Business and the Environment2

1. Business and the Environment2 • http://online.wsj.com/article/SB122304950601802565.html Carbon footprint • Lecture 2: Drivers of manager decision making within firms—stake holders, market structure/conditions. • Understand the pressures and conditions that affect managerial decisions regarding environmental efforts. • Firm objective to maximize profits: Problem areas that affect firm behavior and responses to the environment. • Two key problems:

2. Business and the Environment • Agency problems. Deviation of management from share owner interests. Social Responsibility of business debate. • Problem of uninternalized benefits and costs in profit maximization. • The source of the environmental and natural resource problem. • We will return to this issue in more depth because it is central to the environmental problem. • How to link environmental action to firm profitability?

3. Business and the Environment • Other factors affecting firm managers as they consider environmental issues. • Internal decision making • Trade offs on products within profit constraints. • Trade offs on short/long term, R&D • Revenue enhancement via market research and new offerings • Cost containment via lifecycle analysis and supply chain management

4. Business and the Environment • Drivers of environmental positions. • Hoffman slide (Hoffman, 2000, p. 17). • Regulatory • Tax • Regulation • Market instruments • Uncertainty • Efforts to mold policy and gain a strategic advantage • We will return to this issue with regard to GHG regulation and other environmental policies.

5. Business and the Environment • Drivers: Financial resource—investors, insurance companies, banks • Risk to insurance companies for liability for environmental damages. Strict liability; negligence rules. Depends on how the law is structured. • Nuisance actions.—defend the right to use one’s property free from disturbances or influence from activities created by others (externalities).

6. Business and the Environment • Negligence actions.—defend against injury due to loss of due care. Standards? Was due care applied? Changes in polluttee behavior. Precaution. • Strict liability—Polluter pays. Liable for damages to third parties, even if they could not be avoided with due care. Used when there is a likelihood of great harm. Incentive effects. Polluters consider costs. May over compensate. Pollutees do not consider costs.

7. Business and the Environment • Risk to investors if unready for policy or policy is harmful. • Risk to investors. Due diligence for environmental damages that could place the loan at risk. • Environmental performance proxies for overall performance. • TXU case.

8. Business and the Environment • Drivers: Consumers • Willingness to pay of some market segments • Changes in taste. • High incomes. • High education levels • This is a fundamental challenge—market differentiation—market segmentation, determining willingness to pay, barriers to entry.

9. Business and the Environment • Which consumer groups will be concerned about environmental quality?—Segment markets by gender, age, education, ethnicity, location, income, urban/rural, north/south, political affiliation • Core competencies of a firm—how to match with environmental differentiation? • Will return to this issue. • Major strategy issue for firms.

10. Business and the Environment • Drivers: Competitors • Lose competitive position vis a vis competitors who more rapidly and credibly respond to market demand for environmental action. • Alternatively gain competitive advantage vis a vis competitors who do not meet new demands. First mover. • Toyota-General Motors example.

11. Business and the Environment • Drivers: Trade Associations and other forms of collective action. • Use norms, rules for members to follow. • Group certification. Reputation. Industry wide. Larger firms are most active-why?

12. Business and the Environment • May preempt government regulation. • Might be preferable to industry—more industry specific, more flexible, more focused, less uncertain, less risk, more discretion. • May be less regulation than society desires, but if lower cost and more effective may be superior to government regulation. • Customers might benefit if more flexible and lower cost.

13. Business and the Environment • Can force higher costs on competitors—usually incumbents gain advantages over smaller new entrants. There are differences in compliance costs. Upfront, fixed costs that can be spread across larger output in larger firms. • Examples • Chemical Manufacturers Association—Responsible Care.

14. Business and the Environment • Motivation— • Crises. Bhopal, Love Canal, PCBs in the Hudson River. • A series of federal actions—1976 Toxic Substance Control Act and Resource Conservation and Recovery Act. Empowered EPA to regulate. 1980 Superfund Law with joint and several liability for industrial wastes. Ex post liability for entire cleanup costs. • Industry fears more.

15. Business and the Environment • 1984 RC launched. • Largest firms. • Provided motivation for public good provision without government regulation. • Focus on management practices not numerical targets (why?). • Action plans to implement management codes—emergency response, pollution prevention, safety, health, product stewardship, distribution. • http://www.americanchemistry.com/s_responsiblecare/doc.asp?CID=1298&DID=5086 • Various studies of its effectiveness.

16. Business and the Environment • Other examples: Forest Stewardship Council (FSC) founded by environmental groups and Sustainable Forestry Initiative (SFI), founded by industry groups. • SFI 1994 by American Forest and Paper Assn. • Largest companies advocates. Some small. • Crises—concerns about land management practices.

17. Business and the Environment • Collective action to set up principles and action plans. Some defection among smaller firms over costs. • Less world wide coverage. Differences in land management and forestry practices around the world. Harder to have uniform regulations. • Issues of how strict are the rules and coverage.

