Chapter and verse: The case against mandatory ESG standards

This week De Gruyter Brill published the book ESG Investing: Current Theory and Practice, edited by John Hill of Fairfield University’s Dolan School of Business. I contributed a chapter to this new volume titled “The Case Against Mandatory ESG Standards.” De Gruyter describes the book as “valuable resource for students, academics, investors, and practitioners” that “provides a comprehensive understanding of the evolving landscape of ESG finance.” I certainly hope that readers will agree with that assessment.

The title provides a reasonable idea of the argument that the chapter advances. My position on environmental, social, and governance (ESG) investing has been consistent since I started working on this issue several years ago, and that I described in my first major paper on the topic in 2021. That is, that people should be able to invest their own money however they want and to advance any lawful values they hold through that process. But ESG theory and policy are often imposed from above, and in especially non-transparent and anti-democratic ways. That’s the primary problem, not that it is left wing or “woke” per se. A right-wing version of ESG would be just as problematic, which is why principled conservatives tend to prefer a “back to neutral” approach to corporate governance.

Secondarily, because a lot of ESG enthusiasm is simply political and social activism disguised as portfolio management, the movement spends a lot of its time cloaking its real motives and manipulating or misusing data. People who believe that ESG-adjacent environmental and social goals are obviously correct will have very little incentive to rigorously investigate the data behind them. When a disinterested research team actually does so, they often find the empirical case for ESG investing to be extremely weak or based entirely on faulty data. The multi-year work of Florian Berg, Julian F Kölbel, and Roberto Rigobon of MIT’s Sloan School (the “Aggregate Confusion Project”) is a good example of this. The debunking of the infamous McKinsey “Diversity Wins” study by Alex Edmans of London Business School is another.

But while the world of ESG theory and advocacy has plenty of internal contradictions that should make any observer cautious, it is the explicit involvement of government that creates the worst problems. In the chapter I argue that even people with progressive-left policy preferences – those most likely to be in favor of ESG – should be wary of mixing the world of business enterprise and public policy. In the chapter, I wrote:

The cost and dysfunction involved in using government regulation to achieve one’s environmental and social aims is underrated by many activists, including those promoting ESG investing theory. When and if ESG management guidelines are adopted by national governments and multilateral organizations, they will be subject to the same significant pathologies as all interest-group politics. Those mandatory policies, once enacted, will also become a roadblock to any additional improvements in the areas being regulated, even assuming that there was a net advantage to the enactment of the initial rules themselves. Mandatory ESG standards would likely become a ceiling rather than a floor, allowing firms to ignore calls for more ambitious targets by pointing to their compliance with whatever mandates managed to make it through the sausage-factory of political policymaking. Advocates for societal progress through ESG-informed business practices should be the ones demanding more than that.

Perhaps the most interesting thing about the process of writing this chapter, which started with a request to contribute to the book all the way back in February 2023, is how much has changed since then. We went from a time when ESG had acquired some vocal critics but was still riding pretty high to a time when the status of ESG as an investing philosophy seems to be in freefall. Major financial institutions have been fleeing climate activist alliances like Net Zero Asset Managers, ESG-aligned funds have been seeing major outflows, and policy moves at the state and federal level have cooled overall enthusiasm significantly. And, as Stand Together’s Russ Greene has recently pointed out, interest rates played a big role both in ESG’s initial success and its recent decline.

You can buy a copy of ESG Investing: Current Theory and Practice here.