Could you speak a little bit about the dilemmas you faced in that industry?

Well, the experience I had in being an owner and CEO of a coal-mining company was that, just to put it very bluntly, we had a “death rate.” And that was one person per thousand per year. And I must say when I first got involved in the business, I had no idea that there was such a thing as a death rate. I mean I wasn’t so naïve as to think that it was safe; on the other hand I didn’t realize that there was such a consistency to people dying in coal mines. And I took a lot of time and energy when I was there and I went into the mines to ask, “Is there anything that really can be done?” Now stop and think for a minute what it’s like. You go several thousand feet underground and when you’re there you’re on your knees, or very much crouched over – in my case it was my knees because I’m so tall. And it’s dark … there’s a lot of machinery running around in the dark…it has headlights but it’s all sort of confusing… there are a lot of sharp objects… and often there’s a lot of gas in the coal…the entire environment is one that just defies the imagination for safety. No matter what you do, you simply cannot insulate people working thousands of feet underground from certain consequences. Well, I personally could not get used to the idea of being in a business with those characteristics, so I sold out of it. But I think it raises the question for society as a whole of “Do we want to permit commercial activity in which fatalities are an inevitable consequence?”

Are there any societies which you think do a better job of this?

Well, many years ago I did business with steel companies in Sweden. And the Swedes, at that time, had outlawed underground mining in their country. But the situation wasn’t quite as simple as you’d think, because they had, at the same time, acquired underground mines in Africa, which gave them a way of getting most of what they needed.

Do you see any meaningful movement for change in this area today?

I think that we have seen in the last year a very clear call for sensible leadership in the area of defining acceptable business activity. The biggest energy sources in our society today are coal, oil and nuclear power, and in the last year or so we have had the largest coal disaster that we’ve had for a long time in West Virginia, the Gulf of Mexico oil spill, and the nuclear incident in Japan. So, what this is telling us is that we have adopted a value system that requires us to meet our needs by accepting risks that we really don’t understand when we start, and may well be unacceptable. Well, is that a sensible way for us to run a world? It clearly isn’t. There’s a need here to stand back and have a bit of humility and say, “Look, what do we do? Do we consume less? Do we have a different source of supply? Or do we continue to go along and figure that the levels of risks that we’re running in the traditional areas are worthwhile and that we should continue to run those risks?”

Who do you think will take the lead on asking those questions?

It would be well if companies did, but they won’t. So it would probably have to be some sort of NGO or government. And to be meaningful it would have to be inter-governmental; it would have to involve both developing countries and mature countries. There are agencies that concern themselves with these sorts of things, but I haven’t seen anyone really call for the evaluation of the consequences of the last year and these major disasters in the three areas. It would seem to me to be a clear call for effective action.

In the meantime what could CEOs, shareholders or other stakeholders of companies in these industries do to act responsibly?

I think that companies ought to begin to do their calculation of future investments based on a far, far larger calculation of estimated costs. They need to consider that society will require a far larger percentage of the societal costs to be borne by the private companies. When you stop and think about it, there really is no reason why a private company shouldn’t bear the full cost of what it does; it is simply that, culturally, we’ve never done it.

As I said earlier, many areas of accounting rely on measures that cannot be fully accurate. Well, it’s a little bit of a leap to go into a new area where you know it’s not always susceptible of a precise measure, but it isn’t that far from where we already are, and hopefully we can learn to deal with this ambiguity in a positive way.

Stay tuned for “Part 2” of Michelle’s conversation with Bob in an upcoming Founders’ Forum post.

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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