Companies go the distance to tell consumers how sustainable and socially conscious they are. But increasingly, there’s another group they’re trying to impress: investors.
Money managers have put a premium on companies that claim to be engaged in positive environmental, social, and governance (ESG) activities, but the practice has its critics.
“Some folks view that the role of firms is to generate returns for the shareholder, only. Some view that it has to be generating stakeholder value. But the bigger question is, is it indeed the role of the firm to solve societal problems and advocate for social welfare?” said Aaron Yoon, an assistant professor of accounting and information management at Kellogg.
On this episode of The Insightful Leader, we trace the origins of ESG investing and consider its future as a meaningful investment approach.
Laura PAVIN: You’re listening to The Insightful Leader. I’m Laura Pavin.
Jessica LOVE: And I’m Jess Love.
PAVIN: Jess, I’m excited to have you here with me today because I’ve got a big status update on something I’ve been noodling over.
LOVE: Go on.
PAVIN: So you know how, these days, it seems like so many companies are making promises about what they’re doing to be greener and more sustainable?
LOVE: Yeah, kinda feels like the status-quo thing to say.
[Microsoft clip] At Microsoft, we’re taking measurable steps toward becoming carbon negative, water positive, and zero waste by 2030 …
[Apple] Apple has a plan and a promise to make every single Apple product carbon neutral by 2030.
[Delta] That’s why Delta is committed to net-zero carbon emissions by 2050 and why we’re also getting rid of 4.9 million pounds of single-use plastics annually …
PAVIN: The messaging on this is nonstop. And it’s not just promises about going green and fighting climate change. It’s also about how they care about their communities and workers, too.
[Amazon] It’s really awesome that you have all these outgoing, fun-loving people, working for Amazon under one roof. Thank you. Thank you, have a good one.
LOVE: There seem to be a lot of companies campaigning to be the most responsible one out there.
PAVIN: There really, really are a lot of them.
PAVIN: And it seems to be a response to this societal desire for companies—for capitalism—to be about more than just a bottom line. We want to know that the organizations we work for and invest in are impacting the world in a positive way.
PAVIN: But the thing that I wanted to know was, can we really know when a company is walking the talk around their promises to do and be better? And when it comes to environmental and social responsibility, what is reasonable and what isn’t reasonable to expect out of companies in the first place?
LOVE: I’m intrigued.
PAVIN: Good! So, let’s get into it.
PAVIN: Alright, so Jess, the whole impetus for my reporting journey started with a question from a listener about something called greenwashing. Are you familiar with what that is?
LOVE: Yeah, isn’t it when companies make all of these claims that they’re super environmentally friendly? But then you look deeper and it seems like maybe they aren’t?
PAVIN: You got it. It’s basically a marketing strategy that companies use to try and convince everyone that they’re greener and more sustainable than they actually are. In other words, it’s a lot of smoke and not much fire. Back in 2019, for instance, McDonalds was accused of greenwashing.
[BBC] New paper straws in McDonalds restaurants which the company describes as eco-friendly actually cannot be recycled. Last year, the fast food chain axed plastic straws, even though they are recyclable.
PAVIN: Now greenwashing is normally discussed in terms of trying to make yourself look good for consumers so they’ll be more likely to buy your products or services.
But increasingly, there’s another group that companies are trying to impress. Investors.
LOVE: Okay. So they’re trying to convince investors that ... what? They’re not pumping toxic fumes into the atmosphere?
PAVIN: I mean, yeah, there’s stuff like that. But it’s not just about environmental impact. It’s other things too—like a company’s track record around protecting the health and safety of workers. There’s just a lot of social good–type activities that we now seem to be measuring companies against these days.
LOVE: Okay. So help me understand why an investor would care about these things. I get why a consumer would care: they want their money to support companies that aren’t treating people or the environment horribly. But when you think about what an investor cares about, you imagine it’s all about profitability, right? Why would they care about the feel-good ancillary stuff?
PAVIN: So that’s why I wanted to talk to Kellogg faculty member Aaron Yoon.
Aaron YOON: My name is Aaron Yoon, and I’m an assistant professor at the accounting unit.
