Introduction

The report examines the debate around discount rates for sustainability investments, proposing a lower social discount rate for natural and social capital. Contrasting the Nordhaus (4.3%) and Stern (1.4%) rates, it argues that a lower rate reflects long-term environmental and social benefits and supports sustainable investment.

Responsible companies

Traditionally, companies focus on financial returns, leaving societal responsibilities to governments. However, as externalities grow, companies must incorporate these factors into their objectives. A shift to the stakeholder model is suggested, balancing financial, social, and environmental capital. Benefit corporations, or B Corps, demonstrate this approach by pursuing both profit and impact.

Impact measurement and valuation

Balancing social, environmental, and financial capital requires quantifying non-financial impacts. Recent advances enable companies to monetise impacts, using shadow pricing to estimate costs like carbon emissions. For instance, the EU’s shadow carbon price is €204 per tonne of CO₂, significantly higher than market rates. Monetising these impacts supports an integrated balance sheet, reflecting overall corporate impact.

The social discount rate

The report advocates a social discount rate incorporating time preference, growth, and risk, establishing a base rate of 2.2%. Unlike financial rates, it includes a near-zero time preference to equally consider future generations. For financial professionals, this rate offers a framework for prioritising long-term impact.

Adding a risk parameter

A risk parameter is added to account for rare disasters, including climate and AI-related risks. The annual catastrophe risk parameter of 0.2% contributes to a 2.2% social discount rate, accounting for large-scale disruptions. This risk component significantly impacts the valuation of sustainability projects.

Variation in social discount rate

The report explores applying different rates for sustainability projects, suggesting higher rates for projects with positive social capital. Adjustments for regions with higher growth rates, such as emerging economies, may also be relevant. This flexibility aids in tailoring discount rates to specific project and regional contexts.

Interaction between the financial and the social discount rate

Social and financial discount rates interact as companies internalise social costs. For instance, climate-related risks, impacting cash flows and capital costs, demonstrate this interaction. Companies with substantial environmental liabilities may experience higher financial costs, encouraging proactive risk management. Financial professionals might consider social discounting in projections to assess long-term value impact.

Results

Applying the social discount rate shows that projects with positive social or environmental impacts have a larger present value than equivalent financial flows, given lower discounting. Case studies reveal that, when discounted at 2.2%, social flows can rival or offset financial flows, highlighting the potential of social discounting for sustainability outcomes.

Conclusions

The report concludes that a lower social discount rate could encourage more investments in social and natural capital, aiding future generations and preserving planetary boundaries. It recommends further research to refine these valuation techniques and integrate social and environmental impacts into corporate finance practices.