How impact accounting might make companies act more responsibly
Accountability from a tangible and quantifiable framework
TLDR: Impact investing has been around for decades. Impact accounting, on the other hand, is the attempt to create frameworks to quantify and evaluate impact. Impact statements could then be issued alongside financial statements to help investors with their decisions. Unlike many ESG-related frameworks, much of impact-related information is expressed in monetary terms, which comes with its advantages and limitations. Similar to ESG criteria, impact accounts can be mandated in legislation or by leveraged for financial models. This would help hold companies more accountable for their actions and help crack down on false marketing claims.
Impact investing as a concept has been around since the year 2000, when Baruch Lev of the NYU’s Stern School of Business published his thoughts about intangible assets. The term “impact investing” was finally coined in 2005 by Mark Zapletal of Wartenberg Trust.
The market for impact investing quickly grew, reaching about 26 billion dollars in 2009 just in the US. Today, this figure is over one trillion dollars.
Generally speaking, the goal is to achieve a measurable environmental and social impact alongside financial returns. In this way, it resembles ESG investing, where funds are placed not only according to financial criteria but also according to environmental, social, and governance-related considerations.
Institutional investors typically structure impact investments like venture capital deals. In contrast to the latter, however, the payment times are often longer. Such institutional investors count pretty much any institution that might also invest in traditional assets, such as corporate funds, pension funds, foundations, private equity firms, and more.
Impact investing often intersects with blended finance, where public and private institutions come together to finance a deal. This can be useful because private institutions often have more experience structuring a deal and can bring more capital to the table, while public institutions (such as government offices, for example) are often more skilled at assessing nonfinancial impact.
That being said, private institutions are getting more and more skilled at impact assessment. This might accelerate the impact investment market and help meet the U.N. Sustainable Development Goals.
How impact investing differs from ESG investing
Although there is some overlap, there are key differences between impact- and ESG investing. Both seek to address sustainability-related issues; however, the way they go about this differs fundamentally:
Time direction: ESG is a backward-looking framework. ESG investors choose to invest in a target based on past financial and non-financial performance. In contrast, impact is forward-looking. Impact investors place their capital with the intention to achieve a specific environmental or social goal.
Fiduciary scrutiny: Asset managers have a fiduciary duty to act solely in the interests of the beneficiary, i.e., the investors. This makes ESG investing tricky if it yields lower returns than the market, because it implies that the asset manager might have acted also in the interest of ESG-related goals and not just the beneficiary. On the other hand, impact investment funds are usually standalone funds that do not face fiduciary scrutiny.
Exclusion criteria: Many ESG funds do not invest in certain sectors (e.g. defense, tobacco, oil and gas). They might also use ESG scores to identify targets that have done particularly well in the past. Impact investing, on the other hand, does not ex- or include any investment based on its sector or on a score. Instead, it aims to achieve a certain goal with the project it invests in.
Public and private markets: Most ESG investments take place in public markets, where ESG-related reporting is mandated in many jurisdictions and where data is easy to obtain. Impact investments, on the other hand, have traditionally been concentrated in private markets. The lines might be blurring, though, because ESG-related disclosure is getting increasingly important also for private companies, and because some impact-related projects eventually go public.
Scope: For impact investments, it is best practice to incorporate ESG criteria into future projects. Pure ESG investments, on the other hand, do not seek to achieve specific impact goals in the future. ESG investments therefore do not automatically satisfy impact criteria; impact investments on the other hand almost always satisfy ESG criteria because they align with the intended goal of the financed project.
There is some overlap and some blurred lines, but generally speaking impact investment tends to be project-specific and forward-looking, while ESG investments tend to be company-, country-, or sector-specific and backward-looking.
How impact accounting works
Impact accounting is a way of keeping track of and quantifying impact goals. As of today, many impact investors develop their own metrics and frameworks for this purpose. Driven by the shift of sustainability into the investing mainstream and the emergence of sustainability-related regulation, common practices are beginning to get established now.
In the long term, developers of such accounting methodologies aim to develop standards that are as established as financial accounting. This means that companies must not only report on their financial performance in their financial reports, but also on their environmental and social impact.
This is somewhat tangential to ESG reports that are already being mandated alongside the well-established corporate financial reports. That being said, key differences include the fact that ESG reports only need to disclose past performance and not keep track of achieving specific goals (although many companies to set goals and include these in their ESG reports voluntarily). Another difference is that many ESG-related variables are expressed in the units that are most pertinent to them, for example tonnes of carbon, number of species per hectare, or percentage of disabled workers across the workforce. Some impact accounting methodologies try to express every variable in monetary terms in order to make them as comparable as possible with financial reports.
Like ESG-related exercises, impact accounting starts with a materiality assessment. This means that the subsequent work is limited to the criteria or impacts that matter most for a specific company. A recruiting company, for example, might want to put a lot of attention towards adequate wages for their employees and clients, but not factor in their positive or negative impact on biodiversity because it is likely very small.
Given the fact that ESG reporting is becoming a lot more established and and is being standardized faster than impact accounting, it is likely that ESG reporting will at some point absorb most of the elements in impact accounting. That being said, impact accounting does offer some interesting benefits to the financial sector.
Impact accounting might help financial analysts
Impact accounting can help financial analysts in two key ways: First, they have another tool to assess the non-financial impact of their investment. Second, it might help them refine their financial projections.
In traditional ESG investing, analysts know that their portfolios meet a certain baseline when it comes to environmental and social value creation. It is often difficult, however, to understand how much environmental and social value they truly helped create with their investments.