PAVIN: Fun fact: before he got into academia, Yoon worked as a trader. As an academic, he’s done research on something called ESG.
YOON: ESG is an acronym that stands for environmental-, social-, governance-related activities that firms make.
PAVIN: So, you know how, as a consumer, you see the word “sustainable” slapped on a brand, and you know it’s good, but you don’t really know why. So, is it cruelty-free and not tested on animals? Is it fair trade? Or is it made from organic ingredients? Umm, sure? All of the above?
LOVE: Right, it’s like, “hey consumers, we’re good. Buy us.”
PAVIN: Yup. And this is basically what this ESG acronym is communicating—but on the investor side. And its meaning is really broad.
YOON: To be frank, I mean, there are many things that go in there. You know some people argue that everything under heaven is ESG these days in terms of firm activities, because they can always be classified into E, S, or G.
LOVE: So when Yoon talks about these buckets of E, S, and G, what actually goes into those buckets?
PAVIN: On the E side: the bucket might include things like a company’s environmental record and what it’s doing to achieve net-zero carbon emissions. That’s the goal post we heard companies like Apple and Microsoft talking about at the top of the episode in their ad spots.
LOVE: And how about the S and the G?
PAVIN: Like he said, the S stands for social. And that could be anything from a company’s health and safety practices to its paid leave and childcare policies. The G has to do with corporate governance—so things like executive comp and being more transparent about business operations. Also the diversity makeup of corporate boards.
LOVE: Got it. I see what he means when he says that everything under the sun can be considered ESG. What did he say about how all of this started? Like what’s the origin story behind ESG?
PAVIN: Yoon says the philosophy behind ESG isn’t exactly new. Starting in the 1970s, academics and economic policy think tanks started talking about the so-called social contract that companies had with consumers and the wider world.
PAVIN: Since then, there’s been an alphabet soup of different acronyms to describe some version of this. There’s CSR …
YOON: Corporate social responsibility.
PAVIN: And SRI …
YOON: Socially responsible investing.
LOVE: Yes, these acronyms sound familiar.
PAVIN: Yeah, and with CSR and SRI, the idea was that those investments and funds might get the same or maybe slightly lower returns compared to traditional investments. But it was worth it in the end because you got to sync up your investment choices with your values and who knows, maybe you’d help make the world a better place? Here’s Yoon again explaining the sales pitch:
YOON: The proposition is that, “Hey, you’re going to allocate capital to me, you can still make just as much as that or slightly less than that, but why don’t you allocate to a good cause and we’ll do something good as well as giving you the return?”
LOVE: So what’s the difference between ESG and these other things like CSR and SRI?
PAVIN: I asked Yoon about that:
YOON: ESG is not really something new from CSR or SRI at the conceptual level, though some scholars have a very strong view about that, but it’s just adding G to CSR and kind of coining it as ESG.
LOVE: OK. So ESG was just kind of an update to the older acronyms.
PAVIN: Yeah. And it’s really in the wake of the financial crisis of 2008 that ESG gained traction.
PAVIN: Well after the markets collapsed in 2008, the U.S. government pumped a lot of money into Wall Street. Remember “Too Big to Fail”? Here’s former President George W. Bush explaining why the country needed the Troubled Asset Relief Program—that big bank bailout legislation that Congress eventually passed in 2009.
[President George W. Bush] The market is not functioning properly. There has been a widespread loss of confidence. And major sectors of America’s financial system are at risk of shutting down.
PAVIN: And we saw a kind of rinse and repeat in 2020 with the Covid CARES act, which injected more than $2 trillion dollars into the economy during the pandemic. This kind of infusion of government cash into the economy is called “quantitative easing.”
YOON: After ’08, the U.S. market as well as globally, we’ve been essentially engaging in quantitative easing, injecting money into the market to sort of boost the market up after the financial crisis, up until I would say 2020, 2021. And when markets sort of were going up you know 10 percent, 15 percent every year, there is very little room for active management. Because if you buy index funds and ETFs, you will make 10 percent, 15 percent a year. So why pay higher commission to active investment managers and effectively get the same performance and pay more fees right? So ESG happened around that time when different asset managers especially were looking for ways to market their product.
