Environmental, social, and governance considerations are playing an increasingly prominent role in business. ESG is now central to how firms in a wide range of sectors, including finance and asset management, define their purpose, mission, and strategy, and it is increasingly shaping hiring practices and regulatory activity. But whether the apparent embrace of ESG will deliver real progress remains to be seen.
The promise of ESG stems from an important proposition. The key challenges we face today – from achieving reasonable levels of equity and equality of opportunity to ensuring environmental sustainability – cannot be overcome by any single actor, not even the government. On the contrary, effective solutions will require all hands on deck, including business, government, finance, education, the courts, and the nonprofit sphere.
By embracing ESG, businesses are effectively agreeing to do their part. They are promising to align their objectives – including how they measure their performance – with broader imperatives relating to sustainability, development, and social well-being. But achieving this will require effective incentives, and creating them is not a straightforward matter.
Much attention has focused on the shift from shareholder primacy to a multi-stakeholder model. The definition of “stakeholder” is vague, but it is normally understood to include, in addition to a company’s shareholders, its customers, suppliers, employees (actual and potential), the communities in which it operates, and society in general.
Shareholders have a clear interest in satisfying at least some other stakeholders. If a company’s business model and practices are perceived to run counter to widely held values, it is likely to struggle to attract and retain customers and employees. Conversely, if a company’s activities are viewed as responsible or beneficial, it will have a much easier time attracting and retaining both. These can amount to powerful incentives.
But where is the line between responsible and irresponsible, beneficial and harmful? Sometimes, the answer is clear-cut: companies have faced public pressure to address unsafe working conditions and child labor in their supply chains. But in most cases, there are tradeoffs; you cannot simultaneously maximize two or more variables unless they are monotonically functionally related (they always go up and down together).
Consider the outsourcing of manufacturing activity to developing countries. This lowers prices for consumers in the company’s home market and bolsters growth, development, and employment in the country to which manufacturing is outsourced. But it also hurts the communities that used to produce the relevant goods and were heavily dependent on that employment. Even if the overall benefits outweigh the costs – assuming they could all be accurately quantified – the community still has a problem.
Complicating matters further are the vast differences among types of businesses. Some have large carbon footprints, and others do not. Some employ thousands of people who may be vulnerable to job displacement due to automation, but many do not. Given this, there can be no single formula for aligning a company’s business model and practices with environmental and social goals.
This is not to diminish the value of the multi-stakeholder framework. On the contrary, one question that deserves more attention is whether stakeholders should have greater representation in governance structures. An examination of corporate-governance systems across countries could help to clarify the issues and tradeoffs. Legal scholars have an important role to play here.
In any case, it seems clear that ESG is ultimately a creative exercise. This is not necessarily a bad thing; challenges that call for innovation and creativity motivate people. But, amid such uncertainty, clear and effective incentives become even more important.