Stock prices already force executives to think green and ratings can be gamed

Photo by Waldemar on Unspash

The ESG (environmental, social, and governance) investment framework is a much livelier topic than it really ought to be. It ought to be boring.

Institutional investors, who know an ill wind when they feel one, are clearly concerned that climate change and lax corporate governance will imperil the value of their holdings. The prospect of stranded assets and Enron-level scandal can have that effect.

Investors have been pushing for an independent standardized way of rating ESG that would help them compare the performance of publicly traded businesses on, say, carbon emissions or diversity targets. ESG serves that purpose, albeit as an imperfect and ever-evolving rating tool.

Yet, for some, ESG rating by investors is “a dangerous political agenda masquerading as altruism” that may constitute a hub-and-spoke (or even Chinese!) conspiracy. It’s some grotesque result of a woke agenda — at the very least a scam.

You can only begin to understand this reaction by viewing ESG not as a tool for rating but as a tool for alignment. It is one means by which investors can align the priorities of senior management teams of companies in their portfolios with the investors’ concerns for sustainability and good governance. By trading stocks, they bake these concerns into the share price, a metric guaranteed to get any CEO’s attention.

The same logic can hold for corporate boards. If ESG is an alignment tool for institutional investors, surely it can be the same for board directors. Boards have long incorporated share price into compensation packages to focus executive attention on boosting short-term profits and mitigating losses. They could certainly incorporate ESG into executive compensation to align executives on non-financial outcomes as well.

Many corporate boards agree. According to one survey, 77 percent of major companies across North America and Europe include ESG metrics in their executive incentive plans (from 69 percent in the U.S. to about 90 percent in Europe and the UK).

This type of ESG uptake is yet one more alarming proof point for conspiracists and culture warriors. Yet the use of ESG in executive compensation …