Can’t tell the players without a scorecard: Sorting out ESG, impact and sustainability

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Guest Author

Bob Eccles

The Land of ESG is embroiled in a two-front war. Identifying the combatants and their arguments may help practitioners keep track of the conversation, and get on with the work of making both their companies and the world better places. 

ESG, short for environmental, social and governance, was first attacked from the “left” by what I’ve called the “Sustainability Taliban.” These purists decry that ESG, which is about a company’s operations and activities, is not true sustainability. The criticism is that ESG is only about “single materiality,” that is, the issues a company must address to ensure long-term value creation. Organizations like the Sustainability Accounting Standards Board, now part of the IFRS Foundation, have long been focused on such single materiality.

These attacks were stealth tactics aimed at prominent proponents of ESG and thus not visible to the broader citizenry. For the sustainability Taliban, what matters more is “double materiality,” covering the impact, or positive and negative externalities, created by a company’s products and services. This is the focus of the Global Reporting Initiative which defines materiality in terms of externalities.

The Sustainability Taliban are so convinced of the righteousness of their views that they delight in such juvenile rhetorical devices as demeaning the International Sustainability Standards Board as “the I?SB.” It is certainly appropriate to call out ways in which the company is making the world a worse place even as it makes money. But in the end companies have to deliver returns to their shareholders; it is how they do so that is at issue.

The attack from Sustainability Flat-Earthers on the “right” was much more dramatic and visible. In his May 26, 2022 op-ed in The Wall Street Journal (where else?) former Vice President Mike Pence thundered about “a handful of very large and powerful Wall Street financiers promoting left-wing environmental, social and governance goals (ESG), and ignoring the interests of businesses and their employees.” 

Demonstrating the careful planning and strategic sophistication of the Flat-Earthers, this was followed up by a June 27, 2022 memorandum from the congressional Republican Study Committee, “The War on American Energy: Ground Zero.” It helpfully defined ESG as “the progressive scheme through which the Left pressures corporate America to take positions on social and political issues that have nothing to do with business.”

Not to be outdone in his quest for the 2024 Republican presidential nomination, Florida Gov. Ron DeSantis, along with fellow trustees of the State Board of Administration on August 23 passed a resolution “that prioritizes the highest return on investment for Florida’s taxpayers and retirees without considering the ideological agenda of the environmental, social, and corporate governance (ESG) movement.” 

Both the Pence editorial and the Florida resolution conveniently ignore the growing body of literature which shows that good management of material ESG issues contributes to financial performance. Why worry about facts when defining ESG as a left-wing conspiracy is such an effective political rallying cry?

The irony is obvious. The sustainability Taliban hate ESG because it is only about enterprise value creation. The Flat-Earthers hate it because they assert that hurts enterprise value creation. 

Risk factors and externalities

Going beyond their fiery rhetoric, the Taliban are right to point out the difference between ESG and impact. A company can score very well on ESG in its operations while simultaneously creating substantial negative impacts with its products and services. Example A: ExxonMobil, which is considered to run a tight ship. 

Conversely, a company’s products and services can have a very positive impact even if the company scores low on ESG. Take Tesla, for example, which has transformed transportation, but was booted from the S&P 500 ESG Index in May. Tesla gets a low ESG rating because of extensive labor problems including a stressful working environment, racial discrimination, and Elon Musk’s anti-union attitude. According to SASB, labor practices are one of the four material issues for an automobile manufacturer. 

The Flat-Earthers, such as the members of the Republican Study Committee, confound things when they, somewhat ironically, complain about ExxonMobil having a higher ESG rating than Tesla. 

Putting ideology aside, the difference between ESG and impact is a clear and easy one. ESG is about the material environmental, social, and governance risk factors that matter to enterprise value-creation. Impact is about the positive and negative externalities created by a company’s products and services.

Yes, good ESG performance can mean less in the way of negative externalities imposed on the world by a company’s operations and activities. But these are typically dwarfed by the impact of a company’s products and services. And it is worth noting that even within ESG there are tradeoffs. Good performance on an environmental dimension can come at a cost to performance on a social one.

