The market demands ESG discipline, period. Whether you view ESG as the alpha and the omega, an opportunity for capitalism to atone and course correct, or as a Trojan horse for a woke agenda, this fact is a stubborn one.
For example, around $120 billion poured into sustainable investments during 2021, and the amount invested in ESG strategies increased tenfold from 2018 to 2020. Last year, about $1 of every $3 managed globally lived in ESG strategies. As myriad surveys from major consultancies will tell you, millennials are about to experience the largest wealth transfer in this country’s history, and they love this ESG stuff.
On the surface, these numbers scream “win!” but not all — even those within the ESG camp — see this growth as cause for celebration. I’m not referring to critiques such as those of U.S. Securities and Exchange Commissioner Hester Peirce, who sees the way corporations are being assessed according to ESG factors as “labeling based on incomplete information, public shaming, and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences.”
I’m talking about the voices within the ESG camp that have risen this past year to illuminate some issues that, rightfully, give pause as to what we’re celebrating.
Most notable here is a three–part series by Tariq Fancy, BlackRock’s first chief investment officer of sustainable investing, which challenges business leaders to offer a serious rebuttal (have they?) to his claims that ESG as an investment lens offers a convenient fantasy for an inconvenient truth. Fancy has raised issues with some elements of ESG strategy that, behind closed doors, many of us agree are material issues.
Another voice in this vein that I track closely is Alison Taylor, executive director at research organization Ethical Systems, advisor to BSR and adjunct professor at NYU Stern School of Business. When some novel element rocks the ESG boat, like geopolitical risk tied to a war in Eastern Europe, I look to see how Taylor is making sense of it.
Upton Sinclair once said, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” I’m not implying that all of us ESGers are touting the benefits of ESG simply because it’s our job (or because the ESG fund fees are juicy), but given we’re at such a critical juncture for the progress of this space, some orthodoxies are developing that likely won’t serve us in the long run and should be addressed openly.
As such, I checked in with Taylor to see what concerning orthodoxies she’s seeing begin to ossify, and what she thinks leadership in ESG investing should really be doing right now.
Grant Harrison: What are the most potent misconceptions about ESG investing you’re seeing right now, from both the ESG advocate and the ESG naysayer side?
Alison Taylor: I think the clue is in the question. We’ve fallen prey to unhelpful binaries everywhere, and ESG is no exception. ESG coverage tends to treat the issue as a boxing match between free market advocates who think this is all a dangerous effort to manipulate us, and people who imagine that ESG will save the world. This isn’t just the media. A lot of academic studies on whether ESG links to financial performance seem to want to prove or disprove the link to financial performance, so there’s a lot of confirmation bias in the studies.
The biggest misconception is that there’s a universal thing called ESG that is either the problem or the solution. The reality is much messier, partly because ESG is so nascent, and partly because we might debate whether it even makes sense to have a thing called “ESG” at all. I tend to think of ESG as the financialization of sustainability — but there’s huge disagreement on the origins and purpose of ESG investing, which causes confusion. There is not a single ESG strategy, set of ratings, measurement approach or ultimate goal. This makes it impossible to say whether ESG is good or bad, so pundits talk endlessly past each other.
By the time an environmental or social issue has become enough of a risk to damage financial performance, it’s too late to prevent it. That’s why even if you think ESG is all about better risk management, you need to start with your impact on stakeholders
Another misconception is that once all the reporting bodies have agreed on the right metrics, the ESG problem is solved. When I think of the breadth of issues involved and the notion that a score, or even a series of quantitative indicators, could ever provide the “answer” on a company’s non-financial performance, I’m clear that’s ultimately a doomed exercise. Even if it wasn’t, the notion that forcing disclosure will force companies to do something also seems tenuous. Very often disclosure is a delay tactic — the [Intergovernmental Panel on Climate Change] just acknowledged this. ESG is often compared to the earliest days of financial accounting, but it’s significantly more complicated than that.
A final misconception is that the ESG ratings industry helps businesses be more responsible. Investor interest in ESG issues is useful, but how it manifests, not so much. What the ESG ratings industry does is incentivize ticking the box on dozens of issues at the expense of what is really needed, which is for companies to focus on a few material issues. The realities of organizational life mean that we need to get real about this. This is another dimension of the binary nature of the discussion. Companies try to get a good score and seem like a “clean” business, but the only thing that matters is the direction of travel. Running a responsible business is incredibly difficult, it involves trade-offs. Even Patagonia and Unilever aren’t good at everything. It speaks volumes how few of my students can think of other “good” companies. If we really want businesses to be more responsible, we have to help them be more honest and transparent, instead of incentivizing them to juke the stats.
Harrison: There are some assumptions within the ESG investing industry that are becoming or risk becoming orthodoxy, many of which don’t serve the ESG space’s progress or the stakeholders that ESG investing intends to serve (the planet and underserved communities). What themes in this vein are top of mind or most frustrating for you right now?
Taylor: There are so many. I want to focus on one that is top of mind since Russia invaded Ukraine, which is that ESG and ethics have nothing to do with each other. It’s fascinating how many ESG leaders at big investment firms stress that ESG is not about making business more ethical but allowing better identification of social and environmental risks. For example, Hortense Bioy, Morningstar’s global head of sustainability research, said “there are still people who inappropriately conflate sustainability and ethics.”
