January 2023 | 

ESG: It’s Not Ideology, It’s Economics

ESG: It’s Not Ideology, It’s Economics

Do you believe ESG factors are financially material?

  1. No, ESG is a fad. There is little or no substance behind the feel-good rhetoric.
  2. Not systematically, but there may be value for certain projects, firms, and industries.
  3. Yes, information on ESG should become an integral part of valuation by investors and corporates.

Wharton management professor Witold Henisz has been asking this question in executive classrooms over the past few years to get a sense of where participants stand before he begins a teaching session. “I used to get 30 to 50 percent yeses, and now I'm getting 70 to 90 percent yeses. The classrooms are moving the way the society is moving,” he says.

For the UN officials who worked with the finance industry on incorporating ESG in the early 2000s, that movement might seem slow. They argued that investors’ fiduciary responsibilities should include the use of ESG factors in their financial analyses, because ESG data could protect investments by avoiding the financial risks associated with climate change, worker disputes, human rights issues in supply chains, and poor corporate governance and resulting litigation.

But as the economic impact of ESG factors gains greater acceptance, a backlash is also growing. The backlash claims ESG investing is somehow “woke” and, through legislation or regulation, restricts the ability in certain (primarily red or Republican) states to engage in various financial transactions with financial institutions that take ESG factors into account. That backlash, says Henisz, is about “ideology, not economics. I don't see any evidence that climate risk, for example, is going away, or it's going to have less of a financial impact in a few years. Extreme weather is getting more severe, storms are getting bigger, and the days above X wet-bulb temperature1 are growing in number.”

“In response, we have a group of people who think climate risk is investment risk, and they want to figure out how, when, where, and for what assets,” says Henisz. “They believe figuring that out is good investing. The anti-ESG movement is saying in response, ‘we're not going to allow you figure out the links between climate risk and financial risk. It’s ‘woke.’ It is introducing non-economic factors into financial analyses and it shouldn’t be done.’ While I understand the political effectiveness of describing something as woke, I’m also a little puzzled about why being asleep in the face of the climate crisis is seen as desirable,” Henisz retorts.

A Work in Progress

That’s not to say that many of the criticisms of ESG aren’t valid and require work. “The data's not particularly good,” says Henisz. “Which asset is going to outperform or underperform because of climate change, and what is the timeline over which the result will occur? There is widespread disagreement over these kinds of issues.”

And as ESG factors become more important to stakeholders across the spectrum, some companies are responding by creating narratives that purport to show just how environmentally responsible they are. “There’s a lot of greenwashing [companies deceptively making consumers and investors believe they are environmentally responsible] and other forms of virtue claiming going on,” says Henisz. “Some say they're doing wonderful things and when you look under the hood it’s clear that they're not. Some investment firms created so-called ESG funds by loading up on the tech sector, because tech companies don't pump out a lot of carbon. And they created these funds at a time when tech was really profitable. But now that the sector, and the funds, are underperforming, they’re being looked at much more closely.”

The question now, says Henisz, is what do we do about it? “At Wharton, we're rolling up our sleeves and doing the hard work to address the problems, because the underlying logic is sound. Climate risk is investment risk.”

Providing a How-To for Getting Up to Speed

Between the anti-ESG backlash; the greenwashing; and the growing demand for viable, transparent ESG metrics, the need for business and financial services leaders, consultants, and entrepreneurs to learn at the frontier of ESG research and practice is crucial.

Wharton is responding with a newly-launched suite of ESG Executive Certificates for Financial Professionals, Senior Leaders, and Strategists, respectively, as well as an ESG Essentials foundational program for professionals. These new programs are designed to provide the knowledge and frameworks that will show participants how to “separate themselves from their peers who aren't serious about the risks to business that ESG issues represent,” says Henisz.

“You will be able to distinguish yourself as a real leader, not as just a talker. We want to help the companies who recognize that just saying you have an ESG strategy, an ESG fund, or an ESG project isn't enough anymore. The tools and lessons of two or three years ago are already out of date. Harness the power of Wharton, where our faculty are writing the tools of tomorrow.”

Henisz says some participants may discover that they’re not doing enough on environmental, social, and governance factors, or that they're focused and spending money on the wrong thing. “We're not advocates and we're not taking a position,” he notes. “We're helping you do the analysis, and providing an increasingly important set of tools and frameworks to both value ESG factors and create strategies, including investment strategies, that address them. That's going to mean different outcomes for different firms.”

1. Wet-bulb temperature takes into account temperature, humidity, wind speed, sun angle, and cloud cover (solar radiation). This differs from the heat index, which takes into consideration temperature and humidity and is calculated for shady areas.