ESG - Beyond the Headlines

02 Mar 2020

Harold Hutchinson

Head of Research

ESG is a buzzword in board rooms and investment committees alike; simultaneously a new tiller for corporate strategy and an investor pool of capital. Estimates suggest committed sustainable investment funds already exceed $30 trillion globally. But while there's a lot of attention, there's not always a lot of explanation of its purpose.

Whatever the precise definition or context, the term ESG (environmental, social and governance) is hard to divorce from difficult philosophical, political and economic considerations. Two different views of the foundations for economic and social progress need to be distinguished. The first is sometimes associated with the views of the late Milton Friedman, an intellectual leader of the Chicago School of Economics. He argued for market liberalisation, encouraging corporates to maximise shareholder value given competitive price signals. In so doing, a sympathetic invisible hand ensures society’s best interests.
 
The second, articulated recently by Joseph Stiglitz, like Friedman, a Nobel Laureate in economics, argues for a more inclusive capitalism. Market failures, “missing” markets and distorted price signals all pervade the economy to varying degrees. Opportunists may benefit, taking an unjust share of the pie. For corporates, maximising shareholder value is inappropriate and sub-optimal. A broad cohort of stakeholders, including workers, suppliers, debtholders, government and investors, all need consideration to optimise society’s welfare.
The ESG agenda is usually thought to flow from this latter perspective. That said, an interesting question is whether we can subsume ESG within a conventional market-centred paradigm. The answer here is complex. It is undoubtedly possible to recast some parts of the ESG agenda easily into the conventional model. For example, Warren Buffett would comfortably distinguish short-term profit maximisation from longer-term wealth creation, every bit as much as an ESG analyst. Further, as a methodology to screen out “tail risks”, ESG may be compatible with classical views on decision making under uncertainty. ScottishPower’s move to a 100% renewable generating fleet in 2019 might be interpreted as sensible avoidance of stranded asset risk.
Today’s corporate model is challenged by three defining problems of our age: the social and economic implications of digitalisation, the preservation of our environment, and wealth inequality.
 
However, if this is all there is to it, why is the ESG knell tolling so loudly from Stiglitz et al.? The answer, at least in part, relates to scale. Today’s corporate model is challenged by three defining problems of our age: the social and economic implications of digitalisation, the preservation of our environment, and wealth inequality. All have global dimensions. The uncomfortable truth is that decisions taken by some boards of directors, with the implicit support of their shareholders, have accelerated problems in these three areas, unwittingly or otherwise. Older tragedies of the local commons are reappearing on the global stage, with risks magnified exponentially.
 
The real value of ESG may lie in reminding us that our global village and civilisation may be unique, in the absence of Elon Musk’s vision of us evolving our back-up populations in space. It might just be very lonely out there, so we had better be careful stewards of our pale blue dot.
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