In the guide below, we outline the potential pros and cons (benefits and disadvantages) of Environmental, Social & Governance (ESG).
We present these potential pros and cons mainly from the perspective of ESG in business, however, we also discuss ESG in investing.
It’s worth noting that ESG in business and ESG in investing might each have more specific and in-depth pros and cons other than the general pros and cons listed in this guide. So, it’s worth doing additional independent research on both.
(Note – the information in this guide is general information only. It doesn’t constitute professional financial advice. See a suitably qualified financial professional for expert advice)
Summary – Potential Pros & Cons Of ESG (Benefits & Disadvantages)
Firstly, What Is ESG?
We outline what ESG is, and what it involves in another guide.
Potential Pros
May Deliver Environmental Benefits
May Deliver Social Benefits
May Deliver Corporate Governance Benefits
May Deliver Other Benefits For The Companies Implementing ESG Goals
May Be Beneficial For Both Consumers & Investors In Several Ways
ESG Framework Exists For Organizations To Reference
ESG Assets Under Management Represent Significant Economic Value, & Capital Flowing Into ESG-Linked Products Has Grown Significantly In Recent Times
Some Argue That ESG Does Not Damage A Company’s Financial Performance
Some Investment Funds Weighted Towards ESG Scores May Show Evidence Of Performing Higher Over Short Periods
ESG Considerations May Be Playing More Of A Role In The Decisions Of Investors
Some Argue That Implementation Of Both ESG & Sustainability Principles, In Both Business & Investing, Will Be Inevitable In The Future
Potential Cons
ESG Involves Costs
Some Argue That ESG & Social Responsibility Negatively Impacts An Organization’s Financial Performance
Whether Or Not ESG & Responsible Investment Helps Protect And/Or Maximize Investment Portfolio Returns Is Debated By Some, & There May Be Limitations In Some Countries
At This Point In Time, Most Investors May Not Consider ESG Before Investing
ESG Systems, Standards, Compliance, Reporting, & Ratings Are Not Uniform Yet In All Places
Some ESG-Linked Products May Not Have The Desired Impact That Some Sustainability Advocates Want Them To
Some Suggest That Some ESG-Linked Products Could Be Susceptible To ‘Greenwashing’ Or Misleading Claims
Some Argue That External Groups With Authority Or Influence In ESG, Should Not Be Interfering With An Organization’s Autonomy, Free Markets, Or The Economy As A Whole
Potential Pros Of ESG
May Deliver Environmental Benefits
ESG involves an expansion of organizational objectives to include the environment and even natural resource management.
There may be a corresponding range of benefits in these areas where organizations are using ESG framework.
May Deliver Social Benefits
ESG involves an expansion of organzational objectives to include social/societal goals (for wider society and the community)
There may be a corresponding range of benefits in this area where organizations are using ESG framework.
Some examples of social benefits might include, but aren’t limited to:
– Basic rights and working conditions for workers
– Reduced health and safety risks for the general public
– Consumer protection
May Deliver Corporate Governance Benefits
ESG involves an expansion of organzational objectives to include ‘corporate governance’ goals (within a company).
There may be a corresponding range of benefits in this area where organizations are using ESG framework.
One example of a corporate governance benefit might be better employee relations, leading to greater satisfaction for employees at work.
May Deliver Other Benefits For The Companies Implementing ESG Goals
Some benefits might include:
– Improved brand equity (we outlined some of the potential benefits of improved brand equity in this guide)
– Potentially recruiting employees and talent who want to work at a company that has a good relationship with it’s employees
wikipedia.org lists other potential benefits for companies that implement corporate governance, such as:
‘… maximized productivity, ensured corporate efficiency and … the sourcing and utilizing of superior management talents’
May Be Beneficial For Both Consumers & Investors In Several Ways
– For Consumers
Consumers who value ESG objectives have the option to purchase from companies who implement ESG in their businesses.
Additionally, where ESG requires companies to make certain information available to the public (i.e. disclose it), there is more transparency for consumers to make up their mind about companies and keep them accountable.
– For Investors
Investors who value ESG objectives can choose to invest in ESG-linked products..
ESG Framework Exists For Organizations To Reference
For example, the United Nation’s Sustainable Development Goals (SDGs) exist, and these goals might be considered a basic framework for organizations to base some of their own ESG goals around.
ESG Assets Under Management Represent Significant Economic Value, & Capital Flowing Into ESG-Linked Products Has Grown Significantly In Recent Times
Refer to the wikipedia.org article for the exact figures
But, some paraphrased figures from that article are:
– Value Of ESG Assets Under Management
wikipedia.org indicates that (paraphrased) ESG assets under management are in the tens of trillions of US dollars
– Value Of Assets In Sustainable Funds
But, another figure from wikipedia.org indicates that ‘… sustainable funds held $1.65 trillion in assets [globally] at the end of 2020’
Whether or not ‘sustainable funds’ is the same thing as ‘ESG assets under management’ would need to be clarified
– Growth In Money Flowing Into ESG-Linked Products
wikipedia.org also indicate that in 2019 alone, tens of billions of US dollars flowed into ESG-linked products, which was ‘… an almost 525 percent increase from 2015’
Some Argue That ESG Does Not Damage A Company’s Financial Performance
In recent decades, there’s been challenges to the assumption that being ethically responsible impacts the financial return and profits of a company.
There’s at least some studies that suggest that companies that perform well across some ESG goals aren’t negatively impacted financially, at least when measuring this metric by the return on their stocks.