I understand what she means, because she is differentiating ESG from earlier socially responsible investing, which meant accepting lower returns. But the underlying assumptions here are all false. By the time an environmental or social issue has become enough of a risk to damage financial performance, it’s too late to prevent it. That’s why even if you think ESG is all about better risk management, you need to start with your impact on stakeholders. Those impacts are the things that can kick back and become your risks.
Lots of ESG ratings use reputational risk as an evaluation criteria, but that’s backward-looking and reactive, not a good guide to evaluation. That’s how we ended up declaring public health an ESG issue two years ago and have now decided “Ukraine” is an ESG issue. This thinking is a great reason why ESG loses credibility — it seems to involve everything and nothing. By the way, Ukraine is not an ESG issue, but corruption and business integrity are. I don’t blame companies or investors for not knowing the ins and outs of what Putin might do next, but if you are a responsible investor you should be looking at your exposure to kleptocrats, oligarchs and state-owned businesses in authoritarian countries. It’s not that hard.
The reality is that ESG exists because investors, citizens, customers, suppliers and employees want business to be more responsible about its impacts. It is simple, it’s a change from older ideas, and it is definitely about ethics. Critics of ESG still need to account for these forces, because they aren’t going away. I’m frustrated that we spend so much time debating whether ESG drives alpha at the expense of far more interesting questions about how ESG needs to evolve.
The final point I’d make here is that ordinary investors want to be able to make sure their pension money is being invested in ways that don’t make the world worse. So I’d like to see asset managers do a better job thinking about strategies to do that, not make excuses for what they missed.
Harrison: The “thought leadership” realm for ESG and sustainable finance is a quite noisy one. Are there any voices — individuals and institutions alike — whose leadership you think should be elevated right now but is not currently?
Taylor: In general, I do think journalism has gotten a lot better, and there’s lots of great reading out there if you can wade through the noise of consultants, accountants and other vested interests peddling “solutions.” It’s a shame that companies feel under such pressure to put out advertorials on what a marvelous win-win this all is, as there is so much to learn from the people struggling to make sustainability a reality outside companies, and we hardly ever hear it. The Time interview with [former CEO Emmanuel] Faber after he was fired from Danone was a notable exception. We need much more of this critical commentary.
The reality is that ESG exists because investors, citizens, customers, suppliers and employees want business to be more responsible about its impacts. It is simple, it’s a change from older ideas, and it is definitely about ethics.
In general, I recommend reading widely and beyond ESG, but there are some people I always pay attention to. [Researcher] Duncan Austin writes very thoughtfully about how market-led sustainability is a fix that fails. Jerome Tagger’s think and do tank, Preventable Surprises, does great work and has a great network of “positive mavericks,” who are all worth following. Gillian Marcelle [managing member of Resilience Capital Ventures] has an interesting perspective informed by long experience in development. Praveen Gupta has helped me learn about the view from India. [Author] Denise Hearn does fascinating work on capitalism and monopoly and has a fantastic blog called Embodied Economics. My absolute favorite person on social media is Professor Guido Palazzo — I never miss a post.
I also recommend the “Power of Us” (book and Substack), which is about group dynamics and collective behavior, from social psychologists Jay Van Bavel and Dominic Packer. Everyone interested in ESG should study social psychology.
Harrison: Ethical Systems “makes academic research accessible to businesspeople, helps them assess their company cultures, and guides them in applying research-based strategies to improve trust, integrity and cooperation.” What should the GreenBiz audience know about what you’re currently working on?
Taylor: Now you will understand why I keep talking about unhelpful binaries. We are working on a project on business and polarization, and I think the ESG debate is a big part of what is going wrong here. That’s why we are having such an unproductive conversation about “woke capitalism.”
We are also working on a project on incentives, ethical culture and ESG. Many companies are using ESG metrics in their compensation now, but getting this right is a minefield. More to come on this soon.
Harrison: You’re sitting at the table with the heads of ESG investing for the five largest asset managers in the world, and you’ve got the floor for 10 minutes, uninterrupted. What do you tell them, ask them or implore them to do or not do?
Taylor: Wow. Are they definitely listening and not looking at their phones? I think I’d ask them to hire more social psychologists, behavioral scientists and anthropologists, for two reasons: to study their influence on the wider financial and corporate ecosystem, and to get much more deliberate and thoughtful about the second- and third-order consequences of their decisions.
They play such a huge role, not just in influencing companies directly but in shaping wider behavior in the system. That’s a huge responsibility, and they need help. These teams could also focus on identifying how to measure culture and governance from the outside. If you can get this right, you don’t need all the other ESG metrics. It’s the only thing that matters.
Harrison: You’ve taught at the Fordham University School of Law and currently teach “professional responsibility and leadership” to MBA students at NYU Stern School of Business. Do you see any major disconnects between formal business education and the purported shift to a clean economy that business and finance leaders have been talking a lot about this past year?
Taylor: Professional responsibility is a required class, so I get a good view on where business students are at, and I do my very best to teach them to be smart and critical, not cheerleading. From next year I’ll teach sustainability too, but that’s an elective so it attracts people who are already convinced, which is part of the problem. For sure, business schools are struggling, like everyone else, with how to adjust to a world where the focus on shareholder value has not disappeared but powerful new forces have emerged that all businesses need to account for and deal with.
I think students can get very mixed messages from different professors, which can be good as they can make their own decisions, but I am not sure it prepares them well enough for future leadership challenges. Young people clearly want a new style of leadership — I’m not sure we are ready for how much corporate life is about to change.