Yichuan Cao/Sipa USA via AP Images
Activists protest in front of investment firm BlackRock’s offices in San Francisco, December 6, 2019, urging the company to invest in green energy and divest fossil fuel.
More than a few of the CEOs who descend on the U.N. Climate Change Conference (COP26) in Glasgow will depart feeling pretty good about themselves.
They’ll have spoken on panels about the urgency of tackling climate change, luxuriating in the warm glow acquired from talking publicly about a problem without having to do anything about it. They’ll have applauded the good intentions and earnest promises of their fellow attendees (and, by extension, themselves), as if intentions and promises extracted carbon from the atmosphere—or counteracted the money many of them still invest in lobbying against climate action.
They’ll have pledged their companies to net-zero targets by 2050, long after most will have retired, long after the planet will have crossed critical and irreversible climate thresholds, long after the supply of trees to be planted and carbon offsets to be purchased will have run out, and long after these pledges will have been forgotten or discarded, since pledges are nonbinding.
The most fundamental reason why CEOs will jet home feeling good, however, is that they’ll have convinced themselves that they’re part of the solution. They’ll have found a way to use capitalism and financial self-interest—the same incentive structure responsible for the climate crisis—to save the world.
Ozy and ESG attracted a self-reinforcing cycle of investments and media hype by telling people what they wanted to hear.
It’s a seductive idea, in part because it’s so comforting. Instead of having to acknowledge that their companies and industries helped bring the planet to the brink of catastrophe, they can instead reframe themselves as its saviors. All of the heroism without any sacrifice: It’s the kind of deal making that makes them good at their jobs.
To be fair, it’s not just chief executives. Enormous sums of money and media attention are flowing into “environmental, social, and corporate governance,” or ESG, investments. As of May, investment funds deemed “sustainable” were increasing by $3 billion every day. In August, Morningstar estimated that global ESG assets had grown to more than $2 trillion. One report put the sum of sustainable assets around the world at $35 trillion. By focusing financial resources on “good” companies, we are told, the free market can save the planet and fatten portfolios simultaneously.
If CEOs, corporations, and capital are all moving toward ESG investments, that must mean there’s something to it, right? To answer that question, it’s worth considering another much-hyped and highly valued entity: the now-defunct online media company Ozy.
Imperfect though the analogy is, both Ozy and ESG are premised on the notion that businesses can make a profit and gain a competitive advantage by serving a social purpose. Ozy promised to reach the “change generation” through media; ESG promises to use capitalism to solve global challenges. Both generated huge investor inflows based on comforting stories, rather than on solid evidence that they are capable of, or even genuinely interested in, reaching their stated goals.
Most fundamentally, both Ozy and ESG attracted a self-reinforcing cycle of investments and media hype by telling people what they wanted to hear, and by convincing them that what they wanted to be true was in fact possible. Until one day, it wasn’t.
OZY’S DOWNFALL HAPPENED practically overnight. On September 26, The New York Times’ Ben Smith published a column describing an Ozy-arranged conference call between representatives from Goldman Sachs, which was considering a $40 million investment in Ozy, and YouTube, where Ozy claimed to have tens of millions of highly engaged viewers. But the YouTube executive on the call, who lauded Ozy as a “great success” on the streaming video platform, was actually an Ozy leader impersonating a YouTube executive.
While Ozy founder and CEO Carlos Watson tried to explain away the incident by blaming it on his colleague’s “very personal mental health issue,” Smith’s column prompted a cascade of other stories about Ozy’s overinflated claims of audience size, which had been what one CNN columnist called “the biggest open secret in digital media.” Board members and top employees left, and the company imploded.
If the story of Ozy, which was founded in 2013, rested on such obviously false and empty promises, how did the company get away with it for so long? Because wealthy investors, who wanted to believe the story, kept pouring money into it. “Part of the genius of people like Mr. Watson … is what they reflect back to people who put up the money,” Smith noted in a follow-up column. “The most interesting part of their stories,” Smith wrote, “is the mirror they hold up to the ones who believed.”
