Taylor Gray, Ph.D.
The world is a better place when companies are good corporate citizens. I remain focused on developing meaningful and actionable insights from empirical data in pursuit of a better world.
ESG is big now, but it may not always mean what we think it means, as we discussed before.
If you feel like you may not fully understand all the complexities of ESG, don’t worry, neither do many of the consultants out there presenting themselves as ESG experts.
A clear example of this can be seen in a recent article put forth by a large advisory firm with a solid legacy in business management and an impressively large audience. Now it should be noted that this firm is only recently entering the ESG space as the latter becomes of ever more interest to business management and strategic development, so some room for error should be permitted within a learning curve.
The Complexity Begins
This article opens with: “... the data required to assess if ESG assets have achieved a positive social and environmental impact is often missing, incomplete, unreliable, or unstandardized.”. This is an unfortunate statement. It’s not that it isn’t correct, but rather that it misconstrues ESG at a fundamental level.
I am not linking to the article in question because this is not an exercise in trying to shame someone. Rather, I am using this article because it is an excellent example of just how easy it is for all of us, even business management experts, to get lost in some of the complexities of ESG.
To be clear, the statement is accurate in that much of ESG data is missing, incomplete, unreliable, or unstandardized. ESG data has grown quite organically over the past 15 years through a steady stream of push and pull forces from market supply and demand. So much of ESG, in fact nearly all of it, is unregulated and voluntary. What we have today is so much better than what we had even just five years ago, but development has not been homogenous nor continuous across all industries, markets, and use cases.
Where the statement is inaccurate is in the allusion that ESG assets are intended to achieve a positive social and environmental impact. The last two years have brought about an explosion of interest in ESG and related assets, and now the term is often used interchangeably with ‘sustainability’, ‘social responsibility’, or ‘stakeholder capitalism’--but this is wholly inaccurate and likely to lead to many misunderstandings.
ESG developed as a lens to manage impacts on the firm and not about managing the impacts of the firm.
Clearing the Air
ESG is simply data. It is data which relates a firm’s environmental, social, and governance performance to its financial performance. This is key to understanding ESG as we experience it now.
ESG is focused on materiality, and since its inception, materiality has been framed as that which has a measurable impact on a firm’s financial performance. In this view, ESG is not about the firm’s impact on society and the environment, but rather about how the firm is managing its relationship with the social and environmental elements which have a measurable impact on it.
To be concerned with impacts on society and the environment is an outward focus. To be concerned with how developments in society and the environment impact the firm is an inward focus. To date, ESG has always been inwardly focused. People--and marketing departments in particular--may speak about an outward focus, but this is not supported by the structure and character of the actual data. ESG developed as a lens to manage impacts on the firm and not about managing the impacts of the firm.
This doesn’t mean that ESG assets can’t have positive impacts, but it does mean that ESG in itself is not a measure of impact. ESG is data, and it is data that we never had access to before. It allows us to better understand how a firm is operating--and this is powerful.
ESG is data, it can be used to determine sustainability or impact, but it is not an inherent measure of sustainability or impact.
Data Needs a Framework
Think of ESG as a pool of potential. Within this pool is all the information I need to make the decisions I want to make, but while it is all jumbled in the pool it remains simply as potential and not direction.
If I want to determine which companies are the most sustainable I can do so if I first establish a framework to define and measure sustainability. With the framework in place, I can draw on the ESG pool to complete my comparative assessments and determine, with empirical evidence, which companies are the most sustainable.
If I want to determine which companies have the most positive impacts on society and the environment I can do so if I first establish a framework to define the impacts I am interested in. With the framework in place, I can draw on the ESG pool to complete my comparative assessments and determine, with empirical evidence, which companies represent the most positive contributions.
ESG on its own will never tell me what I want to know, but it can populate a framework which can tell me what it is I want to know. ESG is data, it can be used to determine sustainability or impact, but it is not an inherent measure of sustainability or impact. Sustainability and impact are ESG, but not all ESG is sustainability or impact.
The complexity of ESG comes from the fact that it can be so much of what we want, yet at the same time it is nothing in and of itself.
Change is Coming
Of course this can change over time. Right now, we are dealing with an ESG landscape born from the interests of institutional investors. The motivations of ESG data collection are that of optimizing financial performance. That doesn’t mean that is all that ESG data can do, but it is an artefact that we must be aware of when dealing with ESG data.
Now that ESG is so popular we see many different organizations, beyond simply institutional investors, making space in this landscape. We may one day co-generate beyond the strictures of financial performance, but for now this is what we have.
ESG is remarkably powerful data, but it can only accomplish what it is we want it to accomplish when we apply it within an appropriate framework...and we each need to identify for ourselves what ‘appropriate’ is.
If you want to invest in assets that have a positive impact on society and the environment then be sure to choose products and services which have a clear framework to transform ESG data into impact insight.
The complexity of ESG comes from the fact that it can be so much of what we want, yet at the same time it is nothing in and of itself. That experienced business management consultants and advisors get tripped up by the fundamental nature of ESG is testament to just how entangled it all can be.
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