Private Discounting for Future? On the Limits of Aligning Corporate Law and Environmental and Sustainability Regulation

In the intense debate about the introduction of ideas and concepts of environmental and sustainability regulation into corporate law, one major issue has been largely missing, namely discounting frameworks. Discounting is an important tool in evaluating the value of future benefits of investment ‘today’, used by both social planners, eg governments and private investors. The higher the discount rate, the lower the net present value of future benefits. Private discounting frameworks rest on shorter time horizons and use (much) higher discount rates than social discounting instruments. Consequently, for many private investors, the costs of ‘green investment’ are not justified by future gains. Therefore, the question is whether private discounting practices should be aligned with social discounting. Without an alignment, reconceiving corporate law as environmental or sustainability law will always be incomplete.

            Against this background, in a chapter of a forthcoming book, I make a novel contribution: The chapter takes up the divergence of social discounting and private discounting as an example of how the different rationales of corporate law, on the one hand, and environmental and sustainability regulation, on the other, play out in practice. Instead of offering the next iteration of the ‘stakeholderism’ vs ‘shareholder value’ debate as a matter of principle, the chapter puts the spotlight on the limits of carrying over core ideas of environmental and sustainability regulation into corporate law. More concretely, it tests the limits of corporate law as an instrument of sustainability regulation by considering the basic function of the corporate form to provide a vehicle for private investment.

            First, the chapter lays out the rationales of environmental and sustainability regulation on the one hand and corporate law on the other. Juxtaposing the two shows why they are an uneasy fit. Whereas the first comprises a long-term and intergenerational perspective and includes both positive and negative externalities, the latter serves the pursuit of project-oriented private investment for a specific purpose. Building on the insight that this is yet another version of the old problem of internalizing externalities and how best to deal with them (both ways, that is, with respect to negative and positive externalities), the chapter then explores to what extent private discounting may be aligned with social discounting.

            It is possible to extend the time horizon of private discounting, both under Fisher separation in complete markets and under more relaxed assumptions of incomplete markets, independent of investors’ green preferences. Because the value of a share represents the sum of future dividends, stretching the time horizon farther into the future maximizes share value to the benefit of all stockholders.

            Expanding the traditional financial risk perspective underlying the capital asset pricing model (‘CAPM’), it is also viable to integrate factors adjusting discount rates for climate and environmental risk. Even traditional investors should be interested in how climate change affects supply chains and asset risk. A modified multi-factor CAPM drives up discount rates of ‘dirty’ businesses and makes them less attractive. This helps green projects. The fact remains, however, that the discount rates of private green projects still hover significantly above the rates applied to public green projects. Consequently, a more comprehensive CAPM, while important, does not solve the core issue identified above, that is, the low value of future benefits of private green investment.

            Moving on, the chapter borrows an idea from prudential regulation, the so-called ‘green supporting factor’, and goes on to analyze whether a ‘green discounting bonus’ should be applied to private green projects. Prima vista, this might appear attractive. Lowering the discount rate drives up the present value of future benefits and thus provides an incentive for green investment. The cost of capital for green firms would be lowered. But the price would be too high. A green discounting bonus would distort risk analysis and set a disincentive for corporate boards to engage in window dressing and greenwashing through claiming third-party benefits which are hard to discern and to verify. This is something not even green investors rationally can wish for. Moreover, in the end, awarding a green discounting bonus would provoke conflict both between different groups of shareholders, eg environmental activists and investors saving for retirement, and between different groups of stakeholders, with one group interested in fostering green investment, whatever the cost for the firm, and the other caring about keeping a going concern.

            Ultimately, this is an example of how treating ‘the law of the corporation as environmental law’ and ‘under[standing] [it] as a fundamental part of environmental law’ does the aims of environmental and sustainability regulation a disservice if it amounts to ignoring central tenets and insights from corporate law and corporate law scholarship about incentive structures and basic purposes of private investment.

The author’s chapter can be found here.

Thilo Kuntz is a Professor of Private, Commercial and Corporate Law and a Managing Director for the Institute for Corporate Law, Heinrich-Heine-University Düsseldorf.