Internalizing external costs

An interesting thought came to mind yesterday in discussion with a colleague of mine over coffee. He is pursuing a path in executive coaching and writing on healthy organizations and leadership. He made the point that, often, companies with poor organizational health and weak leadership don’t pay the price for quite some time – the financial numbers and reports often don’t reflect the long-term impact of the organizational dysfunction.

Our current environmental issues are very much about external costs not being recognized in the actual cost of the service or good produced – societal costs such as pollution, waste, greenhouse gases, and other human negative impacts. I’m a big proponent of allowing the market to find its equilibrium but only after such external costs have been internalized such that the cost of the good sold reflects ALL costs of its production, not just the direct and indirect financial costs. 

So this is where the interesting thought came up . It would be interesting to discuss and explore whether or not a price could be placed on the long-term impact of organizational dysfunction such that it could be reflected in the financial statements, and thus be integrated into the market judgement of the worthiness of the firm? Why must firms that focus on lowering their emissions, or supporting leadership development, or focusing on employee health and well-being, all at their own expense, face a penalty in the market because of lower profits than their peers?

By internalizing the external costs of bad management, could we see a scenario in which all of the costs of running the firm poorly are reflected in the market valuation of the firm? Over the long-term, the true costs are probably reflected in either corporate collapse or a buy-out, but in the short run, it would be more effective if the market valuation had a mechanism for taking external costs into account.