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Investments made today in an oil field that are going to pay off over 40 or 50 years might not pay off because no one
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might want that oil in 2050 or 2060. and so we have to think about the Investments we're making today that have
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a sufficiently long time Horizon with an eye to what the future is going to bring
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in terms of Environmental Policy environmental prices and the use of different sources of fuel welcome to the
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ripple effect the podcast that takes you on a journey through the minds of work and faculty I'm your host Dan Loney and
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in each episode we'll be diving deep into the inspiration behind the groundbreaking research that Wharton
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professors have conducted and exploring how their findings resonate with the world today we'll be covering a diverse
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range of topics bringing you the latest insights and knowledge that you can apply to your life into work so get
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ready to dive into new ideas with the ripple effect let's start with just kind of ESG as the
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concept in the framework because it's obviously been a topic that's been
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talked about a lot especially in the last few years why I guess ESG when we're talking about
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all of these components obviously there is the EVs and the G but what is it that
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has drawn the the want for the connection to this terminology uh well let's make sure all the
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um listeners know what ESG actually stands for e is for environment s for social G for governance and the
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collection of the set of environmental social and governance factors uh that influence materially by the SEC
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definition there are things investors should care about that materially influence the firm's revenues costs or
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efficiencies and should be incorporated into Financial models into investment valuation uh into strategic assessments
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but are often left out they're often not Incorporated they're often not addressed
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they're often taken for granted and the whole ESG movement is about putting them
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in so obviously this has been uh very much an important component of your research
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what was it that Drew you uh to looking at ESG and and climate risk in the first
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place well for 25 years I've been working I guess in the S Dimension and continue to
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still do a lot of my work there I look at political and social risk management so I've looked at how stakeholder
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engagement by firms managing the relationship with government officials with communities with civil society
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organizations is really a key value driver I did a lot of that work in the extractive space oil gas mining also
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heavy manufacturing like semiconductors or Pharmaceuticals you might have the formal rights to do something you might
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have all the permits you might have all the licenses but if you don't have the
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support of all the external stakeholders not just those in your value chain not just suppliers and buyers but those
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secondary stakeholders the community the government the Civil Society you might get stopped in your tracks by protests
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by strikes or you might operate for a while and then get sued there might be a regulatory inquiry you might get shut
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down and at one level when you tell that story it's really obvious but because
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those costs are in the future and they're unknown firms often don't manage
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them particularly well they under invest up front in the relationships that could
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help forestall certain risks and so for a long time I tried to make that argument clear and I tried to work with
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alternative data because there isn't publicly available data that often helps
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and help make the business case that more attention to political risk to social issues was actually good business
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and the ESG movement needed exactly the same thing an eye for a different approach to data and Analysis and a way
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of making the link between these ESG factors and the p l so you talk about the business case for addressing climate
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change and that's obviously been a back and forth now uh for for a little while
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make the financial case for addressing climate change at this point well I think it's increasingly easy and
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straightforward I mean they're going to be assets that are literally underwater
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whether it's a real estate investment or whether it's a Factory close to a port
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certain assets by 2030 2040 if we don't do something about the four or five degree scenario we're on are going to be
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underwater and you should be incorporating that into your evaluation models we're probably and hopefully
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shifting away from a heavy dependence on fossil fuels uh to more green sources of
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energy whether it be Hydro wind solar Investments made today in an oil field that's that are going to pay off over 40
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or 50 years might not pay off because no one might want that oil in 2050 or 2060.
