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What’s Really at Stake with ESG

Theories of business, investment, and corporate management come and go. Recent events suggest that we might be closer to such a tipping point with ESG.

Before its very public implosion in November 2022, the now-bankrupt multi-billion dollar cryptocurrency exchange, FTX, enjoyed very high ESG ratings. Apparently those doing the rating hadn’t been paying attention to FTX’s failure to adhere to basic good-governance practice. Compounding matters, FTX’s former CEO Sam Bankman-Fried has admitted that he regarded ESG largely as a virtue-signaling exercise. It also came to light that developing a reputation as a company that took ESG seriously was part of FTX’s strategy for getting close to legislators to try and secure a regulatory environment that directly benefited FTX rather than consumers.

If that was not enough, ESG’s credibility has taken another hit from statements by prominent figures once involved in forming major firms’ ESG investment strategies that they do not believe that ESG works. The most thorough and empirical of such critiques has been articulated by former Blackrock senior executive Terrence Keeley. After ten years of involvement in this area, Keeley determined that ESG had largely failed to fulfill its stated objectives. Other former Blackrock executives have arrived at similar conclusions.

But these emerging critiques of ESG from within corporate America, plus the growing backlash against prominent CEOs who have sounded like Chief Wokeness Officers for some time, do not indicate that debates about ESG are over. For arguments about ESG reflect long-standing disputes about business’s role in society, the obligations that companies owe to constituencies beyond their owners, and the state’s role vis-à-vis commercial enterprises.

ESG and the State

This last issue is central to Jennifer J. Schulp’s response to my essay “Why Business Should Dispense with ESG.” Her thesis is that whatever you think of ESG and the progressive causes with which it is almost universally associated, we should be wary of using government power to pressure corporations to distance themselves from ESG.  

Do we really want, Schulp argues, government officials informing investment funds that they must divest themselves from enterprises for pro-ESG or anti-ESG reasons? Doesn’t anti-ESG activism on the state’s part constitute just as much an interference with the economic freedom of businesses and the property rights on which such liberties are grounded as trying to force ESG priorities and methods on businesses?

These are good questions that ESG critics should not ignore. As stated in my essay, I think that a company should be free to embrace ESG as an investment strategy and method of assessment if it does not conflict with existing corporate law or the company’s by-laws, and if no pre-existing contractual arrangements preclude a company going down such a path. If investors want to pay the higher fees and accept the lower returns that ESG funds tend to deliver, and if businesses want to embrace what I regard as ESG’s multiple incoherences, they should be free to do so—provided, however, that such companies and their investors bear the full costs of any failure and don’t try and pass their losses onto taxpayers.

The flipside is that the same principles should be applied to ESG advocates. They can argue in favor of ESG as much as they like, but they should refrain from working with legislators and regulators to impose ESG on others. The freedom to embrace ESG implies the liberty for those businesses who regard ESG as offering sub-optimal returns, who do not consider themselves obliged to promote assorted political causes, or who regard ESG as a way for executives to excuse subpar performance, to reject ESG and all its works. In other words, the protections accorded by market freedom should cut both ways for ESG advocates and skeptics.

The Ends of Business

This question of the nexus between business, state power, and ESG is central to Austin Stone’s essay in this forum. Stone shares most of my critique of ESG. Nevertheless, he is more willing to consider using government power to push back against ESG’s advance throughout corporate America. Advocates of ESG, he maintains, are not interested in questions of fairness and justice. They only care about power. And if all someone cares about is power, Stone suggests, you need to face up to that fact and act accordingly.

Variants of this argument flourish on much of the right today about a range of political and economic questions. The problem is that if you use state power to punish companies that freely adopt ESG, you validate the methods of those ESG supporters who have already shown, as Stone notes, that they are more than willing to play that game. The fact that someone acts in ways that indicate an ambivalence about justice does not legitimate a choice on your part to do the same. Even good ends never justify wrong means. Economic freedom and property rights are not absolute, but the standard for overriding them to address a problem like ESG in societies that purport to take constitutionally limited government seriously ought to be very high indeed.

What I find curious and encouraging, however, about the specific solutions to ESG floated by Stone is that they are far more free-market than power-political in their orientation. Stone refers, for instance, to attorneys suing investment funds on behalf of clients who believe that a corporation’s embrace of ESG violates pre-existing promises to maximize shareholder value. That’s a case of using contract law for redress against breach of promise. This is entirely consistent with free market principles concerning the importance of contract enforcement.

Or consider the primary example that Stone offers of using power to strike back at ESG: the decision by several state government officials to withdraw the public funds that they have invested in ESG-friendly outfits like Blackrock. Yes, the rhetoric surrounding decisions to divest state funds from these companies has been of the anti-woke variety. But the formal legal reasoning used is less a matter of intervention (in the sense of directly coercing businesses to do things that they would otherwise not do) than it is state officials judging that, to the extent that such firms embrace ESG, they are not fulfilling their fiduciary responsibility to maximize shareholder value.

