Finding value in ESG

John Goetz

Pzena Investment Management

Carbon Footprint Reporting: Challenges and Alternatives

Consistent and comparable reporting of a company’s carbon footprint is important if regulators are to set policies that will put society on a path toward Net Zero¹ by 2050. As investors, we also need this information to understand where there may be embedded climate transition risks or opportunities in a company’s business. However, defining and understanding a company’s carbon footprint is not always straightforward.

Current reporting methodologies break down a company’s total carbon footprint into three categories: scope 1 (direct), scope 2 (power purchased and consumed), and scope 3 (indirect value chain²). We have historically focused our attention on understanding and engaging with companies on scope 1 and 2 emissions because these are directly within company control and, consequently, more accurately measured, reported, and implicitly reduced over time.

Scope 3—often the largest source of emissions—is increasingly being viewed as a more “comprehensive” assessment of a company’s contribution to climate change. We agree stakeholders need a more complete view of a company’s carbon profile to make informed decisions but disagree that the current approach to measuring scope 3 emissions is the best means to hold companies accountable for more than what is in their direct control. We will examine some of the major flaws underlying the current approach and propose an alternative that may help provide critical information to consumers, investors, and policymakers in the pursuit of reaching Net Zero by 2050.

Scope 3: Current Flaws and Limitations

1) Outside direct company control - Scope 3 emissions are, by definition, outside the direct reporting control of the company. Management must either rely on disclosures from other value chain entities or expend significant resources estimating those emissions, which can be both costly and time consuming.

2) Reliance on estimate - Heavy reliance on estimates, which can vary widely, has its own set of problems. Aside from the obvious challenge this poses when trying to financialize ESG risk, it can undermine the usefulness of company reporting (e.g., when aligning portfolio carbon budgets with regulatory guidelines). Companies could also come to be legally liable for estimation errors and/or for reporting that fails to accurately capture climate risk exposure.

3) Double and triple counting - Current scope 3 reporting creates unnecessary redundancies and inefficiencies, as companies take on responsibility for reporting not only their own emissions but those of other entities with whom they do business. To paraphrase, one company’s scope 1 or 2 emissions are another’s scope 3 emissions.

Other considerations

It is also worth considering whether the outcome of scope 3 emissions reporting justifies the effort required. While in theory scope 3 emissions can be helpful in uncovering and assessing exposure to long-term climate transition vulnerabilities, reporting scope 3 emissions does not necessarily accelerate the transition to Net Zero by 2050. For example, knowing the scope 3 emissions released during the use phase of a product (e.g., a consumer burning gas in their cars) does nothing to impact consumption or incentivize demand-side carbon reductions. When it comes to demand for carbon, we believe governments should have the primary responsibility for legislating the regulatory framework (e.g., carbon taxes or tax breaks for green energy) aimed at altering consumer behavior.

In addition, absent the appropriate regulatory incentives, companies that are optimizing for shareholder value may not have the luxury of developing “greener” products if the costs of doing so make their products uncompetitive. Pursuing long-term shareholder value creation within a regulatory framework that is designed to level the playing field and optimize for society’s best interests seems, in our view, a more effective way of benefiting both society and shareholders.

An alternative methodology

Instead of trying to fix the specific flaws with scope 3 emissions reporting, we are proposing a more radical overhaul of the way companies account for emissions, following the principles of cost accounting. We think this would accelerate, rather than hinder, the transition to Net Zero. This was inspired by a 2021 Harvard Business School paper “How to Fix ESG Reporting” by Robert S. Kaplan and Karthik Ramanna.

Their framework would have companies mirror standard accounting practices for accumulating and reporting a product’s greenhouse gas emissions across the value chain. Companies would track and pass on a product’s “e-liability” in a similar manner to how they currently record costs in their financial statements. Accounting principles do not require a company to estimate the purchase prices paid by all organizations in the value chain but instead simply record payments to immediate suppliers and their own production costs. For emissions, the “e-liability” would similarly be accumulated and recognized across the value chain from sourcing to end use of the good.

Exhibit 1 illustrates how emissions would be quantified and recorded in practice through an illustrative and intentionally simplistic value chain.
Exhibit 1: Value Chain Emissions

If companies choose to directly eliminate greenhouse gas emissions from the atmosphere (e.g., carbon capture or reforestation), these emissions can be subtracted from the total e-liability assigned to their products. This, in turn, transfers a lower e-liability to the next company in the distribution chain and ultimately the end consumer, which can be an incentive if selling to more environmentally sensitive end consumers.

This method of accounting for emissions is not yet tested in practice, but we agree with authors Kaplan and Ramanna that this methodology offers a more robust, incentive-aligned, and auditable approach to measuring emissions. The scope 1, 2, and 3 numbers are replaced by a clear chain of emissions accounting. In turn, this chain provides regulators, companies, and investors with a way to measure and appropriately account for the negative externality of carbon emissions. End consumers are also more informed with direct visibility of the carbon that went into producing one product vs. another. If that carbon is also taxed efficiently by regulators, consumers of carbon, whether companies or individuals, are incentivized to lower their carbon consumption and thereby reduce overall demand for carbon over time.


Since we are in favor of more consistent and comparable reporting of a company’s exposure to climate change risks and opportunities, we have engaged with several organizations of which we are a member (PRI3 and SASB4), to start a dialogue on this issue amongst peers in the industry. In the meantime, we will continue to assess scope 3 reporting methodologies and engage management teams to try and find additional solutions to these reporting challenges. Even if this specific cost accounting approach does not upend the pre-existing reporting protocols for reporting emissions, it may at least pave the way for further dialogue.


