The UK is to require quoted companies to report on their greenhouse gas emissions (1). This modest measure raises a number of economic issues.
Why is the government introducing this requirement? It believes that mandatory reporting will complement pricing instruments in inducing businesses to reduce GHG emissions. Other stated aims are to help businesses reduce fuel costs and manage climate change risk, and to help investors take account of climate change risk (2).
Don’t many companies already report on their emissions?
Yes. Many companies report on-site emissions under the EU Emissions Trading System or the Carbon Reduction Commitment Energy Efficiency Scheme. There is also much reporting under voluntary schemes such as the Carbon Disclosure Project (3).
So what exactly will change?
Quoted companies will have to report emissions in a specified place (their annual directors’ reports), stating their methodology. As well as on-site emissions, they will have to report emissions from freight transport (4), and indirect emissions associated with their purchased electricity, heat, steam and cooling (5). Emissions reports should become more consistent and comprehensive, and easier to access and interpret.
What about indirect emissions from companies’ supply chains, including overseas suppliers?
In general these are excluded, a significant limitation, although their inclusion would greatly increase compliance costs and perhaps be hard to enforce. The treatment of emissions from joint ventures and leased assets is currently uncertain (6).
How can information on emissions help in managing climate change risk?
The physical risks to a company from climate change are related to the effect on climate of cumulative global emissions, but not to its own emissions, so reporting emissions will not help in managing physical risk. Reporting emissions can however be helpful in managing the risks from government policies on emissions. Information on a company’s emissions provides a baseline for assessing the risk associated with possible future events such as a price rise within an emissions trading scheme or the introduction of a carbon tax.
Will mandatory reporting help address the fundamental market failure that companies emitting GHG’s do not bear the full cost of the damaging climate change to which they contribute?
No. It will not significantly change the costs borne by companies. The compliance cost is a tiny fraction of the external cost due to company emissions, valued at any reasonable carbon price.
Is there a more specific market failure in respect of information on emissions that mandatory reporting will address?
Given two otherwise equivalent investments, one associated with higher emissions and therefore greater policy risk, an investor might make the wrong choice because of lack of information. This could be financially detrimental to the investor, but also harmful to society if many investors make such wrong choices so that projects with higher emissions go ahead in preference to equivalent projects with lower emissions. Mandatory reporting can mitigate this source of market failure in respect of capital allocation.
What about the argument that mandatory reporting will help ensure that managers give due attention to their companies’ emissions?
The idea here could be that managers are focused on their companies’ interests and need to be induced to have regard to society’s interest in reducing emissions. It is credible that mandatory reporting, and the reputational pressures to which it might lead, could have a small effect in this direction. Alternatively, the idea might be that, because of the agency problem in large companies arising from the separation of ownership and management, managers are not always focused on their companies’ interests, and need to be induced to have regard to their companies’ climate change risk. While the agency problem is real, this is a poor reason for intervention since governments cannot have sufficient knowledge of companies to correct their varied internal failings.
Given the importance of climate change, shouldn’t the public have a right to information on company emissions, irrespective of any effects of reporting on company behaviour?
This is an interesting argument, albeit not one used by the government. The underlying principle might be that where a) a company’s activities give rise to significant external costs, b) the nature of the externality is such that its source and scale are not obvious to those affected (unlike, say, noise from a building site), and c) information can be provided at reasonable cost, then those affected should have a right to information. In the case of emissions and climate change, of course, ‘those affected’ includes everyone.
An overall assessment?
This is a sensible measure. The capital allocation argument is sufficient justification, and this argument is strongest for precisely those companies the government is targetting, that is, quoted companies owned by or seeking funding from a large body of investors who may lack close familiarity with their activities or the bargaining power to demand information.
Notes & References
1. DEFRA (2012) The Greenhouse Gas Emissions (Directors’ Reports) Regulations 2013 (Draft) http://www.defra.gov.uk/consult/files/consult-ghg-regulations-20131.pdf
2. DEFRA (2011) Impact Assessment of Options for Company GHG Reporting p 1 http://www.defra.gov.uk/consult/files/20120620-ghg-consult-final-ia.pdf
3. Kauffmann C & Less C T Transition to a Low-Carbon Economy: Public Goals and Corporate Practices OECD (2010) pp 15-17 http://www.oecd.org/investment/guidelinesformultinationalenterprises/45513642.pdf
4. See the Impact Assessment (above) Table 13 p 44, which shows most of the estimated benefit coming from freight transport.
5. Draft Regulations (above) para. 3(3).
6. Deloitte LLP Consultation Response to DEFRA 18/10/2012 pp 1-2 http://www.iasplus.com/en/publications/united-kingdom/comment-letters/uk-ghg-comment-letter
Economic Droplets 