We need to get real on climate change. The world is now awash in grand promises and ambitions to deliver net-zero carbon emissions by 2050, in line with a 1.5°C global warming cap, but these promises are not being backed by hard capital commitments. Turning the spotlight on the hidden world of accounting can help.

Companies’ financial statements play a central role in guiding management decisions to deploy capital. The highest reported returns get the most capital flows. Accounting losses drive capital withdrawal. 

Many presume that accounting is just adding up numbers, checking their veracity and then reporting the result to shareholders. Far from it. Accounting requires judgement and forward-looking assumptions. In checking for write-downs, for instance, you must estimate future cash flows, often over several years, using assumptions about future prices, margins and demand. 

Management assumptions have a material bearing on reported profits and capital strength. This in turn affects capital deployment.

Because accounting is so critical for directing capital flows, financial statements must properly reflect the economic consequences of climate change and decarbonization. If, for example, an oil and gas company ignores phasing out oil demand, it will likely overstate its assets’ value and profitability. This would mean too much capital allocated to further oil investment. That’s bad for investors and the planet.

 In short, ignoring decarbonization in accounting means it is ignored in capital deployment. This may be one of the most potent obstacles to robust action on climate change. Incentives simply are not aligned with the Paris Agreement goals.

The good news is that shareholders have powerful levers to drive climate-conscious accounting. 

First, they vote for the appointment of audit committee directors who oversee the accounting processes. If accounts do not consider global decarbonization, they potentially misrepresent the entity’s economic health. Investors representing over $100 trillion in assets have called for all carbon-intensive companies to align their accounting with a sustainable planet. Shareholders should vote against audit committees that do not respond.

Second, shareholders vote to reappoint the external auditor. The auditors check that the accounts present an accurate view of the entity’s financial position. They must call out misrepresentation. Investors have sent public letters to the Big Four audit firms in the UK, U.S. and France setting out their expectation for auditors. Shareholders should vote against the reappointment of auditors that fail to sound the alarm.

Third, shareholders can file resolutions seeking audits of the financial implications of a 1.5C pathway. In 2022, resolutions are pending at Bank of America, Chevron, Citigroup, Duke Energy, ExxonMobil, Marathon Oil, and Valero Energy. While such audits would sit outside of a routine financial statement, they could force boards to confront decarbonization’s financial reality. They also would provide vital insights to investors.

By voting for audit committees and auditors that will deliver 1.5°C-aligned accounting, shareholders should look beyond high-level promises for net zero, and help pivot the capital allocation machine toward a more sustainable future.

Natasha Landell-Mills
Partner and Head of Stewardship, Sarasin & Partners LLP