The Perils of ESG

For decades, maximizing shareholder value was the dominant theme for investors but its dominance has given way in recent years to stakeholder capitalism – the idea that a corporation should meet the needs of all its stakeholders, including the community and society as a whole, and not just to its investors.

Stakeholder capitalism has allowed ESG, or Environmental, Social, and Governance issues, to play an increasingly important role in how a corporation measures performance, in the same way financial metrics could be used to assess a corporation’s performance. As large institutional investors exert their significant influence over these investment decisions, their prioritization of ESG factors has become increasingly prevalent.  From the outset, ESG sounds like laudable goals many people would agree with.  But not defined in federal securities law, ESG can mean anything from reducing greenhouse gas emissions to social justice, and anything in between.  This subjectivity is a feature, not a bug, which allows activists to define it as anything they would like to achieve.

The lack of definition around these details that has permitted ESG, whatever the definition, to take hold in corporate boardrooms, often to the detriment of its shareholders.  Take, for example, the “E” component.  Activists have commandeered this by focusing solely on climate change and the adoption of greenhouse gas emission reduction targets as the savior for humanity.  This short-sighted, religious zeal for the energy transition to renewables manifests in penalizing businesses for using or developing fossil fuels.  While climate change is a complex issue, it is indisputable that wealthier societies with access to affordable and reliable energy are more resilient and able to deal with negative outcomes associated with climate change like extreme weather events.   Yet this Western-world focus turns a blind eye to the fact that one-third of the world still lives in economic and, not unrelatedly, energy poverty.  It also ignores the fact that the United States has reduced its carbon footprint more than any other nation in recent years, while others such as China continues to increase its greenhouse gas emissions and has built more coal plants in the last year than any other time in the last seven years.

The “S” component does not fare any better.  As rioters took to the streets in violent protest of George Floyd’s death, corporate America was judged by its commitment to being a force for societal change through its corporate giving. Black Lives Matter Global Network Foundation (BLMGNF) co-founder Patrisse Cullors, called the money her group received in 2020 the result of “white corporate guilt.”  A newly-released Black Lives Matter (BLM) Funding Database that tracks corporate contributions and pledges to the BLM movement and related causes priced that “white corporate guilt” at nearly $83 billion. As the creators of the database point out, this exceeds the GDP of 46 African countries.  Yet, there is little to show in terms of results for this staggering amount of corporate giving, other than serious questions surrounding BLM finances and calls for independent financial audits.

The “G,” or governance component, isn’t actually about good governance at all. While the “S” focuses on the social impacts of businesses on minority communities, the “G” centers on adding people of color to corporate boards and other diversity, equity, and inclusion (DEI) initiatives.  People generally understand all these terms individually and, on their face, no one would have an issue with more diversity or ensuring a workplace that accepts co-workers regardless of their race, color, religion, sex, and national origin.  Yet, corporate reporting translates DEI into what sounds a lot like hiring quotas, something long held illegal under Title VII of the Civil Rights Act and its prohibitions on racial discrimination.  DEI, as a component of ESG, has become an ideological litmus test that injects political and social goals into the governance of corporations in ways that the government cannot do through legislation or regulation.

The massive redistribution of corporate wealth for the promotion of the ESG political agenda should be a cause for concern for us all.  It is a direct assault on shareholder primacy and a co-opting of the democratic principles that our country was founded upon.   It allows activists to take up the mantle for political causes by implementing in the boardroom what they cannot do through the ballot box.

Some argue that the corporations are merely taking the “long-view” of corporate risk and that the risk of climate change should take primacy.  However, the only acceptable result of this view is a rapid transition from fossil fuels to renewable energy.  President Biden also agrees with this, pledging on his campaign that he will put an end to fossil fuels.  Unable to reach this unrealistic goal through legislation, ESG has taken up the mantle in corporate boardrooms.  The idea that a sound environmental policy would mean anything other than the eventual end to fossil fuels does not allow corporations to prioritize risk in the way it sees fit in order to maximize value for the shareholder.

Shareholder activism famously made the headlines in 2021 when climate activist investor Engine No. 1 waged a battle to install three directors on the board of Exxon Mobile.  With the help of institutional investors like BlackRock, the hedge fund was successful, and activists immediately touted the success of the measure by pointing to Exxon’s share price increase.  However, profits at the oil company are closely tied to oil prices so it’s not an adequate benchmark in this case.  The problem with subjective measures of success is that social good as a benchmark is nebulous at best.  Therein lies the ultimate problem with ESG.  When the concept of social good has been defined as only what activists determine, ESG becomes a cudgel to force activist goals.

What does this mean for the average American?  With the change in how asset managers view ESG priorities, it is time for people to actively understand how their retirement funds are being used towards these ends. Most Americans individually do not have the necessary stake in a corporation to make much difference with their individual vote.  Make sure your dollars aren’t going to investment managers who will use your hard-earned dollars for the benefit of their own social goals.  Americans have worked too hard to have ESG-focused managers gamble with their retirement.  Luckily there are asset managers who are prioritizing maximizing investment over political ideology.  Pay attention to where your retirement funds are invested and how asset managers are using your dollars to vote on shareholder initiatives.  If you don’t agree with the ESG priorities of your money manager, as the old saying goes, you should be putting your money where your mouth is.