00:00:00
And then it developed.
00:00:01
And really, the institutional
investors had a very
00:00:05
large hand in pushing a
development of ESG criteria.
00:00:12
And the primary
direction of it was to try to
00:00:15
measure when these
kinds of different factors—
00:00:19
and there are many factors that are not
traditionally financially material factors
00:00:25
that you would see in annual reports to
the SEC, for example.
00:00:30
To what extent do they
affect the bottom line?
00:00:32
To what extent are they financially
material?
00:00:36
Welcome to <i>The Ripple
Effect</i>, the podcast that takes
00:00:39
you on a journey through
the minds of Wharton faculty.
00:00:42
I'm your host, Dan Loney.
00:00:43
And in each episode, we'll be diving deep
into the inspiration behind the
00:00:47
groundbreaking research that Wharton
professors have conducted and exploring
00:00:51
how their findings resonate with the world
today.
00:00:55
There continues to be a deep discussion
about the path of ESG.
00:00:59
Some of the discussion is around the
ethical side of things.
00:01:03
You have various levels of
investment, which can be designed
00:01:06
to capitalize on the potential
profit that can be gained.
00:01:09
But you also have to
have a focus on the benefits
00:01:12
that can be brought
forward to the public at large.
00:01:14
And how do those two balance each other
out?
00:01:17
A new book tackles these ethical
questions.
00:01:20
Wharton's Eric Orts is
co-author of the new
00:01:23
book titled <i>The Ethics of
ESG</i>, and he joins us right now.
00:01:27
Hi, Eric.
00:01:27
Great to catch up again.
00:01:29
Hi, and great to see you
again, too.
00:01:31
Thanks for asking me on here.
00:01:33
Thank you.
00:01:34
So you and I have talked about ESG in one
form or another, I think for about 15
00:01:39
years now, as long as I have been
connected with Wharton.
00:01:42
As you look back over this
time, how do you think the world
00:01:47
around ESG has kind of
evolved during that time frame?
00:01:52
Well, that's a good question.
00:01:55
First of all, I think since we've been
talking, ESG really has come into being.
00:02:02
So the origin story of ESG is that the
United Nations
00:02:06
met with a lot of—
a number of large
00:02:10
institutional investors and said,
"Hey, we want you to do something about
00:02:15
large topics that are affecting the whole
world, including the climate change
00:02:20
problem, biodiversity
loss, social issues like
00:02:25
human rights, using slave— using
slavery to produce goods.
00:02:32
So there was a push
then to get the investing
00:02:34
community on board with
some kind of general project.
00:02:40
And that's where ESG,
which stands for environmental,
00:02:44
social and governance
criteria, got its start.
00:02:48
And then it developed.
00:02:50
And really, the institutional
investors had a very
00:02:55
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,
00:03:18
for example. To what extent do they affect
the bottom line?
00:03:22
To what extent are they financially
material?
00:03:25
And the idea there was
that there were some—
00:03:28
low— there was a lot of low-hanging
fruit on this issue.
00:03:32
And there's also an idea that if you take,
for example, climate change, there's a
00:03:37
really— there's a long-term effect
00:03:39
that may not have been
economic effect.
00:03:42
They may not have been
taken into account by a lot
00:03:46
of businesses that are
just looking very short term.
00:03:49
So the basic idea and the original
conception, at least as the institutional
00:03:55
investors saw it, was that you were
improving the financial materiality
00:04:01
measures, and that this would help to have
a win win solution.
00:04:04
So you'd get some gain on issues like
climate, etc.
00:04:09
But that would be because you'd be having
long-term financial gain.
00:04:13
The problem is that also in this picture
was the United Nations.
00:04:18
And notably not in the picture
particularly strongly were nonprofit
00:04:22
organizations that care about issues like
climate and human rights and other things.
00:04:27
Because their interest is not only in
financial materiality, they care about
00:04:33
actually making a difference that the
world feels.
00:04:36
So in other words, you really have a
reduction of human rights violations or
00:04:39
you have a reduction in traffic and sexual
trafficking.
00:04:43
You have a reduction of greenhouse gas
emissions.
00:04:47
And it's not just because you care about
the long term economic health of investors.
00:04:52
It's because you care about everybody
having a collective— collective achievement.