PAVIN: So to recap: ESG was a kind of rebranding opportunity that helped active investment managers attract more capital and more customers. Kind of like: Hey, put your money over here! We’re doing good things!
LOVE: So it sounds like at least part of the pitch was really appealing to people’s emotions: it was worth paying the extra management fees for these ESG funds because they offered a social and environmental ROI. Investors would be getting something more for their money.
PAVIN: Right. And also because, at least in theory, companies that focused on ESG were more likely to be good companies and therefore profitable over the long term. So they seemed like they should be good investments. After all, if you’re not pumping toxic chemicals into the air, you’ll probably get slapped with fewer lawsuits. Or you might be in a position to work *with* communities or regulators rather than against them.
But Yoon says that it was around 2020 that some people started questioning ESG as an investment philosophy.
[CNBC] A provocative new op ed from Blackrock’s former CIO of sustainable investing claims “the financial services industry is duping the American public with its pro environment sustainable investing practices …”
PAVIN: There was this whistleblower case in 2021 where a former Blackrock executive put ESG on blast. I mean Blackrock is one of the biggest asset-management firms around. They manage trillions of dollars in funds. Here’s that Blackrock whistleblower, Tariq Fancy, being interviewed on CNBC.
[TARIQ FANCY] ESG is not as good for investing processes as people claim. And that’s very important because it effectively is financial jargon, sort of proxy way of saying does it pay to be responsible? The reality is it doesn’t pay that much to be responsible. It works in a few instances, in a few strategies. It’s being blown out of proportion. And none of it has any real social impact.
PAVIN: Fancy said that there was simply no evidence that “sustainable investing” did any good for the world at all. And it wasn’t clear it was any more profitable, either.
PAVIN: The former BlackRock investor wasn’t the only one criticizing ESG, though. Under the Trump administration, the U.S. Department of Labor made this rule where retirement-plan managers were restricted from using ESG considerations in making investment decisions. The Biden administration overturned that rule. But we’ve seen ESG continue to be a political lightning rod.
[Rep Congressman Aaron Bean] To be clear, ESG is more government control. ESG is less freedom for Americans …
PAVIN: That’s Republican Congressman Aaron Bean from Florida speaking at a Congressional hearing in 2023.
[Rep Congressman Aaron Bean] ESG simply is a woke capitalist scam posing as responsible corporate governments which robs Americans of their hard-earned retirement investments.
LOVE: What do people on the other side of the aisle have to say?
[Rhode Island congressman Seth Magaziner] The evidence is clear. Companies that adopt thoughtful policies to manage their environmental, social, and governance risks outperform those that don’t.
PAVIN: That’s Rhode Island congressman Seth Magaziner. He argued at that same hearing that investors would be foolish to ignore a company’s ESG record. That ESG considerations are critical to a company’s performance.
LOVE: So the politicians and lawmakers are having this discussion about whether it actually makes sense to invest money based on a company’s ESG activities. What are the investors actually doing?
PAVIN: The money isn’t flowing into ESG funds as much. Part of it has to do with the politically charged conversation happening at the national level, but there’s skepticism coming from other places, too. The SEC has started to scrutinize funds that make any kind of ESG claims. Academics like Yoon have been interrogating it. There are all these concerns about how you even measure something like this. There’s just a lot more people stopping and going “wait a minute, what are we putting our money into?”
LOVE: OK! So ESG has lost some steam. I’m curious to know what Yoon has to say about all of this. What does he think about ESG investing? Is it just a bunch of nonsense or is there something to it?
PAVIN: He sees all of the concerns people have about it. But he thinks there’s still value in ESG. With an important caveat.
YOON: It’s very important, at least in the current institutional framework, for firms to focus on ESG efforts that create value and return for the shareholders. So if you generate value for the shareholders, You’re creating social impact or environmental impact as well as generating returns. And I do believe that there’s still money out there to be made by focusing on certain ESG efforts that shareholder value creation happens.
LOVE: So he’s saying that ESG can be a win–win. Like, investors should focus their attention on ESG activities that both do good and generate returns.
