One major (theoretical) dimension that you’re missing is that ESG companies should have higher access to capital, thus keeping them able to compete even if they’re not quite as good at the bottom line. This also works in the reverse direction, where non-ESG companies will have less access to capital, making them less competitive. Of course, this only matters if enough investors are ESG investors, or the marginal effects won’t matter.
A lot of ESG investment is from retail investors as well[0], so it’s not really true that it’s just prioritizing rich people’s values. On top of that, as long as we exist in a capitalistic society, we fundamentally prioritize the values of the wealthy over the not wealthy. If you disagree with that, the thing to attack isn’t ESG, it’s the market economy as a whole.
Retail investor dollars are more likely to be held by rich people; normal people's stock ownership is probably via a 401k or other institutional intermediary.
I recently came across carboncollective.co who create 401ks which are explicitly climate positive and not ESG driven as their research highlights how many climate destructive companies are on most 𝗘𝗦𝗚 indices. It’s got a lot of small caps but it’s an interesting approach (full disclosure, I am implementing their 401k plan for my own climate startup).
ESG is just something to make people feel good and lacks any reasonable definition. One can point to obvious companies that may produce problematic stuff such as cigarettes and alcoholic beverages. The coal industry is disappearing without any of us having to do much at all. The US is going to need oil and gas for at least the next 15 years and perhaps longer. If something is a societal necessity, how can it be anti-ESG?
I've been a stock investor all my life and have seen fads come and go. One can have biases against certain companies or industries and that's fine. Grouping things under any rubric is foolish and overlooks potential opportunities for capital appreciation.
ESG might also just be shifting the focus from short term to long term profit. A company that’s focusing on long term sustainability might give up some profit now, but something like climate change could end up being more costly in the long run. It’s hard to sell products during a hurricane or wildfire or what have you. And it’s especially hard if your real estate is literally underwater.
Climate isn’t the only thing like that, too. The G in ESG seems pretty relevant for companies that have interests in China because their government is having serious impacts on businesses. So maybe an ESG strategy would have them open a factory in a place that’s more expensive but also doesn’t have that giant risk of the government just deciding to screw you over completely.
I think it should be looked at more as insurance. You might give up some money, but disasters like climate collapse or authoritarianism are really really expensive. Even more mundane stuff like plastic in the oceans is really bad for the profits of e.g fishing companies. So this gives you the option to try and avoid those catastrophies.
I think what has happened is that people wanted ESG for nonmonetary reasons, and then just sort of assumed (and started claiming, without evidence) that ESG also makes money. Which would be nice if it were true, but is probably not true for most ESG stuff. But maybe for some! Certainly in the case of climate, getting the jump on switching to green energy seems like a wise business strategy.
I think it can work as a (bad) standin for regulations. There's a bunch of stuff that causes way more harm than benefit that ideally would just get regulated out of existence, but we don't really have a government that can reliably do that. And I think a lot of the people involved in ESG are politically lean pretty far from where the government is. As an individual investor you can't really fix the regulators but you can at least make sure none of your money goes to stuff that's screwing the world up.
Thanks for this article. It’s something I’ve spent time wondering about too. I guess I have a few questions/thoughts.
- I choose to not invest in companies that make cigarettes. Isn’t that a form of ESG investing?
- Similarly I have chosen to invest in companies that make renewable energy, also a form of ESG investing I think. Are we saying that both of these decisions are ill-advised, or not necessary?
- An implication is that product purchases are a better way to make ESG goals happen? (As in Netflix). If I choose to not purchase Netflix because of its product choice, Should I ignore that in my investments because a profit-only focus creates a better societal outcome? Should I apply that dichotomous logic to other purchase/investment decisions, such as Amazon or Chick-fil-a?
I mean obviously as an investor you should invest in what you care about! But if companies make socially responsible choices that end up causing them to lose money and lose market share, then those companies simply won't stick around for long. So in a sense it's the market's choice which of these companies survive and thrive, not the investor's choice. If the market becomes much more competitive, it'll become a harsher environment for companies that want to ignore the bottom line to do the right thing.
Thanks so much for writing this article! I love the range of topics you delve into, and this perspective in particular. A few thoughts / questions:
1) It’s unclear to me what ESG has to do with, for example, content choices at Netflix. What is the policy mechanism that ties this to what would come out of an ESG strategy? I am not really understanding what “woke” means re: ESG specifically
2) ESG definitely represents non-market considerations but doesn’t only have higher cost impacts. This is both directly (e.g. ESG investors require a lower cost of capital) and indirectly (e.g. talent competition and better corporate governance) I’d want more research on how much that cost of capital bonus is and how durable it is in different market cycles
3) It feels like ESG is being conflated with contemporary corporate culture which I don’t think is necessarily the same thing. Again, “woke capital” feels like it’s more about positioning on political / cultural disputes vs. a specific ESG policy (e.g. abortion, gun control <> DEI, carbon footprint, compensation) - what’s an example of an ESG policy that would not withstand under increased competition?
