Not so long ago, zeal for corporate action on ESG was skyrocketing. Now? Not so much. What happened? Many have attributed the decline in appetite for ESG to the politicization of ESG and particularly to ESG backlash. This paper from the Rock Center for Corporate governance at Stanford has another idea. Has “ESG enthusiasm” reached its expiration date or, as the paper posits, is it like an alligator Birkin bag, just a luxury—something to pursue only when you’re “feeling flush”? In economics, the authors explain, demand for most items declines as prices increase. Not so with luxury goods, where “a high price tag stimulates demand in part because of the social benefits the purchaser receives by signaling to others their ability to afford it.” Demand for luxury goods often rises and falls with the economy; when times are prosperous, demand for luxury goods increases and when money is tight, demand falls. In that light, a “case can be made,” the authors contend, “that ESG is a luxury good.”
The authors first observe that “enthusiasm for ESG has waned.” They base their observation on data such as net outflows from U.S.-based sustainability funds and declines in support for environmental- and social-related shareholder proposals.
The authors also point to a 60% decrease in the number of companies discussing ESG initiatives on earnings calls.
In addition, the authors point out, there has been a movement at the state level—sometimes referred to as “ESG backlash”—to limit the use of ESG criteria in pension-fund investing.
The authors acknowledge that it’s not known “[w]hether ESG has hit a cyclical peak or is in permanent decline.” They attribute this uncertainty in part to the absence of sophisticated independent empirical research regarding the economic consequences of ESG and to the “difficulties of measurement and establishing causality” in this context. Can observers determine if ESG investments “make companies more profitable, or are more profitable companies better positioned to invest in stakeholders”? Do ESG initiatives result in “higher and more sustainable long-term profits” or will a strict focus on increasing shareholder value—“to the extent it generates long- or short-term economic benefit”—be enough incentive, by itself, to invest in ESG ? Is ESG a ‘nice to have’ or a ‘must have’”? On balance, “is ESG a net contributor to financial performance, or a net cost? These are questions, the authors suggest, that are important for corporate directors deciding whether to give ESG initiatives the go-ahead. When pressure to undertake ESG initiatives was intense, the authors show that boards acted to support those initiatives. But now that demand is “in reverse, boards are left to consider what changes, if any, to make to these initiatives.”
The authors suggest that “[i]t bears considering how investors view the ESG characteristics of firms in their portfolio.” And that’s where the luxury goods analysis comes in. The authors find a correlation between the initial rise in ESG corporate commitments and investment in sustainability funds—when there was “economic prosperity, low inflation, and a strong bull market”—and today’s high inflation, high interest rates and economic pessimism—when the authors find “evidence that investors’ taste for environmental and social advocacy has waned considerably.” During that period of prosperity, the authors contend, “companies that were financially positioned to invest in stakeholder initiatives were rewarded for doing so through public recognition. Investors, too, who financially benefited from a bull market demonstrated their support for ESG by investing in sustainability funds.” But current “economic headwinds have scrambled the equation,” leading to the current decline.
As corroboration, the authors cite a Stanford survey, demonstrating a decline in young investors’ willingness to forfeit some of their investment savings to support ESG issues—from amenability to forego between 6% and 10% of their investment savings in 2022 to giving up only 1% to 5% in 2023. The survey also showed a decline in their serious concern for environmental issues of over 20 percentage points and for social issues of more than 10 percentage points. In the survey, only 52% of investors said they owned an ESG fund compared to 78% the prior year. The authors also report that investors have significantly lower expectations for stock market returns. A different survey demonstrated that institutional investors have receded in their commitment to ESG, with only 20% “explicitly consider[ing] ESG factors as central to an investment thesis,” and the
“vast majority consider[ing] ESG as part of a laundry list of factors. Furthermore, the list of ESG factors they do consider—with the exception of climate change—is dominated by traditional governance factors (such as the structure of the board, ownership structure, board diversity, and the quality of financial reporting) and not the environmental and social issues that more appropriately might be considered stakeholder-oriented….Illustrating just how much ESG has changed, 68 percent of institutional investors say governance is the most important aspect of ESG; only 2 percent say social factors are.”
The authors observe that, if their analogy to luxury goods is apt and “demand for ESG follows the economic pattern of a luxury good”—that is, demand correlating to the economic cycle—then “boards will want to rethink how they plan, prioritize, and invest in ESG.” To that end, the authors advise, boards “will want to be more deliberate about the initiatives they support, prioritizing those with a clear link to the company’s business model.” But how do boards “determine what stakeholder initiatives are central to their business model,” the authors ask? The authors suggest that management should “be asked to justify—so that board members, in turn, can communicate to stakeholders—how each initiative contributes to the financial performance or risk reduction of the firm.” Consistent with the luxury goods model, the authors suggest that companies may decide to “increase investment in a broader set of initiatives” during periods of prosperity, but expect to “decrease these investments when times change.” That would include exercising greater selectivity and “prioritizing those with sound economic justification.” Nevertheless, they recommend, “the board will want to maintain investment in its core set of ESG initiatives through the business cycle. When stakeholder pressure is higher, the board will be able to point to the long-term investment it made and explain how these served the dual-purpose that ESG always purported to support, increasing both profits and social welfare.”