PAVIN: Yeah, like it’s great when companies do good, just make sure you’re also considering whether that will pay off monetarily in the end.
LOVE: How can they figure that sort of thing out? How can they know what kinds of ESG activities pay off more than others?
PAVIN: Well, Yoon actually did some research on this. And he found that the ESG initiatives that generate better returns are ones that have some kind of tie to the company’s core products or services.
LOVE: Explain that to me.
PAVIN: So, say a company in the finance industry builds a new environmentally friendly headquarters. Sure, that’s good for the environment, but it doesn’t really have anything to do with the company’s core business, which is finance. If you’re an investor, you might want to think twice about putting any kind of weight on this ESG activity.
But if you see that a food and beverage company has committed to sourcing ingredients in a more sustainable, environmentally conscious way? Well, that’s an ESG initiative to take note of. The ESG activity is very tied to the company’s core business.
And in another study, Yoon looked more at the S in ESG. He found that investments in people that lead to higher employee satisfaction are also linked to greater profitability.
LOVE: That sounds pretty cool.
PAVIN: Yeah, but ESG investing still has its downsides. In particular, Yoon thinks one of the biggest problems for investors and consumers is that there’s a lack of regulation around ESG. So even though there’s this new cottage industry of ESG-ratings firms that give out ESG scores to help investors make sense of it all, those scores are based on the ESG information that companies are voluntarily disclosing.
YOON: So the problem is that ESG-related disclosure largely, even now globally, is not mandated for the most part. And we just have issues disentangling firm ESG-related claims and their actual follow-through.
LOVE: Ah, right, greenwashing. In other words—a company might say they’re doing X, Y, or Z to get to net zero emissions by 2030, or some other ESG target, but how do we know if they’re actually telling the truth?
PAVIN: Right. For instance, in 2023, Delta Airlines was hit with a billion-dollar class-action lawsuit. The plaintiffs alleged that Delta misled the public about claiming to be the world’s so-called first carbon-neutral airline.
LOVE: OK. So where does all of this leave investors?
PAVIN: Honestly, not in a great place to make informed decisions. Even when you look at ESG ratings, you can see big differences in any given company’s ESG score. It depends in part on which firm is doing the rating. There isn’t any kind of standardization in how these ratings are done. And that’s really the first step that has to happen before we can better understand those bigger questions, like exactly what kind of longer-term financial payoff we can expect from different ESG investments.
LOVE: Did Yoon have any advice or insights about what might happen next in this space?
PAVIN: Yes! He thinks that we’ll see more ESG reporting guidelines and regulation into the future.
And he thinks that the everyday consumer concerned about the other kind of greenwashing can play a role in pushing for change.
YOON: If consumers get together and have enough critical mass to demand transparency and communication on follow-through, I think it’ll make a huge difference.
PAVIN: In the meantime, there’s a bigger philosophical question at play here: Should we—the everyday human consumer or perhaps investor—expect corporations to solve social problems in the first place?
YOON: Some folks view that the role of firms is to generate returns for the shareholder only. Some view that it has to be, you know, generating stakeholder value. But the bigger question is, is it indeed the role of firm to solve societal problems and advocate for social welfare?
You know, if you talk to people in Singapore, for example, they’re worried about their country going below water, and they really care very seriously about net-zero and temperature change, which is a very valid concern. So from their perspective, how can companies exist if the country doesn’t exist, right? And if so, what are the necessary mechanisms and incentives that need to be given from government, from consumers, from different stakeholders for firms to achieve that right? So it’s incredibly important for firms to generate stakeholder value, but if they can’t generate shareholder value, they’re not going to be around.
LOVE: Thanks, Laura.
PAVIN: Thanks, Jess.
PAVIN: This episode of The Insightful Leader was written by Nancy Rosenbaum. It was produced and edited by Laura Pavin, Jessica Love, Susie Allen, Fred Schmalz, Maja Kos, and Blake Goble. It was mixed by Nancy Rosenbaum. Special thanks to Aaron Yoon. Want more The Insightful Leader episodes? You can find us on iTunes, Spotify, or our website: insight.kellogg.northwestern.edu. We’ll be back in a couple weeks with another episode of The Insightful Leader Podcast.