18. Business and the Environment • Drivers: Suppliers • Risk of lost business when suppliers are linked to one or two producers. • Alternatively, supply chain management—firm seeks to avoid problems with suppliers in supply chain. Damage product or service reputation in the market. Firms can require that their suppliers adhere to certain environmental standards

19. Business and the Environment • Risk in this, with competition if it raises cost, so that firms in perfectly competitive markets may not be responsive. • Green supply chain—works if there are cost advantages. Firm can appropriate some of the social benefits. Implies that the firm is in an oligopoly or less competitive industry.

20. Business and the Environment • Drivers: NGOs • Can be influential interest groups—both as a market segment and as a political force. • Hoffman, 2000, p. 107, 108. • Source of legal challenges. Uncertainty. Time costs. • Cooperate. Place on Board of Directors, etc. • Cooperate in design of policy. Environmental Defense.

21. Business and the Environment • Alliances with NGOs • Corporate sponsorship • Firm contributes to the environmental group financially or in kind through becoming involved in specific environmental causes or fund raising • NGO provides product endorsement • Task force to develop economically feasible solutions for the greening of business practices

22. Business and the Environment • Perceived crisis and shortcomings of adversarial approaches to problem solving • Lawsuits might take years and results in greater costs • Problems that are so complex that they require multiple actors to solve them, disagreement over solution, • Environmental groups may have expertise and public support but lack power of implementing solution

23. Business and the Environment • Firm perspective • Access to complementary assets • Credibility • Additional communication channels • Scientific knowledge • NGO perspective • Direct impact on firm’s behavior, potential ripple effect within industry

24. Business and the Environment • Firm perspective • Negative backlash if the project fails • Confidentiality issues • How to retain the Intellectual property rights? • NGO perspective • Open to criticism that is becomes and ally of industry (“sleeping with the enemy”) • Open to criticism that it looses neutrality

25. Business and the Environment • Ability of the parties to provide complementary assets. • Keep alliance based on subjects that are far from firm’s IP (packaging for McDonald’s) • Clear definition of objectives • Maintain an arm’s length relationship: formal contract

26. Business and the Environment • Other drivers • Employees—motivation and company culture. • Press and other media—mold demand. • Religious—mold taste regarding the environment.

27. Business and the Environment • Academy—research on impact. Information. • Global warming concerns, water, waste, energy • Ozone layer. Mario J. Molina & F. Sherwood Rowland, Stratospheric Sink for Chlorofluoromethanes: Chlorine Atomic Catalyzed Destruction of Ozone, 249 Nature 810, 810 (1974). Helped to galvanize firm support for regulation and Montreal Protocol.

28. Business and the Environment • Firms face market pressures as they consider responding to environmental problems. • Overall market considerations. Market slide • Demand issues. • Price elasticity of demand. • Want it to be less than one. • Which markets will satisfy this condition?

29. Business and the Environment • Market segments have different willingness to pay—taste and income. • Price discrimination (where different prices are charged to different consumer groups) depends upon competitive conditions. • We will examine these in more detail as part of market structure.

30. Business and the Environment • Supply issues. • Cost of responding. • Innovation options. • Input costs and past contracts may limit options. • Government policies—subsidies, tax, regulation. • Productivity, cost and firm size. Returns to scale, constant cost, increasing cost. Small firms may have fewer options? Or be more flexible.

31. Business and the Environment • Market structure as it affects firm response. • Competitive— • many firms, many very close substitutes, ease of entry, consumer power, high price elasticity, pressure on price and cost. • Commodities—computer hardware, ag products • Trade. Globalization. • In such markets firms may be reluctant to adopt environmental products or processes. Why?

32. Business and the Environment • Monopolistic competition. • Many firms, somewhat differentiated products. • Ease of entry. • More market segmentation possible. • Mass retail. • Specialized retail, niche markets. • Possibly limited individual firm response to environmental pressures. Why?

33. Business and the Environment • Oligopoly. • Few firms. • Differentiated products. • Lower price elasticity of demand. • More power over price and output. Price discrimination possible. • Market segmentation. • Firms may be more responsive to environmental demands. Why?

34. Business and the Environment • Monopoly. • One firm. • Differentiated products. • Price discrimination. • Low price elasticity of demand. • Market segmentation. • Firm may or may not be responsive to environmental demands. Why?

35. Business and the Environment • Measures of market structure. • Concentration. Herfindahl index—sum of the squared market shares, HHI = 0 to 10,000 (more concentrated). Affects competitive environment. • More differentiated, generally competitive markets are more likely to have firms that are responsive to environmental concerns. • Heterogeneity. • Non price competition. Differentiation.

36. Business and the Environment • We have covered: • Drivers of environmental action by firm managers. • Market structure impact.