Is it time to move on from ESG?

Employers should go beyond what has become common environmental, social, and governance (ESG) practices or even just completely move on from the idea, according to experts at the Fraser Institute.

While the idea behind ESG is to be of help to the community, it can actually be detrimental to people’s lives, say Fraser Institute expert Jack Mintz, president’s fellow, School of Public Policy, University of Calgary; and Bryce Tingle, N. Murray Edwards Chair in Business Law, University of Calgary.

“Basic economic theory suggests that higher costs associated with ESG will result in a reduction of output, a rise in market prices, a fall in economic rents, and lower share prices. In other words, the firm will be unable to cover its cost of capital,” they say. 

This is not even a controversial claim, says the experts.

“This is not saying anything controversial: ESG is a transfer of wealth from shareholders to other parties. In general, shareholders do not like declining share prices and they tend to punish managers who are responsible.”

ESG is a crucial consideration for employment among young workers, according to a previous report.

What are the negative effects of ESG?

“The problems with our current infatuation with ESG can be easily summarized,” say Mintz and Tingle in their essay titled ESG: Myths and Realities: Putting Economics Back into ESG:

1. To the extent that the expensive ideas that make up ESG are accepted by Canadian securities regulators and investors, it will render our public markets less attractive to new entrants.
2. To the extent regulation or shareholder pressure imposes some ESG obligations on Canadian companies, they will grow less competitive relative to their international peers.
3. To the extent some ESG behaviours are imposed on Canadian corporations only, individual investors will be harmed as the competitive position of those corporations declines.
4. Focusing on ESG rather than the health of our markets and fostering innovation, reflects a major misunderstanding of where progress arises.
5. As we have seen, it is impossible in the presence of competitive markets for companies to make material, voluntary, unilateral ESG investments. 

How can ESG be improved?

To fix these problems, the two experts provide the following solutions:

1. ESG should be expanded to include economics.
2. The securities commissions in Canada should stop regulating “purely political matters unrelated to facilitating price discovery and ensuring market integrity”.
3. Companies and investment funds that make ESG claims should be held liable in the normal course if those claims are untrue.
4. Impose liability for the use of ESG ratings, which are “invalid”.
5. Regulate proxy advisors as their work is “often flawed” and the assumptions behind their governance decisions are “frequently contradicted by the empirical literature”.

Meanwhile, Steven Globerman, senior fellow and Addington chair in measurement at Fraser Institute, claims that “It’s Time to Move on from ESG,” a statement which he used as title for his essay.

He claims that, to date, academic research “has failed to identify a consistent and statistically significant positive relationship between corporate ESG ratings and the stock market performance of companies”.

The essay summarizes the arguments against imposing top-down ESG mandates. In particular, evidence shows that: 

1. ESG-branded investment funds do not perform better than conventional investment funds,
2. Companies that proclaim to pursue ESG-related activities are not more profitable than companies that do not, and 
3. Mandating ESG-related corporate disclosures imposes additional costs on public companies and diverts resources away from productivity-enhancing investments, harming workers.

A majority of Canadian employers are not prepared to meet ESG mandates, according to a previous report.

“There is no reason to believe that managers of operating and investment companies enjoy any comparative advantage in identifying and implementing broad environmental and social policies compared to politicians and regulators,” Globerman says.

He concludes, citing research throughout the essay, that “the private sector best serves the interests of society when it focuses on maximizing shareholder wealth within the confines of the established laws”.

Mounting pressures around ESG requirement compliance could be increasing the risk for employers, as many are falling for ESG fraud, according to another study.