What Makes a Company Address Climate Risks?

In the context of climate change, internalization refers to addressing an external risk such as pollution or sea-level rise, internally. Market forces, social movements, and regulation can all compel a company to address risks it may have otherwise externalized.

In this video, Todd Cort, Program Convenor in the Corporate Sustainability Management: Risk, Profit, and Purpose online program from the Yale School of Management Executive Education, explains the three factors that lead to a company internalizing risk.

Transcript

Internalization refers to when we have a risk that is outside of the company, what is the mechanism or mechanisms by which that risk could be internalized to the company? IE why would the company have to pay for this risk?

Well, there’s actually a variety of ways that a company might have to pay for a particular risk. And let’s look at climate change as an example of how those internalization pathways might play out.

So the first internalization pathway to think about is what we think of as market forces. And these are the forces that the market creates to either make costs for our business or to create opportunities for more revenue for our business. So how does climate change impact market forces? Well, this seawall is a great example of how climate change impacts market forces. This seawall sits in front of a community, which you can see behind me, that is concerned about rising sea levels and storm surges that could flood the community.

Well, that can have an impact on property values, it can have an impact on insurance premiums, it can have an impact on the direct costs that that community has to make in order to fix their homes or their property when the storm surge occurs. So how do we mitigate that risk? We build a seawall. We build a seawall that is high enough that not only it can take care of storm surges and sea level today, but it’s able to take care of storm surges and sea levels tomorrow and into the future.

And we have to pay for that seawall. We have to pay for that mitigation and those adaptation mechanisms for climate change, because otherwise we’re going to accrue greater costs.

A second way is social movements. We see a number of examples of social movements in climate change today. For example, we see protests around the world that are arguing that climate change is an existential threat to our communities, and that we and companies need to address those risks right now. We also see social movements on the consumer side, where consumers might prefer products that have a lighter carbon impact, or they might be looking for products like greater electrification and less fossil fuel use.

The third major internalization pathway is regulation. Regulation really refers to when a government implements policies or regulation to either incentivize or to put a cost on the ESG or the sustainability issue.

So thinking about climate change, there’s a really obvious example of this and that is carbon taxes. Governments around the world have decided that carbon emissions are a danger to communities and to economies. And therefore we should disincentivize companies from emitting carbon. So we put a tax on that carbon. So companies have to pay for more carbon when they emit it, and therefore we incentivize those companies to reduce their carbon emissions.

So all three of these factors – market forces, social movements, and regulation – these are all ways by which an external risk can be internalized as a cost or revenue driver for a company. And so it’s incumbent on a business to really think about not only what is the risk that they’re looking at, but how is that risk going to be internalized into the company? So I can mitigate that risk most effectively based on what kind of a cost or an opportunity I’m going to see in the future.