There’s also other metrics by which ESG might at least have some financial benefits
wikipedia.org for example mentions that in one published paper: ‘… the “100 Best Companies to Work For” outperformed their peers in terms of stock returns by 2–3% a year over 1984–2009’
Another study references by wikipedia.org ‘… found that “ESG generally improves returns and cuts client costs over time”‘
In their article, wikipedia.org also references other research/studies that provide arguments that integration of ESG doesn’t reduce financial performance, or even that non-social responsibility related practices and social responsibility practices may even be complimentary to maximise financial performance.
Some Investment Funds Weighted Towards ESG Scores May Show Evidence Of Performing Higher Over Short Periods
wikipedia.org provides the data on this for funds in different geographic regions, over a fiver year period
The higher performance figures (paraphrased) range from 0.13% to 1.59% (in terms of annual average return) across the different funds and markets
ESG Considerations May Be Playing More Of A Role In The Decisions Of Investors
Some reports indicate that a certain % of investors at least consider ESG in their investment decisions
There’s also been other developments in the investment industry that have brought more information about ESG-linked products and investments to the awareness of investors
Some Argue That Implementation Of Both ESG & Sustainability Principles, In Both Business & Investing, Will Be Inevitable In The Future
Those in the investment industry, and also in various other industries, may see the incorporation of both sustainability and also ESG factors becoming inevitable in the future.
Some of this might be because society is valuing these things more, and some of it might be because environmental, social and corporate governance problems are becoming more important and more critical to address.
There can be other reasons too.
wikipedia.org even mentions (paraphrased) that it may become part of an investment companies’ fiduciary duty in some jurisdictions to integrate ESG into investment practices and decision making.
Part of this might be because ESG might be considered a ‘long term investment value driver’
They reference a report that concludes something similar to this.
Potential Cons Of ESG
ESG Can Be Costly
Implementing and maintaining ESG goals and practices into an organization costs money, time and resources in various ways.
Not only might this impact profit margin, but, businesses also only have finite resources to allocate to ESG based practices.
So, there might be a limit on what businesses can do from an ESG perspective.
Some Argue That ESG & Social Responsibility Negatively Impacts An Organization’s Financial Performance
Some economists for example have argued on an academic basis, that philanthropy and social responsibility adversely impact an organization’s financial performance, and even the macro economy too.
They may argue that an organization should primarily focus on the organization’s own interests, and financial objectives instead (like cost, profit, and so on)
Whether Or Not ESG & Responsible Investment Helps Protect And/Or Maximize Investment Portfolio Returns Is Debated By Some, & There May Be Limitations In Some Countries
This is a contentious point, because it involves comparing individual investing strategies, and other personal investing strategies.
It also depends on the laws and case law in different countries.
But, there are examples and accounts of people experiencing higher fees and lower returns with ESG weighted funds vs non ESG funds.
wikipedia.org also mentions that in some countries: ‘… there are legal limitations on the extent to which investment decisions can be based on factors other than maximizing plan participants’ economic returns’
At This Point In Time, Most Investors May Not Consider ESG Before Investing
From wikipedia.org:
… many investors have yet to fully integrate ESG issues into their investment decision-making processes
ESG Systems, Standards, Compliance, Reporting, & Ratings Are Not Uniform Yet In All Places
Frameworks for ESG goals exist, such as those from the UN (with their SDGs)
However, ESG systems, standards, and compliance are not uniform yet across different regions and countries yet, and there’s also no industry-wide set of common standards..
Even ESG ratings agencies also use different metrics to measure company compliance and performance.
Some argue that this makes it difficult to determine (or verify) to what extent an organization is actually following ESG criteria, and what exact impact it’s having.
It also makes ESG intangibles highly subjective (although they can be subjective in general), and difficult to quantify and verify.
wikipedia.org discusses this issue more in the ‘Disclosure and regulation’ section of their article
This might be evidenced by the following from wikipedia.org:
In 2021, several organizations were working to make ESG compliance a better understood process in order to establish standards between rating agencies, amongst industries, and across jurisdictions.
[Technology tools, developing common themes in different industries, and government regulations, might be part of the solution]
Some ESG-Linked Products May Not Have The Desired Impact That Some Sustainability Advocates Want Them To
wikipedia.org gives one example of this, indicating that:
‘ESG-linked products have not and are unlikely to have the intended impact of raising the cost of capital for polluting firms …’
This is obviously an issue if people are investing in these ESG-linked products, and the products aren’t creating an impact that aligns with the views and values of those that are investing in them.
Some Suggest That Some ESG-Linked Products Could Be Susceptible To ‘Greenwashing’ Or Misleading Claims
This relates to some of the above listed ‘cons’.
If some ESG-linked products aren’t leading to more sustainable outcomes in some areas of the economy, and/or there isn’t credible way to verify the claims or performance of certain companies, organizations may make be able to make claims that amount to ‘greenwashing’ (to varying degrees), or that mislead investors and consumers into thinking they deliver something that they don’t.
Universal standards and measurements (that help with compliance and verification) may be just one way to partially address this.
Some Argue That External Groups With Authority Or Influence In ESG, Should Not Be Interfering With An Organization’s Autonomy, Free Markets, Or The Economy As A Whole
Where regulations, standards, schemes, ratings/assessments, and other frameworks, systems, and tools are implemented to manage ESG, the external groups with influence in these areas have a certain amount of power over the companies and organizations that have to follow it.
Some argue that these groups shouldn’t be able to impact an organization’s autonomy, or free markets and the economy as a whole with framework based on what amounts to social responsibility.
Sources
1. Various ‘Better Meets Reality’ guides
2. https://en.wikipedia.org/wiki/Environmental,_social,_and_corporate_governance#Disclosure_and_regulation
3. https://corporatefinanceinstitute.com/resources/knowledge/other/esg-environmental-social-governance/
4. https://www.techtarget.com/whatis/feature/5-ESG-benefits-for-businesses
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