Impact accounting can help here because it quantifies ESG- (and impact-) related performance. It also helps determine whether that performance was enabled specifically because of the investment, or whether it would have occurred anyway. In the latter case, it would not be counted as impact.
At Wangari, we are starting to put this approach into place for our own performance. Once it is fully enabled, our software will enable financial analysts to spot businesses that likely will perform well financially specifically because of (or despite) their environmental and social performance. In the long term, we want to help create environmental and social value in the billions of dollars, if not more.
Impact accounting might also help financial analysts refine their projections. By leveraging historical or sector-wide correlations between impact-related variables and financial variables, they can put their financial models on a more robust footing and help their funds make more informed investment decisions. The same goes for ESG-related variables. This is precisely what Wangari’s software intends to help financial analysts with.
The impact of greenhouse gas emissions
A preliminary methodology for measuring the impact of greenhouse gas emissions has just been released by the International Foundation for Valuing Impacts (IFVI) and the Value Balancing Alliance (VBA). This methodology aims to show in monetary terms the causal links between “GHG emissions with outcomes and impacts that affect the well-being of people through changes in the condition of the natural environment.”
The methodology is based on the social cost of carbon, a well-established methodology that aims to put a price tag on emissions. It includes scope 1, 2, and 3 emissions, which relate to whether emissions where directly caused by a company or whether they happened indirectly through energy purchases or activities up and down the supply chain.
It also stipulates that their carbon price tag reflects the effect of emissions on the whole of society and not on some discrete group of stakeholders. This contrasts with the intentions of typical financial reports, but stays true to the line of thought in impact investing.
Finally, it does not include avoided emissions, renewable energy certificates, or carbon offsets. This simplifies the methodology and avoids having to deal with a carbon market fraught with problems and abusive actors.
IFVI and VBA set the value factor (i.e. the damage every ton of greenhouse gas emissions cause to the planet) to 236 dollars for every metric ton of carbon emitted in 2023, and to 239 dollars in 2024, adjusted for inflation. These prices will be continuously updated as their research methods refine, and economic and environmental data gets available.
The impact of adequate wages
This is the second topical methodology issued by IFVI and VBA, with more to follow. The impact of adequate wages explicitly does not include any other workplace conditions as these will be researched in the future. It covers both a company’s own workforce and the workers up and down the value chain.
It focuses on the direct effect on the workers themselves, not the indirect effect their pay has for wider society, such as economic development, lower crime, and greater civic participation. It also only covers the value that the pay brings to the workers themselves, not the value that paying workers brings to the company.
Two impacts are considered: First, the remuneration impact, i.e., the impact that each additional dollar has on a worker’s well-being. Second, if the pay falls below the living wage in a particular country, the living wage deficit wage impact quantifies how much every dollar below the living wage impairs a worker’s ability to maintain a decent standard of living.
To account for the different economic outcomes of every country, value factors are applied. These are country-specific numbers that quantify the effect of each dollar in income. Generally speaking, the higher a country’s GDP, the lower its value factor because one dollar does not make much of a difference. Conversely, a dollar carries a high value factor in countries with a low GDP.
There are also inflection points: Above a certain point, the marginal utility of an additional dollar plateaus out. A worker earning more than 100,000 dollars a year does not feel the effect of another dollar on their lives as strongly as a worker earning only 20,000 dollars.
This methodology allows to quantify the impact that changes to a worker’s pay have on their well-being. It does not, however, quantify how this pay impacts wider society.
The future of impact accounting is bright
Impact accounting still faces a variety of hurdles. Though many different impacts have been studied in academic and corporate research, access to high-quality data remains a thorny issue. This is particularly the case for data about activities that are not confined to a company itself but happen along the value chain.
As ESG-related data is moving towards greater transparency, impact accounting stands to benefit from this. Organizations that transparently report all their data might be favored by investors because they make it easy to assess them and draw conclusions on their performance.
ESG and impact are different but very interconnected topics. ESG investing is a burgeoning market, and impact investing has seen tremendous growth in the past couple of decades as well. It is plausible, then, that impact investing and impact accounting methodologies will only grow in the years to come.
This is good news for investors, and even better news for the planet!
What we’re reading at Wangari
A short, sweet, and insightful piece on why Low-carbon energy does not have the same energy security risks as fossil fuels, penned by
. As she points out, energy security of fossil fuels is direct: A country without access to oil and gas simply has no energy. And most countries do not have sufficient oil and gas reserves to power themselves! With renewables, some countries have more rare minerals than others. But these are processing capabilities. Nobody can cut off their sun and wind. Once solar panels, wind turbines, batteries and grids are installed, geopolitical tensions do not result in a large-scale energy crisis.The world’s largest meatpacking company, JBS, has invested millions in media campaigns to promote its plans for its net zero by 2040 target, amongst other claims of environmental sustainability. The catch? The ads, which have run in many reputable news outlets, are greenwashing according to experts. In their piece Big Meat is lying about sustainability. These media outlets are helping.
and detail how many established news sources have been complicit in this greenwashing campaign. On a more positive note, the New York Attorney General is suing JBS for its campaign.Geoengineering might sound scary, but the idea is gaining steam. As
writes in The Geoengineering Question, injecting sulfur dioxide into the stratosphere — which is the most-discussed approach to geoengineering — would indeed block sunlight from the Earth and undo some of the global warming. As the piece explains, it is good to have such approaches as options of last resort. They are not, however, a lasting solution for climate change. What’s scary is that geoengineering is incredibly cheap, meaning that a single country or even a rogue billionaire could in principle decide to manipulate the weather however they want it to be.