Bulletin
Investor Alert

New York Markets Open in:

Project Syndicate Archives | Email alerts

April 4, 2022, 12:30 p.m. EDT

Socially responsible investors should harness the power of the profit motive instead of fighting it

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    Orpea S.A. (ORP)

or Cancel Already have a watchlist? Log In

By Bertrand Badre, Benoit Mercereau

PARIS ( Project Syndicate )—Environmental, social, and governance (ESG) standards are the talk of the investment world these days. But despite the trillions of dollars of investments that have been labeled “ESG,” this form of investing has yet to have much real-world impact.

This is especially true on the environmental front (though such investments’ social impact has not been much more evident). Investor coalitions to combat climate change have exploded onto the scene, promising to steer a massive amount of capital toward “green” businesses and industries.

At last year’s United Nations Climate Change Conference (COP26), private financial institutions pledged to mobilize  $130 trillion —a figure greater than global gross domestic product—for clean energy. And yet, the climate outlook is only worsening. Last month’s  report  from the Intergovernmental Panel on Climate Change  offered  “the bleakest warning yet” about what awaits humanity on a rapidly warming planet.

Profits drive business

Welcome to the world of greenwashing: Though firms’ owners have committed to cutting carbon-dioxide emissions, they have not actually ordered firms’ managers to do so. But, instead of blaming investors or companies, ESG activists should consider why there is such a large, persistent gap between public commitments and action. Simply put, climate advocates have failed to persuade investors and firms to act because they have failed to understand what ultimately drives business.

Like it or not, most investors quietly share Milton Friedman’s  view  that “the social responsibility of business is to increase its profits.”

Investment managers hear from clients when their financial returns are too low, not too high. Most investors would like to do good in addition to doing well, but they also prefer it when the right hand can claim ignorance of what the left hand is doing—when they can seize on the exhortation to “save the world” while continuing to maximize profits with ruthless efficiency.

ESG advocates should acknowledge investors’ reality rather than trying to fight or change it. Because businesses will be held accountable by their investors if they do not make more money, ESG proponents must make the  business  case for such standards. If a company’s positive ESG impact will increase its profits, investors will stop at almost nothing to maximize that impact.

For the business case to be persuasive, it needs to be thoughtful and realistic. According to  research  by Arabesque, 88% of “operational performance studies show that solid ESG practices result in better operational performance.”

But while ESG can unlock shareholder value, not all ESG actions will boost profits. For example, whereas raising wages by 10% will benefit employees and help to attract and retain talent, tripling wages would likely endanger a firm’s financial viability.

The bottom line

Investors therefore should identify the “material” ESG issues that directly affect a firm’s bottom line. Financially immaterial ESG issues can still be relevant for overall impact, but as George Serafeim of Harvard Business School  puts it , “spending resources on immaterial issues is like philanthropy.”

Identifying material ESG issues is not always easy. The French retirement home Orpea /zigman2/quotes/204431094/delayed FR:ORP -0.20% was highly rated in ESG terms; but earlier this year, its stock price  fell  by 60%, following allegations that it was mistreating elderly patients.

Investors also must set priorities among the various ESG components. ESG ratings are a weighted average of hundreds of indicators. Even if all were material, it would not be feasible for any firm to set hundreds of new goals for itself. Instead, investors must focus on the ESG initiatives that will boost shareholder value the most.

/zigman2/quotes/204431094/delayed
FR : France: Euronext Paris
24.46
-0.05 -0.20%
Volume: 19,845
Aug. 8, 2022 9:23a
P/E Ratio
26.53
Dividend Yield
0.00%
Market Cap
€1.58 billion
Rev. per Employee
€63,351
loading...
1 2
This Story has 0 Comments
Be the first to comment
More News In
Investing

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.