Does ESG Really Matter?

Writing in their book, ESG Matters: How to Save the Planet, Empower People, and Outperform the Competition, Brown and Brown (2021) state that ESG makes sense because a responsible company that cares about its people, customers, and the environment is more likely to outperform competitors and be successful and resilient than one that does not. A company that is committed to an ESG-based approach is more than just a way of attracting and retaining capital. It is much broader. At its core, embracing ESG is about doing the right thing.

Views on Reporting ESG Components

The fifth edition of the Morgan Stanley Sustainable Signals: Individual Investor Survey (2023) conducted by Dynata LLC on behalf of the Institute for Sustainable Investing, reported that 72 percent of surveyed investors believe that companies with good ESG practices can achieve higher profitability and are better long-term investments. Additional results seem to confirm the fact that investors are interested in ESG data and the results matter: 77 percent of global investors are interested in sustainable investing and 70 percent believe strong ESG practices can deliver financial returns.

A Gallup poll was conducted during the April 3-25, 2023 period through telephone interviews with a random sample of 1,013 adults. The pollsters found that efforts to promote adoption of the ESG framework in investing have gained traction in previous years and become the subject of pro-and anti-ESG legislation, yet the general public did not seem to be more familiar with ESG at the time of the survey compared to two years prior. Indeed, 37 percent of Americans reported being “very” or “somewhat familiar” with ESG, basically unchanged from 36 percent in 2021. Another 22% were “not too familiar,” while 40 percent were “not too familiar at all.” (Saad 2023).

Does ESG Reporting Really Matter?

An article in McKinsey Quarterly, Does ESG really matter—and why? examines the criticisms of ESG and identifies four categories of objections as follows (Pérez et al., 2022).

• ESG is not desirable, because it is a distraction.
• ESG is not feasible because it is intrinsically too difficult.
• ESG is not measurable, at least to any practicable degree.
• Even when ESG can be measured, there is no meaningful relationship with financial performance.

The measurement issue is of paramount importance. While individual components may be measurable, the aggregate score has little meaning. Moreover, organizations such as GRI and SASB can measure the same event differently. For example, GRI considers employee training, in part, by amounts invested in training, while SASB measures by training hours. This would mean that different ratings and score providers—which use their own analyses and weightings—would provide diverging scores. Moreover, major investors might use their own proprietary methodologies that derive from a variety of inputs (including ESG scores), which these investors have enhanced over the years. The key issues associated with the different rating agencies include the following (Pérez et al., 2022):

• Lack of objectivity of ESG ratings.
• Data is self-reported.
• Data is often obtained from third parties.
• Data is unaudited.
• Setting up Policies is Different from Having Measurable Impact

Criticisms of Reporting

In addition to the rating agency chaos, greenwashing is another common criticism leveled against environmental data. It involves making an unsupportable claim to deceive consumers into believing that a company’s products are environmentally friendly or have a greater positive environmental impact than they actually do. A company might emphasize sustainable aspects of a product to overshadow its involvement in environmentally harmful practices. Another practice is to use false information to intentionally hide wrongdoing, such as misleading labels. This practice is known as “whitewashing.”

The bottom line is that a company may adopt practices that suggest environmentally conscious or friendly practices in an attempt to capitalize on the growing demand for environmentally sound products. Another practice that creates challenges is greenhushing which is the opposite of greenwashing, the latter of which is when companies overstate their sustainability in an attempt to market to environmentally conscious consumers. Greenhushing is when a company intentionally does not publicize its environmental or social efforts, such as climate-friendly actions or goals. Companies may do this out of fear of criticism or backlash, such as being perceived as greenwashing or not meeting their stated goals.

In evaluating the usefulness of ESG data, we need to look beyond investors, who seek maximum returns on their investments, and creditors who seek to protect their outstanding amounts due and look at the interests of other stakeholders including customers, suppliers, employees and society at large. These user groups should welcome ESG data, especially information related to social activities and governance. Indeed, the governance data alone provides a valuable perspective on whether a company manages its financial and non-financial risks.

Ernst & Young LLP (2023) commissioned a survey on the business relevance of sustainability and ESG initiatives. Responses from the C-suite across a number of Fortune 1000 companies indicate that ESG is still very much in the sights of American executives and at the top of every agenda. There was one overarching issue addressed: Just how important is sustainability and ESG in business today? The overwhelming and definitive response: very. From the survey, every single respondent indicated ESG issues are important to their organization, with 87% believing those initiatives are very to extremely important to their businesses and long-term success.

Relevance of Reporting

These results seem contradictory when compared to recent developments questioning the value of ESG. It seems like a backlash may be brewing against ESG reporting. Winston (2023) refers to a loosely defined collection of beliefs and actions aimed at fighting a perceived shift towards progressive ideas in society and business, which he refers to as the “anti-ESG” movement. There is also a concern about the lack of agreement about just what ESG reporting entails. There is a lack of consistency in some cases due to the lack of clear-cut standards.

A survey conducted of Conference Board members (2023) indicates that 61 percent of U.S. companies expect the recent ESG backlash to continue or increase over the next two years. The report recommends that corporate boards and management view the backlash as an opportunity to clarify their strategy and communications. The response of these companies is somewhat unexpected in that just 11 percent are changing the substance of their ESG programs, while a majority are focusing more on the link between ESG and core business strategy. Moreover, nearly half are changing terminology to use terms such as “sustainability.” These respondents state that while “ESG” resonates well with investors, “sustainability” tends to be more readily understood by employees, customers, and policymakers.

While the UN Development Program (2024) admits to some pushback against ESG including mentioning legislation in some U.S. states, threatening businesses with missions like reducing carbon emissions, and questioning diversity, equity and inclusion (DEI) initiatives, there are also increasing calls for better ESG standards, greater transparency, and rejection of greenwashing. According to the U.N. group, governments, recognizing the importance of stronger ESG governance, are adopting new regulations to govern standards and reporting.

The question whether an ESG backlash is forthcoming seems unclear, perhaps because not everyone understands what the purpose is of collecting ESG data. It could be that support for sustainability broadly will increase over time in part because Gen Z and millennials seem to be more supportive of this concept than employees from older generations. In the meantime, accounting standard setters, especially in the U.S., should work with their international counterparts because there is global support for ESG standards.

Posted by Steven Mintz, Ph.D., aka Ethics Sage, on July 11, 2024. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/.