From this perspective, state officials made a judgment about likely return-on-investment and then employed a market mechanism (divesting) to give effect to that choice. This sent a market signal to some major corporations: that to the extent ESG compromises a business’s ability to maximize profit, some rather large investors will take their capital elsewhere. Judging from the backpedaling of some once outspoken ESG advocates in corporate America, such signals had an effect. What’s important, however, is that none of these decisions involved trampling over anyone’s property rights or economic freedom. On the contrary, they demonstrated the importance of these liberties and protections.

Despite recent scandals and road bumps, ESG will continue to make considerable inroads until business leaders themselves become far more explicit and confident about the real good that business does.

Stone’s essay raises, however, a wider issue. For all its faults, he argues, ESG’s rise reflects the need for business to adopt a telos that goes beyond making profits. Profit, Stone suggests, is too narrow a focus when it comes to the good that business does. The implication is that, absent a more expansive conception of the values that business should pursue, the various progressive causes which underpin ESG will enter the void.

I don’t doubt that one of ESG’s attractions is its appeal to people who are uneasy about working for enterprises that are in the business of making money. Immense problems, however, emerge once you seek to expand a business’s core purposes beyond making profit and realizing shareholder value within the parameters of just laws. Businesses are not families or NGOs. Nor are your employees and employers necessarily your friends. Things start going wrong when companies forget these truths. Stone himself references the fuzziness, artificiality, and false expectations that arise when the language of community gets associated with the enterprise of business.

A better way forward would be for businesses to cultivate wider awareness of the many goods whose realization becomes possible through companies pursuing profit. CEOs should, for example, take the lead in explaining that, for instance, profit usually indicates that a business is meeting its customers’ wants and needs through the prudent organization and deployment of the resources at its disposal. In the absence of fraud or other injustices, business executives should stress, this state of affairs is a good thing in itself. Likewise, they should underscore that it is through pursuing profit that businesses create possibilities for individuals to exercise their talents cooperatively with others, provide people with the incomes that they need to pursue many non-material goods, and help maintain and grow the material resources that any society needs if it is to prosper in material and non-material ways.

Certainly, these good things are realized indirectly and even somewhat unintentionally when a business pursues profit. Nonetheless, CEOs should stress that it is through pursuing profit that commercial enterprises contribute to society’s general welfare in ways that other organizations are not designed to do. If more business leaders were more skilled at explaining these truths, there might be far less of a values void in business that schemes like ESG try to fill.

A High Stakes Game

Russell Greene’s contribution to this forum likewise focuses on the questions that ESG raises about business’s core purpose. In doing so, he reminds us of an important fact: that discussions of the nature and ends of business long precede ESG’s emergence and will persist long after ESG has been added to the ever-growing junkyard of redundant business theories and acronyms.

Much of that discussion, Greene observes, has revolved around the relationship between business and politics. ESG, he notes, has often functioned as a surrogate for political agendas to infiltrate businesses and eventually, if some ESG advocates had their way, become central to a business’s raison d’être.

In this context some companies, Greene points out, present themselves as deploying ESG not as a matter of embracing wokeness but rather as a means of mitigating systemic risks. Some of the risks that these companies have in mind, I’d argue, are surely those of the political kind: legislators, regulatory authorities, and various activist groups who demand appeasing.

Playing the ESG card, however, is unlikely to deter some political actors from pursuing what had long been a progressive goal: the subordination of business to the realization of ends inimical to private enterprise’s long-term well-being. Here Greene argues that ESG should be understood as part of a wider approach by some progressives to use all the means potentially at their disposal to strip away the freedom of private companies and investors to pursue what they deem to be in their best interests.

For the most part, progressives aren’t pursuing the diminishment of this liberty via old-fashioned means like socialization of the means of production. But when combined with ideas like stakeholder capitalism, DEI, specific initiatives identified by Greene like the Accountable Capitalism Act, as well as efforts by the Department of Labor to push retirement savings into ESG funds, ESG can be clearly seen as part of a broader effort to make politics rather than consumers the primary locus of economic activity.

The conclusion which flows from this is, Greene states, that “we must steadfastly defend our current system of corporate governance and finance from all attempts to centrally direct capital towards a single political agenda.” Greene observes that ESG skeptics have considerable resources at their disposal to do so. These range from long-standing American respect for pluralism to the opportunities afforded by federalist political arrangements.

In the end, however, intellectual opponents of ESG—whatever their politics or training—can only do so much. It is awfully hard to defend the liberty of business if commercial enterprises play the appeasement game or avert their eyes from the wider agenda with which some ESG proposals are associated. Despite recent scandals and road bumps, ESG will continue to make considerable inroads until business leaders themselves become far more explicit and confident about the real good that business does, and crystal-clear about how ESG threatens to compromise their ability to bring such goods into being.

Milton Friedman regularly observed that business leaders were often the weakest defenders of a form of human activity to which many of them devoted their careers. Their well-intentioned, naïve, or calculated endorsement of schemes rather similar to today’s ESG proposals, he commented, would open the door to government bureaucrats undermining the very freedoms on which successful business depends. Joining the struggle to prevent ESG from becoming effectively mandated through executive, legislative, or regulatory fiat would be one way for business leaders to prove that, on this occasion, Friedman had misjudged them.

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