00:00:00
And then it developed. And really, the institutional
investors had a very large hand in pushing a
development of ESG criteria.
00:00:12
And the primary
direction of it was to try to measure when these
kinds of different factors—
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and there are many factors that are not
traditionally financially material factors
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that you would see in annual reports to
the SEC, for example. To what extent do they
affect the bottom line?
00:00:32
To what extent are they financially
material? Welcome to <i>The Ripple
Effect</i>, the podcast that takes
00:00:39
you on a journey through
the minds of Wharton faculty. I'm your host, Dan Loney.
00:00:43
And in each episode, we'll be diving deep
into the inspiration behind the groundbreaking research that Wharton
professors have conducted and exploring
00:00:51
how their findings resonate with the world
today. There continues to be a deep discussion
about the path of ESG.
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Some of the discussion is around the
ethical side of things. You have various levels of
investment, which can be designed
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to capitalize on the potential
profit that can be gained. But you also have to
have a focus on the benefits
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that can be brought
forward to the public at large. And how do those two balance each other
out?
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A new book tackles these ethical
questions. Wharton's Eric Orts is
co-author of the new
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book titled <i>The Ethics of
ESG</i>, and he joins us right now. Hi, Eric.
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Great to catch up again. Hi, and great to see you
again, too. Thanks for asking me on here.
00:01:33
Thank you. So you and I have talked about ESG in one
form or another, I think for about 15
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years now, as long as I have been
connected with Wharton. As you look back over this
time, how do you think the world
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around ESG has kind of
evolved during that time frame? Well, that's a good question.
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First of all, I think since we've been
talking, ESG really has come into being.
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So the origin story of ESG is that the
United Nations met with a lot of—
a number of large
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institutional investors and said,
"Hey, we want you to do something about large topics that are affecting the whole
world, including the climate change
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problem, biodiversity
loss, social issues like human rights, using slave— using
slavery to produce goods.
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So there was a push
then to get the investing community on board with
some kind of general project.
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And that's where ESG,
which stands for environmental, social and governance
criteria, got its start.
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And then it developed. And really, the institutional
investors had a very large hand in pushing a
development of ESG criteria.
00:03:01
And the primary direction of it was to try
to measure when these kinds of different
00:03:08
factors, and there are many factors that
are not traditionally financially material
00:03:14
factors that you would see in annual
reports to the SEC, for example. To what extent do they affect
the bottom line?
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To what extent are they financially
material? And the idea there was
that there were some—
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low— there was a lot of low-hanging
fruit on this issue. And there's also an idea that if you take,
for example, climate change, there's a
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really— there's a long-term effect that may not have been
economic effect. They may not have been
taken into account by a lot
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of businesses that are
just looking very short term. So the basic idea and the original
conception, at least as the institutional
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investors saw it, was that you were
improving the financial materiality measures, and that this would help to have
a win win solution.
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So you'd get some gain on issues like
climate, etc. But that would be because you'd be having
long-term financial gain.
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The problem is that also in this picture
was the United Nations. And notably not in the picture
particularly strongly were nonprofit
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organizations that care about issues like
climate and human rights and other things.
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Because their interest is not only in
financial materiality, they care about actually making a difference that the
world feels.
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So in other words, you really have a
reduction of human rights violations or you have a reduction in traffic and sexual
trafficking.
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You have a reduction of greenhouse gas
emissions. And it's not just because you care about
the long term economic health of investors.
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It's because you care about everybody
having a collective— collective achievement.
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So that kind of tension
that really goes back to the time when we were talking
15 years ago is still there.
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There's a tension between these two kinds
of forces. And what we see now is an updating of
that.
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And we also have seen, you have to put on
the table, a politicization of this issue.
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So that it's not just business trying to
do one thing or another. It's also become politicized.
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And so the acronym ESG
has joined the acronym DEI as a targeted enemy for political—
for some political forces.
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And part of the problem there is that
there's a lot of misinterpretation. - Right.
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One of the problems
with the acronym is it means different things
for different people.
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And then when one side that has a lot of
influence and is currently in power in Washington has targeted the whole idea,
then you're going to have a retreat away
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from it because you don't want to be—
you know, no business really wants to get
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in the line of fire of the White House
right now. And so the book tackles
kind of that balance, I
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guess, that needs to be
looked at even greater. The morality of how you approach ESG as we
move forward, both from the business side,
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but also from those that
are concerned about the environment and climate
change and more, correct?
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Yeah, exactly. So what we do in this
is— the subtitle is that we critically assess
what's happening with ESG.
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And we try to go beyond sort of "Yes,
it's good," "No, it's not good," into
understanding what are
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different people talking
about in this debate. And we have different perspectives that
are represented.
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So some people, some of the contributors,
Lisa Fairfax at Penn Law School and Joseph
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Heath at University of Toronto are
examples, really think this will work still if we focus the understanding of ESG
on shareholders, so that we continue with
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what I would call sort of mainstream ESG,
which is trying to explain to people, no, this is really just about financial
materiality.
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So it's really the same kind
of thing that businesses have been expected to be doing for
a long time before you had ESG.
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It's just improving that process. And we really have to stay with that. Now, others of us, and I'm included
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on this side, are saying,
"Well, wait a second. This really doesn't— it doesn't
always make sense.
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And it's confusing if you're saying,
for example, we're measuring our
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environmental impact and part of that's
climate. But if you're then saying, but it's only
when it's affecting the financial
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materiality, that is not
covering what most people understand if you say we're
acting to help the environment.
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And so one really
interesting development that we've seen here
adopts that point of view.
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And that point of view is— and that's in
Europe. So the European Union has adopted
what some of—
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has adopted a series
of corporate sustainability and financial sustainability regulations that attempt to
solve this by saying, "No, you also have to
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report on something
called impact sustainability, the actual effects you're
having on the climate."
