By Tim Bovy
Globally, we are poised at an economic inflection point and mired in a political interregnum. As a result, business, led by institutional investors and the World Economic Forum (WEF), will take the lead in setting the standards for environmental, social, and governance (ESG) issues, while governments struggle with what Antonio Gramsci described as a crisis of authority. “The crisis,” he said, “consists precisely in the fact that the old order is dying and the new order cannot be born; in this interregnum a great variety of morbid symptoms appear.” These symptoms include: “open political violence, outbreaks and manifestations of mass discontent, the rise and acceptance of extreme political positions and their respective leaders, and the sudden depletion of once strong institutions.” Although this state of affairs in world politics is unsettling, and will remain so for some time as democracies vie with autocracies to define the 21st-century world order, institutional investors and the WEF are stepping in to provide the stability and continuity necessary to ensure the permanence of ESG. But, how did they bring about this critical inflection point in economics?
Writing in 1970, Milton Friedman said that businessmen who “declaim that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends; that business has a ‘social conscience’ and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers” were living in a kind of cloud cuckoo land of “pure and unadulterated socialism, ” and were the “unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.” Klaus Schwab, the founder of the World Economic Forum (WEF), recently declared that “this form of capitalism is no longer sustainable.”  He attributes this change in thinking in part to “the ’Greta Thunberg’ effect: The young Swedish climate activist has reminded us that adherence to the current economic system represents a betrayal of future generations, owing to its environmental unsustainability.”
The WEF is proposing that we shift to stakeholder capitalism. In shareholder capitalism, “the responsibility of business is to increase its profits”; in stakeholder capitalism, “society’s goal is to increase the well being of people and the planet.” Shareholder capitalism emphasizes “short-term profit maximization as the highest good”; stakeholder capitalism focuses upon “long-term value creation and ESG measures.” Investors have added their voices to the stakeholder capitalism chorus.
As Forbes has graphically demonstrated, “investor activities across the ESG field have accelerated. It started with BlackRock announcing that all of its $9trillion in assets under management would be governed by ESG considerations. It continues with the Net Zero Asset Managers Initiative being launched [in December 2020] with 30 of the world’s biggest asset
managers – including Legal & General Investment Management and UBS Asset Management – setting the goal of achieving net zero carbon emissions across their portfolios by 2050 with interim 2030 targets.”
Because ESG focuses upon non-financial reporting, there is considerable cynicism regarding its value, despite the global momentum gathering behind its adoption. But, herein lies a paradox: meeting non-financial ESG objectives improves financial performance. Larry Fink at Blackrock, for example, has pointed out that “companies with better ESG profiles are performing better than their peers, enjoying a ‘sustainability premium.’” This premium is based upon the MSCI ESG leaders index “designed for institutional investors seeking exposure to companies with a strong sustainability profile and with a relatively low tracking error to the underlying equity market.”
Encouragingly, small investors, such as Engine No. 1, with $250 million in assets, are also promoting ESG as a way to increase a company’s profitability and value. Their story regarding Exxon is instructive. Although Engine No. 1 has just a 0.02% investment in the oil giant, it “staged the first major rebellion against Exxon at the company’s annual shareholder meeting [at the end of May] by galvanising the support of the biggest investors in the world [including two of the largest US pension funds: New York’s $255bn Common Retirement Fund and California’s $300bn teachers retirement fund (plus Blackrock)] behind its plan to oust Exxon’s board members in favour of handpicked candidates with the nous to transform the climate laggard.” Engine No. 1 now has three members on the Exxon board. “Industry commentators believe their success proves that the world’s biggest investors are finally aligned with climate campaigners in accepting that sustainability is not only essential for the survival of the planet, but for the future of major companies too.”
Yet, and it is an important “yet”, Engine No. 1 is not motivated by non-financial ESG issues. On the contrary, it is motivated by profit: “ultimately the aim is to create wealth.” Their pitch is on the side of common sense: “’We strongly believe that climate risk is business risk,’” [Chris James, the company’s founder] says. “’Fossil fuels have big negative impacts. We take a long-term view to value creation, which means taking these externalities into account. There’s an intrinsic link.’” Exxon proves their point.
The irony is that whether an organization’s focus is upon non-financial ESG issues, or purely upon profit, with a commitment to ESG as a primary business strategy for reducing risk, the beneficiaries are the same: society, the environment, and the board. One can, of course, construct elaborate models to test the “sustainability premium” concept, as some academics have done. Abraham Lioui and Andrea Tarelli’s in-depth study, “Chasing the ESG Factor,” for example, challenges the idea of accepting such a premium as a given. Yet, detailed analyses, as useful as they are, do not account for the need of organizations across the entire spectrum, from shareholder capitalism to stakeholder capitalism, to develop an ESG strategy that increases profits and attracts investors. Ignoring the impact of ESG on the bottom line is simply too large a business risk, regardless of where on the spectrum an organization falls.
It is vital too that organizations not just focus on the E in ESG; the S is equally important. For example, “In BlackRock’s 2021 proxy voting guidelines and recent stewardship publications, the company emphasized that it is now asking US companies to disclose the racial, ethnic, and gender makeup of their employees. BlackRock did not stop there—it is also requiring companies to report the measures that they are taking to improve diversity, equity, and inclusion.”
