Environmental Risk Management 8803 Business and the Environment Beril Toktay College of Management Georgia Institute of Technology

Flow of Course Product Sustainability Fundamentals Eco-efficiency Stewardship Sustainability Strategy Fundamentals Eco-efficiency Environmental Impact Pollution Prevention The Role of Companies Waste Reduction Core Dilemma: Tragedy of the Commons ISO 14000 Life-cycle Analysis The Role of Legislation Risk Mitigation

Environmental Risk Legal/environmental perspective: possibility of damage to ecosystems or human health Business perspective: loss of firm value that may result from environmental concern (similar to currency risk, price risk, etc.) e.g. business interruption, loss of goodwill and reputation, liabilities (e.g. fines for violating environmental laws), contingent liabilities

Contingent Environmental Liabilities liabilities arising from unforeseen environmental risks where the dollar amount was unknown and depended upon future events can be incurred even if in compliance with all environmental laws and regulations e.g. PCB, asbestos e.g. Superfund (strict, joint, several liability) Strict = no fault standard Joint and several = can be found responsible even only if partial contribution to pollution

Impact Insurance companies Banks Businesses Reduced ability to collect on loans Contamination can reduce value of collateral Responsible for cleanup on foreclosed property Low priority in a bankruptcy proceeding profitability cost of capital stock price Under-pricing

Types of financial risk management Risk avoidance Eliminate exposure by ceasing activity Loss prevention and control Reducing probabilities and impacts Risk retention Bearing risk internally Risk transfer Reducing risk responsibility (hedging, insurance)

Environmental Risk Management Factors affecting environmental risk Probability of adverse event Total social burden if event occurs The fraction of total burden firm is responsible for Risk reduction tactics: Invest in reducing factors above Improve information to make better decisions Example: Marine spill

Quantifying Environmental Risk (using DEMA) Goal: make env. risk mgt more systematic and efficient, supplement judgment with analytic reasoning Motivation: present value of benefits should exceed costs to deliver value to shareholders Method: Calculate expected benefit/cost ratio, prioritize high-ratio projects Difficulty: assessing benefits (using conversion factors)

Quantifying Environmental Risk (using DEMA) Yes because Clarify costs and benefits, reduce more risk w/ less funds Forces consideration of long-term consequences, limiting risk retention, focusing attention on changing business practices at possibly low cost No because Bad publicity associated with explicit valuation Low value since factors are bound to be arbitrary Expected net benefit may not be appropriate goal (e.g. reducing from 50% to 40% a $10M risk versus reducing from 0.01% to 0 a $1B risk)

Trends Today More systematic analysis of risk and risk reduction proposals Integrate more closely with core risk management function of the firm via Closer consultation with financial risk management officers Systematic consideration of entire set of managerial incentives

Interesting Links http://www.chevron.com/cr_report/2004/ http://www.chevron.com/cr_report/2004/management_approach/corporate_governance/operating_elements.asp Environmental Risk Resources Association: http://www.erraonline.org/ Wharton Risk Management Center http://grace.wharton.upenn.edu/risk/