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So you're moving toward a double
materiality standard in Europe. And on the other hand, in the United States
and other countries, there's not that view.
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China has adopted an ESG interpretation. And once China says we're doing ESG,
then everyone in China has to do ESG.
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- Right. Right. The system works a little differently. So what you have is a continuing evolution
of what we're really talking about here.
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And whether we're going to continue to
call this ESG or not, I think is an open
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question. Because a number of people have
said, "Look, what are we really looking at?
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If we're really going to— maybe we should
drill down and just look at the climate,
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for example, or other particular issues
without trying to put everything that is
00:09:30
not an ordinary
business concern into this bucket called ESG that's
not very well defined."
00:09:37
And I guess is the hope by being able to
do that, that you can get more people, countries, on board to
have a better understanding
00:09:47
of what the actual
attainable goal is, so you can get more
people focusing on that area,
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and you can have a better
outcome down the road? Yeah, exactly. And I think that, you know, to give credit
where it's due, I think that— I mean,
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I saw the political backlash
against ESG coming early on. And actually, when it
was first being proposed.
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And when schools like the Wharton School
were standing up ESG programs, too, and we've adjusted to this criticism
as well over time.
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But the problem— in some ways, the
criticism is correct because there was a way in which the institutional investors
that I think had a good spirit about this—
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I think they really wanted to do
good with this. But the way it comes across to people is
that, wait a second, who gave Vanguard and
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the big institutional investors the right
to decide to push on this issue? And their defense was, well, no, we're
just being financially responsible here.
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That's all the ESG is. But when you call it ESG, then people
don't— it's hard for people to believe it.
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- Yeah. And when you have a critique— to some
extent, I think it's valid— of elites,
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you know, a criticism
of the elites of the world pushing down
their view on other folks,
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that's part of what's driven a populist
backlash, I think, in the United States.
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And to some extent, I think
what that means is you really do have to integrate this
into a legitimate political shift.
00:11:31
And what I think that means— and this is
my own personal opinion, I'm not representing all of the authors in this
book, and it's a co-edited book.
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But what I think you
have to get down to is everyone agreeing to
some kind of a regulation.
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I mean, when I first got into
this, I went to the— Wharton paid for me to go to
the original Earth Summit.
00:11:53
This is showing how old I am, because I
was just starting here. - I thought that was last year, Eric.
I thought that was just last year.
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Yeah, unfortunately not. It was in 1992. George H.W. Bush was hosting the U.S.
side on that.
00:12:09
And there was a major
treaty that was agreed about climate, saying this— we need a
framework for dealing with this.
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And there's a major treaty agreed about
biodiversity. I also was amazed to see a huge business
contingent that was there.
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And so already then, businesses
were getting involved and saying, "We understand this
is a problem for everybody."
00:12:33
- Right.
- And I think what we need to get back to is that sort of consensus, where you have everyone kind of
agreeing that this is a problem.
00:12:43
And then it works through the regular
political process. You can't just say, "We're going to do it.
00:12:49
All the big companies and big investors of
the world are going to do this."
00:12:53
Because then I think we run into this
political backlash. And my sense— you know,
one other footnote there is,
00:13:00
you know, I don't think
that's going to last forever. If you talk to a lot of
the big businesses and
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investors, et cetera, the
science doesn't really lie. And people still have to orient the risks
that their businesses are taking,
00:13:17
et cetera. I just heard from a top executive in an
insurance company in my class yesterday,
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where they're— one of my colleagues
calls it "green hushing." They still recognize, look, if you're an
insurance company, you can't say,
00:13:35
"Well, it's not politically favorable to
worry about the climate problem anymore."
00:13:39
Because it's changing your risk profiles. If you write insurance in California,
you can't pretend that wildfires aren't
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breaking out more frequently and burning
more houses down, right? So— and that's true of a lot of big major
players.
00:13:56
So I think you'll see that pendulum shift
back eventually, even in the United States.
00:14:04
And the other thing to say is, this is
really mostly a U.S. phenomenon right now, this backlash
against ESG.
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And in many other countries, you still
have this development of new standards, new legislation, et cetera, that we're
going to see.
00:14:20
Right. And so then that leads me to believe that
we are still a ways away from having some
00:14:26
middle ground that we'll be able to find,
where all parties are kind of in unison of
00:14:34
focusing on the importance of this topic,
understanding that there's a financial
00:14:39
component to it, but also working through
the moral side of this as well. Yeah, I think that's right.
00:14:45
And this has been— I've been
teaching in business ethics and in sustainability and the
business law side for a long time.
00:14:55
And it's not really new. This is an issue that we have,
a tension that we have in our system.
00:15:01
On the one hand, our
market-based, rules-based system has been incredibly productive
and beneficial for many people.
00:15:11
At the same time, it doesn't always
consider some of the ethical issues or the
00:15:18
social issues that are really important to
maintaining the actual system. So that's the— I think that's— ESG is
part of that more general process that
00:15:29
we're always negotiating, I think,
as long as we have that kind of system. And I hope we continue to do that because
the world, the livelihood of many billions
00:15:39
of people is depending on us to getting
that right. Eric, I appreciate the time today.
00:15:44
All the best, sir. All right. Thanks for this time, too. You got it. Eric Orts, a professor at the Wharton
School.
00:15:51
The book is titled <i>The Ethics of ESG</i>. There it is right there.
00:15:55
It is available for your pickup and
purchase to read at your convenience. Thanks, Eric.
00:16:02
Thank you for listening to <i>The Ripple
Effect.</i> We hope you found this episode informative
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00:16:07
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00:16:11
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