Like Watson in digital media, other opportunists have spotted lucrative openings in ESG investing. One of them, the private equity executive Arif Naqvi, made hundreds of millions of dollars and “fooled the global elite” by “promis[ing] to give capitalism a conscience,” as The Guardian put it, before being arrested on charges of money laundering and fraud. Meanwhile, most every CEO and corporate PR executive has learned that they can win easy plaudits by peppering employee communications, social media accounts, and press releases with anti-racism statements and net-zero pledges and platitudes about social responsibility and “purpose,” while rarely being held to account for following through on their lofty commitments.
But neither genuine scammers like Naqvi, nor socially acceptable scammers in the C-suite who hide business as usual behind curated performances of benevolent capitalism, are solely responsible for the ESG bonanza. Instead, like Ozy, ESG reflects what its believers want to be true.
IF YOU’RE WONDERING why I haven’t yet defined ESG, you’ve stumbled across its first flaw: No one can agree on what, exactly, ESG is. Even as billions of dollars flow daily into funds labeled “sustainable” or “ESG,” what constitutes ESG, who determines whether a company or an investment meets that standard, and how these standards are measured all remain almost entirely subject to change and open to selective interpretation.
For example, in a November 2019 exploration of why “[e]ight of the 10 biggest U.S. sustainable funds are invested in oil-and-gas companies,” The Wall Street Journal looked at a few ESG funds offered by large institutional investors. One exchange-traded fund, or ETF, from BlackRock—the world’s largest asset manager, with nearly $10 trillion in assets—promised to “track an index of companies with ‘positive environmental, social and governance characteristics.’” Yet one of the companies in which that ESG-positive fund invested was ExxonMobil, the oil and gas giant perhaps more responsible than any other single firm for manufacturing climate denialism and hindering global efforts to address climate change.
In theory, a company or collection of companies that bears the ESG label is said to be operating in ways that meet certain “non-financial” criteria, from limits on carbon emissions to a minimum threshold for board diversity to the presence of human rights and labor protections throughout supply chains. But is a company responsible for only its own emissions or for the emissions of its suppliers and customers as well? And who’s responsible for measuring? What counts as board diversity? Is a firm’s self-produced corporate social responsibility report sufficient to certify the absence of human rights or labor violations—and if not, who does the certifying?
All of this complexity and inconsistency is bad news for the ordinary retail investor who wants to make sure their retirement fund aligns with their values, but who doesn’t have time to become a full-time financial analyst or an investigative journalist. But this same complexity and inconsistency is great news for two other constituencies: companies who want to brand themselves as woke, green, and purpose-driven, and companies who want to make money helping them do that.
SASB, IIRC, WEF-IBC, TCFD, GRI, UNPRI, CDP, CDSB, IFRS, ISSB, and MSCI are among the dozens of acronyms, organizations, and coalitions that offer proprietary sets of ESG metrics or principles, and work with companies to measure, certify, and report their performance against them. ESG standard-setting has become a lucrative industry, helping firms make their best case that they are taking action to protect the planet.
You often hear CEOs and investors bemoan the lack of standardization among what the Financial Times called an “‘alphabet soup’ of ESG arbiters.” Companies argue that it’s expensive and confusing to have to report against so many different sets of standards, which it is. But you’ll rarely hear them discuss one of the benefits of having so many different sets of metrics and standards: the ability to cherry-pick an ESG ranking that prioritizes measurements and targets on which the company is likely to perform well.
Companies can shop around for a service that might not measure or probe their shortcomings too deeply, or use “sustainability performance on one dimension to cover up poor performance on another,” as one ESG expert put it. In a 2019 study titled “Aggregate Confusion,” three researchers from the MIT Sloan School of Management studied the widespread divergence in ESG metrics. Among the study’s conclusions was that “ESG ratings do not, currently, play as important a role as they could in guiding companies toward improvement.”
Nor will companies readily admit that all of this reporting does not necessarily change how they run their businesses. “The focus on reporting may actually be an obstacle to progress,” Kenneth P. Pucker, Timberland’s former chief operating officer, wrote earlier this year, “consuming bandwidth, exaggerating gains, and distracting from the very real need for changes in mindsets, regulation, and corporate behavior.” Pucker pointed out that even as the number of companies issuing reports using the Global Reporting Initiative metrics has “increased a hundredfold in the past two decades,” global CO2 emissions have increased right along with them.
