How to speak ‘ESG’

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ESG. What does ESG mean? Even if you are familiar with the term, you may still struggle with its meaning. Environmental, social, and governance. Is it about risk? The effects of climate change on companies' growth prospects, for example? Is it about what companies do to the environment? Or how they should behave with workers? Why is governance included in ESG? In our first episode, we look into the language of ESG. We look at why investors and regulators care about it. And why learning to speak this language language actually matters for business leaders of today and tomorrow. I'm Silvia Pavoni, your host, and this is Sustainable Views, the podcast. In this first episode, we hear from one of the most interesting voices out there trying to decode ESG. Her name is Alison Taylor. She teaches at NYU Stern School of Business, and she's also in charge of the university's ethical systems platform. Alison actually thinks that ESG as an umbrella term isn't that bad. At least it spells out the areas it attempts to capture. But is it useful?

It's a good question. I like the term in that at least it is specific about what we're talking about: environmental, social, governance. So in that sense, I think I prefer it to sustainability, which I find is usually still often understood as exclusively environmental. Whereas, of course, what we're really trying to do with this field is make things broader. So in that sense, I like that the acronym is very specific. That said, I'm not sure that it's intuitively clear to anyone why governance is in there. We can certainly see that environmental and social issues relate to a business's negative externalities, whereas governance is internal. So I think that is already confusing. And then I think this is, of course, a field with far too many acronyms. So I think it would be better if we had fewer acronyms and spoke about all these ideas in a language that it's easy to understand if you're not steeped in the jargon of this, this entire area.

For those less familiar with this language, the other terms or jargon that Alison refers to include things like TCFD, SFDR, SDGs, ESRS, and also ISSB, EFRAG, G Funds. There are many more, and you can find out what they mean on our website.

This is an area with a ton of jargon. And I think that is a feature, not a bug. There is a tendency for people to constantly try to coin the latest language and latest term and get the world behind them. And I think that seems to suck up a lot of energy that we could be spending on more productive things.

But what underpins this language? Should ESG be understood as ethics?

I'm not sure it should just be ethics, because what we are trying to do is identify ways of holding businesses accountable for their negative externalities that they haven't been held accountable for financially in the past. We are also trying to identify opportunities to innovate and grow and ways to make more money from the fact that the world is changing and consumer demand is changing and what we're worrying about is changing. And there are ethical obligations that stem from these negative externalities. So I think that one of the challenges is we're trying to get a lot of different goals achieved under this umbrella. And I think you really, really start to see that show up when we start to look at incentive design, where you end up with companies setting a lot of goals where it's not necessarily clear whether what they're trying to incentivize is more innovation and more business development, or they're trying to set ethical guardrails around what we're doing. And so Because we don't differentiate adequately between these two concepts, we can't design the kind of governance incentives that we need to get the job done.

Alison has actually written about ESG incentives for Sustainable Views. You'll find the link to her opinion piece in the show notes.

But I think you really, really see those conceptual contradictions and problems with ESG when you start to look at what we're trying to incentivize businesses to do. And then more broadly, I would make that point about report reporting frameworks in general, where we are saying simultaneously, just be transparent and give us all your data and keep disclosing more and more and more things and everything will be great. And that will drive win-win shareholder value and stakeholder engagement and all these wonderful things. We say that and just give us all this data and we will use it to score you and rate your company and decide what we're going to do with capital and whether we're going to withdraw it and punish you if you're are not doing a good enough job.

What she's referring to is the proliferation of ESG disclosure frameworks over the years, some of the terms mentioned earlier, and the growth of data providers and rating agencies scoring companies based on those ESG metrics. So where does that leave companies and investors?

Are we treating transparency as an opportunity or a weapon? And so given that we're not clear about that, I don't think it's It's super surprising that what we tend to get out of corporations is a sort of curated impression management and trying to tell our stories.

Transparency is important, essential, actually. But trying to meet the needs of different users, shareholders versus stakeholders, is a complex task. And the different point of views of different bodies designing those frameworks is, at least at this stage, adding to the confusion. Are these efforts making things better or worse? And are they useful?

If you look at how companies are reporting on their carbon emissions, for example, at the moment, it's a complete free-for-all. And if you're trying to compare across companies, it's almost impossible. So I certainly don't think it's a bad thing to require some set of disclosures. I think we are fooling ourselves if we think that that is going to be sufficient. If company— if we think that companies are not going to try to curate those disclosures to show themselves in the best light possible. And also, if we think that's going to tell us everything that we need to know about a company, the reality is that we can't treat these data points as objective performance metrics. Whether your water use is high or low depends very much on the operating context of your industry and also the geographies that you're in. And so none of this data makes any sense out of context. And I fear that what we are doing is trying to please investors by providing them with apples-to-apples data so they can put companies in a portfolio and create a score. And that kind of incentive towards a company is not necessarily what you need in terms of finding what the real strategic priorities are and focusing. I have never spent more than 5 minutes in any corporation that can meaningfully prioritize 30 or 40 issues, not least issues that are not seen as core to the business, but there are issues that you need to get right for some kind of, I wouldn't say necessarily side reason, but these are not core strategic growth imperatives. They're other priorities that we've now decided business should meet. It is not to me sensible to think that any business is going to be able to execute and be ambitious on 30 or 40 issues. They may be able to prioritize 1 or 2 meaningful strategic priorities. So there's a massive tension between breadth and depth. And what I would always say to a company, if I'm advising a company, is these metrics are useful. They're a useful part of the landscape. They're a terrible guide to strategy, and they're a terrible guide to thinking about what you need to be doing as an organization to really make sustainability happen. So yes, pay attention to these frameworks, pay attention to how social and environmental pressures are evolving and what investors are focusing on, but do Do not manage to the metrics and do not think this is going to help you in any way come up with some kind of corporate strategy around these issues.

