Environmental, Social and Governance Criteria

Environmental Social and Governance Criteria

Source: Adapted from World Economic Forum (2020) Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.

Environmental, social, and governance (ESG) criteria have been advocated by the World Economic Forum as a stakeholder capitalism approach trying to define corporate standards that can be used for investment purposes. Several terms have previously been used for such a purpose, including socially responsible investing and sustainable investing. ESG, as its name states, is oriented along three major criteria. The first, environmental, reports how a corporation has strategies for safeguarding the environment, such as reducing its carbon emissions and impacts on ecosystems. The second, social, is a proxy for corporate relations with a variety of stakeholders such as employees, suppliers, and customers, which is expanded to include communities in which it is located. The last, governance, covers issues such as compensation (leadership and workers), the composition of the workforce, and ethical behavior.

These criteria have been articulated around a series of indicators that can be used to assess to what extent a corporation meets stated ESG goals by a variety of rating agencies that have developed ESG indices, particularly those involved in market capitalization. The best known are Bloomberg, Standard and Poors, and Dow Jones. Still, ESG is subject to controversy since it exposes a corporation to external compliance factors unrelated to its real role and function; providing goods and services. The most notable issues include:

  • Effectiveness. Are the ESG goals and criteria really reflective of sustainability? The benefits are not necessarily clear and more than often represent ideological judgments of value. Assessments about sustainability and environmental impacts in the past have been spectacularly wrong.
  • Loss of focus. A corporation engaging in ESG is forced to consider a multiplicity of issues by pursuing metrics and meeting standards with unsubstantiated benefits based on inaccurate science, particularly the social and environmental components. By allowing leadership to partake in virtue signaling, ESG can incite a diversion of capital and efforts into activities providing limited value to the corporation and its customers.
  • Legitimacy of rating agencies. ESG is not assigned by market principles but through compliance with rating agencies claiming legitimacy over the evaluation process. These agencies can be subject to ideological capture by advocacy groups and perpetuate their own biases that tend to be inclined toward socialism. This can create a sense of overreach in internal corporate matters by actors having no stakes in the outcome.
  • Burden of reporting. ESG can be highly demanding in terms of metrics requiring resources to collect data. It can also devolve into an exercise of ticking boxes and falsifying or exaggerating outcomes. Further, ESG data is unlikely to be comparable across industries and even across corporations within the same industry.
  • Lack of vision. ESG anchors evaluation perspectives into a mechanistic approach focused on compliance with the risk of overlooking real and transformative opportunities.
  • Unfair competition. ESG can allow large firms to solidify their handhold on markets by preventing smaller or new firms from competing because of the imposed regulatory burden. In this context, ESG becomes a tool for monopolistic or oligopolistic behavior.