11 Jul The Academization of ESG
The following commentary/analysis is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers. I am sharing it here today because I thought it might be useful to some of you.
On the Changing Nature of the ESG Discussion
Last month, Rupert Darwall, a senior fellow of the RealClearFoundation, penned a long and fascinating review of three of the latest books on ESG. As always, Darwall’s keen analysis and insightful commentary are cause enough to read his essay, but this one is a “must-read” for other reasons as well.
To start, the three books Darwall reviews (The Case for Shareholder Capitalism: How the Pursuit of Profit Benefits All, by R. David McLean; The Race to Zero: How ESG Investing Will Crater the Global Financial System, by Paul H. Tice; and May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases—and What We Can Do About It, by Alex Edmans) are all important tomes that add considerably to the literature on ESG (and related subjects). Edmans’ book in particular has rightly created quite a stir in the financial world and has threatened many of the key premises underlying ESG. Darwall writes:
When it comes to claims about ESG, Edmans provides examples that suggest that the book’s title is underdone. It’s a pretty safe bet that a pro-ESG statement will contain lies….Edmans relates that a House of Commons committee asserted that an academic paper found that high wage disparities damage corporate performance, despite Edmans telling the clerk to the committee that the conclusion had been from a preprint that, post–peer review, came to the opposite conclusion.
Then there is the case of the “world-famous” investor who invites Edmans to partner in a new fund focused on pro-gender-diversity companies—if he could come up with supportive research. Edmans and a colleague crunch 24 relevant measures; 22 are negatively associated with company performance; one has a statistically insignificant relationship, leaving only one (fewer media reports on diversity controversies are linked to stronger corporate performance). Six months later, the investor launches a diversity fund backed by other research claiming that female-friendly firms perform better. Data mining, Edmans says. Even by Wall Street standards, pushing ESG investment products demands unusual levels of cynicism.
Additionally, and more to the point – for the purposes of this commentary, at least – the books Darwall reviews are important specifically because of their authors. David McLean is the William G. Droms Professor of Finance and Finance Area Chair at Georgetown University’s McDonough School of Business. Alex Edmans is a professor of Finance at London Business School and was previously a tenured professor at Wharton. Paul Tice is a Wall Street veteran but is also an adjunct professor of finance at the Stern School of Business at New York University. In short, two of the three are full-time and long-time academics, while the third is, at the very least, academic-adjacent.
I have long believed (and have argued in person, if not in print) that the evaluation of ESG is entering a new stage. For several years, ESG was strictly a market phenomenon. It was discussed and analyzed largely by market participants and was assessed largely in market terms.
Maybe a decade or so ago, that began to change, and ESG became a political phenomenon as well. As market-based advocates for ESG started to discuss the political predispositions underlying and animating the investment strategy more openly, aggressively, and smugly, those who opposed the politicization of markets (yours truly, included) responded in kind, exposing the ideological foundations of the movement and emphasizing the risks it poses to the stability of both markets politics.
In turn, this created something of a stalemate in assessing the effectiveness and appropriateness of ESG in investment decisions and corporate engagement. Despite the extensive efforts of those who oppose ESG and the consequent politicization of markets to present their case as non-ideological and non-partisan, the binary/Manichaean nature of contemporary political discourse has turned the ESG debate into a “good vs. evil”/“us vs. them” contest in which the definitions of those terms depends on one’s ideology/partisan affiliation. In retrospect, this development was probably as inevitable as it is unfortunate.
About a year ago, the discussion began to change – again. Andy King, a professor of business strategy at Boston University, led the earnest academic assessment of ESG. Although various “studies” and academic analyses had always been a part of the ESG discourse, King (and contemporaries like Edmans) conducted the first serious, thorough, and intellectually honest academic analyses of the phenomenon and drew the first serious, thorough, and intellectually honest conclusions:
King, a professor of business strategy at Boston University, questioned the studies’ conclusions. In decades of analyzing whether companies could profitably reduce their harm to the environment, King had found the financial gains were often too small to affect the bottom line. Digging into the latest research, scrutinizing complex mathematical formulas and parsing tens of thousands of data points, he discovered what he says are flaws that skewed the results. “The evidence supporting ESG just wasn’t solid,” King says.
Other scholars are increasingly reaching similar conclusions, with researchers from Columbia University, the University of California at Berkeley, the Massachusetts Institute of Technology and beyond releasing studies that bolster King’s work. These academics, generally supportive of efforts to combat global warming, have sparked a debate over the so-called ESG programs—guided by environmental, social and governance considerations—adopted by many corporations.
Going forward, it is highly unlikely that any discussion of ESG performance will be considered valid unless and until it is confirmed or, at least, buttressed by academic research. (And for the record, this is in addition to and separate from assessments about ESG’s ethical legitimacy and moral foundations).
In some ways, this is a positive development for those who have always questioned ESG’s validity. When they are honest and thorough, even academics on the political Left – people like Alex Edmans – are fairly unified in their conclusion that there is no legitimate econometric evidence supporting the idea that ESG strategies perform as well (much less better than) non-ESG strategies. ESG is largely unjustifiable in purely financial terms.
In other ways, of course, this is a negative development. It almost goes without saying, but not all academics are as honest or as willing to subjugate their political predispositions to the evidence as Edmans is. Recently, for example, Dr. Travis Roach, an associate professor and the chairman of the Department of Economics at the University of Central Oklahoma, published a study titled “Unintended Consequences of the Energy Discrimination Elimination Act in Oklahoma,” which was highly critical of Oklahoma’s anti-ESG law and has been used by ESG supporters to attack that law.
The first problem with the study is that it’s a methodological mess, as the inimitable Jerry Bowyer demonstrates here. The second problem – an even more significant problem – is that Roach’s qualifications to conduct the study and his motivations for doing are also highly suspect, as Derek Kreifels, the CEO of the State Financial Officers Foundation noted in an email:
[T]he American Accountability Foundation has uncovered troubling information about the author of the study, Dr. Travis Roach.
Their findings suggest that Dr. Roach may have negligently or intentionally misled the public. In an email to a colleague (screenshot below) Dr. Roach admitted that he knows “almost nothing about” the impact of ESG on local government finances—the very topic of his research report.
What’s even more egregious is that the Oklahoma Rural Association paid Dr. Roach $6,800 for this research, leveraging both his academic credentials and the credibility of the University of Central Oklahoma.
In the end, the “academization” of the assessment of ESG is neither all good nor all bad. It simply is. This development was largely inevitable and certainly represents a step forward both for those who seek honest answers about ESG performance and for academia in general, parts of which had previously taught ESG principles uncritically and to their own reputational detriment.
