Al Gore: How to modify capitalism so it takes a greener long view

Firms should focus on long term sustainable investments, say founders of Generation Investment Management.

The practice of companies issuing earnings guidance every quarter should be stopped, in the name of long-term and environmentally sustainable investing, according to Al Gore.

Quarterly reporting is mandatory for public companies in the US, and has been increasingly widely adopted in Europe and other regions. But the practice of issuing guidance on future earnings at the same time leads to a focus on short-term results and an unwillingness to make investments that can take years to bear fruit, such as energy efficiency, said Al Gore and David Blood, the founders of Generation Investment Management and two of the world's leading sustainable investors.

The pair, who have been responsible for hundreds of millions of pounds in investment funds since 2004, have written a white paper setting out five key measures that companies and investors should take, in order to reflect properly the risks from environmentally unsustainable investments.

Gore, chairman of Generation Investment Management, robustly defended capitalism as "fundamentally superior to any other system for organising economic activity", but he criticised current investment practices for their short term outlook and their disregard for environmental and social factors. Joining in a now widespread debate on how future financial crises can be avoided, Gore said he wanted to reform capitalism to make it more sensitive to social and environmental issues.

He said: "Some of the ways in which [capitalism] is now practised do not incorporate sufficient regard for its impact on people, society and the planet. Capitalism in its current form is creating and fostering numerous challenges, not least short-termism, over-reliance on GDP growth as a primary metric of prosperity, rising inequality, increasing volatility in the global financial market, and growing contributions to the climate crisis."

Blood, a former Goldman Sachs banker, called on investors and shareholders, whether institutional or individuals, to help to reform the companies in which they have a stake. He said governments and citizens must take the leading role in tackling climate change and other environmental and social problems, but added: "Ultimately it will be companies and investors that will mobilise the capital needed to overcome [these problems]."

GIM has published a white paper calling for reform of the ways in which investors view stocks, and in which companies treat their financial performance.

The white paper concluded that issuing financial guidance every quarter creates incentives for executives to manage for the short term and "encourages some investors to overemphasise the significance of these measures at the expense of the longer term, more meaningful measure of sustainable value creation." Issuing financial results and guidance every six months or year would encourage investors to take a longer term view, and help companies to make investments, such as in energy efficiency, that would pay off over longer time periods than the next three months.

Unilever is one of the few companies to stop issuing quarterly reports, a move instigated by the CEO, Paul Polman, when he took charge in 2009. Last month the former CEO of Ikea and now non-executive director of Kingfisher, Anders Dahlvig, said quarterly reports at Kingsfisher feel "like having a millstone round your neck. If Kingfisher were freed from that, they would be able to spend more time in the boardroom looking at long-term issues and build a sustainable business with a good reputation."

Gore and Blood warned that the risks from climate change and other environmental problems were not being adequately reflected in current investment practices. To reflect these risks correctly, companies should factor in key considerations such as the possibility of high-carbon assets, including fossil fuel power stations, becoming effectively useless or high-cost, because of the need to cut carbon dioxide emissions.

Potential "stranded assets", defined as "those with a value that would change dramatically under certain scenarios such as a reasonable price on carbon or water, or improved regulation of labour standards in emerging economies", should be accounted for in company reports.

Companies should also opt for "integrated reporting", according to the white paper. This is a new method of accounting that requires companies to include their performance on various environmental and social indicators alongside their financial results in reports to shareholders. GIM called for this practice to be mandatory rather than voluntary, as it is at present.

In order to ensure that companies are run on a more sustainable basis, the pay and bonuses for senior managers should also be aligned with long-term rather than short-term performance, and include environmental and social indicators, according to the white paper. At present, "most compensation schemes emphasise short-term actions disproportionately and fail to hold finance professionals and corporate executives accountable for the ramifications of their decisions over the long term. Instead, financial rewards should be paid out over the period during which these results are realised, and compensation should be linked to fundamental drivers of long-term value, employing rolling multiyear milestones for performance evaluation."

Investors should also be encouraged to hold shares for the long term, by issuing "loyalty driven securities". These are financial instruments that only pay off when investors hold them for long periods of time, usually of several years. Blood and Gore said this was a good means by which to encourage investors to view the long-term interests of a company before putting their money into it.

Guardian, 16 Feb 2012