00:04:58
So that kind of tension
that really goes back to the
00:05:01
time when we were talking
15 years ago is still there.
00:05:08
There's a tension between these two kinds
of forces.
00:05:11
And what we see now is an updating of
that.
00:05:15
And we also have seen, you have to put on
the table, a politicization of this issue.
00:05:21
So that it's not just business trying to
do one thing or another.
00:05:25
It's also become politicized.
00:05:27
And so the acronym ESG
has joined the acronym DEI
00:05:33
as a targeted enemy for political—
for some political forces.
00:05:41
And part of the problem there is that
there's a lot of misinterpretation.
00:05:45
- Right.
00:05:46
One of the problems
with the acronym is it
00:05:48
means different things
for different people.
00:05:50
And then when one side that has a lot of
influence and is currently in power in
00:05:56
Washington has targeted the whole idea,
then you're going to have a retreat away
00:06:01
from it because you don't want to be—
you know, no business really wants to get
00:06:05
in the line of fire of the White House
right now.
00:06:08
And so the book tackles
kind of that balance, I
00:06:13
guess, that needs to be
looked at even greater.
00:06:17
The morality of how you approach ESG as we
move forward, both from the business side,
00:06:24
but also from those that
are concerned about the
00:06:28
environment and climate
change and more, correct?
00:06:33
Yeah, exactly.
00:06:34
So what we do in this
is— the subtitle is that
00:06:38
we critically assess
what's happening with ESG.
00:06:43
And we try to go beyond sort of "Yes,
it's good,"
00:06:47
"No, it's not good," into
understanding what are
00:06:50
different people talking
about in this debate.
00:06:55
And we have different perspectives that
are represented.
00:06:58
So some people, some of the contributors,
Lisa Fairfax at Penn Law School and Joseph
00:07:05
Heath at University of Toronto are
examples, really think this will work
00:07:10
still if we focus the understanding of ESG
on shareholders, so that we continue with
00:07:19
what I would call sort of mainstream ESG,
which is trying to explain to people,
00:07:25
no, this is really just about financial
materiality.
00:07:28
So it's really the same kind
of thing that businesses have
00:07:31
been expected to be doing for
a long time before you had ESG.
00:07:35
It's just improving that process.
00:07:38
And we really have to stay with that.
00:07:40
Now, others of us, and I'm included
00:07:43
on this side, are saying,
"Well, wait a second.
00:07:46
This really doesn't— it doesn't
always make sense.
00:07:49
And it's confusing if you're saying,
for example, we're measuring our
00:07:53
environmental impact and part of that's
climate.
00:07:57
But if you're then saying, but it's only
when it's affecting the financial
00:08:01
materiality, that is not
covering what most people
00:08:05
understand if you say we're
acting to help the environment.
00:08:10
And so one really
interesting development that
00:08:13
we've seen here
adopts that point of view.
00:08:16
And that point of view is— and that's in
Europe.
00:08:19
So the European Union has adopted
what some of—
00:08:23
has adopted a series
of corporate sustainability and financial
00:08:28
sustainability regulations that attempt to
solve this by saying, "No, you also have to
00:08:34
report on something
called impact sustainability,
00:08:37
the actual effects you're
having on the climate."
00:08:40
So you're moving toward a double
materiality standard in Europe.
00:08:44
And on the other hand, in the United States
and other countries, there's not that view.
00:08:51
China has adopted an ESG interpretation.
00:08:55
And once China says we're doing ESG,
then everyone in China has to do ESG.
00:09:00
- Right. Right.
00:09:01
The system works a little differently.
00:09:03
So what you have is a continuing evolution
of what we're really talking about here.
00:09:09
And whether we're going to continue to
call this ESG or not, I think is an open
00:09:14
question. Because a number of people have
said, "Look, what are we really looking at?
00:09:19
If we're really going to— maybe we should
drill down and just look at the climate,
00:09:23
for example, or other particular issues
without trying to put everything that is
00:09:30
not an ordinary
business concern into this
00:09:33
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,
00:09:43
countries, on board to
have a better understanding
00:09:47
of what the actual
attainable goal is,
00:09:50
so you can get more
people focusing on that area,
00:09:54
and you can have a better
outcome down the road?
