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Using criteria based on environmental, social, and governance (ESG) considerations has become an increasingly important aspect of investment decision making, particularly for high-profile institutional investors. On February 8, 2019, Justina Lee at Bloomberg reported that Europe alone has “some $12 trillion committed to sustainable investing.” Fish, Kim, and Venkatraman (2019) state that sustainable assets under management worldwide were approximately $30 trillion by 2019. Matos (2020) reports that signatories to the Principles of Responsible Investment accounted for more than $80 trillion of AUM worldwide by the end of 2019. Despite its large and growing popularity, ESG investing has a number of related and important conceptual issues that are not often appreciated. The purpose of this article is to highlight and review those issues.
This article focuses on the environmental (E) part of ESG because it is the most clearly defined. Nonetheless, virtually all of the analysis applies to the social part as well. Bundling governance—a measure that has historically been defined in terms of responsiveness of managers at publicly traded companies to their shareholders with environmental responsiveness and social consciousness, two concepts that often require managers to put the interests of other stakeholder groups ahead of shareholders—seems misplaced. It may be that the governance incorporated in the ESG concept is different from the conventional governance measures, but if it is, any references to the payoff to good corporate governance should be not be part of the ESG, because it represents a mindset diametrically opposed to the stakeholder value mindset that underlies ESG. For these reasons, an analysis of governance is not presented here.
The first issue is defining exactly what is meant by ESG. The following section turns to the potential impact of applying ESG criteria in investment decision making on portfolio performance. The subsequent section addresses the more fundamental question of whether ESG considerations imply that the corporate objective used in finance theory of maximizing shareholder value should be abandoned in favor of a more comprehensive stakeholder model. It also includes a discussion of the role of disclosure. The final section summarizes and concludes.
WHAT CONSTITUTES AN ESG INVESTMENT?
The starting point for ESG investing is determining what constitutes an ESG investment. It turns out that many organizations are attempting to answer that question. Li...