Environmental, social, and governance (ESG) principles have emerged to dominate the corporate governance and investing landscape. The rise of ESG investing threatens to displace the longstanding paradigm in corporate law that the purpose of the corporation is to maximize value for shareholders.
ESG investing ignores the role of government in solving problems and inserts the corporation as the primary source of solutions to the great issues of the day.
The rise of ESG investing has been meteoric in recent years. As of this writing, almost half of investors are currently investing in ESG products, which is almost double the number of investors including ESG products in their portfolios as recently as 2019.
Investors are placing a significant emphasis on managers’ ESG policies when deciding whether to invest, as evidenced by the fact that most investors (88%) ask managers how ESG is incorporated into their investment decision-making. A recent Morgan Stanley Bank survey found that almost 90% of millennials would prefer to have investments that are consistent with their own ESG principles.
In fact, it is fair to say we are living in the age of ESG investing as ESG funds captured $51.1 billion of net new money from investors in 2020—a record—and more than double the 2019 figure of $21 billion.
ESG Movement: A Libertarian Turn
Clearly, the real and existential threat of climate change has galvanized the investing public into taking some sort of action. People also are increasingly concerned about the growing gap in wealth and income between the very top and the very bottom of the socioeconomic ladder. But it is odd that so much energy is being directed at private companies, rather than at the government. It is well worth noting that it is the private sector and not government that the ESG movement looks to for solutions to the major problems of the day.
In other words, the ESG movement reflects a significant libertarian turn in American economic and political life. After all, one naturally would think that government rather than the private sector would be the place to look for solutions to broad societal problems like social injustice and protecting the environment.
The emergence of ESG investing and governance clearly demonstrates that there is a broad consensus that government lacks credibility and cannot be viewed by rational citizens as a likely source of solutions to these broad problems. In simple terms, government unresponsiveness and ineptitude have created a vacuum, and the ESG movement reflects a broad shift from primary reliance on government to primary reliance on the private sector as the source of solutions to broad social problems.
Thus, ESG investing and governance can be explained, at least in part, as a response to the failure of government. People are turning to corporations for solutions to problems that are in the proper domain of government because government has failed. This explains the “E” and the “S” in ESG. But it does not explain the “G” or governance component.
A New Form of Anti-Takeover Device
Besides lack of faith in government, the emergence of ESG is attributable to the fact that the ESG movement focuses intensely on allowing management to govern for the “long term.” This focus serves the private interests of important political groups such as organized labor and corporate management because it takes pressure off of management to focus on profit maximization or on objective criteria such as share prices for evaluating managerial performance.
In addition, ESG governance is a new form of anti-takeover device and a convenient tool for enabling ineffective management to escape accountability.
Managers like ESG investing because the concept is so complex and multi-faceted that almost any action short of theft or outright destruction of corporate property can be defended on some ESG ground or the other. Closing a plant, opening a new plant, relocating, hiring workers, firing workers can all by justified on some ostensible ESG basis.
Moreover, poor corporate performance as measured by returns to investors can be rationalized on the grounds that the company was not supposed to maximize profits in the first place, but rather to maximize ESG impact, which, of course, is impossible to measure.
Despite all of the hoopla surrounding ESG investing, it is highly unlikely that the problems of climate changes and sharply uneven distributions of wealth and income will be meaningfully addressed by ESG investing.
Profit-Maximizing Goals Remain
While companies may claim to be abandoning—or at least modifying—the profit maximization paradigm, three key incentive structures remain unchanged:
- First, managers are still compensated on the basis of share price performance and other measures tied to shareholder wealth.
- Second, the threat of activist hedge funds and takeovers requires managers to keep share prices high.
- Third, shareholders and only shareholders get to vote in elections for corporate directors.
These three incentive-based systems are part of the deep structure of corporate governance and they are a mighty bulwark protecting the profit-maximizing tradition from incursions by ESG investors.
The recent emergence of the ESG movement is attributable to the confluence of the private interests of management with a secular loss of confidence in the ability of government even to address, much less to solve, the important environmental and social problems of the day. This loss of confidence has played conveniently into the hands of corporate managers who wish to avoid accountability.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jonathan Macey is the Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale Law School, and Professor in the Yale School of Management.