Investors care more than ever about the environmental and social impact of companies they invest in.
In the big picture, this is progress towards making the world a better place. But when it comes to influencing business decisions, we should be careful about good intentions leading the economy astray.
There are now a variety of Environmental, Social, and Governance (ESG) indices to help investors steer their capital toward companies that show good corporate citizenship. But there is a problem: many of these different ranking systems don’t agree. In fact, they are so uncorrelated that rankings cannot agree on which companies are doing well versus poorly.
Ranking companies on these metrics can be challenging. Does positive environmental impact mean they only use non-toxic chemicals? Low carbon emissions? Recycled materials? Local sourcing? A percentage of profits donated to Greenpeace? Is a Tesla great for the environment because it runs on electricity, or bad for the environment because the manufacture of all those batteries is extremely energy intensive? It’s really hard to know.
Social impact and governance have the same problems. The answer you get depends on what you decide to measure, and these concepts are too vague to measure with confidence. The intention to invest in companies that do good is a nice one, but without meaningful metrics, it’s currently more confusing than beneficial.
If enough investors jump aboard the train to ethical investing then business leaders will take notice and adjust their priorities even faster than they already are.
But if the metrics don’t measure the right things or no consensus develops, then I see this movement creating more harm than good, as perverse incentives steer businesses into making loss-making decisions that are bad for shareholders but score well on certain metrics.
There could be other unintended consequences also. For example, somebody who wants to help an impoverished community might donate a bunch of free stuff like school supplies, kids’ toys, clothes, etc. If those giveaways are what you measure, you’d think you were really helping. But what if the deeper result is that you drove the only local businesses into bankruptcy, because nobody can compete with free? Those do-good metrics would completely miss the economic harm and the real impact.
Money isn’t everything, and things like social impact absolutely do matter. But there are really good reasons why profits, returns on investment, and other financial metrics are so central to our business culture. They are clear, factual, and reliable. Financial returns give us an unambiguous scorecard to measure our decision-making. That’s why I always keep an eye on shareholder value. It’s the most proven way to ensure long term success.
Hopefully ESG metrics will improve over time. Until then, I’ll watch them, cautiously.