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2.3.2. Ecological Return on Investment
As described above, the financial ROI determines the profitability of the investment. The calculation divides the average profits generated through the investment object by the capital investment needed to acquire the investment object. Schaltegger and Sturm (2000) suggest a transfer of the ROI to an Ecological Return on Investment (EROI). As with the EPP, financial cash flows are replaced with environmental aspects. Hence, the avoided environmental aspects over the operational lifetime of the investment object are set in relation to the environmental aspects caused over the investment object’s life cycle (ibid.). Therefore, the formula can be expressed as follows:
Equation 3: Ecological Return on Investment formula for capital investment objects
Schaltegger and Sturm (2000) claim that an investment should be regarded as efficient if the outcome is > 1. However, in case of investments not intending to avoid emissions (i.e. investments expanding already existing facilities), the decision-maker should invest in the object which is closest to zero (ibid.).
In contrast to the EPP, the EROI focuses on the life cycle of the project. On the one hand, this comprehensive view satisfies scientific requirements since relevant environmental aspects are not excluded from the analysis. On the other hand, the same criticism applies for the EROI as with the EPP.
2.3.3. Ecological Net Present Value
The financial NPV method classifies as dynamic investment appraisal method since it considers the time value of money. Cash inflows and cash outflows, which occur at different points of time, are discounted or compounded to the same point of time via an interest factor. The discount factor is also in the focus of suggestions regarding an Ecological Net Present Value (ENPV).
Günther (2008) discusses possible adjustment opportunities of the discount factor within the NPV calculation. The premise of the author is that the decision-maker tends to prefer investment objects with cash outflows in the distant future than investment objects with cash outflows in the near future (ibid.). The underlying argument is again the time value of money. One monetary unit in distant future implies less value compared to one monetary unit in near future due to inflation (Götze et al., 2008).
Building on this premise, Günther (2008) discusses transferring this issue on investments and their impacts on the environment. On the one hand, the author claims that expected technical development should lead to an increase of the discount factor since cost savings are expected in distant future. On the other hand, expected stricter threshold values should lead to a decrease of the discount factor, offering the incentive for immediate investment. (ibid.)
The discussion about adjusting the discount factor, with the intention to recognise future environmental impacts, gained popularity with the Second Assessment Report (SAR) of the Intergovernmental Panel on Climate Change (IPCC) published in 1996. The SAR differentiates between a prescriptive discount rate (in literature also referred to as the social or environmental discount rate) and a descriptive discount rate. (Halsnaes et al., 2007)
The descriptive discount rate bases on market-based interest rates. These interest rates are either determined by central banks and are referred to as prime rates or base rates. Another option is the London Interbank Offered Rates (LIBOR), which is defined by the British Bankers’ Association and represents the daily average inter-bank interest rate. An alternative to LIBOR is the EURIBOR, which is published by the European Banking Federation and focuses on the average inter-bank interest rate of financial institutions within the European Union. (Becker, 2012)
In contrast to this, the prescriptive discount rate tries to sketch the tendency of humans to prefer paying costs for environmental protection in distant future than paying these costs today. This tendency is also referred to as pure-time preference. (Kula, 2011) Halsnaes et al. (2007:136) define the prescriptive discount rate as “the sum of the rate of pure-time-preference and the rate of increased welfare derived from higher per capita incomes in the future”.
While descriptive discount rates tend towards high rates of four percent or more (especially for risky funds), prescriptive discount rates tend to be the opposite (Halsnaes et al., 2007). In this context, Stern (2007:45) points towards the controversial discussion about environmental discount rates since high discount rates “favour avoiding costs of reducing emissions now, since the gains from a safer and better climate in the future are a long way off and heavily discounted”.
Shaikh (2012) notes that the debate about discounting environmental impacts overloads the ability of the discount rate since the debate diverges from the original intention of the discount rate, which is the representation of the time value of money. In addition, the debate concentrates on defining an appropriate level for an environmental discount rate and not on the question whether or not discounting is the right tool to achieve inter-generational equity in financial projections. Shaikh (2012) adds that economists generally do not intend to discuss ethical questions within their calculations.
Besides the vast criticism, the government of the UK has determined a discount rate for public long-term projects that declines over the years (see Table 2). While France also prescribes a four percent discount rate for projects below 30 years and a two percent discount rate for projects of over 30 years lifetime, the US government suggests voluntary implementation of declining environmental discount rates. (Halsnaes et al., 2007) However, there is no transparent reasoning behind the determination of these discount rates. In addition, whether or not the level of these discount rates is appropriate with regard to a fair representation of generations of today and the future, is a discussion which is unlikely to end with a globally accepted consensus in the near future.
