Claims by corporations and investment managers that they incorporate or demand ESG (environmental, social and governance) values don’t always stand up to close scrutiny. Only “accountable capitalism” can ensure that all stakeholders in the ESG movement perform their roles, according to Witold Henisz, Wharton vice dean and faculty director of the ESG Initiative at the school, where he is also management professor. He shared those observations at a Wharton Executive Education LinkedIn Live event titled “ESG: Dispatch from the Front Lines of Accountable Capitalism” on August 22, 2023, which he moderated. (Watch the video.)
The conference panelists were Jennifer Grancio, CEO of Engine No. 1, an investment firm best known for wresting three board seats at ExxonMobil two years ago; Monica Dimitracopoulos, EY Americas Corporate Sustainability Leader; Viviana Alvarez, board advisor at the Center for Responsible Business at the University of California’s Haas School of Business, who was former head of sustainability at Unilever North America; and Arthur Van Benthem, faculty co-director of the Wharton Climate Center and a Wharton professor of business economics and public policy who researches the impact of policy responses to societal threats such as climate change.
Half-truths in ESG Investing
Henisz pointed out that on the one hand are claims that sustainable investment globally has crossed $35 trillion and reports that it will cross $50 trillion by 2025. “On the other hand, some of these industry estimates of assets under management for ESG have been halved in recent years, using more realistic or conservative definitions,” he said. He cited recent research by experts at Wharton and elsewhere that found a sobering reality: The actual amount of ESG investing may be only 6% of the $31.3 trillion in assets that the largest financial institutions manage, or about $3 trillion. “The evidence that these ESG factors are driving change, launching new products, transforming companies, while often heard on the ski slopes of Davos, is a little less apparent in the data, the workplaces, and the discourses on firms and capitalism more broadly.”
Henisz did a reality check with the conference panelists on how accountable capitalism is increasing “the transparency of externalities imposed or created by business models,” and if governments, financiers, and employers are taking note of those. He also sought their views on finding better data and building better models to “drive substantive change” and secure meaningful reform for the ESG movement.
“Some of these industry estimates of assets under management for ESG have been halved in recent years, using more realistic or conservative definitions.”— Witold Henisz
Below are highlights of the panelists’ views on select aspects of the ESG chessboard:
Accountable Capitalism Defined
The panelists defined accountable capitalism as “a system in which stakeholders hold organizations accountable for the externalities they create, thereby better aligning long-term value created and distributed with the short-term incentives faced by financiers, resource owners, managers, and workers.”
Who’s Winning and Who Loses?
“Everybody loses if we have an ideological conversation where we don’t go deep enough into what the risk factors are, and what the data tells us,” Grancio said. “We should always be able to drive — and have a point of view on — what’s causal in terms of long-term economic returns. Our dialogue today is shallow. It’s not data rich, and it’s too short term. That has to change, or we all lose.”
On the wins, Grancio said it was gratifying to see “great conversations” taking place on incorporating data on risks in investments. That helps separate data that captures investment performance and that which is values-based, she explained.
Companies are all across the spectrum in terms of their “maturity and openness in embracing accountable capitalism and what it means for their business,” said Dimitracopoulos of her EY clients. The more mature companies “are truly differentiating themselves and driving innovation with a clear sense of what their stakeholders expect of them, going far beyond just their shareholders,” she noted. At the other end of the spectrum are companies that are defensive and merely ensuring that they meet regulatory expectations. In the middle are the bulk of the companies, who are pursuing ESG initiatives that they have defined, but have to do more work in embedding them in their strategy and operations, she added.
Five Things Winning Companies Do
Dimitracopoulos said winning companies have a five-fold approach to ESG: One, they are “generally deepening their understanding of stakeholder expectations.” Two, they are putting in place “the right governance” at the board and executive leadership team levels, and also “embedding this as a lens into how they think about their strategic priorities and growth agenda.” Three, they are moving toward operationalizing those initiatives and allocating the right amounts of capital. Four, they’re “staying very connected to the market, to their stakeholders, and transparently reporting on progress or lack thereof.” Five, they are improving the quality of their data and what they can share from that.
Early Adopters Set the Tone
Unilever is often counted among the early crop of companies to embrace sustainability in a meaningful way, Henisz said, as he probed Alvarez on how it inspired other companies. Unilever did give momentum to the sustainability movement. “Thankfully, there’s more than the Unilevers,” Alvarez said. She cited outdoor clothing brand Patagonia, and ice-cream brand Ben & Jerry’s, a Unilever subsidiary. Ben & Jerry’s investors are not surprised, a Wall Street Journal report noted, when it “supports returning to Native Americans what it claims is stolen land, when it advocates overturning voter-integrity laws, or when it favors defunding the police….”
