ESG’s Midlife Crisis

For 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.

Read the full article at National Review.