4) Last thought, I think it assumes that certain tenets of ESG / ESG culture aren’t becoming tablestakes - Absent litigation a la DeSantis, what’s the basis for believing that companies can backtrack on these commitments without paying a real penalty?
5) Companies will likely only pursue ESG policies that will save them money or align strongly with their existing purpose / competitive advantage. Are we arguing that ESG is what damaged Netflix or hurt Disney? Don’t they need / want to have content / identity that aligns with their current and more
1) The Netflix thing was an example of corporate social responsibility (or lack thereof); ESG is an investing strategy, so they're not the same thing, but related! I just thought it was an interesting anecdote.
2) It's not clear that corporate governance is any better with ESG investors. I looked for evidence of that and could not find it.
4) Companies are VERY good at backtracking, and also very good at tokenism and hypocrisy!
Very interesting thoughts, two of mine in response. I wonder if ESG generated investment cut backs in oil has brought other investors into the field who see a market opportunity as prices rise. To be sure it has, but only some, and if it increases it may undermine the ESG movement, or at least divide companies along culture war lines.
The other thought is that perhaps Netflix and others who are saying no to woke morals are doing it because they are losing the other half of their customers, the ones who resent the criticism of Chappelle and others.
There may be some kind of balancing act going on here.
I think, in a nutshell, that stakeholder capitalism needs to be enforced by the GOVERNMENT. Rules like co-determination and sectoral bargaining can force companies to give workers a greater voice in corporate governance. Environmental laws can ensure that communities have a say about what gets dumped in their air and water (though we've also seen this backfire very badly in the case of NIMBYism). Consumer protection laws can protect consumers. In other words, this is a job for government; the market, on its own, will only ever make small moves toward stakeholder capitalism.
ESG objectives will be achieved when companies deliver better products, at better value, profitably. Good at a greater value than bad. If they do, they will garner resources and address the issue at scale. ESG needs to be a product feature desired by customers not the investment.
In my mind this is consistent to the context at the time Milton Friedman made his point.
Becker's Rule is "equality of opportunity", (Woke) ESG is "equality of outcome". The former is the nature of the world, the latter a vacuous virtue. If ESG is backed by the state or other non-financial institution, it is harder to displace.
Alternatively, displace ESG with oversight on pollution, slave/prison labor, and tracking fair wages, are easier. Why aren't people focus on quantifiable real issues instead? (Or is this some kind of Gervais Principle corporate bloat problem?)
I heard Dan Ariely on a podcast talking about ESG before the pandemic (I think). He has an investment thesis that the greater return on investment seen among companies who are rated high in ESG elements is actually only among those firms who are rated highly by their employees. He has a firm that he has started to invest only in those companies and it had been doing well at the time of taping.
I think the Becker theory is so attenuated in its usefulness that we should think of it more as a possible outcome/influence than a predictive tool.
I was just debating a similar issue with someone else today, and what popped out at me was that the core mechanical aspect of Becker is that it only works past a certain threshold of social agreement on whatever discrimination is being mitigated.
What's important is that the converse is actually easier to flip than the obverse. Jim Crow, for instance, was pretty easy to enact on a ground level. The Becker effect wasn't able to stop it in the short window it was given to do so -- in fact, that was the *impetus* of the Redeemer movement, to roll back Reconstruction before it was too late.
Although ESG is on the other side of the Becker effect from where we are with racial discrimination -- IE, restating your thesis that it's enacting a discrimination -- we should also note that the cultural trendline is both *towards* ESG's objectives (meaning that it'd be easy to flip into a discrimination-only regime) and also that its three main categories of objective are all decouple-able. That is, at some point in the future, the popularity of its pro-environment discrimination could easily diverge from that of its pro-social or pro-governance discrimination.
At any rate, I think that it's also easy enough to flip Becker on its head and say that sharedholder-value holdouts will suffer at a competitive disadvantage because they aren't focused enough on long-term stability.
At this point in the argument, though, it's hard not to notice how attenuated, subjective, and conditional the terms we're talking in have gotten. I'd posit that there's probably a more valid model -- publics/counterpublics, for instance -- for reformulating Becker into something more causally robust, and thus more useful.
One major (theoretical) dimension that you’re missing is that ESG companies should have higher access to capital, thus keeping them able to compete even if they’re not quite as good at the bottom line. This also works in the reverse direction, where non-ESG companies will have less access to capital, making them less competitive. Of course, this only matters if enough investors are ESG investors, or the marginal effects won’t matter.
