Should Companies Report Estimated Climate Change Losses?

 

On December 14, 2016 the Wall Street Journal reported that a panel of financial and business executives chaired by Michael Bloomberg recommended that “Companies should publish an assessment of the losses they could suffer through climate change as part of their routine financial statements.” The panel believes that “… investors need better information to assess which firms are most vulnerable to shifting weather patterns and related threats.” This, says the Journal is “… part of a wider push to prod companies to disclose more climate-related information, a contentious effort that implies such issues are material to a company’s performance.” Note: This is not an isolated initiative. The SEC is currently considering similar disclosure requirements for public companies on the effect of global warming on their business. So, this is an issue requiring serious consideration.

I am not in favor of requiring public companies to disclose in their financial reports possible impacts of climate change on their operations. For quite some time I have observed with alarm the constantly growing number and impact of subjective managerial estimates and forecasts on financial reports. It used to be that accounting was primarily about facts (after all, accounting comes from counting real things, like money or inventory). Nowadays, courtesy the FASB, accounting and financial reports are all about subjective estimates, and sometimes sheer guesses. Assets are reported on the balance sheet net of depreciation (an estimated), and when deemed impaired (loss of value) such assets and goodwill values are lowered by an estimated impairment loss. Accounts receivable are reported net of an estimated bad debt reserve. And most expenses in the income statement, like pension and warranties expenses, employee stock option expense, and amortization of acquired intangibles, are based on layers of estimates. Many of these estimates, like the “expected gain on pension assets,” which affects the amount of pension expense, or the marking-to-market of non-traded assets (an oxymoron), are sheer guesses, prone to manipulation.

In the End of accounting …, chapter 9, we demonstrate empirically that the proliferation of managerial estimates underlying financial reports is a major cause of the fast deterioration in the usefulness of financial information to investors. Estimates, particularly “managerial” ones, detract from the reliability of corporate information, thereby enhancing investors’ uncertainty and ambiguity. So, rather than improving transparency, accounting regulators enhance ambiguity and ambivalence. The figure below shows vividly the huge increase in the average number of estimates in financial reports.

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Now, the SEC and other do-gooders wish to add to the current plethora of estimates new estimates of climate change presumed impacts. Will they do any good to investors? I don’t think so. While many (though by no means all) believe that the “science is settled” regarding global warming and humans’ contribution to it, the science is far from settled, or even emerging, regarding the measurement of the effects of potential future global warming on business operations and growth potential. In fact, I am not aware of any reliable methodology predicting the impact of, say one degree warming on enterprises’ sales, costs, or asset values. I have yet to see a serious study assessing the impact of expected climate change on companies’ operations and value. So, how will companies estimate and report climate change effects?

Thus, the suggested requirement for disclosing climate change impact in financial reports will result in largely unsubstantiated and unreliable information and numbers, likely to be ignored by investors. These impact estimates, however, will definitely not be ignored by “climate activists” and trial lawyers who will demand more and more information about alleged climate impact and file lawsuits against companies and their managers. These estimates will also embolden activists to advance costly shareholder proposals to change companies’ strategies and conduct. Full employment act for climate lawyers and activists without real benefits to shareholders.

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