Investors Under Attack
A once-obscure term used only by the investment community has been making mainstream headlines: politicians are vilifying “ESG investing” (considering the impact of environmental and social issues on financial return). The trigger for the furor is political opportunism: because ESG issues often mirror political issues, it is easy to mischaracterize consideration of social and environmental investment risks as leftist politics in another guise.
In a nutshell, U.S. politicians are claiming that considering the effect rising temperatures, growing inequality, or similar issues have on corporate profits is just leftist activism in disguise. One very popular avenue for this attack has been preventing state-managed investments (often pension funds for state and municipal employees) from accounting for the risks that social and environmental impacts create for their investments. ALEC, a group of corporations and legislators that works to create corporation-favorable laws in state legislatures, has written a model bill that attempts to preclude state fund managers from considering any ESG factors.
The investment community is responding to the attacks by making it clear that pension plans and other fiduciaries must account for all risks to their investment portfolios. The fact that some of those risks rhyme with politically sensitive issues is simply irrelevant to the value proposition for investors.
For example, it’s just nuts (to use a technical term) to insist that stock portfolios held on behalf of state and municipal workers be managed without reference to the Inflation Reduction Act (the recently adopted law designed to reduce fossil fuel use significantly in the United States); even if you fervently oppose the law, it will inevitably impact on the business models of companies that produce, deliver, or use energy (i.e., most every company). But that’s precisely what new rules in Texas, Florida, and West Virginia try to do: to require that their pension funds ignore the economic impact of the new law or any other climate-related developments.
Anti-ESG Politicians Interfere with Markets
In a weird inversion, the right-leaning politicians behind these laws are encouraging government interference with the heart of the free-market system. If investors and corporate executives are precluded from investing in innovation and workforces in the manner they believe to be most productive, then markets will not operate to assign our limited investment resources to efficient uses. The resulting misallocation of resources will not only lead to reduced productivity, however; it will also sacrifice the pocketbooks of workers and citizens. One study has shown that Texas has already incurred $300-500 million in extra interest obligations by boycotting banks that account for climate impact in their underwriting businesses.
But there’s no mystery as to why these politicians, who historically championed markets and objected to government interference have changed their tune. They’re protecting the businesses (like the petroleum industry in Texas) that fund them. Or they’re seeking to score political points by mischaracterizing common sense business decisions (like paying for employee healthcare) as political.
How Companies Leverage Anti-ESG Politicians
This political strategy protects corporations that make money by externalizing costs with business plans that don’t account for the social and environmental costs they create. Consider a company that reduces its expenses through practices that contribute to deforestation and human rights violations. This may boost the company’s profits but ultimately hurt the company’s diversified shareholders, who have investments in many other companies that are put at risk when fragile environmental and social systems are threatened. By passing laws that stop shareholders from exercising their rights to challenge such practices, these politicians are enriching corporate executives, but risking the savings of the workers who rely on pensions or 401(k) plans to provide a decent retirement.
Corporations’ ability to aggregate multiple investors’ capital and participate in free-market competition has delivered the material bounty we enjoy. Our theory of change at The Shareholder Commons is all about reforming that system by ensuring that the market accounts for all costs. We want to keep the baby (price discovery) and throw out the bath water (externalized social and environmental costs). In pursuing that goal, we often find ourselves at odds with “ESG investing” as currently practiced, because we think it is too focused on enterprise value, and thus misses the opportunity to protect critical systems from practices that are good for individual company bottom lines, but bad for the planet and its inhabitants.
But that is a healthy debate: How do we best use our understanding of businesses’ social and environmental impacts to manage individual companies and the economy that comprises them? There’s no question that the institutional investors with whom we sometimes disagree are nevertheless working hard to satisfy their fiduciary duties to optimize beneficiaries’ financial returns.
Duties of Directors
One argument from the anti-ESG crowd is that companies can’t consider the impact of externalities on their diversified shareholders; instead, it’s argued, corporate executives must endeavor to maximize a company’s financial returns, no matter the cost. On Monday, October 3, a class action was filed against the directors of Meta Platforms (formerly Facebook, Inc.) that challenges this narrow understanding of fiduciary duty, alleging multiple breaches of fiduciary duty based on the conduct outlined in The Facebook Files series published last year in the Wall Street Journal. The complaint alleges not that the conduct was bad for Meta’s finances, but rather that the conduct harms the global economy, thereby threatening the portfolios of the Company’s diversified shareholders. As the lawsuit charges:
[T]he well-established doctrine of stockholder primacy cannot be rationally applied on behalf of investors without recognizing the impact of portfolio theory, which inextricably links common stock ownership to broad portfolio diversification. The economic benefits from—indeed the viability of—a system of corporate law rooted in maximizing financial value for stockholders would vanish if it forced directors to make decisions that increased corporate value but depressed portfolio values for most of its stockholders.
We look forward to Meta’s response.
There are plenty of flaws in shareholders’ current ESG practices, and we often lead in calling for course correction. But it appears to us that the loudest voices in the current anti-ESG movement aren’t interested in a healthy debate about advancing the interests of investors or the economy. The shouting seems to come from a cynical, if not nihilistic, group of politicians interested in furthering their careers and the interests of their patrons, who have little regard for the actual human investors whose pensions they’re putting at risk.
This debate is going to grow louder for some time. We have no magic bullet to stop the rhetoric. Our second piece of advice to the investment community is to focus on their jobs: creating value for investors. As long as that principle guides your decisions, you will be doing the right thing. Our first piece of advice? Don’t forget to breathe.