Table 2: Environmental discount rates as prescribed by the UK Government
Source: According to Halsnaes et al., 2007
In its discussion about adjusting the discount factor within the NPV calculation, Günther (2008) refers to the inability of the discount factor to appropriately represent inter-generational equity. This argumentation is also shared by Schaltegger and Sturm (2000), who also argue that an adjustment of the discount factor would contradict the inter-generational paradigm as described in the Brundtland report.
2.4. Environmental impact assessment in companies
The problem situation of this thesis highlights amongst others the necessity to express strategic environmental goals in quantitative values to determine environmental impacts of decisions and to enable supporting these strategic goals. However, to determine the environmental impacts of an investment decision, it is necessary to collect, monitor and analyse environmental data in the same quality as corporate financial data is collected, monitored and analysed.
The department coordinating environmental data is the environmental management of a company. The main purpose of environmental management is to ensure a continuous improvement of a company’s environmental performance (Förtsch and Meinholz, 2014). Hence, the organisation along the Plan-Do-Check-Act (PDCA) cycle ensures a standardised way of repetitively defining environmental goals, organisational structures, responsibilities, the execution of programs and audits as well as its documentation (Müller-Christ, 2010).
Successful environmental management necessitates cross-functional collaboration with other departments. In this context, Rathje (2009) assesses the organisational positioning of environmental management departments in companies. Since the author identifies a variety of locations within the organisational structures, Ratje (2009) concludes that the location depends on the overall organisational structure of the company. Nevertheless, since environmental management affects all areas of a company, the hierarchical location of the department plays a minor role when assessing the degree of cross-departmental collaboration regarding environmental management issues. (ibid.)
As the aim of an environmental management system is the continuous improvement of a company’s environmental performance, this performance needs to be quantified so that development can be monitored, documented and reported. This process of measuring, monitoring and reporting environmental performance data is referred to as ‘environmental management accounting’ (IFAC, 2005).
Burschel (2004) notes that the current academic literature has not agreed on a uniform definition of environmental management accounting due to its intense discussion and diverse dissemination in business practice. The author analyses different forms of environmental management accounting systems and differentiates between:
- the connection of environmental management accounting to financial accounting
parallel system to financial accounting
extension of financial accounting
- the scale of assessment of environmental management accounting
focus on physical input and output flows
focus on monetary flows
- the scope of assessment of environmental management accounting
assessing environmental impacts of products and processes
assessing environmental impacts of the whole company (ibid.)
Nevertheless, Baumast (2009) defines environmental management accounting as subsystem of the management accounting business function that extends the classical management accounting tools by ecological components to integrate environment-related issues. Faßbender-Wylands (2009) agrees by referring to the functions of environmental management accounting which match with the functions of a financial management accounting system. Although the author claims that classical management accounting instruments are not originally designed and thus not suited for tracking environmental performance. In addition, the author notes that suitable instruments of environmental management accounting are still under development (ibid.).
Tschandl and Posch (2012) focus on the task of providing information on eco-efficiency and eco-effectiveness as well as identifying opportunities and threats of sustainable development practices. Therefore, environmental management accounting concentrates on physical flows such as waste, water, emissions, energy or other related consumption of resources. (ibid.)
The basis for environmental management accounting is an integrated environmental information system which records all relevant environmental aspects of a company (ibid.). According to an analysis by Isensee and Michel (2011), the most-advanced companies in integrating environmental management accounting still face a lack of additional and detailed environmental data. In most cases, companies are not able to track and monitor data on environmental aspects on equipment level. Resource and emission flows are only available on an aggregated level (i.e. plant or hall level) requiring additional measuring points on equipment level. This fact leads the authors to the conclusion that the development of environmental management accounting is still far from established professional application (ibid.).
Besides the location of measurement equipment of resource and emission flows, an additional issue for the environmental management accounting system concerns the scope of measurement. While the financial management accounting is primary interested in cost-related environmental aspects (e.g. energy or water), the environmental management has to track additional resource and emission flows due to compliance checks with given threshold values.
When exploring the underlying reasons for the lacking detail of environmental performance data, the differentiation between environmental aspects and environmental impacts is vital. According to the ISO (2009:11), an environmental aspect is defined as an “element of an organization’s […] activities or products or services that can interact with the environment”.
Furthermore, the literature differentiates between direct and indirect environmental aspects. Direct environmental aspects are defined as decisions and activities in the context of business operations of the own company. These activities comprise amongst others the development, production, transport and marketing of products. In contrast to that, indirect environmental aspects comprise decisions and activities of suppliers or business partners of a company. (Prammer, 2009)
While this definition of environmental aspects emphasises the interaction between the operations of a company with the environment, the ISO (2009) recommends the establishment of an input-output model as a basis for further quantification and measurement. In this context, the IFAC (2005:30) suggests “accounting for all energy, water, materials and wastes” in order to build a so-called “input-output balance”.
