ESG Misconceptions: The need for Balancing Financial Results and Sustainable Practices

This article was originally published in Valor Econ?mico S/A on 27/02/24 under the title "ESG e Resultados Financeiros: Equilíbrio Possível e Necessário" in this link: ESG e resultados financeiros: o equilíbrio possível e necessário | ESG | Valor Econ?mico (globo.com)

The increasing interest in Environmental, Social, and Governance (ESG) initiatives occasionally leads to misunderstandings between its advocates and those seeking financial results. It is a misconception to believe that ESG actions should be pursued at any cost, just as it is misguided to solely focus on short-term financial outcomes. Maximizing a company's value requires a comprehensive vision that not only considers tangible profits of the present but also future outcomes and associated risks. In this context, the consideration of ESG factors emerges as a necessity that has always been present.

ESG actions should not be pursued blindly or dogmatically. They should be dispassionately founded on critical analyses, free of illusions about an automatic harmony between the three pillars and business sustainability. For example, the exploitation of a new oil discovery may be beneficial for society and the company but may have adverse effects on the environment.

The creation of mechanisms for the compensation of externalities, such as the carbon market, represents an important step in the right direction. By assigning a monetary value to environmental externalities, this market encourages the adoption of more sustainable practices, aligning the financial interests of companies with the long-term objectives of society.

Practices of "Greenwashing" and "Socialwashing" pose a significant threat to the integrity of ESG. Similarly, mere "on paper" compliance with good governance practices without effective implementation constitutes "Governancewashing," potentially concealing cases of fraud or corruption.

For a company's ESG initiatives to generate genuine value, it is essential that they align with its core essence. Actions disconnected from its activities, if they imply few resources, can be considered demagogic; and if they demand many resources, a diversion from purpose. The company must focus its efforts on what is related to its business without neglecting its environmental and social impact.

Assessing the economic benefits of ESG practices requires careful analysis. Although some actions show viability on a small scale, their scalability may not be sustainable. For instance, an organic food producer that chooses to pay its employees above the market average may pass these costs onto the final product price, attracting consumers in a specific niche willing to pay more for responsible production. However, considering the average income of the world's eight billion inhabitants, the limitations of these actions become evident.

Studies associating financial gains with ESG practices require careful analysis, avoiding the uncritical acceptance of conclusions potentially influenced by confirmation bias.

An example of this would be the widely held and confirmed notion that diversity in Boards of Directors leads to better financial results. However, as highlighted by Alex Edmans in a recent article titled "Is diversity actually good for business?"[1], many of these studies lack methodological robustness and could lead to different conclusions than a more rigorous study would.

However, it is reasonable to expect that finance professionals can easily understand the benefits derived from diversity. Simply applying the principles of the Capital Asset Pricing Model (CAPM). Both diversity and financial diversification share the premise of mitigating risks. In this sense, diversity mitigates risks associated with groupthink, cognitive biases, and blind spots, elements often present in more homogeneous teams.

Sonia Consiglio points out that "we need to start talking about EESG - Economic, Environmental, Social, and Governance. We need to bring the 'E' of economic inside, along with, incorporated into, the ESG factors. Or vice versa."[2] ESG cannot exist in a world apart from economic issues.

Besides ensuring that ESG initiatives add value to the company, it is also up to the company to adequately report its initiatives. We have seen advances with new standards issued by the International Sustainability Standards Board (ISSB) (ISSB) and other regulatory bodies. But accounting needs to go further by modernizing itself to report not only how much money a company makes but how it makes money.[3] Both negative and positive externalities need to be captured, measured, and reported.

The finance executive emerges as a central figure in this process, entrusted with the responsibility of capturing and reporting relevant information transparently and accurately. Therefore, finance professionals have to become literate in sustainability topics and know how to consider environmental, social, and governance (ESG) factors.

In the end, the effective integration of EESG considerations into decision-making not only strengthens the competitive position of companies but also contributes to a more sustainable future. This process requires a balanced and grounded approach, free of illusions and based on careful analysis of the real impact of ESG initiatives and their financial implications.

Charles Laganá Putz

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[1] Is diversity actually good for business? | The Spectator, Alex Edmans

?[2] EESG, o novo ESG | Finan?as | Valor Econ?mico (globo.com), Sonia Favaretto, Valor Econ?mico, 14 de Abril de 2020

[3] “Accountants Will Save the World”, Peter Bakker, 05 de Mar?o de 2023, Harvard Business Review,?? an open access version of the article is available on this link: https://hbr.org/2013/03/accountants-will-save-the-worl

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