In the debate over introducing ideas from environmental and sustainability regulation to corporate law, one major issue has been largely missing: discounting frameworks. Discounting is important for evaluating the future benefits of investment today and is used by both social planners such as governments and private investors. The higher the discount rate, the lower the net present value of future benefits. Private discounting frameworks use shorter time horizons and much higher discount rates than so-called “social discounting” employed by governments and public authorities. Consequently, for many private investors, the costs of green investment are not justified by future gains. Unless private discounting practices are aligned with  social discounting, reconceiving corporate law as environmental or sustainability law will always be incomplete.

In a new chapter, I use the differences between social and private discounting as an example of how the different rationales for corporate law and environmental and sustainability regulation play out in practice. Instead of offering the next iteration of the stakeholderism vs. shareholder value debate, the chapter highlights  the limits of transferring core ideas from environmental and sustainability regulation to corporate law. It tests the limits of corporate law as an instrument of sustainability regulation by considering the basic function of the corporate form as a vehicle for private investment.

Comparing the rationales for environmental and sustainability regulation and corporate law shows why the two are an uneasy fit. The first takes a long-term and intergenerational perspective and includes both positive and negative externalities, while the latter serves the pursuit of project-oriented private investment for a specific purpose. This is yet another version of the old problem of internalizing externalities and how best to deal with them, and in the chapter. I explore to what extent private discounting may be aligned to social discounting.

It is possible to extend the time horizon of private discounting, independent of investors’ green preferences. This holds both under the assumptions of “complete” or “perfect” markets where a firm’s choice of investment is separated from the shareholders’ subjective preferences (“Fisher separation”), leaving profit maximization as the firm’s objective, and in incomplete markets marked by transaction costs and unequal lending and borrowing rates. Because the value of a share represents the sum of future dividends, stretching the time horizon farther into the future maximizes share value to the benefit of all stockholders.

Expanding the traditional financial-risk perspective underlying the capital asset pricing model (‘CAPM’), it is also possible to adjust discount rates for climate and environmental risk. Even traditional investors should be interested in how climate change affects supply chains and asset risk. A modified multi-factor CAPM drives up discount rates of “dirty” business and makes it less attractive. This helps green projects. The fact remains, however, that the discount rates of private green projects are still significantly higher than the rates applied to public green projects. Consequently, a more comprehensive CAPM, while important, does not solve the core issue of the low value of future benefits of private green investment.

My chapter borrows an idea from prudential regulation, the so-called “green supporting factor,” to analyze whether a “green discounting bonus” should be applied to private green projects. At first glance, this might appear attractive. Lowering the discount rate drives up the present value of future benefits and thus provides an incentive for green investment. Cost of capital for green firms would be lowered. But the price would be too high. A green discounting bonus would distort risk analysis and create a disincentive for corporate boards to engage in greenwashing by claiming third-party benefits that are hard to verify. This is something not even green investors rationally can wish for. In the end, awarding a green discounting bonus would provoke conflict among different groups of shareholders, e.g., environmental activists and investors saving for retirement, and different groups of stakeholders, with one group interested in fostering green investment, whatever the cost for the firm, and the other caring about keeping a going concern.

Ultimately, this is an example of how treating the reconceiving of corporate law as environmental and sustainability law does the aims of environmental and sustainability regulation a disservice if it amounts to ignoring central tenets and insights from corporate law and corporate law scholarship about incentives and basic purposes of private investment.

This post comes to us from Thilo Kuntz, a professor of private, commercial, and corporate law and managing director of the Institute for Corporate Law at Heinrich-Heine-University Düsseldorf. It is based on his recent book chapter, “Private Discounting for Future? On the Limits of Aligning Corporate Law and Environmental and Sustainability Regulation,” available here. A version of this post appeared on the Oxford Business Law Blog.