00:09:58
Yeah, exactly.
00:09:59
And I think that, you know, to give credit
where it's due, I think that— I mean,
00:10:04
I saw the political backlash
against ESG coming early
00:10:08
on. And actually, when it
was first being proposed.
00:10:12
And when schools like the Wharton School
were standing up ESG programs,
00:10:17
too, and we've adjusted to this criticism
as well over time.
00:10:24
But the problem— in some ways, the
criticism is correct because there was a
00:10:30
way in which the institutional investors
that I think had a good spirit about this—
00:10:36
I think they really wanted to do
good with this.
00:10:39
But the way it comes across to people is
that, wait a second, who gave Vanguard and
00:10:46
the big institutional investors the right
to decide to push on this issue?
00:10:52
And their defense was, well, no, we're
just being financially responsible here.
00:10:58
That's all the ESG is.
00:11:00
But when you call it ESG, then people
don't— it's hard for people to believe it.
00:11:04
- Yeah.
00:11:05
And when you have a critique— to some
extent, I think it's valid— of elites,
00:11:11
you know, a criticism
of the elites of the
00:11:13
world pushing down
their view on other folks,
00:11:17
that's part of what's driven a populist
backlash, I think, in the United States.
00:11:21
And to some extent, I think
what that means is you really
00:11:24
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
00:11:36
representing all of the authors in this
book, and it's a co-edited book.
00:11:40
But what I think you
have to get down to is
00:11:42
everyone agreeing to
some kind of a regulation.
00:11:45
I mean, when I first got into
this, I went to the— Wharton
00:11:50
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.
00:11:57
- I thought that was last year, Eric.
I thought that was just last year.
00:12:00
Yeah, unfortunately not.
00:12:02
It was in 1992.
00:12:04
George H.W. Bush
00:12:06
was hosting the U.S.
side on that.
00:12:09
And there was a major
treaty that was agreed about
00:12:13
climate, saying this— we need a
framework for dealing with this.
00:12:17
And there's a major treaty agreed about
biodiversity.
00:12:20
I also was amazed to see a huge business
contingent that was there.
00:12:26
And so already then, businesses
were getting involved and
00:12:30
saying, "We understand this
is a problem for everybody."
00:12:33
- Right.
- And I think what we need to get
00:12:35
back to is that sort of consensus,
00:12:38
where you have everyone kind of
agreeing that this is a problem.
00:12:43
And then it works through the regular
political process.
00:12:46
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.
00:12:57
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.
00:13:03
If you talk to a lot of
the big businesses and
00:13:06
investors, et cetera, the
science doesn't really lie.
00:13:11
And people still have to orient the risks
that their businesses are taking,
00:13:17
et cetera.
00:13:17
I just heard from a top executive in an
insurance company in my class yesterday,
00:13:23
where they're— one of my colleagues
calls it "green hushing."
00:13:28
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.
00:13:42
If you write insurance in California,
you can't pretend that wildfires aren't
00:13:47
breaking out more frequently and burning
more houses down, right? So—
00:13:51
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.
00:14:07
phenomenon right now, this backlash
against ESG.
00:14:11
And in many other countries, you still
have this development of new standards,
00:14:17
new legislation, et cetera, that we're
going to see.
00:14:20
Right.
00:14:21
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.
00:14:44
Yeah, I think that's right.
00:14:45
And this has been— I've been
teaching in business ethics and
00:14:50
in sustainability and the
business law side for a long time.
00:14:55
And it's not really new.
00:14:57
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
00:15:06
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.
00:15:23
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.
00:15:33
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.
00:15:43
Eric, I appreciate the time today.
00:15:44
All the best, sir.
00:15:46
All right.
00:15:46
Thanks for this time, too.
00:15:47
You got it.
00:15:48
Eric Orts, a professor at the Wharton
School.
00:15:51
The book is titled <i>The Ethics of ESG</i>.
00:15:53
There it is right there.
00:15:55
It is available for your pickup and
purchase to read at your convenience.
00:16:01
Thanks, Eric.
00:16:02
Thank you for listening to <i>The Ripple
Effect.</i>
00:16:04
We hope you found this episode informative
and engaging.
00:16:07
Don't forget to subscribe and leave us a
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00:16:11
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