Companies are paying greater heed to Environmental, Social and Governance (ESG) matters — their social credit score. Does it make a difference?

Decoder Are companies becoming better social citizens

Business investment concept (Elnur/Canva)

In 1970, prominent American economist Milton Friedman argued that the social responsibility of businesses is to boost profits. In the 1987 film “Wall Street,” the fictional villain Gordon Gekko said, “Greed, for the lack of a better word, is good.”

Things have certainly changed since then. Given climate change, global warming and the fight to emerge from the COVID-19 pandemic, are corporations trying to become more responsible global citizens?

More corporations are disclosing metrics in their annual reports or in sustainability reports on Environmental, Social and Governance (ESG) matters. ESG evaluates a firm’s stance towards social and environmental factors — a kind of corporate social credit score.

ESG issues were first raised in the 2006 United Nations Principles for Responsible Investment report “Who Cares Wins,” according to Forbes. “ESG criteria was, for the first time, required to be incorporated in the financial evaluations of companies,” the magazine wrote.

Global ESG assets under management are on track to exceed $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total assets under management, according to Bloomberg News.

According to Investor’s Business Daily, some of the best ESG companies include Microsoft, specialty chemicals company Linde, computer-tech services firm Accenture, trucking company J.B. Hunt and water technology company Xylem.

Take what some companies say about ESG with a grain of salt.

Can we trust what companies say about their sustainability practices?

You’re best to retain a dose of healthy skepticism. With higher investor interest in ESGs has come a rise in green skepticism and accusations of greenwashing or false green marketing.

EcoWatch said signs of greenwashing include selective corporate disclosures, for example highlighting the environmental positives of their products while ignoring negatives or being vague about certifications for eco-friendliness claims.

Let’s take a closer look at ESGs, given the flood of money into sustainable investing. Below are questions posed to two Wall Street experts.

Michael Lipper, a Wall Street veteran, is president of Lipper Advisory Services Inc, former president of the New York Society for Security Analysts and former president of Lipper Analytical Services, home of a global array of Lipper indices, averages and performance analyses for mutual funds.

Mary Green, a vice president and client portfolio manager at Federated Hermes focused on ESG investing, has 25 years of investment experience. Federated Hermes has $634 billion in assets under management. The international business of Federated Hermes was a founding member and chair of the drafting committee that created the UN Principle of Responsible Investment in 2006.

No global standard for ESG

Q: How do you sift through a corporation’s ESG disclosures and measure them when there is no global standard yet?

Lipper: “The concerns behind ESG have been a part of company analysis since professionals advised on buying shares or whole companies. I remember in the 1960s when doing work on steel companies, the relative level of air and water pollution between steel companies was a factor in the companies’ stock prices. It was assumed that they would have to pay for clean up. Note the change in air quality now and 60 years ago in Pittsburgh. A somewhat similar thing occurred in cleaning up, largely, with the LA smog.

“Part of the difficulty in dealing with ESG is that one must deal with people and their different skill sets and motivations. These differences are difficult to capture and measure. As a numbers guy, I know, on average, the height of basketball players is often a factor of successful basketball teams. But a number of college and professional teams have much smaller players who are some of the best scorers and more important playmakers. By the way, in picking members of championship chess players, height is ignored. Some measures need to be developed based on specific needs.”

Q: Why do ESG funds charge higher fees to investors?

Lipper: “The reasons for ESG-oriented mutual funds underperformance are that ESG requires additional research money, additional high-priced labor at companies, and don’t lead to increased earnings and more importantly dividends that people live on and educational endowments that subsidize schools and universities.”

Q: Do you consider ESG to be a marketing gimmick?

Lipper: “ESG is definitely a marketing ploy in the institutional market and covers a fair amount of relative underperformance. In terms of whether it is a retail fad, it may depend on getting some entertainment personal sponsorship. Possibly a song or skit would bring people to it.”

(Institutional investors are entities that pool money to invest, such as mutual funds, pension funds and hedge funds. Retail investors are individuals who buy stocks.)

ESG can help citizens align social values with investments.

Green disagreed. “Let me clarify what ESG is and isn’t,” she said. “ESG is not a strategy, it is data — valuable incremental information to help investors make better informed investment decisions. Environmental, social and governance considerations are material non-financial factors that can have long-term financial and operational implications for a company. Therefore they must be considered in the investment decision-making process. Investment firms that use it as a marketing ploy will be exposed as green washers.

Green continued: “ESG is adding dimension to investment analysis. Sustainable funds, or funds with environmental or societal objectives, can help investors align their investments with their values and even help them invest in change. ESG is here to stay.”

Q: What is the correlation between high ESG scores and strong corporate financial performance?

Green: “80% of ESG studies show that stock price performance is positively correlated with good corporate responsibility practices. Generally, a high ESG score indicates a company is managing environmental, social and governance risks well. And when a company is less risky, it can enjoy a lower cost of capital (for example, lower interest rates on its bonds). Good social practices include employee relations and working conditions, which can lead to lower turnover. This means less cost incurred with hiring and training.”

Q: Many investors say that climate change is a priority. How can they best track some or all of their portfolio’s carbon emissions?

Green: “One option is an online tool at fossilfreefunds.org that compares the fossil fuel investments and carbon footprints of different funds. If a fund investment has a poor grade, it’s important to know if the investment manager is engaging with the portfolio holdings to help address material emitters.”

Q: I don’t want to downplay the importance of some ESG goals. But how would you balance scores, for example, in an investment in a company claiming concrete movement on lowering emissions versus a company that installs an all-female board of directors?

Green: “It is important to evaluate ESG considerations through the lens of materiality, prioritizing those factors which are likely to have the greatest financial impact, that is the most material. It can vary by industry. For example, decarbonization is more material to utilities, energy producers or auto manufacturers than it is to a health care company. Governance issues like board composition are universally important, including skillset and qualifications of the board.”

Questions to consider:

  1. What is ESG and sustainable investing?
  2. Where can you learn more about a company’s ESG successes and efforts, and should you believe the claims?
  3. Among some of your local shops, what ESG practices have you noticed?
Betty Wong

Betty Wong was global managing editor of Reuters from 2008 to 2011, with 29 years of experience at the Wall Street Journal and Reuters. She covered white collar crime on Wall Street from Ivan Boesky to Michael Milken in the 1980s, led U.S. corporate news coverage from the dot-com bubble to rubble and was global equities editor for Reuters.

Share This
DecodersDecoder: Are companies becoming better social citizens?