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Investments made today in an oil field
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that are going to pay off over 40 or 50
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years might not pay off because no one
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might want that oil in 2050 or 2060. and
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so we have to think about the
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Investments we're making today that have
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a sufficiently long time Horizon with an
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eye to what the future is going to bring
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in terms of Environmental Policy
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environmental prices and the use of
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different sources of fuel welcome to the
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ripple effect the podcast that takes you
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on a journey through the minds of work
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and faculty I'm your host Dan Loney and
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in each episode we'll be diving deep
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into the inspiration behind the
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groundbreaking research that Wharton
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professors have conducted and exploring
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how their findings resonate with the
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world today we'll be covering a diverse
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range of topics bringing you the latest
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insights and knowledge that you can
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apply to your life into work so get
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ready to dive into new ideas with the
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ripple effect
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let's start with just kind of ESG as the
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concept in the framework because it's
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obviously been a topic that's been
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talked about a lot especially in the
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last few years
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why I guess ESG when we're talking about
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all of these components obviously there
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is the EVs and the G but what is it that
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has drawn the the want for the
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connection to this terminology
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uh well let's make sure all the
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um listeners know what ESG actually
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stands for e is for environment s for
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social G for governance and the
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collection of the set of environmental
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social and governance factors uh that
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influence materially by the SEC
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definition there are things investors
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should care about that materially
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influence the firm's revenues costs or
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efficiencies and should be incorporated
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into Financial models into investment
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valuation uh into strategic assessments
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but are often left out they're often not
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Incorporated they're often not addressed
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they're often taken for granted and the
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whole ESG movement is about putting them
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in
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so obviously this has been uh very much
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an important component of your research
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what was it that Drew you uh to looking
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at ESG and and climate risk in the first
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place
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well for 25 years I've been working I
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guess in the S Dimension and continue to
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still do a lot of my work there I look
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at political and social risk management
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so I've looked at how stakeholder
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engagement by firms managing the
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relationship with government officials
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with communities with civil society
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organizations is really a key value
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driver I did a lot of that work in the
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extractive space oil gas mining also
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heavy manufacturing like semiconductors
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or Pharmaceuticals you might have the
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formal rights to do something you might
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have all the permits you might have all
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the licenses but if you don't have the
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support of all the external stakeholders
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not just those in your value chain not
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just suppliers and buyers but those
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secondary stakeholders the community the
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government the Civil Society you might
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get stopped in your tracks by protests
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by strikes or you might operate for a
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while and then get sued there might be a
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regulatory inquiry you might get shut
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down and at one level when you tell that
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story it's really obvious but because
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those costs are in the future and
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they're unknown firms often don't manage
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them particularly well they under invest
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up front in the relationships that could
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help forestall certain risks and so for
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a long time I tried to make that
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argument clear and I tried to work with
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alternative data because there isn't
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publicly available data that often helps
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and help make the business case that
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more attention to political risk to
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social issues was actually good business
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and the ESG movement needed exactly the
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same thing an eye for a different
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approach to data and Analysis and a way
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of making the link between these ESG
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factors and the p l so you talk about
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the business case for addressing climate
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change and that's obviously been a back
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and forth now uh for for a little while
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make the financial case for addressing
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climate change at this point
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well I think it's increasingly easy and
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straightforward I mean they're going to
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be assets that are literally underwater
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whether it's a real estate investment or
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whether it's a Factory close to a port
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certain assets by 2030 2040 if we don't
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do something about the four or five
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degree scenario we're on are going to be
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underwater and you should be
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incorporating that into your evaluation
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models we're probably and hopefully
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shifting away from a heavy dependence on
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fossil fuels uh to more green sources of
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energy whether it be Hydro wind solar
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Investments made today in an oil field
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that's that are going to pay off over 40
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or 50 years might not pay off because no
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one might want that oil in 2050 or 2060.
