A greener free market

With the recent financial market meltdown and related bailout, the term “free market” is not particularly in vogue at the moment. Instead, everyone seems to be looking for government intervention to force companies to do not only what’s right, but what in many cases is in the best interest of those companies.

Much of such regulation is probably necessary. Corporate managers are notorious for focusing on short-term profits, even if it comes at the expense of the longer-term future. And who can blame them? Executive compensation is almost always tied to short-term — or at the most medium-term — success. Unfortunately, this spells major disaster for our environment, which tends to show the effects of today’s behavior many years from now, by which time a corporate executive will most probably have changed jobs multiple times. So our only hope is to sit back and wait (stretch, yawn) for the government to step in.

Or is it? It turns out that not everyone is waiting for government intervention. A group of activist investors (and by investors, I’m talking about the people who have the greatest interest in bigger corporate profits) realized years ago that climate change poses a major threat to long-term corporate profits. As a result, the Investor Network on Climate Risk has decided to start policing companies on its own given the slowness of government action in this area.

With a membership of 70 institutions managing over $7 trillion in assets, INCR has catalyzed a growing movement within the asset management industry. This movement is aimed at (among other things) measuring the impact of climate risk on the long-term profit potential of corporations, and prioritizing investments in companies that score well in this measurement.

Another firm, Innovest, has started to rate companies based upon their exposure to climate risk and their ability to manage or mitigate that risk. Such ratings are intended to increase (or decrease) investor interest in such firms, as the ratings reflect the likelihood that a particular firm’s profits will rise or fall in the future due to climate change.

These developments represent a major breakthrough in private sector thinking in this area. Environmentalism was once the enemy of corporate profits, with most companies acting to reduce their environmental impact only because they were forced to by government. But with the leadership of groups like INCR and Innovest, many corporate executives will find themselves confronted by angry shareholders if they don’t start taking a more pro-active approach to addressing climate change.

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