Richard Shotwell/Invision/AP
Ozy co-founder Carlos Watson during the PBS Television Critics Association summer press tour, July 2016
THE SAME LACK OF RIGOR and consistency that casts doubt on the veracity of individual company ratings also plagues the credentials of ESG funds overall. This brings us to ESG’s second fundamental flaw: Its ratings don’t always say much about whether ESG-denominated entities are actually more environmentally friendly, more socially responsible, or more effectively governed than those without the label.
A recent study by the investment analytics company Util assessed 281 “sustainable” funds to see how each fund contributed to the U.N. Sustainable Development Goals, or SDGs. The study concluded that “[w]hile 77 of the sustainable fund names contain the terms ‘green,’ ‘clean,’ ‘climate,’ or ‘sustainable,’ only four have a positive impact across any of the environmental SDGs.”
In another 2021 study, Aneesh Raghunandan of the London School of Economics and Shiva Rajgopal of Columbia Business School looked at different sets of ESG scores to see whether firms that were rated highly also had lower carbon emissions and fewer citations for violating federal “environmental, labor, and securities laws.” The researchers found that “ESG scores are not correlated with federal compliance records or carbon emissions metrics but are correlated with the presence of voluntary disclosure[s] about ESG.” In other words, if you want to know which firms publish a lot of different ESG metrics, look for the ones with high ESG ratings. But if you want to know which firms operate in a genuinely responsible and environmentally conscious way, you might be out of luck.
In that 2019 Wall Street Journal report, a BlackRock spokesperson justified including ExxonMobil in one of its ESG funds by saying that the fund strives to “offer investors similar risk and returns that they would achieve in broad market indexes while including the highest ESG-rated companies in each sector.” What this means is that while the fund might not include the most egregiously destructive oil and gas firms, it’s not going to avoid the entire oil and gas industry. “The grading is on a curve,” as Bloomberg’s Matt Levine described this practice. “[I]f there’s a whole sector that is not particularly environmentally conscious, then you just invest in the least bad companies in that sector.”
A former BlackRock employee who worked frequently with BlackRock chairman and CEO Larry Fink told me that Fink doesn’t see it as his company’s job to tell people where they should and should not invest. Instead, he seems to believe that BlackRock should simply provide the option for people to invest more responsibly if they so choose. It’s hard to object to giving investors that choice—it’s their money, after all—but Fink’s argument also happens to be extraordinarily convenient for him and his firm.
Over the past few years, Fink has carefully cultivated a reputation as a conscious capitalist who is using BlackRock’s $10 trillion portfolio to force companies to deliver “profits and purpose.” Fink’s reputation as “The New Conscience of Wall Street,” as Barron’s called him, stems mostly from his annual letters to CEOs, where his gentle lecturing and largely noncommittal threats to act against irresponsible companies have been interpreted by business pundits and corporate leaders as seismic, game-changing events.
By giving investors the option to put their money into ESG-branded funds while quietly continuing to offer “irresponsible” or “dirty” investment opportunities, BlackRock enhances its socially responsible reputation and cashes in on the ESG gold rush and gets to keep making money from those irresponsible and dirty investments. It’s a win-win-win.
Companies can shop around for a service that might not measure or probe their shortcomings too deeply.
Today, nearly two years after the Journal story, BlackRock offers a number of similar funds, including its iShares ESG Aware MSCI USA ETF. As of October 22, this fund—let’s call it “ESG Aware” for short—still includes ExxonMobil in its holdings, as well as Chevron and ConocoPhillips. But together, these three fossil fuel giants make up less than 1.5 percent of the fund. Technology companies, on the other hand, including Apple, Microsoft, Amazon, Alphabet, and Facebook, comprise more than 20 percent, including six of the fund’s seven largest individual holdings.