A lot of ESG investment is from retail investors as well[0], so it’s not really true that it’s just prioritizing rich people’s values. On top of that, as long as we exist in a capitalistic society, we fundamentally prioritize the values of the wealthy over the not wealthy. If you disagree with that, the thing to attack isn’t ESG, it’s the market economy as a whole.
[0]: https://globescan.com/2021/12/14/retail-investors-show-strong-and-growing-interest-in-esg/
Retail investor dollars are more likely to be held by rich people; normal people's stock ownership is probably via a 401k or other institutional intermediary.
I recently came across carboncollective.co who create 401ks which are explicitly climate positive and not ESG driven as their research highlights how many climate destructive companies are on most 𝗘𝗦𝗚 indices. It’s got a lot of small caps but it’s an interesting approach (full disclosure, I am implementing their 401k plan for my own climate startup).
ESG is just something to make people feel good and lacks any reasonable definition. One can point to obvious companies that may produce problematic stuff such as cigarettes and alcoholic beverages. The coal industry is disappearing without any of us having to do much at all. The US is going to need oil and gas for at least the next 15 years and perhaps longer. If something is a societal necessity, how can it be anti-ESG?
I've been a stock investor all my life and have seen fads come and go. One can have biases against certain companies or industries and that's fine. Grouping things under any rubric is foolish and overlooks potential opportunities for capital appreciation.
Seems like a good time to investigate how ESG actually works in practice — in short, not well!
https://www.bloomberg.com/graphics/2021-what-is-esg-investing-msci-ratings-focus-on-corporate-bottom-line/
Thanks, hadn't seen that!
ESG might also just be shifting the focus from short term to long term profit. A company that’s focusing on long term sustainability might give up some profit now, but something like climate change could end up being more costly in the long run. It’s hard to sell products during a hurricane or wildfire or what have you. And it’s especially hard if your real estate is literally underwater.
Climate isn’t the only thing like that, too. The G in ESG seems pretty relevant for companies that have interests in China because their government is having serious impacts on businesses. So maybe an ESG strategy would have them open a factory in a place that’s more expensive but also doesn’t have that giant risk of the government just deciding to screw you over completely.
I think it should be looked at more as insurance. You might give up some money, but disasters like climate collapse or authoritarianism are really really expensive. Even more mundane stuff like plastic in the oceans is really bad for the profits of e.g fishing companies. So this gives you the option to try and avoid those catastrophies.
I think what has happened is that people wanted ESG for nonmonetary reasons, and then just sort of assumed (and started claiming, without evidence) that ESG also makes money. Which would be nice if it were true, but is probably not true for most ESG stuff. But maybe for some! Certainly in the case of climate, getting the jump on switching to green energy seems like a wise business strategy.
I think it can work as a (bad) standin for regulations. There's a bunch of stuff that causes way more harm than benefit that ideally would just get regulated out of existence, but we don't really have a government that can reliably do that. And I think a lot of the people involved in ESG are politically lean pretty far from where the government is. As an individual investor you can't really fix the regulators but you can at least make sure none of your money goes to stuff that's screwing the world up.
Thanks for this article. It’s something I’ve spent time wondering about too. I guess I have a few questions/thoughts.
- I choose to not invest in companies that make cigarettes. Isn’t that a form of ESG investing?
- Similarly I have chosen to invest in companies that make renewable energy, also a form of ESG investing I think. Are we saying that both of these decisions are ill-advised, or not necessary?
- An implication is that product purchases are a better way to make ESG goals happen? (As in Netflix). If I choose to not purchase Netflix because of its product choice, Should I ignore that in my investments because a profit-only focus creates a better societal outcome? Should I apply that dichotomous logic to other purchase/investment decisions, such as Amazon or Chick-fil-a?
I mean obviously as an investor you should invest in what you care about! But if companies make socially responsible choices that end up causing them to lose money and lose market share, then those companies simply won't stick around for long. So in a sense it's the market's choice which of these companies survive and thrive, not the investor's choice. If the market becomes much more competitive, it'll become a harsher environment for companies that want to ignore the bottom line to do the right thing.
Thanks so much for writing this article! I love the range of topics you delve into, and this perspective in particular. A few thoughts / questions:
1) It’s unclear to me what ESG has to do with, for example, content choices at Netflix. What is the policy mechanism that ties this to what would come out of an ESG strategy? I am not really understanding what “woke” means re: ESG specifically
2) ESG definitely represents non-market considerations but doesn’t only have higher cost impacts. This is both directly (e.g. ESG investors require a lower cost of capital) and indirectly (e.g. talent competition and better corporate governance) I’d want more research on how much that cost of capital bonus is and how durable it is in different market cycles
3) It feels like ESG is being conflated with contemporary corporate culture which I don’t think is necessarily the same thing. Again, “woke capital” feels like it’s more about positioning on political / cultural disputes vs. a specific ESG policy (e.g. abortion, gun control <> DEI, carbon footprint, compensation) - what’s an example of an ESG policy that would not withstand under increased competition?
