Darby Joyce
Content Marketing Coordinator
With companies and consumers taking increasingly proactive roles to promote sustainability in business, those who don’t keep up are taking a financial risk. Companies that engage in environmentally harmful practices face public scrutiny, increased operating costs, and potential legal issues. One way to measure a business’s tendency to experience these issues is carbon risk—the problems faced directly from high carbon output and overreliance on fossil fuels.
The wide variety of consequences caused by high carbon risk inspired Kogod School of Business professor of accounting Tharindra Ranasinghe to explore it further in his research. As somebody who frequently studies risk management, his interest in carbon risk stemmed from its impact on firms across industries and the scope of its effects on business.
“There are papers that find carbon risk increases a firm’s cost of capital, affects its future profitability, and increases litigation risk,” he explained. “It affects businesses’ reputation, social legitimacy, and financial attributes. Even from a purely financial perspective, managers must actively work to reduce carbon risk.”
Though the issues caused by carbon risk are well-documented, Professor Ranasinghe’s research has uncovered even more. He’s currently working on papers highlighting high carbon risk’s hidden costs, ranging from higher job risk to increased rates of financial misreporting. In one paper, for instance, Ranasinghe discovered that CEOs of firms with high carbon risk face greater job insecurity and therefore seek higher pay to compensate for the possibility of losing their jobs later. In another, he found that these firms are also more inclined to engage in questionable reporting practices.
“During periods of high carbon emissions, firms are more likely to engage in earnings management—that is, creative use of accounting methods to report inflated profits,” Ranasinghe said. “This is presumably to offset investor concerns over these higher emissions by reporting higher profits. My paper suggests that carbon risk exacerbates other risks, such as financial misreporting.”
Professor Ranasinghe’s research challenges the idea that ESG (environmental, social, and governance) issues are purely societal. “When we think of these issues, we tend to think of the firm from a stakeholder perspective—the firm ensuring the welfare of a broader group of constituents and not just the shareholder,” he said. “But even from a pure shareholder perspective, carbon risk entails a broad range of costs and risks.”
Even if you’re concerned with nothing but a firm's financial performance, you still have to take carbon risk very seriously.”
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Tharindra Ranasinghe
Professor of Accounting, Kogod School of Business
Though sustainability is vital for business as we advance, people with a monetary interest in firms might have worries about the cost of changing how the firm runs. Knowing the financial benefits of pursuing sustainability initiatives can help firms assuage the concerns of their investors while making much-needed changes.
Despite the increased focus and lively discussion around sustainability in business, Ranasinghe emphasized that reporting on ESG issues in the United States is still in its early days. In particular, how companies report on their sustainability initiatives needs to be more reliable and standardized, leaving him with questions about how much work firms actually put into the efforts they say they are making. “If we think about financial reports of public firms, we have a higher degree of faith in them because independent auditors audit them,” Ranasinghe explained. “I think independent assurance of sustainability reporting will become increasingly important in the future.” With that in mind, he wants to spend more time looking into the quality and reliability of current sustainability reporting and how independent audits may improve both.
Kogod provides a perfect backdrop for Professor Ranasinghe to pursue these questions alongside students and faculty. Between the school’s unique MS in sustainability management program, its Gamechangers in Sustainability event series, and the recent creation of its student-advised ESG investment fund, Ranasinghe is confident in Kogod’s commitment to preparing its students for the future. “We’re one of a handful of business schools in the US, if not the only business school, to make this level of commitment to ESG by putting our money where our mouth is,” he said of the investment fund. “This shows that we’re not just paying lip service—we’re truly committed to these issues. I’m excited to be part of it.”
Professor Ranasinghe isn’t just teaching sustainability topics to students, however; he’s also taking the opportunity to learn more about them himself. This semester, he’s participating as a student in a course on sustainability reporting taught by fellow Kogod professor of accounting Ajay Adhikari. “It’s exciting to be on the other side of the classroom and to have this learning experience after such a long time,” he said.
Because this area is rapidly growing and the landscape is rapidly changing, to me, it’s not just about teaching or doing research, but also about learning.”
Tharindra Ranasinghe
Professor of Accounting, Kogod School of Business
In a field evolving as frequently as ESG is, Ranasinghe knows that it’s just as important to keep learning and adapting himself as it is to prepare his students to do the same.
As a professor, Ranasinghe does his best to impart the importance of learning about sustainability from a personal and career perspective. “Sustainability is a topic that is critical for everyone, regardless of major, because it focuses on an existential challenge to the human race,” he said. “From this perspective, it’s a no-brainer that everyone should be interested in learning more about it.” From a more specific perspective, however, Ranasinghe has found that understanding ESG issues is vital to a future business career. As he speaks with employers across industries, he’s found that the demand for employees with a sustainability background is skyrocketing to the point where companies can’t find enough qualified professionals.
With a Kogod education, students across majors will learn enough about these topics to set them apart once they graduate. At this point, ESG topics are woven into careers across the business sphere, and Professor Ranasinghe strives to leave his students ready to create a more sustainable future.