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uh similarly investments in
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um you know that are counting on there
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being fossil fuel vehicles in 2050 or
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2060. may or may not pay off depending
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on how fast we have the uptick of
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electric vehicles and so we have to
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think about the Investments we're making
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today that have a sufficiently long time
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Horizon with an eye to what the future
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is going to bring in terms of
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Environmental Policy environmental
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prices and the use of different sources
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of fuel and I guess part of the
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discussion really is about the path that
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a lot of Corporations and their
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leadership are taking in this uh in this
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space uh one of the cases that is really
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talked about a lot in terms of being a
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potential important uh element in terms
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of moving this forward uh is engine
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number one and them winning uh seats on
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the board with Exxon Mobil now you were
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kind of around that and I guess let's
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start by talking a little bit about how
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that all developed over a course of time
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well engine number one began uh and its
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core business model uh is really focused
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on the idea of bringing ESG factors in
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but most people first became aware of
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them because of their campaign to unseat
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uh four board members of Exxon Mobil and
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they built a brilliant 78-page deck that
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analyzed the business case uh for Exxon
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Mobil doing more on the energy
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transition and highlighting that the
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company was actually destroying
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shareholder value uh by not attending to
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the energy transition they had forecasts
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for the future price of oil that were
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Rosier than OPEC they had forecasts for
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the future demand of electric vehicles
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that were more pessimistic than just
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about anybody in the world and they were
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making investment decisions today
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accordingly and that was leading to a
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massive waste of shareholder Capital
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um estimates of over 200 billion dollars
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of shareholder value destroyed uh there
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was also the question of Darren Woods's
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pay and the corporate governance of the
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company the G Factor uh during the time
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that he destroyed 200 billion dollars of
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shareholder value he got 70 million
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dollars of bonuses uh is that good
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corporate governance does that make any
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sense he also appointed to the board a
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series of Executives who underperformed
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their Industries when they were CEOs and
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had absolutely no energy sector
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experience so no one on the board could
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give him any realistic or tangible
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advice on the energy transition and what
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to do about climate transition because
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none of them knew anything about the
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energy sector again that's just bad
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corporate governance so you put all that
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together and you've got a very strong
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case uh that they needed more oversight
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and they needed more awareness to the
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energy transition on the board and
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engine number one mounted a campaign to
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do that I became involved as an advisor
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to engine number one on a different
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project what they call the total value
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framework which I co-developed together
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with a group from a major consultancy to
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generalize the case if you will of Exxon
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Mobil try to analyze which companies are
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destroying value to stakeholders and
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think about when that might hit
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shareholder value and we did that for
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the entire S P 500 and now it's been
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extended to the Russell 1000 and that
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was a major research project to really
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try to build a data set that would allow
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them to look not just in one company but
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at a whole set of companies and make
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investment decisions and engagements
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accordingly and I continue to to work
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with them on that project but in the
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scope of this process that's played out
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now for quite some time a lot of people
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talk about that movement to win board
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seats by engine number one as really