In writing about ESG materiality in fixed income investing, Trinity Church Wall Street’s Bhakti Mirchandani notes research that suggests that higher product-related E and S scores – in other words, greater impact – are associated with a lower cost of debt. By contrast, higher environment, community, and human rights scores are linked to a slightly higher – though statistically insignificant – cost of debt.

If the “actively do good” aspects of ESG matter more than the “do no harm” for bond yields, the opposite is true for equities. The lack of ESG controversies is a more accurate predictor of five-year returns on invested capital than ESG scores themselves, according to an analysis of MSCI’s All Country World Index from 1999 to 2017.

It should also be noted that measuring impact is harder than measuring ESG performance. Measuring impact requires data from outside the company’s legal boundaries. An article in Science frames this in terms of outputs, outcomes, and impacts. 

Take pharmaceuticals as an example. Outputs includes spatially distributed drug sales (a company will know where its drugs are sold). Outcomes are target populations reached, perhaps as a percent of total population. For this, the company will need population data from a third party source. Impacts could be lives extended, hospitalizations and sick days avoided, and reduced health-care spending. All are very hard to measure and require approximations and modeling.

A practical example of this is Utrecht-based Gilde Healthcare, a venture capital and private equity firm with $2 billion in assets under management and an impact  goal of “Better Care at Lower Cost.” Gilde integrates ESG data from portfolio companies into its investment decisions through a proprietary ESG Maturity Model. Through active ownership, Gilde works with these companies to improve their ESG performance on material risks in order to increase their economic value. 

In terms of impact, Gilde looks to how the products and services of its portfolio companies contribute to the world’s environmental and social challenges. That includes healthcare challenges of increasing and evolving demand, growing costs, and constrained health providers. 

For example, the digital therapeutic product Sleepio, from Gilde’s portfolio company Big Health, is designed to help people with insomnia, which is estimated to affect 10-20% of the world’s population. Sleepio’s adoption in the U.K. is estimated to have reduced primary care costs by £20 million in the first year.

Two meanings of sustainability

Distinguishing between sustainability and both ESG and impact is more difficult for two reasons. The first is that most practitioners in the corporate and investment community see sustainability and ESG as synonymous. They are trying to get their arms around how to incorporate these ideas into real world decisions. Most find the war cry of the sustainability Taliban about the need to distinguish between the two (vociferously raised over this piece) irrelevant to their work.  

The second reason is that the term sustainability is used at two different levels of analysis: company and system. At the company level, it’s about “sustainable value creation,” and thus, essentially, ESG. At the system level, it’s about making the world a better place: in effect, impact. 

Given the polarization over terms, we believe it is better to consider ESG as “material risk factors that matter for enterprise value creation.” Then, rather than arguing what ESG means, the discussion can be about whether an environmental or social issue is or is not a material risk factor. 

Similarly, a more precise term for impact is “positive and negative externalities.” Good management of ESG reduces negative externalities but it does not create positive externalities. Those come from a company’s products and services.

Sustainability is still useful as a term if one is clear about to what it is being implied. Sustainable enterprise value-creation at the company level is different from sustainable development at the system level. If enterprise value-creation is based on products and services that create positive externalities, then it contributes to sustainable development. But if the execution of the business model is done with shoddy management of material risk factors, it will contribute to some dilution in sustainable development.

Those who are using the term ESG to wage political campaigns aren’t going to change their behavior (even on the remote chance they are reading this piece). But here’s three pieces of advice for everyone else. 

1. Don’t overpromise on ESG by conflating it with impact and sustainability at the system level. This is the fundamental problem with greenwashing by investment funds, which has led to legitimate criticism across the political spectrum. 

2. Don’t underestimate the importance of ESG simply because it’s not “true” impact and sustainability. Good management of material risk factors lays the groundwork for good management of impact. 

3. Accept that tradeoffs exist, both between material ESG factors and between enterprise value-creation and impact. Address these tradeoffs in a rational and constructive way. 

The Sustainability Taliban need to accept the fact that companies need to make money. The Sustainability Flat-Earthers need to accept that fact while making money, a company cannot be completely indifferent to its impact on society.   


Bob Eccles is a visiting professor of management practice at Oxford’s Saïd Business School.