Published April 12, 2010
A few weeks ago, my students and I discussed a local drug company’s new LEED platinum building. The building was the first to be given the highest level of certification for environmental performance by the US Green Business Council. By building it, the drug company received voluminous and tremendously positive press coverage. And yet, the more my class and I looked into it, the more we doubted the building’s merits.
According to the information we could obtain, several of the credits needed to boost the LEED certification from Gold to platinum came from additional steps to conserve water and use green power. Although water and energy conservation seem praiseworthy, the real question that should be asked by anyone interested in sustainability is: “do these investments improve total human happiness?” And according to our calculation, in the case of this building the answer was an emphatic “NO!” The building’s carbon reductions were obtained at a cost more than double that required to purchase carbon offsets. Similarly, the water savings turned out to cost a little less than $4 per thousand gallons – a number comparable to the most inefficient means of producing fresh water. By our calculation, the drug company could have achieved the same energy and water objectives at a lower cost and had some money left over to give back to its investors – many of whom have been upset by the firm’s recent poor financial performance.
If the managers of this company really wanted to spend the same amount of money in improving social welfare, how should they have spent it? By using their comparative advantage in drug discovery to find drugs for neglected diseases, we concluded. For example, they could have invested more money in programs to find cures for diseases like Malaria or tuberculosis which are of growing concern worldwide. In fact, the company has a program to do just this, but its annual budget is a fraction of the money required to push their building over the LEED platinum threshold.
My class and I concluded that just as we should criticize firms for inefficiently failing to seize profitable ways to reduce their effect on the environment, so should we castigate them for spending money wastefully to reduce their environmental impact. A firm deserves praise, we concluded when it tries to maximize human happiness, and not when it acts not to reduce energy consumption at any cost.
Unfortunately, not all stakeholders respond as economists think they should, and as I mentioned earlier, the building was widely praised. When I asked a local elected official about this at a recent dinner party, her response was “But being the first platinum building made a big difference to city officials. The company got a lot of good will.” I said, “But wouldn’t they have gotten as much good will for using the money to work on drug-resistant TB or malaria?” Her response was “No, they [local elected officials] don’t care at all about that.” This surprised me because drug resistant TB is already a health problem, and malaria may become one – particularly in low lying areas like my home town.
As economists and management scholars, we often assume that firms are acting in response to well-reasoned stakeholder demands. The resulting give and take between firms and stakeholders, we hope, brings about a situation where both parties are better off. But the story of this particular LEED building suggests that such interactions can also lead to wasteful outcomes. Under what conditions do good outcomes emerge from interactions between stakeholders and firms, and when and how do things go wrong? ARCS scholars like Tom Lyon (Michigan), John Maxwell (Indiana), Mike Lenox (Darden) and I are working on exactly this issue. We are beginning to understand when stakeholder pressure leads to good outcomes and when it leads to green washing and waste. More on that in my next post.