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kind of a pivot moment
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how so do you think that that is the
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case
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well I think there are a couple factors
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in play I mean when they first started
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everybody kind of wrote them off you own
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0.02 percent of the stock who are you
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guys you're gonna unsee three board
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members really and then I kind of gather
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momentum you're like wait wait a minute
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this is credible this is serious look at
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this analysis and then there was a day
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where three of the four proposed board
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members were ousted and I think the next
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morning just about every board member in
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a publicly traded company anywhere in
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the world reading that newspaper article
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said I don't want to be them
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I want to keep my job what am I missing
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what do I need to understand about the
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hidden risks or the missed opportunities
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from ESG factors I better get a report
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about those at the next board meeting I
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want to make sure that I'm doing my job
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and I can stand up to this kind of
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attack and I think that amplification of
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the message not just the headlines not
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just the fact that it was Exxon Mobil
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not just David versus Goliath but the
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fact that every publicly traded company
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in the world's board is suddenly
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starting to talk about ESG factors at
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the next annual meeting I think that was
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the biggest impact that engine number
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one has had up to date well then that
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puts an even greater focus on the data
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that is out there for each of these
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particular companies around ESG and I
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guess the question is how can we better
00:09:39
use that data to move that needle
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forward
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uh well let's start with the current
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state of the data that we have most of
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it honestly is quite bad it's based on
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voluntary unaudited Disclosure by
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corporations they either put stuff in
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their sustainability report or they
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answer these really long surveys that
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companies sell them and then different
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companies sell us the data
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um we're only getting a snapshot of what
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the company wants to share and what some
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third-party data provider can kind of
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Cobble together and then the bigger
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problem even if that data was accurate
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there's like a hundred factors sometimes
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300 factors how do we weight them how do
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we put them together because we've got
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you know performance measured in one set
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of units here and performance on another
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factor in a different set of units here
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and another Factor you know should they
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be all equally weighted probably not you
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know Carbon emissions matters more for
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Exxon Mobil than it does for I don't
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know Facebook teenage depression matters
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more for Facebook than it does for Exxon
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Mobil but how do we shift the weights
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and and how do we turn tons of carbon
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and number of teenage girls in
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depression to dollar values that might
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hit shareholder value those are the
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questions the Kearney SG data sets don't
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answer and and frankly need to be
00:10:54
answered so the total value framework
00:10:56
was a big step towards doing that but
00:10:58
but we've got a long way to go uh we've
00:11:00
got to really measure the impact that
00:11:02
companies are having and that's more
00:11:04
akin to like impact uh investment or
00:11:07
impact valuation but then we have to
00:11:09
have a point of view about when those
00:11:10
positive or negative impacts are going
00:11:12
to hit shareholder value
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some firms some cases that's going to
00:11:17
happen really quickly that happened with
00:11:18
Exxon Mobil other cases maybe Facebook
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there's a more difficult pathway there's
00:11:24
more protection for the firm from these
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stakeholder forces and it's harder to
00:11:28
build a business case even though the
00:11:30
firm is creating harm it's harder to say
00:11:33
that shareholders are going to Bear the
00:11:34
brunt in the short term and so we really
00:11:36
need to think through both of those and
00:11:38
very few ESG data sets allow us to do
00:11:40
that
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what kind of role do you think then that
00:11:44
Regulators will have to play in this
00:11:46
process as we move forward
00:11:48
well we're starting to see greater
00:11:49
requirements for disclosure of things
00:11:51
like the emissions you release and also
00:11:54
greater attention to your risk
00:11:56
mitigation mechanisms so what would
00:11:58
happen to you if there was a four degree
00:11:59
scenario how many of your assets would
00:12:01
be underwater or what would happen to
00:12:04
you if we had a one and a half degree
00:12:05
scenario which means we have some kind
00:12:07
