Externalities are environmental, social, and economic impacts from the operation and activities of an organisation borne by others external to the organisation. They are not reflected as a cost to the organisation, even though there is evidence to show that over time these externalised costs converge and get internalised by the organisation.
The ability of organisations to incorporate externalities into decision-making enables them to consider the implications of actions taken now and in the future. It summarises the essence of sustainability thinking and reporting.
Organisations interact with their environment and should operate with a sense of shared prosperity for all their stakeholders. It is the unique story shared through reporting. For example, a mining company contemplating an expansion of its drilling operation at the expense of a loss of biodiversity would approach that decision cautiously.
It is because the company would have to weigh the short-term benefits like profits against the adverse environmental impact on the local community. Therefore, organisations should embrace reporting on externalities to aid decision-making and promote sustainability thinking for long-term survival.
Sustainability reporting requires organisations to think more broadly about their overall impact to monitor and respond to these externalities that impact the organisation’s long-term viability.
Organisations should provide stakeholders with disclosures on climate-related risks, opportunities, and financial impact by embracing the TCFD (Task Force on Climate-related Financial Disclosures) framework. It would enable organisations to communicate the threats, opportunities, and potential economic impact of physical and transition risks regarding the environment.
The international integrated reporting framework could also assist organisations when disclosing the trade-offs made by the organisation regarding the improvement of one capital at the expense of another, such as investing in renewable energy solutions that improve the environmental capital at the expense of financial capital in the short term.
Stakeholders are eager to understand the externalities not factored into an organisation’s cost of production. This information is critical in assessing the future viability of an organisation based on the level of reporting provided by the organisation of how the threats posed and opportunities arising from these externalities are taken into consideration to guarantee long-term survival and success.
Akinyemi Awodumila is an Associate Director at PwC Kenya. An author who writes and speaks widely on corporate reporting topics