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uh similarly investments in um you know that are counting on there being fossil fuel vehicles in 2050 or
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2060. may or may not pay off depending on how fast we have the uptick of electric vehicles and so we have to
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think about the Investments we're making today that have a sufficiently long time
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Horizon with an eye to what the future is going to bring in terms of Environmental Policy environmental
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prices and the use of different sources of fuel and I guess part of the discussion really is about the path that
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a lot of Corporations and their leadership are taking in this uh in this space uh one of the cases that is really
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talked about a lot in terms of being a potential important uh element in terms of moving this forward uh is engine
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number one and them winning uh seats on the board with Exxon Mobil now you were kind of around that and I guess let's
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start by talking a little bit about how that all developed over a course of time
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well engine number one began uh and its core business model uh is really focused
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on the idea of bringing ESG factors in but most people first became aware of them because of their campaign to unseat
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uh four board members of Exxon Mobil and they built a brilliant 78-page deck that
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analyzed the business case uh for Exxon Mobil doing more on the energy transition and highlighting that the
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company was actually destroying shareholder value uh by not attending to the energy transition they had forecasts
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for the future price of oil that were Rosier than OPEC they had forecasts for the future demand of electric vehicles
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that were more pessimistic than just about anybody in the world and they were making investment decisions today
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accordingly and that was leading to a massive waste of shareholder Capital um estimates of over 200 billion dollars
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of shareholder value destroyed uh there was also the question of Darren Woods's
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pay and the corporate governance of the company the G Factor uh during the time that he destroyed 200 billion dollars of
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shareholder value he got 70 million dollars of bonuses uh is that good corporate governance does that make any
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sense he also appointed to the board a series of Executives who underperformed their Industries when they were CEOs and
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had absolutely no energy sector experience so no one on the board could give him any realistic or tangible
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advice on the energy transition and what to do about climate transition because none of them knew anything about the
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energy sector again that's just bad corporate governance so you put all that
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together and you've got a very strong case uh that they needed more oversight
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and they needed more awareness to the energy transition on the board and engine number one mounted a campaign to
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do that I became involved as an advisor to engine number one on a different project what they call the total value
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framework which I co-developed together with a group from a major consultancy to
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generalize the case if you will of Exxon Mobil try to analyze which companies are
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destroying value to stakeholders and think about when that might hit shareholder value and we did that for
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the entire S P 500 and now it's been extended to the Russell 1000 and that was a major research project to really
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try to build a data set that would allow them to look not just in one company but
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at a whole set of companies and make investment decisions and engagements accordingly and I continue to to work
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with them on that project but in the scope of this process that's played out
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now for quite some time a lot of people talk about that movement to win board seats by engine number one as really
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kind of a pivot moment how so do you think that that is the case well I think there are a couple factors
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in play I mean when they first started everybody kind of wrote them off you own 0.02 percent of the stock who are you
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guys you're gonna unsee three board members really and then I kind of gather
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momentum you're like wait wait a minute this is credible this is serious look at
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this analysis and then there was a day where three of the four proposed board members were ousted and I think the next
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morning just about every board member in a publicly traded company anywhere in the world reading that newspaper article
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said I don't want to be them I want to keep my job what am I missing what do I need to understand about the
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hidden risks or the missed opportunities from ESG factors I better get a report about those at the next board meeting I
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want to make sure that I'm doing my job and I can stand up to this kind of attack and I think that amplification of
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the message not just the headlines not just the fact that it was Exxon Mobil not just David versus Goliath but the
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fact that every publicly traded company in the world's board is suddenly starting to talk about ESG factors at
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the next annual meeting I think that was the biggest impact that engine number one has had up to date well then that
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puts an even greater focus on the data that is out there for each of these particular companies around ESG and I
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guess the question is how can we better use that data to move that needle forward
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uh well let's start with the current state of the data that we have most of it honestly is quite bad it's based on
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voluntary unaudited Disclosure by corporations they either put stuff in their sustainability report or they
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answer these really long surveys that companies sell them and then different companies sell us the data
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um we're only getting a snapshot of what the company wants to share and what some
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third-party data provider can kind of Cobble together and then the bigger problem even if that data was accurate
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there's like a hundred factors sometimes 300 factors how do we weight them how do
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we put them together because we've got you know performance measured in one set
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of units here and performance on another factor in a different set of units here
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and another Factor you know should they be all equally weighted probably not you
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know Carbon emissions matters more for Exxon Mobil than it does for I don't know Facebook teenage depression matters
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more for Facebook than it does for Exxon Mobil but how do we shift the weights and and how do we turn tons of carbon
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and number of teenage girls in depression to dollar values that might hit shareholder value those are the
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questions the Kearney SG data sets don't answer and and frankly need to be answered so the total value framework
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was a big step towards doing that but but we've got a long way to go uh we've
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got to really measure the impact that companies are having and that's more akin to like impact uh investment or
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impact valuation but then we have to have a point of view about when those positive or negative impacts are going
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to hit shareholder value some firms some cases that's going to happen really quickly that happened with
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Exxon Mobil other cases maybe Facebook there's a more difficult pathway there's
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more protection for the firm from these stakeholder forces and it's harder to
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build a business case even though the firm is creating harm it's harder to say
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that shareholders are going to Bear the brunt in the short term and so we really
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need to think through both of those and very few ESG data sets allow us to do that