of carbon tax or energy transition is
00:12:10
your strategy robust to that so this is
00:12:12
a major and material risk for companies
00:12:14
and the SEC under the current guidelines
00:12:17
being discussed they haven't been
00:12:18
finally approved yet is demanding that
00:12:20
firms both report their missions but
00:12:22
also undertake scenario analysis on
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different scenarios that could occur in
00:12:27
the future with respect to the climate
00:12:28
transition that's going to help
00:12:30
investors but it's not going to be the
00:12:31
end of the game
00:12:33
there's many uh factors many ESG factors
00:12:36
for which we don't have strong
00:12:38
disclosure standards yet which we're
00:12:39
still figuring things out and some of
00:12:41
those scenarios aren't as clear you know
00:12:44
four degree versus one and a half degree
00:12:45
warming scenario okay that's a pretty
00:12:47
clear thing to model model but what
00:12:49
about the future state of human rights
00:12:51
law or the future state of uh you know
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customer uh customer damages like you
00:12:57
know the Facebook teenage depression
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what how do we model those uh what sort
00:13:02
of uncertainties do we face how do they
00:13:04
differ from the European Union to the
00:13:05
U.S none of that is in the regulations
00:13:08
yet and and it's pretty difficult to put
00:13:10
in there so I think the regulations are
00:13:12
always going to establish a floor and
00:13:14
then companies like engine number one
00:13:16
other asset managers whether it's
00:13:18
BlackRock State Street Alliance
00:13:20
Bernstein Parnassus Morgan Stanley
00:13:22
they're all going to be trying to figure
00:13:23
things out above the floor and so it's
00:13:25
good to raise the floor but there's
00:13:26
always a lot of action above it well and
00:13:28
as you kind of alluded to before there
00:13:31
is in some of these instances kind of a
00:13:33
time window uh that you need to really
00:13:35
see significant action on and so you
00:13:39
know the I guess the concern I have is
00:13:41
is that are we going to be able to
00:13:44
effectively deal with a lot of these
00:13:46
issues
00:13:47
if we have these time Windows really uh
00:13:49
starting to clamp down on us
00:13:52
well I think it's it's a really
00:13:53
important observation it also highlights
00:13:55
a little bit of the limits of ESG
00:13:57
investing some people think that ESG
00:13:59
investing is going to solve all these
00:14:01
problems it's going to solve the
00:14:02
problems of climate change solve the
00:14:03
problems of racial Justice all it's
00:14:06
supposed to do is incorporate ESG
00:14:09
factors into an investment thesis if the
00:14:12
current policies the current stakeholder
00:14:15
opinions don't lead to that being
00:14:17
internalized by shareholders it's not
00:14:19
going to solve the problem it's only
00:14:20
going to make sure we're not leaving
00:14:21
stuff out we may have to go further in
00:14:24
terms of pricing carbon in terms of
00:14:25
addressing systemic racism uh to really
00:14:28
have the impact we want on a society ESG
00:14:31
ESG initiative and ESG investing more
00:14:34
broadly just about not leaving things
00:14:35
out but it's not about getting things
00:14:37
exactly right so we may still need more
00:14:39
policy more legislation more regulation
00:14:41
to achieve what we want as a society on
00:14:45
some of these issues so then I guess the
00:14:47
question becomes is you you also have
00:14:49
this anti-esg push that is out there as
00:14:52
well and it plays out a lot in our
00:14:54
political Discord uh these days uh I I
00:14:57
think some people would say let's hope
00:14:59
we've kind of reached the peak around
00:15:01
anti-esg I think there are others that
00:15:03
would say we're still not at that point
00:15:05
yet
00:15:06
well we're certainly seeing uh from the
00:15:09
time we launched the SD initiative to
00:15:10
the president a real surge in this
00:15:12
anti-esg movement uh and it's gaining a
00:15:15
lot of power especially with the new
00:15:16
Republican Congress
00:15:18
um should soon in the next few days uh
00:15:20
be the target of President Biden's first
00:15:22
veto uh pushing back against the repeal
00:15:24
of and the the uh the allowance uh to do
00:15:28
ESG investing within U.S Pension funds
00:15:31
uh and so making sure that funds can do
00:15:33
that can incorporate ESG factors I think
00:15:36
we are getting to the point if I'm
00:15:37
optimistic that we may be at the point
00:15:39
of peak anti-esg because in recent days
00:15:42
the state of North Dakota which is not
00:15:45
exactly known as a blue state or a
00:15:47
Bastion of progressivism uh nothing
00:15:49
against the residents there my wife's
00:15:51
family is from North Dakota uh but but
00:15:53
overall it's a pretty red State their
00:15:55
legislature voted 90-3 against anti-esg
00:16:00
bills against bills that would restrict
00:16:01
ESG investing why because they said why
00:16:04
should we the government regulate the
00:16:06
Financial Market's ability to
00:16:09
incorporate ESG factors
00:16:11
we're not in the business of regulating
00:16:12
we believe in free markets and it seems
00:16:14
like the free markets value ESG there's
00:16:17
been similar pushback in Indiana in
00:16:20
Kansas and Wyoming a number of states I
00:16:23
was talking to uh representatives in
00:16:25
Arizona yesterday about their efforts to
00:16:27
push back against the anti-history I
00:16:29
think the fact that the business case
00:16:30
the financial models say that there's a
00:16:33
there the history factors are material
00:16:35
by the SEC definition and that the
00:16:38
anti-sg movement is imposing regulation
00:16:41
as a solution it's starting to highlight
00:16:44
that this may not actually be about what
00:16:46
they claim it is may not be about
00:16:48
protecting pensioners value maybe more
00:16:50
about protecting polluters protecting
00:16:52
people who don't care about their
00:16:54
workers or finding a political wedge
00:16:57
issue kind of like critical race Theory
00:16:58
or transgendered bathrooms that that
00:17:01
resonate with some people but may not be
00:17:04
as big of a problem as we think for
00:17:06
society and maybe the costs of
00:17:09
regulating the costs of taking certain
00:17:11
financial institutions out of the market
00:17:13
is our own Daniel Garrett's research has
00:17:15
shown could be much larger than the
00:17:18
political benefits in the short term at
00:17:19
least that's my hope so for those funds
00:17:21
out there that have kind of started to
00:17:23
incorporate uh ESG components in their
00:17:27
funds
00:17:28
what kind of growth do you expect it
00:17:30
you're going to see and maybe even
00:17:31
what's the best way
00:17:33
to attract more investors in that world
00:17:36
of of ESG investing
00:17:39
what we're trying to do with the SG
00:17:40
initiative and what the better investors
00:17:42
are doing is to build the business case
00:17:45
you know in some ways talk less about
00:17:47
ESG and talk more about profits losses
00:17:50
efficiencies costs model the cost curves
00:17:53
of the energy transition look at the
00:17:56
Unexplained variances on the profits and
00:17:58
loss statement and Link them to ESG
00:18:00
factors but start with the p at L and
00:18:02
focus on the p l focus on the business
00:18:05
case the more we do that the more
00:18:07
sophisticated we get in looking at the
00:18:09
energy transition in looking at the
00:18:11
changing Workforce uh in in looking at
00:18:14
ESG factors from a business standpoint
00:18:17
the better our investment decisions will
00:18:19
be the better the Returns on those
00:18:21
investment decisions will be and the
00:18:23
easier it'll be for you as an investor
00:18:26
whether you're red or blue when you go
00:18:28
into the voting box to say this just
00:18:29
makes good Financial sense I don't want
00:18:31
to leave this stuff out let's make sure
00:18:33
it's in
00:18:35
thank you for listening to the ripple
00:18:36
effect we hope you found this episode
00:18:38
informative and engaging don't forget to
00:18:40
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00:18:43
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00:18:45
Insight from the Wharton School
