Harvard Business School professor George Serafeim is offering a new way for businesses to calculate their success.
Traditionally, we look at profits and losses to determine just how successful a corporation is. But Serafeim’s research recommends we look at it from a different lens: by placing a monetary value on the impact of a company’s product and operations on society and the environment, and adding or taking this from its bottom line.1
Serafeim’s suggestion goes against the shareholder theory popularised in the last century by Nobel Prize–winning economist Milton Friedman, who argues that business performance is measured primarily by shareholder value.2 In a famous article published in the New York Times in 1970, Friedman said that the CEO, being an “employee” of shareholders, must act in their best interest and give them the highest return for their money.
According to Friedman, a company that chooses social responsibility over profit was practicing socialism, which he considered a “fundamentally subversive doctrine.” The sole responsibility of businesses was to use their resources and engage in activities to increase its profits.
Shifting of mindsets
Serafeim’s work comes at a time when businesses are looking for ways to help a society that has been suffering due to climate change, poverty, racism—ills that have been magnified by the coronavirus pandemic.
If we don’t monetise the impact that businesses make, we start to think that businesses have no impact. Companies that are profitable can leave huge negative impact on society, Serafeim said.
According to Serafeim, companies should go beyond sustainability reports, sustainability-focused investor relations events, and improving ESG disclosures3—the usual window-dressing and ticking-the-box. “In a world that increasingly judges [companies] on their ESG performance, they must look to more-fundamental drivers—particularly strategy—to achieve real results and be rewarded for them,” Serafeim wrote.
Using machine-learning technology, Serafeim and his team measure “intangible, nonfinancial factors” that goes beyond the usual benchmarks such as greenhouse gases or carbon pricing. They also look at the accessibility and cost of products and services, health and safety, and recyclability. The resulting numbers can be useful in investment decisions, tax incentives, and credit ratings.
An example is Intel, which was credited $6.9 billion in 2018 for paying its people well and helping boost the economies in places where it set up offices. However, Serafeim’s team also found that the company didn’t hire enough women, and that employees had difficulties moving up. In addition, the company didn’t pay enough attention to the health of its employees. All these resulted in a $3.1 billion deduction.
Other factors that Serafeim’s team looks at include wages, the number of black females in high-ranking positions, and incidents of sexual harassment.
Impact transparency
This is the era of “impact transparency,”4 as Serafeim calls it, with impact and profit being the new rules of the game.
In July 2019, when Serafeim and his team published the environmental impact costs of 1,800 companies by the Impact-Weighted Accounts Initiative (IWAI) at Harvard Business School, they found out that many of them were creating environmental costs that would exceed their total profit (EBITDA)5.
In fact, 15% or 252 firms would see their profits wiped out by the environmental impact, while 32% or 543 companies would see EBITDA reduced by 25%.
Impact transparency as a benchmark is expected to bring in results, among them:
• Government will be able to tax companies for their negative impacts such as pollution, paying below the minimum wage, and manufacturing products that cause obesity or make people sick. But even better, they will also be able to reward companies that produce positive impact, through taxes, subsidies, or preferential procurement.
• Investors will be able to put a cost on companies’ environmental and social impacts when they make their investment analysis. Investors are less likely to back firms that have negative impact, which will, in turn, encourage management to improve their corporate impact to increase their stock market value.
• This transparency will help customers and employees to make better decisions to buy or join companies that are aligned with their own personal values.
Next steps
Whether you’re a consumer, investor, leader, or a regulator, you have a role to play in this whole scenario. Business leaders can help usher in changes by measuring impact performances. Investors can demand that companies where they put their money into practice impact transparency. Government officials and regulators can move this forward by mandating the publication of impact-weighted accounts and motivating business to do better through taxes and incentives. Finally, consumers can exercise their vote for impact transparency by backing and purchasing only from businesses that aim to contribute positively to the environment and society as a whole.
1 Saijel Kishan, “How Wrong Was Milton Friedman? Harvard Team Quantifies the Ways,” Bloomberg, December 1, 2020, www.bloomberg.com/amp/news/articles/2020-12-01/how-wrong-was-milton-friedman-
harvard-team-quantifies-the-ways
2 Eric Posner, “Milton Friedman Was Wrong,” The Atlantic, August 22, 2019,
https://www.theatlantic.com/ideas/archive/2019/08/milton-friedman-shareholder-wrong/596545
3 George Serafeim, “Social-Impact Efforts that Create Real Value,” Harvard Business Review, September-October 2020,
4 Ronald Cohen and George Serafeim, “How to Measure a Company’s Real Impact,” Harvard Business
Review, September 2020, https://hbr.org/2020/09/how-to-measure-a-companys-real-impact
5 Ibid.