¹ The point when anthropogenic GHG emissions to the atmosphere are balanced by anthropogenic removals over a specified period (IPCC)

² Includes any emissions not directly produced by the company but that occur both upstream and downstream in the value chain. This includes emissions embedded in sold products.

³ Principles for Responsible Investing

4 Sustainability Accounting Standards Board

These materials are intended solely for informational purposes. The views expressed reflect the current views of Pzena Investment Management (“PIM”) as of the date hereof and are subject to change. PIM is a registered investment adviser registered with the United States Securities and Exchange Commission. PIM does not undertake to advise you of any changes in the views expressed herein. There is no guarantee that any projection, forecast, or opinion in this material will be realized. Past performance is not indicative of future results. All investments involve risk, including risk of total loss. This document does not constitute a current or past recommendation, an offer, or solicitation of an offer to purchase any securities or provide investment advisory services and should not be construed as such. The information contained herein is general in nature and does not constitute legal, tax, or investment advice. PIM does not make any warranty, express or implied, as to the information’s accuracy or completeness. Prospective investors are encouraged to consult their own professional advisers as to the implications of making an investment in any securities or investment advisory services. The specific portfolio securities discussed in this presentation are included for illustrative purposes only and were selected based on their ability to help you better understand our investment process. They were selected from securities in one or more of our strategies and were not selected based on performance. They do not represent all of the securities purchased or sold for our client accounts during any particular period, and it should not be assumed that investments in such securities were or will be profitable. PIM is a discretionary investment manager and does not make “recommendations” to buy or sell any securities. There is no assurance that any securities discussed herein remain in our portfolios at the time you receive this presentation or that securities sold have not been repurchased. The MSCI information may only be used for internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the MSCI Parties) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. For U.K. Investors Only: This marketing communication is issued by Pzena Investment Management, Ltd. (“PIM UK”). PIM UK is a limited company registered in England and Wales with registered number 09380422, and its registered office is at 34-37 Liverpool Street, London EC2M 7PP, United Kingdom. PIM UK is an appointed representative of Mirabella Advisers LLP, which is authorised and regulated by the Financial Conduct Authority. The Pzena documents are only made available to professional clients and eligible counterparties as defined by the FCA. Past performance is not indicative of future results. The value of your investment may go down as well as up, and you may not receive upon redemption the full amount of your original investment. The views and statements contained herein are those of Pzena Investment Management and are based on internal research. For EU Investors Only: This marketing communication is issued by Pzena Investment Management Europe Limited (“PIM Europe”). PIM Europe (No. C457984) is authorised and regulated by the Central Bank of Ireland as a UCITS management company (pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations, 2011, as amended). PIM Europe is registered in Ireland with the Companies Registration Office (No. 699811), with its registered office at Riverside One, Sir John Rogerson’s Quay, Dublin, 2, Ireland. Past performance is not indicative of future results. The value of your investment may go down as well as up, and you may not receive upon redemption the full amount of your original investment. The views and statements contained herein are those of Pzena Investment Management and are based on internal research. For Australia and New Zealand Investors Only: This document has been prepared and issued by Pzena Investment Management, LLC (ARBN 108 743 415), a limited liability company (“Pzena”). Pzena is regulated by the Securities and Exchange Commission (SEC) under U.S. laws, which differ from Australian laws. Pzena is exempt from the requirement to hold an Australian financial services license in Australia in accordance with ASIC Corporations (Repeal and Transitional) Instrument 2016/396. Pzena offers financial services in Australia to ‘wholesale clients’ only pursuant to that exemption. This document is not intended to be distributed or passed on, directly or indirectly, to any other class of persons in Australia. In New Zealand, any offer is limited to ‘wholesale investors’ within the meaning of clause 3(2) of Schedule 1 of the Financial Markets Conduct Act 2013 (‘FMCA’). This document is not to be treated as an offer, and is not capable of acceptance by, any person in New Zealand who is not a Wholesale Investor. For Jersey Investors Only: Consent under the Control of Borrowing (Jersey) Order 1958 (the “COBO” Order) has not been obtained for the circulation of this document. Accordingly, the offer that is the subject of this document may only be made in Jersey where the offer is valid in the United Kingdom or Guernsey and is circulated in Jersey only to persons similar to those to whom, and in a manner similar to that in which, it is for the time being circulated in the United Kingdom, or Guernsey, as the case may be. The directors may, but are not obliged to, apply for such consent in the future. The services and/or products discussed herein are only suitable for sophisticated investors who understand the risks involved. Neither Pzena Investment Management, Ltd. nor Pzena Investment Management, LLC nor the activities of any functionary with regard to either Pzena Investment Management, Ltd. or Pzena Investment Management, LLC are subject to the provisions of the Financial Services (Jersey) Law 1998. For South African Investors Only: Pzena Investment Management, LLC is an authorised financial services provider licensed by the South African Financial Sector Conduct Authority (licence nr: 49029). © Pzena Investment Management, LLC, 2022. All rights reserved.

John Goetz
Managing Principal, Co-Chief Investment Officer
Pzena Investment Management

John is a co-portfolio manager for the Global, International, European, and Japan Focused Value strategies.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.


Sign In or Join Free to comment