Right. If you are the CEO of one of those companies, don't despair. The disclosures investors and regulators are requesting may not necessarily set you on course to be more sustainable, but the request of other stakeholders could prove more beneficial, says Alison Taylor Taylor.

I mean, I think probably the biggest force that's going to drive them is less external than internal. I think it's employees. I think employees are your most important stakeholder. I think it is really where the rubber hits the road on these topics. I think it is where the source of demand really is. And it also explains how companies have got so drawn in, especially in the US, to speaking up on controversial social and political topics because they feel they have no choice but to respond to employee demands about abortion rights, rights or climate change or pay or racism or whatever it might be. So none of those things, or, or only part of those things, are areas where there's a very clear business case in terms of financial returns. But we can see that companies have been drawn into these conversations. So I tend to look at employees and then I would extrapolate from that and I would say do a very rigorous materiality assessment. You need to consult external stakeholders. You need to consult your senior leadership team, but you also need to consult your broader employee population. And you need to identify then a small set of strategic priorities. And I would say 1 to 3, not the same thing as saying 1 to 3 metrics, but 1 to 3 issues that are transformational for your organization. And then what I think you need to do is go to every division in the company and say, what are you going to do to help us meet this strategic imperative? And What combination of growth targets, innovation incentives, ethical imperatives, and guardrails are you going to put in place for your division to make that priority happen? So, so I would, you know, if it's diversity, you need to think not just about diversity metrics in your senior leadership team. You need to think about hiring. You need to think about retention. You need to think about pipelines. You need to think about parental leave and sick leave. You need to think about procurement. You need to think about what kind of philanthropic investments you're going to make if diversity is really a strategic priority. And that's very, very different from saying, we're looking for a certain percentage of women on our board in another 5 years. So, and I think that, you know, this explanation also shows why we can't have 40 issues, because if you're really going to do this properly, 1 to 3 issues would be better.

So we're talking about the language of ESG, but as the subject permeates academic courses as well as corporate life, I've asked Alison how she teaches ESG.

What I try to do is put the concept in historic context, to talk about when this was CSR, when this was thought of as philanthropic, to then talk about where the idea of sustainability comes from, which is really from the development industry, and talk about why and how we saw this as an ethical imperative. And then to try and explain why we've seen this exponential rise in investor interest. And then I really get the class to have a debate debate. I get the class to have a debate about whether they think these business case, uh, kind of arguments are the best arguments to make. I get them to discuss what they think Larry Fink's motivation was in writing his 2018 letter, because it seems very counterintuitive. You have the most powerful shareholder in the world, on the face of it, pushing against his, his self-interest. So I asked them to explore and debate and critique that. We then do a big stakeholder engagement exercise on Facebook Facebook. So I get the class to divide and look at, take the position of an investor or an employee or a user or the government and discuss which other stakeholders are aligned with my interests. What am I going to try and do? What are my options for holding Facebook accountable? So that's to try and get them to understand a stakeholder perspective. And then something else I do is have a debate about would you work at Amazon? So we read a 2015 article about employee employee activism and kind of problematic culture at Amazon. And then we will have a debate with the class about, is this a company you'd work in? Is this somewhere you would take your career? And what I find fascinating about that is you will tend to see a very binary 50/50 divide in the class where half the class will say, of course I would work there. This is the most innovative company in the world. Incredible CV points, incredible opportunity to be at the front of some of the most dynamic thinking out there in the private sector. And then the other half of the class say, one, I wouldn't be able to manage there for more than 5 minutes, and I would never work anywhere so toxic and with such terrible employee conditions, and I believe this company is completely unethical. So I think that debate to me really illustrates the state of the MBA mindset and the MBA job market at the moment and how different it is and how differently young people feel about these questions. So I think we're in the middle of this very messy paradigm shift. But the other thing that I see in the classroom is a very new type of leadership, very new expectations of leaders, certainly an assumption of diversity. Certainly I see students looking at the composition of the senior leadership team and looking to see what companies say about these topics and whether they really mean it when figuring out where to work. So I do see something profound going on. And I'm certainly not teaching just to the sustainability advocates and cheerleaders.

Well, you've heard Alison. Just like speaking ESG, teaching about these factors is complex. There are those that see ESG as a black and white matter, those that find it meaningless and a distraction. And then there is everyone in between. That's where we are with ESG. And that's also it for today's show. I hope you enjoyed it. A big thank you to Alison for joining us. And thank you also to my producer, John Rogers. You will find us again in 2 weeks for the next episode of Sustainable Views, the podcast.

This podcast is supported by Federated Hermes Limited, a global leader in active responsible investment. We follow 3 pathways: active ESG, sustainability, and impact. 3 routes to one destination: sustainable wealth creation. Capital at risk. Professional investors only.