Commentary
In the third of his four part review of Terrence Keeley’s Sustainable, Rupert Darwall writes that ESG rests on a vision of the free-market economy that says capitalism needs to be led by people with the right values, which raises the question: Whose values? This makes ESG inherently divisive, explaining the pushback ESG is now generating in red states. Keeley proposes a solution in keeping with the pluralism and diversity of modern America.
Sustainability is an open-ended concept capable of many diverse interpretations involving multiple conflicting trade-offs and real costs. Moreover, the goal of securing inclusive, sustainable growth contains a second duality: that of harmony between society and nature, on the one hand, and promoting harmony within society, on the other, the latter to address what Keeley calls our second systemic vulnerability—“growing income inequality and its corrosive impact on social cohesion.” This raises the question: Who decides? Keeley quotes Bono: “Capitalism isn’t immoral: it’s amoral. It’s a wild beast that needs to be led.”
ESG provides answers about who decides and who leads. In Keeley’s telling, the most powerful people in investing are those who curate stock and bond indices—companies such as MSCI, S&P Dow Jones, and Bloomberg. They decide what goes in and what comes out of an index, thereby skewing performance measurement. But reading Sustainable suggests a slight modification. According to Harvard Business School professor George Serafeim, a coauthor of the study cited earlier, the only way for companies to outperform will be for them to make material ESG issues central to their strategy. “If companies are bold and strategic with their ESG activities, they will be rewarded,” Serafeim claims. What counts as ESG? In a chapter titled “Hardwiring Corporate Goodness,” Keeley writes that “recognized and universally followed” standard setters like the Sustainable Accounting Standards Board (SASB) and Taskforce on Climate-related Financial Disclosures (TCFD) “must continue to identify and set the right objectives for which corporations must strive to achieve. If they prioritize the wrong material risks or set the wrong methodologies for measuring them, their essential role in directing corporations to make further progress on a range of socially desirable objectives, including the UN’s Sustainable Development Goals, will be compromised.”
Until its merger last year with the International Integrated Reporting Council, the SASB’s largest
funder was Bloomberg Philanthropies. In 2014, Michael Bloomberg was
appointed SASB chair and, a year later,
founded and then chaired the TCFD. Whereas other index providers like MSCI and S&P Global also provide ESG ratings, Bloomberg scores the trifecta of influencing ESG standard setting as well.
In contrast to traditional financial disclosures, which pertain to cash flows, financial liabilities, and monetizable assets, the motivation for ESG disclosures principally involves normative values and attaining wider societal objectives. (ESG standards are sometimes justified on the grounds of firms disclosing risks likely to affect stock prices, but the evidence suggests that this is a smoke screen. Welcoming the SEC’s March 2021 proposed rule on climate financial risk disclosure, Michael Bloomberg
said that its adoption would “accelerate the transition to clean energy and net-zero emissions.”)
Two observations can be made. The first concerns differing visions of the economic process in a market economy. Whereas Bono sees capitalism as needing to be directed and Keeley writes of ESG as an effort to recalibrate the corporate world into “a more benevolent force,” the author of “
The Wealth of Nations” famously wrote that it was not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner “but from regard to their own self-interest.” In “
Capitalism, Socialism, and Democracy,” Joseph Schumpeter took Adam Smith’s insight into the era of the Industrial Revolution when he argued that the hunt for profits propelled the stream of inventions that characterizes it.
In his 2004 book, David Henderson also made the distinction between the motivation of individual businesses and the aggregate outcome of their activities. The immense improvements in people’s material welfare do not depend on a conscious attempt by business leaders to make the world a better place. “The advances that capitalism has brought about did not arise from the resolve of business leaders to make them possible, but from the operation of competitive market economies,” Henderson wrote. Keeley comes close to this when he writes that the most important business of business “is and will always remain the promotion of enduring prosperity, not the single-minded pursuit of cleaner air or enhanced economic mobility.”
The emphasis on ESG, linking executive remuneration to ESG objectives rather than to long-run value generation, along with the belief that ESG ratings drive stock prices (which they do, in the short term)—when trillions of investment dollars are chasing limited ESG investment strategies—risks displacing investor analysis of the factors that maintain and sustain the viability of a company’s business model and distracts management from giving attention to continually investing in a company’s intangible capital to sustain its long-term profitability. The vibrancy of capitalism depends on companies competing against one another to innovate new products, services, and processes. Capitalism’s continued legitimacy depends on sustaining its capacity to keep raising people’s material well-being—what Keeley rightly calls “the most important business of business.” Rather than in some way redeeming capitalism, ESG threatens the ability of free-market capitalism to deliver this good and thereby imperils its survival in anything like its current form.
The second observation relates to politics. Values are inherently subjective. In the
opinion of Karl Popper, an open society is based on the idea of not merely tolerating dissenting opinions but respecting them. Respect does not require agreement, but it does mean that when collective action is required that elevates one set of values and priorities over others, it is legitimized via the mechanism of representative democracy and the ballot box. ESG dispenses with that, short-circuiting the democratic process and popular sovereignty.
