The Character of the Corporation: ESG ESG ESG

Three letters are echoing throughout corporate boardrooms.

Spurred on by political activists, academics, lobbyists, regulators, employees, consumers, professional directors, governance gurus, proxy advisers and, most notably, large institutional investors, environmental, social and governance issues (ESG) have commandeered boardroom conversations.

This unlikely and unwieldy alliance is trying to upend the decades old doctrine of shareholder supremacy by putting forward an expanded model of capitalism based on the overarching themes of purpose, inclusion and sustainability which address the interests and needs of a broad array of stakeholders. Increasingly, corporate chieftains are joining this alliance asserting that their ESG initiatives will enhance bottom-line performance, despite scant empirical evidence of causation. Their assertion is often summed up in the catch-phrase “doing well by doing good.”

What is ESG? The “G” for “governance” can be fairly well defined and accurately measured, and the “E” for “environmental” pretty much so as well. However, the “S” for “social” is open to debate as to what it encompasses and how it can be monitored.

Forty years ago, the “S” stood for corporate social responsibility (CSR). Ten years ago, the “S” morphed into “sustainability” or “sustainable growth.” Back then, sustainability policies were relatively easy to implement because they focused on saving energy, cutting waste and streamlining logistics, which produced higher profits while benefitting the environment.

However, the current wave of sustainability policies may actually raise costs; for example, environmentally friendly consumer goods may turn out to be significantly more expensive, and efforts to combat social inequality may significantly boost wages and training expenses. Though adopting such policies may ultimately improve longer-term profit and improve longer-term competitive position, the present value to current shareholders is uncertain.

Today, ESG has launched discussions about gender equality, climate change, water conservation, gun violence, opioid addiction, employee wellness, pay equity, individual privacy, LGBT rights, affordable housing, etc., etc., etc. In general, each ESG initiative should reflect vital elements of a company's core value as well as being reflective of some possibility of becoming a material balance sheet liability. ESG is fundamentally about risk management, and each ESG initiative should be evaluated for both its potential bottom-line impact and social effect.

Large institutional investors, in particular BlackRock, State Street and Vanguard are focusing attention on ESG and helping to better define the “S” element. They own a large percentage of public stock markets and thus are long-term investors. with not only a stake but also an interest in the longer-term value that can derive from ESG-related initiatives that effect, for example, corporate reputation, brand equity, customer loyalty, employee attraction and retention, and investor interest.

Should boards focus on ESG? Absolutely. Their ESG investments need to be clearly defined and carefully tracked to determine long-term economic value. Directors need to reconcile ESG initiatives with shareholder value creation, because at the end of the day, the “S” should benefit the shareholders. Perhaps when all is said and done, the “S” may stand for social responsibility toward stakeholders with shareholder primacy.