Investment trends (or, if one is being unkind, ‘fads’) come and go. For much of the last two years artificial intelligence has been firmly in the spotlight. Before that the pandemic sparked a wave of interest in biosciences. In the late 2010s, the big trend seemed to be Corporate Social Responsibility (CSR). But whilst media attention has mostly moved on, CSR – and its close relation the use of ESG (Environmental, Social, and Governance) factors when making investment decisions – remains a growing part of the financial landscape.
What seemed, as recently as a decade ago, to be a fairly niche concern for asset markets has now gone mainstream. An article in the Journal of Corporate Finance, published in 2021, set out the numbers. In 2018, 86% of S&P 500 firms released sustainability or corporate responsibility reports compared to less than 20% in 2011. That shift reflects underlying demand for such data from investors and asset allocators. In 2019, 300 mutual funds with ESG mandates received total inflows of $20 billion, up four-fold on the year below. More generally, more than 3,000 institutional investors have signed up to the Principles of Responsible Investment – an international framework for incorporating both ESG issues and CSR concerns into investment decision making processes. Total assets under management at firms signed up to these principles rose from $6.5 trillion in 2006 to more than $86 trillion in 2019.
Broadly speaking, CSR tends to refer to the practice of firms attempting to act as “good corporate citizen” by, for example, attempting to minimize their environmental impact or by promoting wider social goods through their hiring and recruitment policies. CSR can be quite a nebulous idea. ESG is an easier concept to pin down. The term originally appeared in a 2004 report by twenty large financial institutions drawn up for Kofi Annan, the then Secretary-General of the United Nations. The idea was to develop a scorecard that investors could use to show how well, or not, corporations had integrated environmental, social, and governance concerns into their business models. Neither concept is without its critics. As some note, it is perfectly possible for, say, a tobacco firm to score highly on ESG factors. And yet many would argue that even if such firms have excellent programs to offset their carbon emissions, low gender and racial pay gaps, and open and transparent board procedures their core product still kills people and is hardly “socially responsible”.
Whatever one might make of ESG investing and firms pursuing CSR, it is now something that few investors or management teams can choose to ignore. This week the Clark Center Finance Expert Panel examined the topic. The results were both interesting and a little surprising.
Taking the last question first, the panel was asked whether there are “substantial social benefits when managers of public companies make choices that account for the impact of their decisions on customers, employees, and community members beyond the effects on shareholders”. The traditional answer of many economists – and still the answer of some on the panel – might be that of Milton Friedman in his famous New York Times piece of 1970. The only duty of a firm’s management, by his definition, was to look to increase profits whilst staying within the rules of the game. Anything else risked suboptimal outcomes for society as a whole.
The panel though took a somewhat more nuanced view. Weighted by confidence, 9% strongly agreed that such policies led to substantial social benefits and 50% agreed. Just 18% either strongly disagreed or disagreed. In other words, the balance of expert opinion was that firms taking into account the impact of their decisions on wider stakeholders, rather than just shareholders, was a net positive for society as a whole.
On the other hand, it may well not be good for their bottom line. Asked whether public companies that pursue social and environmental initiatives bear no measurable costs (in terms of lower profits) relative to similar companies that do not pursue such initiatives, the results were decisive. 71% of respondents, weighted by confidence, either strongly disagreed or disagreed.
Taken together, the answers suggest that firms taking into account the impact of their actions on employees, customers, and the wider community might well be good for the community overall but is also likely to leave such firms at a competitive disadvantage relative to peers who focus solely on profit margins.
Many proponents of greater CSR and the wider use of ESG factors in investment would not disagree. They see the rise of ESG investing as a way to square the circle. In theory, as a greater proportion of the total sum of investable funds globally becomes concerned with ESG, then it is possible that the cost of capital for ESG compliant firms could fall. That would, again in theory, potentially compensate such firms for the higher cost of doing business in a “responsible” manner.
On this though, the panel remains unconvinced. Asked whether “public companies that pursue social and environmental initiatives benefit from a measurably lower cost of capital than similar companies that do not pursue such initiatives” more than half of respondents were uncertain with the rest fairly evenly split between agreeing and disagreeing.
CSR has become big business over the last decade and ESG is becoming impossible to ignore in asset management. But both, in the grand scheme of things, are still relatively new trends. More evidence and research is needed to fully grasp their effects.
