WASHINGTON, DC - SEPTEMBER 23: Climate change protesters block traffic during a protest to shut down ... [+]
This week we celebrate the 55th anniversary of Earth Day. Perhaps the most serious challenge facing the earth is climate change, which reflects the industrial economy’s reliance on fossil fuels. To decarbonize, governments have enacted a range of mandatory policies. Alongside there is a proliferation of voluntary business efforts. Probably the most well-recognized of business initiatives is ESG (Environmental-Social-Governance), a metric to assess firms’ performance holistically, as opposed to relying predominantly on profits.
The theory is that decarbonization requires substantial changes in how businesses function. Decarbonization policies, whether mandatory or voluntary, tend to impose short-term private costs on firms to produce the global public good of climate mitigation. If firms focus on short-term profit maximization, they will have fewer incentives to pursue decarbonization. The ESG metric is a game changer because it recognizes firms for their pro-environmental efforts. ESG also has social and governance dimensions which are expected to motivate managers to consider the interests of all stakeholders, not only shareholders. This is a big ask because financial markets are programmed to focus on profits.
ESG also reveals a remarkable shift in American politics. Historically, conservatives have criticized government regulations and favored voluntary business self-regulation. In recent years, however, it seems conservatives have revised their opinion about regulations. They are opposing business self-regulatory efforts via ESG. Specifically, they see business leaders succumbing to the pressure of liberal groups and becoming “woke.” For them, ESG means that firms will sacrifice their profit goals to fund liberal priorities.
The ESG debate is moot if ESG supports firms’ profit goals. What if it does not, a topic of spirited debate among scholars? How might then firms respond? Even if they can resist the pressure from the stock market to deliver short-term profits, they might face legal problems for violating the fiduciary duty of serving shareholders. This issue is being employed by conservatives to attack ESG on legal-political grounds.
ESG and Cultural Wars
BlackRock’s CEO Larry Fink is considered to be the most prominent ESG advocate. Our recent research with Nela Mrchkovska shows that Fink, who began writing his “Dear CEO” letters in 2012, used the term ESG for the first time in 2016. Google Trends reveals that in the U.S., ESG rose in prominence in 2019. During its heydays, ESG was a dominant theme in elite gatherings such as the World Economic Forum. Financial firms launched ESG funds and business schools introduced ESG courses.
Interest in ESG peaked in 2023 and its sharp decline seemed to have begun. A recent Wall Street Journal news story was entitled, “The Latest Dirty Word in Corporate America: ESG.” Why did ESG have a relatively short shelf-life? We highlight two factors: cultural wars and the Ukraine crisis.
ESG outlines the vision of stakeholder capitalism. Fink notes: “Stakeholder capitalism is … driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper.” But Fink’s argument is losing its audience. ESG has become a victim of cultural wars. For conservatives, stakeholder capitalism is a smoke screen for liberal corporate managers to pursue political agendas using corporate resources. These managers can escape scrutiny because they can always find some “stakeholder” to support their preferred policy. While stock markets enforce profit-based accountability, stakeholder capitalism allows managers to escape from this discipline.
Firms have a fiduciary duty to maximize shareholders’ wealth. Using this argument, Attorney Generals of several U.S. states have sued financial companies that employ ESG. The U.S. House of Representatives Judiciary Committee has subpoenaed BlackRock and State Street Global Advisors to investigate whether they are colluding to promote ESG. In this politically charged environment, financial investors are backtracking on ESG funds.
ESG and the Ukraine War
For fossil fuel supporters, ESG is a de facto climate standard. The Ukraine war, which focused global attention on energy inflation and energy security, created the political opportunity for this group to strike at ESG.
How so? The Ukraine invasion has changed the political and economic fortunes of the oil and gas industry. It seems keeping gas prices low is a policy priority across the world. With the active blessing of both Democratic and Republican Presidents, the U.S. has emerged as the world’s top oil producer. Fracking has allowed the U.S. to become the top natural gas producer as well. The U.S. has stepped up its natural gas exports and is creating a massive new LNG pipeline infrastructure. Oil and gas firms are gushing in profits. Thus, financial firms have a hard time explaining why they are not investing in highly profitable oil and gas firms, which they are obligated as part of their fiduciary duty.
Just consider the changes in the political environment as the oil and gas industry has gone on the offensive. Exxon Mobil has sued investors to prevent a vote on their pro-climate proposal during the company's shareholder meeting. Larry Fink has retreated from preaching decarbonization to advocating energy pragmatism which involves both renewables and fossil fuels. In a recent S&P Global Energy Conference, Saudi Aramco CEO Amin Nasser predicted that fossil fuel demand will continue to grow and it is a “fantasy” that oil and gas will get phased out.
Was ESG a fad then?
Fads quickly gain prominence and quickly lose steam. The excitement around them is not rooted in reality. ESG was not a fad because the core ideas motivating it reflect the deeper issue of the social responsibility of businesses.
The climate crisis is real and capitalism is in danger due to public backlash to rising income inequalities and declining living standards. The fundamental questions about the social purpose of the firm are even more important today than ever before. In the 1970s, Milton Friedman wrote that the “Social Responsibility of Business is to increase its profits.” For Friedman, corporate social responsibility (CSR) is charity. In his perspective, firms are not in the charity business, and individual shareholders, as owners of firms, should individually decide how they want to spend their profits.
Yet, this approach has caused social and political upheavals and eroded firms’ social license to operate. The CSR movement seeks to reclaim this license. Bowen’s book, Social Responsibilities of the Businessman, outlined the intellectual rationale for it. In the 1980s, Freeman introduced the idea of stakeholder capitalism. Over the years CSR has gone through several iterations such as Triple Bottom Line and the United Nations Global Compact. ESG could be viewed as its most recent version, sculpted to meet the needs of the time. Yet, cultural wars and the Ukraine invasion have created a hostile political and legal climate for firms to embrace ESG.
To conclude, conservatives see ESG as woke capitalism. They are using the government to go after firms that self-regulate! Yet, the reality is that the climate crisis is worsening and the fundamental question about the social purpose of the firm is unresolved. It remains to be seen whether the ESG idea gets resurrected under a new acronym so that firms can explore ways to retain their social and political license to operate and combat climate change.
