ESG – Environmental, Social and Governance – is all the rage in corporate circles these days. Mention of ESG in S&P 500 quarterly earnings calls has increased almost a hundred fold since 2017. And it’s not just energy companies and other big polluters who are making attempts to incorporate it into their strategies. Since Covid, healthcare services companies are increasingly doing so as well. Many healthcare companies are choosing to focus particularly on the S part of ESG, emphasising their ability to improve access to healthcare and contribute to a healthier society.
A whole industry has now been built up with the intention of measuring and rating companies’ ESG performance, and a growing number of investors are increasingly interested in using these ratings to determine both the social impact and the reputational risk of their investments.
But many are critical of the trend, for a variety of reasons. Firstly there are concerns that it amounts to little more than a corporate PR exercise. There has been a lot of concern recently about this with regards to environmental sustainability (E) in particular – the term ‘greenwashing’ has now entered the common lexicon. But the charge can apply equally to the other parts of ESG as well.
There are also concerns around measurement. The ESG rating industry models itself on the credit rating industry, but whilst measurements by different credit raters correlate as much as 99% with one another, the correlation between different ESG raters is just over 50%.
Relatedly, there are deeper concerns that it is just too vague and/or too broad in what it attempts to achieve. This has become more pertinent as the industry has moved away from focusing mostly on the E part, to the S and G as well. What exactly counts as ‘good governance’ or having a ‘positive social impact’? If we can’t agree on an answer to that at a conceptual level then there is little hope that the measurement problem can be solved.
This issue is all the more important given that the different goals that are lumped together under the ESG banner may often conflict with one another. To use an example highlighted by a major healthcare operator we spoke to, a healthcare company may want to promote access to healthcare in a poor country or region by opening new clinics there (good for the S part), but the country or region in question may have less availability of renewable energy sources, meaning the company is forced to obtain its energy from fossil fuels (bad for the E part). If the ESG framework does not provide a widely-agreed-upon framework for measuring and weighting companies’ actions with respect to the various goals it seeks to promote, it is not providing any kind of guidance on how companies should make the inevitable trade-offs between these objectives when they conflict.
And finally, and perhaps most damningly, in the absence of a government-imposed regulatory enforcement mechanism, it is entirely up to companies themselves to choose what aspects of ESG to focus on and largely up to them to choose how to measure their performance.
The Economist published a feature on ESG two weeks ago highlighting some of these issues, and stepped just short of saying the entire concept should be abandoned. It argued that, instead of focusing on the myriad goals and measurements lumped together under ESG, the concept should be boiled down to the E part alone, which should stand simply for ‘emissions’ rather than ‘environment’. That would mean there is a single crucially important measure which companies can be assessed on, providing a much clearer incentive for firms to clean up their acts.
If this alternative vision were adopted it would mean that ESG, or just ‘E’, would become much less relevant to healthcare services companies, who have a lot more to offer society than cuts in their emissions.
But would that be a problem? The multinational hospital group we spoke to talked us through a whole range of impressive ESG initiatives they are engaged with, mostly related to improving (equity of) access to quality healthcare services. But, they conceded, these were things they were doing anyway, well before ESG became popular.
Perhaps, then, the real function ESG performs is to provide a framework for companies wishing to promote the socially beneficial initiatives they are involved in. And maybe that’s OK. But if that is the case, it shouldn’t masquerade as an appropriate framework to objectively measure and compare different companies’ contribution to society or reputational risk.We would welcome your thoughts on this story. Email your views to Martin De Benito Gellner or call 0207 183 3779.