“The ‘Social’ pillar within the traditional ESG agenda,” notes the GRESB, “customarily focuses on organisational policies and practices regarding human rights, business ethics, supply chain management, diversity and inclusion, and social impacts resulting from corporate operations.” But, they go on to say, “the three pillars of ESG are profoundly interconnected and require an integrated approach to maximise overall benefits and explore synergies. Social and environmental issues are effectively two sides of the same coin, and governance is the frame that ties them together.”
Exxon’s blinkered governance enabled Engine No. 1 to place three of their own on its board. The insurgents had impressive backing. First Blackrock acted. Then “Vanguard Group, a $7tn investment adviser and Exxon’s largest shareholder, fell into line with $3tn State Street, which is Exxon’s third largest investor. They both voted to oust two of Exxon directors in favour of Engine No 1’s candidates. BlackRock later said it was ‘concerned about Exxon’s strategic direction’ and that the company could benefit from the new directors who would bring ‘fresh perspectives’ to Exxon’s board.”
What is helping institutional investors and the WEF promote a global message regarding the importance of ESG is that, unlike governments, they are non-ideological. We speak of the World Economic Forum, not the China, or the US, or the EU economic forum. “Society’s goal is to increase the well being of people and the planet,“ not of the citizens of China, or of America, or of Europe. The message is simple: ESG is important, it’s universal, and it’s here to stay. Let’s get this done.
About the Author
Tim Bovy has over 35 years of experience in designing and implementing various types of information and risk management systems for major law firms such as Clifford Chance; and for international accountancy firms such as Deloitte. He has also developed solutions for organizations such as BT, Imperial Tobacco, Rio Tinto, the Kuwaiti government, The Royal Household, and the US House of Representatives. Tim is an elected member of The Royal Institute of International Affairs, Chatham House, an Independent Think Tank based in Central London. Tim holds a BA degree, magna cum laude, from the University of Notre Dame, and MA and C.Phil degrees from the University of California, Davis.
-  Quoted in Milan Babic, “Let’s talk about the interregnum: Gramsci and the crisis of the liberal world order,” International Affairs, volume 96, number 3, May 2020, p. 773
-  Milan Babic, “Let’s talk about the interregnum: Gramsci and the crisis of the liberal world order,” International Affairs, volume 96, number 3, May 2020, p. 773
-  See, for example, Hal Brands, “The Emerging Biden Doctrine: Democracy, Autocracy, and the Defining Clash of Our Time,” Foreign Affairs, June 29, 2021, available at https://www.foreignaffairs.com/articles/united-states/2021-06-29/emerging-biden-doctrine
-  Milton Friedman, “The Social Responsibility of Business is to Increase its Profits,” The New York Times Magazine, September 13, 1970, available at http://umich.edu/~thecore/doc/Friedman.pdf
-  Klaus Schwab, “Why we need the ‘Davos Manifesto’ for a better kind of capitalism,” World Economic Forum, 1 December 2019, available at https://www.weforum.org/agenda/2019/12/why-we-need-the-davos-manifesto-for-better-kind-of-capitalism
-  Please see footnote 5.
-  Klaus Schwab and Peter Vanham, “What is the difference between stakeholder capitalism, shareholder capitalism and state capitalism?”, World Economic Forum, The Davos Agenda 2021, 26 January 2021, available at https://www.weforum.org/agenda/2021/01/what-is-the-difference-between-stakeholder-capitalism-shareholder-capitalism-and-state-capitalism-davos-agenda-2021/
- The International Integrated Reporting Council is also calling time on the Friedmanite model. “A favored few,” they say, “have benefited from the system at the expense of a heavily-exploited ‘bottom of the pyramid’ underclass.” “Integrated Thinking & Strategy”, January 2020, available at https://integratedreporting.org/wp-content/uploads/2020/01/Integrated-Thinking-and-Strategy-State-of-Play-Report_2020.pdf
-  Chuck Ummuna, “ESG Investing Came Of Age In 2020 – Millennials Will Continue To Drive It In 2021,” December 18, 2020, Forbes, available at https://www.forbes.com/sites/chukaumunna/2020/12/18/esg-investing-came-of-age-in-2020millennials-will-continue-to-drive-it-in-2021/?sh=5a3081c5409a
-  Larry Fink, 2021 Letter to CEOs, available at https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
-  Please see: https://www.msci.com/msci-esg-leaders-indexes
-  Jillian Ambrose, “‘This isn’t ideological’: reluctant ‘green hero’ behind Exxon coup,” The Guardian, 4 June 2021, available at https://www.theguardian.com/business/2021/jun/04/exxon-coup-ideological-reluctant-activists-engine-no-1
-  Please see footnote 8.
-  Please see footnote 8.
-  Abraham Lioui and Andrea Tarelli, Chasing The ESG Factor (July 1, 2021). Available at SSRN: https://ssrn.com/abstract=3878314 or http://dx.doi.org/10.2139/ssrn.3878314 (There modelling supports claims of the ESG factor historically but posits that a continuation into the future is unclear from current evidence.)
-  Elizabeth Sisul, “The “S” In ESG,” Forbes, April 6, 2021,
- available at https://www.forbes.com/sites/guidehouse/2021/04/06/the-s-in-esg/?sh=39a496d43839
-  Hoare Lee, “The rise of the “S” in ESG Reporting,” GRESB, April 30, 2021, available at https://gresb.com/the-rise-of-the-s-in-esg-reporting/
- Please see footnote 8.
-  “We have no ideological or commercial interests. This does not mean that we are neutral – we are committed to improving the world in ways that are objective, measurable and sustainable.” “What makes us unique,” World Economic Forum, available at https://www.weforum.org/about/what-makes-us-unique