Recently, we have seen a number of articles and news items about a push-back against ESG or “stakeholder capitalism” (or “woke capitalism” in some circles). One could argue that the asset management industry itself is largely to blame—as interest in sustainable investing grew, more and more asset managers wanted to grab a piece of the pie so they launched all kinds of funds with the words “ESG”, “Sustainable”, or “Green” in their names. These funds could hold just about anything, of course, because asset managers have not been required to show investors how a fund lives up to its name. The SEC has proposed rules to address this, as we discuss here, but some damage has been done.
Having said that, we simply cannot throw the baby (ESG investing) out with the bathwater (greenwashing and shortsightedness about sustainability and value creation).
This article, presented at the World Economic Forum’s annual meeting, may be the best thing we’ve read in a long time on the reasons ESG matters to companies and investors, and why the recent backlash against “stakeholder capitalism” is so misguided. It is so thoughtful and provides so many important insights we were tempted to just copy/paste the entire thing into this space. But that would be plagiarism, which we frown on, so instead we limit ourselves to highlighting some of the key points and hope that motivates you to read the entire thing.
The article starts off by stating that critics of ESG and stakeholder capitalism underestimate their growing impact on financial performance. In particular, it calls out the importance of “stewardship of intangible assets”, which includes people and data, to value creation. Intangible assets can represent a substantial part of a company’s market value. For example, in the tech industry a good chunk of a company’s assets—its workforce, innovative abilities, and brand image, for example—are intangible. Ditto for data-driven companies such as Facebook and Google. According to the WEF article, accounting practices do not reflect the increased importance of intangible assets in today’s economy, and therefore as much as half of market capitalization is unaccounted for on corporate balance sheets.
ESG investing highlights the value of these intangible assets, under the “Social” pillar which recognizes the importance of a firm’s workforce, and the “Governance” pillar with respect to data security and protecting a company’s reputation. As one example of the importance of cultivating an engaged, committed workforce, a recent podcast on the impending tightness in the copper market (Bloomberg’s Odd Lots) discussed that while copper is vital to the transition to electrification, as solar and wind power must be transmitted via copper wires, there is a shortage of metallurgical engineers who can design and build copper mines that meet today’s environmental standards and entire teams have been wooed away by competitors.
Criticisms of stakeholder capitalism
The WEF article goes on to state that “most corporate boards and institutional investors now accept that certain ESG risks and opportunities can be financially material .” But critics point out that ESG practices have been implemented inconsistently within companies, and is often done as a “check-the-box” exercise, or to grandstand and win some favorable PR. The article says that others see a darker motive, namely that by creating the illusion of progress companies can avoid stronger government action. Some detractors claim that if ESG investing and stakeholder capitalism are financially material, then companies that focus on maximizing shareholder value already take them into account, and others are concerned that ESG issues are political and lead to decisions that misallocate resources.
The article rightfully points out that these criticisms contain a germ of truth, but that none of them are potent enough to invalidate ESG and its materiality. Directors, company executives and asset managers have fiduciary responsibilities. ESG issues and their impact on stakeholder interests “cannot be dismissed as mere public relations or politics for the simple reason that history has shown – and recent disruptive shifts in technology, the environment, geopolitics and societal attitudes are underscoring – that they are increasingly important factors in the preservation and creation of enterprise value.” The WEF article cites research by Bank of America Merrill Lynch showing that 15 out of the 17 S&P 500 bankruptcies from 2005 to 2015 were in companies with poor environmental and social scores five years before these events.
Lastly, the article urges business leaders to turn away from framing this issue in terms of shareholder primacy versus corporate social responsibility. We end with a big quote that is worth re-reading a few times:
“Criticism of weak or inconsistent implementation is fair game, and indeed most companies and investors are only beginning to rigorously integrate ESG considerations into their core decision-making processes. But those who seek to politicize ESG investing and stakeholder capitalism by conflating them with the broader cultural debate about “wokeism” or impugning the motives of directors, executives and investors seriously underestimate the changing nature of business value creation.”
We invite you to share this with others who may have come across arguments challenging ESG’s legitimacy – we think this WEF article does a great job of addressing them.