You can’t have the E without the S and the G
In a recent article by The Economist “ESG should be boiled down to one simple measure: Emissions” (July 2022), the author claims that the concept of ESG (Environmental, Social and Governance indicators for business performance) is failing its purpose and should be distilled to just one numerical parameter: carbon emissions. Although the author is correct about some of the problems with ESG measurement, the proposed remedy – to kill ESG and focus solely on carbon, is wrong. It is wrong not only because it’s based on incorrect facts and flawed logic, but especially because mainstreaming such thinking can have grave consequences to our society, environment and ultimately to businesses and investors themselves.
The original article made quite a splash in the business world as certain companies gladly jumped on this bandwagon in an attempt to shake off their social responsibilities (S) and to minimise the importance of governance (G) in their business, supposedly to relentlessly pursue curbing their carbon emissions. However, such tunnel vision is the exact opposite of the system thinking required to navigate the complex reality of building a prosperous business with a healthy long-term economy.
How many investors would be happy to find their name associated with a company involved in forced labour or in tax evasion, even if those scandals come along with a remarkable 10% reduction in carbon emissions that year?
Despite the writers’ claim in the original article, the social aspects (S) measured by the ESG go far beyond simply providing an employment for people. A company that is taking its ESG performance seriously is auditing the conditions in which its employees are working, ensuring they are being paid a living wage, continuously monitoring its supply chain and taking measures to prevent abuse and human rights violations. So when a company tries to focus exclusively on certain environmental performances whilst downplaying its social responsibilities one must ask oneself, is this a case of playing into a popular agenda, or is it a charade?
It’s not that cutting carbon emissions (and costs) through efficiency gains and technological advances is easy, but it sure is more straightforward than learning about the real conditions in which people are working in remote quarries half-way across the world. Owning up and changing those condition across the business’s supply chain is a complex and daunting task, but to claim that it is not the responsibility of the business but only of the government in those areas provides an endorsement to an abuse-based economy.
To demonstrate its point on the irrelevance of corporate-governance measurement (G), the original article has oddly chosen using Elon Musk’s Tesla as an example of a ‘corporate-governance nightmare’ but one that helps tackle climate change. Tesla’s stock has collapsed by 70% in 2022, along with Musk’s reputation. It turns out that a ‘corporate-nightmare’ isn’t investors' dream after all. In comparison, manufacturers with far less corporate-drama such as Volvo, Renault or Honda suffered far milder decline or even a growth in their shares in 2022, while putting millions of electric cars on the road.
Questionable examples aside, one must wonder what sort of company wouldn’t want to exhibit a clean sheet when it comes to corruption, bribery, money laundering and compliance with international sanctions? Wouldn’t you as an investor want to know how the shop is run before putting money into it?
Finally, we get to the E for Environment. The original article claims that the most significant danger from industrial activities are the carbon emissions. That is factually wrong. Although carbon is the most prominent GHG, it is by far not the only one or even the most potent one, with Methane and Nitrogen pollution being as harmful for both humans and the environment. Hence, diminishing the GHG emissions indicators to measure carbon alone makes no scientific sense.
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Further, one should only Google for the Exxon Valdez oil spill or the Bhopal disaster to learn about the impacts of irresponsible industrial activities on communities and environmental health. So why should we then limit the responsibility for pollution to GHG gasses alone? Isn’t that the responsibility of the business and in the interest of the investors to do all possible to prevent such disasters from happening?
Even if we ignore all moral considerations and reputational risks, the numbers speak for themselves: companies with strong ESG performances make for better investment. It is not a big surprise then that the world’s largest investment fund, Black Rock, have integrated ESG considerations across all of their investment decisions.
ESG isn’t some magic tool that helps a company to solve all its stakeholder problems, nor does it provide investors with a perfect reflection on how a company runs its business. However, it does offer the parties with two important instruments: A common language and reference points upon which they can discuss and account the impact a business has on its stakeholders, and the simple but valuable principle of “what gets measured, gets managed”.
That said, the current ESG set up is far from perfect. The Economist correctly asses that the existing ESG rating systems have gaping inconsistencies that are easily gamed and lack transparency. However, wiping out the better part of ESG parameters is throwing away the baby with the bathwater. ESG does need to be reformed and regulated to create more transparency and alignment between the ratings to allow investors to compare ‘apples to apples’ and to reduce the chances of fraud. Attempts to do so has already started with the EU Taxonomy and the recent EU regulation on Corporate Non-Financial Disclosure, with other countries to follow soon.
Like any new concept, ESG is suffering from growing pains. Boiling down the responsibility of the business and the interest of investors to carbon emissions alone will not solve any of the complex problems faced in the modern day, climate change included. Making ESG more user friendly, streamlined and transparent will help investors to put their money where their mouth (and hopefully heart) is, and will force the reluctant businesses to own up to their responsibilities towards their stakeholders.
This article was written as part of the The Economist - Professional Communication: Business Writing and Storytelling course.
Coffee early next year, Julia?
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2 年Julia Vol, this is an insightful post. It is information I would not normally come across on my timeline. I am definitely interested in reading further into the article. Thank you for sharing. If you are an Investor or want to start Investing seriously, you might want to look at Keiretsu at https://bit.ly/2Zful6i, one of the largest Angel Investors networks in the World, recognized by Pitchbook.
Sustainability & Operations
2 年It is amazing how Business always tries to take the fast and easy road... "Alignment" between E, S and the G is the only way to reach a "healthy" and fair Economy, where everybody is a winner and not only the shareholders. GHG emissions alone don't tell us if there is a depletion of material, or kids at work in terrible conditions, or contaminated water rejected in the river... balance is crucial and businesses should see the long terms benefits and the positive impact on the world instead... I mean, who likes to win by cheating ?
Founder and Director of Treetop Biopak - compostable packaging solutions | Aiming to be the change I want to see in the world
2 年Julia Vol thanks for the article. Some leading businesses are trying to break the connection between their businesses practices and impact society and the environment. They can easily find themselves, and their investors, embroiled in serious Human Rights violations as well as environmental damage. Carbon is absolutely not the only issue to tackle.
Senior Scientist at MyHeritage
2 年Very interesting article!