This essay is based on the working paper “Measuring the Long-Term Impact of Environmental Externalities” by Steffen Andersen, Luigi Guiso, Federico Marciano, Paola Sapienza, and Luigi Zingales.
Corporate Governance Debates on Environmental Impact
Debates surrounding corporate governance began in the 1970s, initially focused on conflicts between managers and shareholders and later on issues between debtholders and equity holders. In the new millennium, attention has shifted toward the externalities—unintended side effects of an economic activity that affect third parties such as local communities or society—caused by corporate actions and the need to design corporate governance rules that address these externalities.
This shift has been driven by growing concerns about the undue burdens that corporate activities, in pursuit of profits, may impose on society. In his famous 1970 op-ed in the New York Times defending the doctrine of profit maximization as the “only social responsibility of business,” Milton Friedman anticipated this issue. Friedman argued that it is the government’s responsibility to impose taxes and determine expenditures for social purposes, such as controlling pollution, rather than firms attempting to do this on their own.
Contemporary debate centers on whether government regulation and liability regimes function well enough to force firms to incorporate the external costs to society associated with its environmental impact, or environmental externalities, into its decision-making processes and financial accounting.
Current Methods for Measuring Environmental Externalities Fall Short
We argue that any action (by firms or governments) to reduce environmental externalities requires information that allow us to measure the costs and benefits of such a reduction. However, measuring these externalities, especially their long-term effects, remains a challenge.
A Danish Case Study
We illustrate this point by studying Danish data that contains longitudinal information on pollution from a specific source: waste incinerators. Denmark has a long history of incinerating waste, viewing incineration plants as a practical solution for garbage disposal while also producing energy. Today, Danish waste incineration plants contribute approximately 20 percent of the country’s heating and 5 percent of its electricity.
Our study uses a unique dataset covering the entire Danish population from 1980 to 2018, which includes detailed medical histories, household income, wealth, and marital status. This comprehensive dataset allows us to track long-term health outcomes and correlate them with exposure to pollution.
Proximity to Pollution Sites Matter, but So Does the Length of Exposure
Our results show that over a lifetime, an individual living within 2 km of an incinerator has an increased probability of dying from cancer by about 8 percentage points. Overall, the risk of cancer death due to incinerator emissions decreases sharply with distance, though it remains positive up to 10 km. The proximity to an incinerator has an even stronger effect on lung cancer incidence: people within 2 km of the emission source face almost a 12 percent higher risk of lung cancer—a substantial effect. This risk declines rapidly with distance and becomes statistically insignificant for communities located 10 km away from the incinerator.
These statistics provide information on the risk for average exposure but leave many questions unanswered. How long must an individual be exposed to pollution to face significant risks? Does the quantity and type of pollution matter?
To answer these questions, we first generate a more accurate measure of exposure using an air dispersion model. This model takes into account the coordinates of multiple emission sources, the amount of emissions, chimney height, and weather conditions to estimate the concentration of pollutants in various geographical areas.
Using this methodology, we create a detailed map of pollution concentration from specific sources across Denmark. To estimate the length of exposure (latency), we study the effects of the opening of a new incinerator on a selected sample of individuals who remain in their original location after the opening. We follow these individuals over time, measuring their exposure and comparing them to a demographically similar sample of individuals not exposed to the pollution source.
Consistent with several studies on lung cancer and smoking, we find that it takes several years of exposure to affect health outcomes: the impact of incinerator emissions on lung cancer incidence becomes detectable only twenty-five to thirty years after continuous exposure. This latency means that existing analyses underestimate the negative impact of pollution.
To illustrate this point, we conduct an alternative analysis studying the long-term consequences of the closing of a pollution source. We compare two subgroups of individuals with similar demographics: the first group was exposed to a pollution source prior to its closing, while the comparison group was never exposed. We calculate the probability of developing lung cancer after the plant closure. We discovered that an average amount of cumulative exposure to incinerator emissions increases the risk of lung cancer by approximately 7 percent. This risk remains significant for up to ten years after the incinerator is shut down, emphasizing how a short-term analysis of these data would miss the benefits derived from reducing pollution.
Why Measurement Matters
Measuring environmental externalities poses several challenges and requires a comprehensive approach that considers both immediate and delayed health effects. Our research underscores the necessity of this perspective. Regulation and disclosure are limited in their effectiveness if they rely only on data from short-term exposure. Without long-term data, it is difficult to draw accurate conclusions about how shareholders and managers can address these environmental externalities. Effective corporate governance must be informed by a thorough understanding of both short-term impacts and long-term consequences to truly mitigate the environmental and social costs of business operations.
Read the full paper here.
Paola Sapienza is the Clark/HSBC Chair in Consumer Finance at Northwestern University’s Kellogg School of Management.
This essay is part of the Corporate Governance Research Brief Series. Research briefs highlight research with policy implications for the regulatory systems that impact corporations.
