A rather direct essay by London Business School professor Alex Edmans - 'the 10 Myths of ESG' - appears in the latest Financial Analyst Journal (CFAs will find it in their in-box, others can obtain the document via this link). The essay notes that 'pressure to do something…about ESG…can often lead to actions or statements that … apply ‘gut feel’ rather than being based on careful analysis'. Gut feel, in the author’s view, 'has led to many claims, and current practices, that are contradicted [by years of research]'.
You’ve probably heard one or more of these 'myths' as stated:
Shareholder Value is Short-Termist
Shareholder Primacy Leads to an Exclusive Focus on Shareholder Value
Sustainability Risks Increase the Cost of Capital
Sustainable Stocks Earn Higher Returns
Climate Risk Is Investment Risk
A Company’s ESG Metrics Capture Its Impact on Society
More ESG Is Always Better
More Investor Engagement Is Always Better
You Improve ESG Performance By Paying For ESG Performance
Market Failures Justify Regulatory Intervention
The author takes each in-turn, using published economic and financial research and theory, primarily from an efficient market hypothesis perspective, to debunk each 'myth'.
Selecting a few of interest we repeatedly hear:
2. Shareholder Primacy
…managers do not ignore other stakeholders, for two reasons. The first is that these stakeholders are protected. Some are protected by contract, such as workers, suppliers, and customers. If the firm underpays its workers or suppliers or fails to provide its customers with the promised goods or services, it can be sued. Others are protected by laws, such as environmental regulations. Shareholders have no contractual rights. They are guaranteed no return on their investment; companies are under no obligation to pay any dividend.
4. Sustainable Stocks Earn Higher Returns
ESG factors may indeed lead to superior returns if they are unanticipated. However - In equilibrium, there is no mispricing because investors fully recognize the value of ESG, and [investor] tastes are stable.
5. Climate Risk is Investment Risk
Climate Risk Is an Unpriced Externality. … therefore … climate risk is not investment risk—investors don’t bear the consequences of climate change because polluting companies don’t have to pay for the damage they cause. The author also argues that 'climate risk' is ambiguous: There are two types of climate risk. The first is physical risk, the risk that a company experiences from a warming planet... The second is transition risk, the risk that a company faces from a move to a low carbon economy… Many define climate risk as carbon emissions, which to the author is a transition risk, an externality, and therefore not as important to a company directly as physical risk.
The last one I hear a lot – 'regulation is needed' – but the author notes that 'regulatory failure' should also be a concern (eg, governments don’t always get regulation right, with resulting consequences and costs), 'and so government intervention is only optimal when the market failure is so large that it exceeds even the regulatory failure'. Though the author doesn’t address the natural question; is the market failure on climate risk large?