4) Last thought, I think it assumes that certain tenets of ESG / ESG culture aren’t becoming tablestakes - Absent litigation a la DeSantis, what’s the basis for believing that companies can backtrack on these commitments without paying a real penalty?
5) Companies will likely only pursue ESG policies that will save them money or align strongly with their existing purpose / competitive advantage. Are we arguing that ESG is what damaged Netflix or hurt Disney? Don’t they need / want to have content / identity that aligns with their current and more
Importantly, future customer base?
1) The Netflix thing was an example of corporate social responsibility (or lack thereof); ESG is an investing strategy, so they're not the same thing, but related! I just thought it was an interesting anecdote.
2) It's not clear that corporate governance is any better with ESG investors. I looked for evidence of that and could not find it.
4) Companies are VERY good at backtracking, and also very good at tokenism and hypocrisy!
Very interesting thoughts, two of mine in response. I wonder if ESG generated investment cut backs in oil has brought other investors into the field who see a market opportunity as prices rise. To be sure it has, but only some, and if it increases it may undermine the ESG movement, or at least divide companies along culture war lines.
The other thought is that perhaps Netflix and others who are saying no to woke morals are doing it because they are losing the other half of their customers, the ones who resent the criticism of Chappelle and others.
There may be some kind of balancing act going on here.
Noah, what are your thoughts on the ‘stakeholder’ capitalism movement broadly?
I think, in a nutshell, that stakeholder capitalism needs to be enforced by the GOVERNMENT. Rules like co-determination and sectoral bargaining can force companies to give workers a greater voice in corporate governance. Environmental laws can ensure that communities have a say about what gets dumped in their air and water (though we've also seen this backfire very badly in the case of NIMBYism). Consumer protection laws can protect consumers. In other words, this is a job for government; the market, on its own, will only ever make small moves toward stakeholder capitalism.
You really did a good job on this one.
ESG objectives will be achieved when companies deliver better products, at better value, profitably. Good at a greater value than bad. If they do, they will garner resources and address the issue at scale. ESG needs to be a product feature desired by customers not the investment.
In my mind this is consistent to the context at the time Milton Friedman made his point.
Becker's Rule is "equality of opportunity", (Woke) ESG is "equality of outcome". The former is the nature of the world, the latter a vacuous virtue. If ESG is backed by the state or other non-financial institution, it is harder to displace.
Alternatively, displace ESG with oversight on pollution, slave/prison labor, and tracking fair wages, are easier. Why aren't people focus on quantifiable real issues instead? (Or is this some kind of Gervais Principle corporate bloat problem?)
I heard Dan Ariely on a podcast talking about ESG before the pandemic (I think). He has an investment thesis that the greater return on investment seen among companies who are rated high in ESG elements is actually only among those firms who are rated highly by their employees. He has a firm that he has started to invest only in those companies and it had been doing well at the time of taping.
I think the Becker theory is so attenuated in its usefulness that we should think of it more as a possible outcome/influence than a predictive tool.
I was just debating a similar issue with someone else today, and what popped out at me was that the core mechanical aspect of Becker is that it only works past a certain threshold of social agreement on whatever discrimination is being mitigated.
What's important is that the converse is actually easier to flip than the obverse. Jim Crow, for instance, was pretty easy to enact on a ground level. The Becker effect wasn't able to stop it in the short window it was given to do so -- in fact, that was the *impetus* of the Redeemer movement, to roll back Reconstruction before it was too late.
Although ESG is on the other side of the Becker effect from where we are with racial discrimination -- IE, restating your thesis that it's enacting a discrimination -- we should also note that the cultural trendline is both *towards* ESG's objectives (meaning that it'd be easy to flip into a discrimination-only regime) and also that its three main categories of objective are all decouple-able. That is, at some point in the future, the popularity of its pro-environment discrimination could easily diverge from that of its pro-social or pro-governance discrimination.
At any rate, I think that it's also easy enough to flip Becker on its head and say that sharedholder-value holdouts will suffer at a competitive disadvantage because they aren't focused enough on long-term stability.
At this point in the argument, though, it's hard not to notice how attenuated, subjective, and conditional the terms we're talking in have gotten. I'd posit that there's probably a more valid model -- publics/counterpublics, for instance -- for reformulating Becker into something more causally robust, and thus more useful.