What started with ‘here’s a holistic way to look at your company’ has become ‘this is the list of policies you must adopt.’
We need to stop trying to force companies into a single, politically acceptable management system.
F or the last several years, much of the corporate world has, to a greater or lesser degree, adapted to the demands imposed by “environmental, social, and governance” (ESG) theory, and in that time, those three letters have created a minefield of unintended consequences. Despite the enthusiasm that has fueled the ESG machine, leaders in politics, policy, and the business world have begun to question where it is leading us, with high-profile critics from Tesla CEO Elon Musk to former vice president Mike Pence lining up to denounce it. While we’ve been hearing warnings of a backlash against ESG for some time, it’s worth reflecting on how we got here.
The term “ESG” has become wildly popular over the last decade, with endless business conferences, investment funds, and analyses hyping it as the hottest new thing in finance. It is, however, a very old concept rebranded. Critics of corporate America — including many people within that world — have long wanted corporations to adopt more philanthropic and altruistic goals in addition to their core mission of delivering return to shareholders. Previous generations had thus popularized phrases like “corporate social responsibility,” “stakeholder capitalism,” “socially responsible investing,” and the “triple bottom line.” While promoters will insist that each of these is slightly different, they are all part of the same more-than-just-profits theory of business.
But the ESG orientation in the business world has long since morphed into much more than making philanthropy part of a company’s purpose. Originally, we were told that integrating ESG into a company’s operations meant taking topics like climate change (environmental), civil rights (social), and board composition (governance) into account when making strategy and planning decisions, which allowed businesses to decide how to best pursue these ends. But many ESG advocates now insist that corporations implement specific, activist-driven policies. What started with “here’s a holistic way to look at your company” has become “this is the list of policies you must adopt.” To say that some of these may be controversial is an understatement.
So, for instance, instead of just thinking critically about its firm’s energy use, a company’s management must commit to having a net-zero carbon footprint by 2035. Instead of merely examining board-recruitment strategy, it must implement quotas for future directors based on sex, race, and sexual orientation. ESG strategies now even involve firms and investment funds taking positions on divisive topics like gun control, abortion, and Israeli–Palestinian relations.
This is obviously a problem in a diverse country in which opinions on such topics differ dramatically. There can be no “correct” ESG guidance on, say, abortion or gun control because there’s no consensus on these issues. Some “socially responsible” investors will want to make sure their retirement savings don’t get invested in any firearms manufacturers. But others will happily embrace an investment fund with firearm exposure to showcase their support for the Second Amendment. One progressive market participant may want to reward companies that offer to pay for out-of-state abortions for employees in red states, while a pro-life investor will likely insist on the exact opposite.
Even in areas on which the divide is less obvious, such as decarbonization, one-size-fits-all ESG guidance can create big problems. The Securities and Exchange Commission, for example, is in the process of promulgating a major new rule to require public companies to disclose extensive new data about their energy use. The goal is clearly to pressure investors to divest from carbon-intensive firms and thus push the entire corporate world away from the use of fossil fuels to minimize greenhouse-gas emissions. The White House and the Federal Reserve, among other agencies, have also announced such climate-oriented finance policies intended to drive investment away from oil and gas.
The rapid decarbonization goals of recent years, however, have made a significant contribution to the unprecedented energy crisis now centered in Western Europe — where ESG has established its strongest hold. In a stampede towards a wind- and solar-powered future, chasing goals that included ESG, reliable and affordable sources of energy have either been decommissioned or have gone through a long period of underinvestment before robust replacements could be created. The resulting gap is now creating dangerous shortages and skyrocketing energy prices — problems that were emergent long before Vladimir Putin decided to invade Ukraine. Now nations like Germany and the U.K. are facing a winter during which many of their citizens may have to choose between heating their homes and feeding their children. This is not the cleaner, fairer world that ESG goals were supposed to deliver.
To turn this around, we need to let firms go back to making their own risk–return calculations — without being pressured by financial regulators and central banks in one particular direction. The voluntary ESG commitments of various trade associations notwithstanding, we would likely never have been brought to this point without the continual threat of political and regulatory intervention. We also need to understand that there’s no single set of corporate goals that will optimize every outcome. ESG fans are fond of saying that their theory is new and evolving and will eventually mature into a cohesive system. But their ambition is a chimera: Differences in firm size, maturity, capitalization, and comparative advantage mean that what makes sense for Company A will be folly for Company B. That would be true even if we agreed on the nonfinancial purposes of business — and with hot topics like abortion, guns, and foreign policy, we don’t.
Everyone is entitled to his or her own opinions on ethical business practices, and we should be allowed to buy or boycott whatever investment products we wish. But ESG-inspired policy-makers need to stop trying to force companies into a single, politically acceptable management system. A sustainable, diversified economy will have room for windmills and nuclear power plants and liquefied-natural-gas terminals and hydroelectric dams and, yes — if and where it makes the most economic sense — even coal-fired power plants. Anyone insisting otherwise should spend next January arguing so on the street corners of Hamburg and Glasgow. The reception there is likely to be even chillier than usual.