Setting aside urgent questions of whether Big Tech’s proclivity for surveilling, influencing, and monetizing consumer behavior is good for society or even compatible with democracy, and also setting aside environmental harms from data centers, server farms, rare-earth mineral production, and Amazon’s individualized and carbon-intensive delivery network, there’s something besides regulation that tech companies are skilled at avoiding: taxes. In 2018, for instance, Amazon paid zero dollars in federal income tax, despite generating profits of $11 billion. Salesforce, another firm included in BlackRock’s ESG Aware fund, made $2.6 billion in 2020, but was one of nine tech companies that paid no corporate income tax that year, according to a report by the nonprofit Institute on Taxation and Economic Policy.
ESG promises investors that their money will contribute to society. One of the most effective ways a company can contribute to society is by paying its fair share of taxes, because taxes enable governments to serve society. Taxes alone don’t guarantee effective government, of course, but a lack of revenue pretty much guarantees ineffective government.
Thus, you might expect that ESG indices would recognize socially responsible firms that pay their taxes. But a February 2021 report by StoneX analyst Vincent Deluard found that in general, “companies with a high ESG rating pay a much lower tax rate than their less virtuous peers.” And taxes rarely weigh heavily among the metrics that determine ESG scores. As Deluard points out, while Bloomberg produces ESG scores based on thousands of different metrics, “[o]nly five of the 1,945 ESG metrics … are related to taxes.”
TECH COMPANIES ARE OVERREPRESENTED in ESG funds for another reason: their sky-high financial returns. A study from RBC Wealth Management published in August 2020 found that over the previous 12 months, during which the S&P 500 index grew by nearly 10 percent, the performance of just five stocks—Microsoft, Facebook, Apple, Amazon, and Alphabet—drove almost all of that growth.
At the end of the day, most ESG investors, and certainly the large institutional investors who have a fiduciary responsibility to prioritize their clients’ financial returns, expect to make money. Therein lies the third, and the most insurmountable, flaw at the heart of ESG and the “stakeholder capitalism” movement more broadly: None of the key players, whether investors, corporations, executives, or analysts, is willing to make trade-offs or sacrifice financial returns.
The first two flaws are, theoretically, fixable. This third one is not. Companies “will not say, and nor can they say because the law won’t allow it, that they’re going to do anything other than the most marginal, minimal sacrifice of their profit, of their growth, and of their shareholder value to serve social [and] environmental values,” Joel Bakan, a University of British Columbia law professor and the author of The Corporation and The New Corporation, told me. “The norm is no sacrifice.”
Bakan paused. “Actually,” he said, “the norm is, We’ll do even better by serving these values. Well, then, how much are those values really served? How much social good can you do if you’re not willing to sacrifice at all?” Before even beginning to confront the biggest challenges of our time, including the climate crisis bringing world leaders to Scotland this week, we’ve immediately shrunk the pool of acceptable solutions to the small handful that seem profitable.
It may indeed be true that the only way to get some CEOs and hard-nosed investors to think about sustainability and social responsibility is to pitch it as a win-win, as a way to gain competitive advantage or attract millennial and Gen Z employees or stave off shareholder activism. But by refusing to countenance even slightly less impressive returns, ESG investing consigns itself to differing, at best, only marginally from the traditional kind.
Climate change is not a problem that can be solved at the margins. There just aren’t enough companies that are outperforming other firms while also meeting genuinely rigorous ESG standards. And there are some companies and some industries that cannot be salvaged: Their continued existence is fundamentally incompatible with a habitable planet.
The longer governments, politicians, regulators, and ordinary citizens accept elite assurances that ESG and stakeholder capitalism will halt climate change, reverse inequality, and end poverty and racism, the more time we’ll waste waiting for big businesses to save the world. As Bakan put it, “The very conception of what is ‘good’ becomes hijacked by the need to do well.”
Like Ozy, the promise of ESG investing is a seductive one, and not just for the people who stand to make a lot of money. On some level, ESG appeals to all of us because it’s so convenient. The work of legislating and regulating and policymaking is messy, complicated, unfair, and frustrating. Organizing and activism and advocacy are always difficult, always exhausting, and often thankless. Wouldn’t it be so much easier if capitalism could just fix things on its own?
“The true con artist doesn’t force us to do anything,” Maria Konnikova writes in The Confidence Game, her exploration of why human beings fall for scams. “[H]e makes us complicit in our own undoing. He doesn’t steal. We give … We believe because we want to, not because anyone made us.”