The European Commission (2009:22) provides a more comprehensive list which adds to the following environmental aspects:
- “legal requirements and permit limits
- emissions to air
- releases to water […]
- use and contamination of land
- use of natural resources and raw materials […]
- local issues (noise, vibration, odour, dust, visual appearance, etc.), […]
- risks of environmental accidents and impacts arising, or likely to arise, as consequences of incidents, accidents and potential emergency situations,
- effects on biodiversity.”
While this list also reveals qualitative environmental aspects, it could even be extended by referring to additional literature. However, the environmental management system focuses on the most relevant environmental aspects. Hence, the European Commission (2009:22) assists in determining the relevance of environmental aspects by defining:
“- size, number, frequency and reversibility of the aspect or impact
- existence and requirements of relevant environmental legislation
- importance to the stakeholders and employees of the organisation”
The step of identifying the most relevant environmental aspects provides the basis of assessing the impacts on the environment. While the definition of environmental aspects concentrates on the interaction of business activities with the environment, the definition of environmental impacts focuses on the consequences of this interaction. Prammer (2009) classifies environmental impacts into three categories:
- change of amounts of natural resources (mostly depletion)
- change of material composition of the natural environment
- change of ecosystems and landscape.
In addition, the author states that environmental impacts can be short-term, mid-term or long-term, reversible or irreversible, constant or of temporary character (ibid.). While environmental aspects can be quantified with the help of measurement technology, quantifying environmental impacts is difficult. The lacking knowledge of cause-and-effect of environmental aspects leads to the necessity of assumptions which are hard to determine in an objective and plausible manner. (Tschandl, 2012; Loew et al., 2003)
Furthermore, the environmental impacts under consideration depend on the scope of assessment. Original Equipment Manufacturers (OEM) of the automotive industry, for instance, face responsibility for the environmental impacts of their products occurring from materials used, air emissions, noise and fuel consumption. With regard to the production, environmental impacts occur from emissions into the air or surface waters, consumption of materials, energy or freshwater, noise emissions, waste, land contamination and many more. (Gruden, 2008) With other industries or products under consideration, this set of environmental impacts would vary significantly.
Because of this variety of environmental impacts, the literature discusses several methods assessing and aggregating environmental impacts in indicators or ratios with the aim of measuring and monitoring the environmental performance of a company (Dyckhoff and Souren, 2008). The aim of these methods is to aggregate environmental impacts to function as a basis for decision-making. Therefore, environmental indicators or ratios should be able to compare alternatives or represent the environmental impacts on different levels (i.e. local, regional, national or international level). (Tschandl, 2012)
Yet, the immaturity of most of the environmental indicators is a restricting factor for application in business practice (ibid.). Pöder (2006:141) recognises “significant difficulties in adequate and reproducible assessment of their [companies] environmental aspects”. As a consequence, the author observes two kinds of companies. On the one hand, most companies apply intuitive expert judgements, while on the other hand companies tend to install complex and formal assessment schemes (ibid.). In this context, Lion et al. (2013) complains about an increasing complexity of environmental impact assessment tools which result in a lack of understanding at business practitioners.
Besides the lack of comprehension of environmental impact assessment methods at business professionals, a survey of large German companies conducted by Schaltegger et al. (2011a) reveals another problem. The survey results reveal that only 9.7 percent of the companies apply an environmental accounting. Furthermore, the authors point towards a low involvement of finance and accounting department in sustainability management which is why “a stronger involvement of finance, accounting and management control is highly recommended” (Schaltegger et al., 2011b:144).
These results highlight the necessity of increased collaboration between management accounting professionals and environmental management professionals. Dyckhoff and Souren (2008) claim that the degree of collaboration of both professions depends on their ability to accept mutual agreement. However, in case the environmental management professional strictly keeps the focus on improving environmental impacts and the management accounting professional strictly keeps focusing on profitability, this mutual agreement between both parties is difficult to find (ibid.).
Another problem hindering increased collaboration between both professions is the lacking communication (IFAC, 2005). Since environmental management and management accounting originate from other professions, it is important to find a common wording to enable mutual understanding.
Finally, the uncertainty of interpreting environmental performance data restricts its popularity of applying it in internal decision-making processes. Since a decrease in environmental impacts can be caused through increased resource efficiency, it is difficult to delimit environmental management measures from general efficiency efforts originating from management accounting measures. On the other hand, it is still unclear how far an environmental management system causes an increase in turnover. (Müller-Christ, 2010)
While the effort of increasing resource efficiency represents a common ground of both professions, the collaboration is at risk in case profitability and environmental protection represent conflicting goals. In this context, Müller-Christ (2010) claims that companies shall declare strategic financial goals superior to strategic environmental goals. One reason for this declaration can be seen in the focus of environmental management systems on standardisation and formalisation of an environmentally-focused PDCA cycle. Hence, environmental management systems are unable to resolve possible conflicts between conflicting goals of profitability and environmental protection. (ibid.) These possible conflicts need to be recognised and resolved comprehensively.