But such accountable capitalism must become more widespread and deeper before it achieves critical mass, according to Alvarez. “We either all lose and all win, because even if we add up all the commitments of the Unilevers and many other organizations that are now making tangible steps towards this journey, it’s simply not enough,” she said.
“I expect that carbon markets will continue to grow and therefore that investing in carbon-intensive projects will become increasingly risky.”— Arthur van Benthem
How Public Policy Is Driving Change
According to Wharton’s Van Benthem, “capitalism needs to be steered such that companies pay for the full societal damages that they create.” Companies could “internalize externalities” in several ways, such as pricing carbon or other pollutants with a tax or with tradable permits in a carbon market, he said.
That approach seems to be working: Van Benthem noted that new carbon markets are forming at the U.S. state level, and that prices in almost all carbon markets worldwide have spiked dramatically over the last few years. “I expect that carbon markets will continue to grow and therefore that investing in carbon-intensive projects will become increasingly risky.” He noted that the European Union recently approved the world’s first carbon tax on imports. The tax is designed to make certain products a lot more expensive if they come from manufacturers that aren’t paying for their greenhouse gas emissions, The New York Times explained.
How to Accelerate Accountable Capitalism
Alvarez said that with AI, analytics tools, and scenario planning, “we’re going to have very different conversations in the boardrooms as to what really the impacts and the scenarios are with different externalities, whether that is climate or social inequality.”
But more data is required to track adherence to ESG values, Alvarez said. She pointed out that for instance, less than 20% of the social aspects of ESG are being reported. She also called for more reporting from companies on their human capital.
In scenario planning, as companies continue to innovate, there must be conversations on how they would retrofit their existing assets, Alvarez said. Transition planning is also critical, she added. “A lot of procurement officers don’t really sleep at night because they know [the supply of] commodities depend on a lot of these fragilities.”
Managing supply chains is core to many businesses, and consulting firms help by “integrating this lens into that transformation journey,” said Dimitracopoulos, adding that better data and reporting on operational efficiencies is critical.
From an investor’s perspective, it is important to separate out causal and economic factors in sustainability, Grancio said. Here, she stressed the need to improve education around ESG.
Improving Data Quality
“We have to support more research and more studies, and we have to put more pressure on public companies to disclose ‘people data’ (or data on human capital), so that we can then make it factual and causal.”
Strengthening governance with appropriate incentives would help boost disclosures around sustainability, but they have to be tailored to specific industries, Grancio said. For example, a pharmaceutical company could make disclosures about what it does “to improve the quality of human life” or the environmental impact of its compounds, she noted.
“It is people, people, people. I don’t think there is a company with purpose. There are people with purpose, there are leaders with purpose.”— Viviana Alvarez
What Must Policymakers Do?
Policymakers must eschew the temptation to devise quick fixes to meet environmental targets, and guard against suboptimal approaches that have unintended consequences, Van Benthem cautioned. The European Union levies car taxes based on their CO2 emissions, he noted. “[But] in the U.S., we keep gas taxes minimal and choose a very complicated set of fuel economy standards, which then end up favoring the production of trucks and SUVs,” he said. “The sad end result is that it ends up costing society and taxpayers a lot more per ton of CO2 saved than the gas taxes in Europe.”
Corporate leaders can have “real impact” in shaping policy, Van Benthem continued. He advises companies: “If you truly care about improving the state of the environment, you have a voice to demand smart and effective policies and spend your lobbying dollars on a few politicians who advocate for such policies.”
Disarming Defensiveness in Accountable Capitalism
A big obstacle for accountable capitalism is the pushback from companies. “The million-dollar question is leadership” in fighting back against defensiveness against accountable capitalism, Alvarez said. “The moral compass is missing in all of this.”
The most important thing that corporations must learn is “not to do ESG on the side,” said Grancio. Added Dimitracopoulos: “You really need to embed your ESG or sustainability lens into the core of how you do business.”
Systems thinking in the C-suite will also help remove siloed thinking, Alvarez said. “We have unintended consequences because everything is hyper-connected.” Here, she emphasized two aspects: human capital and scenario planning. On the first aspect, she said, “It is people, people, people. I don’t think there is a company with purpose. There are people with purpose, there are leaders with purpose.”