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what kind of role do you think then that Regulators will have to play in this process as we move forward
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well we're starting to see greater requirements for disclosure of things like the emissions you release and also
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greater attention to your risk mitigation mechanisms so what would happen to you if there was a four degree
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scenario how many of your assets would be underwater or what would happen to you if we had a one and a half degree
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scenario which means we have some kind of carbon tax or energy transition is your strategy robust to that so this is
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a major and material risk for companies and the SEC under the current guidelines
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being discussed they haven't been finally approved yet is demanding that firms both report their missions but
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also undertake scenario analysis on different scenarios that could occur in the future with respect to the climate
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transition that's going to help investors but it's not going to be the end of the game
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there's many uh factors many ESG factors for which we don't have strong disclosure standards yet which we're
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still figuring things out and some of those scenarios aren't as clear you know
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four degree versus one and a half degree warming scenario okay that's a pretty
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clear thing to model model but what about the future state of human rights law or the future state of uh you know
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customer uh customer damages like you know the Facebook teenage depression what how do we model those uh what sort
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of uncertainties do we face how do they differ from the European Union to the U.S none of that is in the regulations
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yet and and it's pretty difficult to put in there so I think the regulations are
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always going to establish a floor and then companies like engine number one other asset managers whether it's
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BlackRock State Street Alliance Bernstein Parnassus Morgan Stanley they're all going to be trying to figure
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things out above the floor and so it's good to raise the floor but there's
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always a lot of action above it well and as you kind of alluded to before there is in some of these instances kind of a
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time window uh that you need to really see significant action on and so you know the I guess the concern I have is
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is that are we going to be able to effectively deal with a lot of these issues if we have these time Windows really uh
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starting to clamp down on us well I think it's it's a really important observation it also highlights
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a little bit of the limits of ESG investing some people think that ESG investing is going to solve all these
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problems it's going to solve the problems of climate change solve the problems of racial Justice all it's
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supposed to do is incorporate ESG factors into an investment thesis if the current policies the current stakeholder
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opinions don't lead to that being internalized by shareholders it's not going to solve the problem it's only
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going to make sure we're not leaving stuff out we may have to go further in terms of pricing carbon in terms of
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addressing systemic racism uh to really have the impact we want on a society ESG
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ESG initiative and ESG investing more broadly just about not leaving things out but it's not about getting things
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exactly right so we may still need more policy more legislation more regulation to achieve what we want as a society on
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some of these issues so then I guess the question becomes is you you also have this anti-esg push that is out there as
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well and it plays out a lot in our political Discord uh these days uh I I think some people would say let's hope
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we've kind of reached the peak around anti-esg I think there are others that
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would say we're still not at that point yet well we're certainly seeing uh from the
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time we launched the SD initiative to the president a real surge in this anti-esg movement uh and it's gaining a
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lot of power especially with the new Republican Congress um should soon in the next few days uh
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be the target of President Biden's first veto uh pushing back against the repeal
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of and the the uh the allowance uh to do ESG investing within U.S Pension funds uh and so making sure that funds can do
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that can incorporate ESG factors I think we are getting to the point if I'm optimistic that we may be at the point
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of peak anti-esg because in recent days the state of North Dakota which is not exactly known as a blue state or a
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Bastion of progressivism uh nothing against the residents there my wife's family is from North Dakota uh but but
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overall it's a pretty red State their legislature voted 90-3 against anti-esg
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bills against bills that would restrict ESG investing why because they said why should we the government regulate the
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Financial Market's ability to incorporate ESG factors we're not in the business of regulating
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we believe in free markets and it seems like the free markets value ESG there's
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been similar pushback in Indiana in Kansas and Wyoming a number of states I was talking to uh representatives in
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Arizona yesterday about their efforts to push back against the anti-history I think the fact that the business case
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the financial models say that there's a there the history factors are material
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by the SEC definition and that the anti-sg movement is imposing regulation as a solution it's starting to highlight
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that this may not actually be about what they claim it is may not be about protecting pensioners value maybe more
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about protecting polluters protecting people who don't care about their workers or finding a political wedge
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issue kind of like critical race Theory or transgendered bathrooms that that resonate with some people but may not be
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as big of a problem as we think for society and maybe the costs of regulating the costs of taking certain
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financial institutions out of the market is our own Daniel Garrett's research has
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shown could be much larger than the political benefits in the short term at least that's my hope so for those funds
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out there that have kind of started to incorporate uh ESG components in their funds
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what kind of growth do you expect it you're going to see and maybe even what's the best way
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to attract more investors in that world of of ESG investing what we're trying to do with the SG
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initiative and what the better investors are doing is to build the business case
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you know in some ways talk less about ESG and talk more about profits losses efficiencies costs model the cost curves
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of the energy transition look at the Unexplained variances on the profits and loss statement and Link them to ESG
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factors but start with the p at L and focus on the p l focus on the business case the more we do that the more
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sophisticated we get in looking at the energy transition in looking at the changing Workforce uh in in looking at
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ESG factors from a business standpoint the better our investment decisions will be the better the Returns on those
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investment decisions will be and the easier it'll be for you as an investor whether you're red or blue when you go
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into the voting box to say this just makes good Financial sense I don't want
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to leave this stuff out let's make sure it's in thank you for listening to the ripple
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effect we hope you found this episode informative and engaging don't forget to
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