The principle behind ESG (Environment, Social, Governance) investing is that the private sector can simultaneously generate profits and invest in environmental, social and good governance areas. ESG investing received an important fillip when Larry Fink, the chairman and CEO of BlackRock, the world’s largest investment manager with USD 7 trillion in assets, directed companies to deliver both financial performance and contribute to society, or risk losing BlackRock money. More recently in January 2020, BlackRock’s open letter announced environmental sustainability and climate change would be its core goal and that it would start divesting from thermal coal, staring with a divestment of USD 500 million.

The Asian Development Bank predicts that the ESG market is now worth USD 23 trillion.

BlackRock through its independent subsidiaries invests in a large number of companies in India, amongst them Infosys, HDFC Bank, Reliance, ICICI bank, Hindustan Lever, Bharti Airtel and Axis Bank. If developing countries, and especially countries in South Asia want to remain competitive, companies here will need to start assuring investors that they are also focusing on ESG related gains.

Good commitments, but perverse results.

A new study by Aneesh Raghunandan at the London School of Economics and Shivaram Rajgopal from Columbia University titled ‘Do the Socially Responsible walk the Talk?’ examines whether the claims of companies and funds on environmental, social and governance issues match their actions. The study found that contrary to popular belief, US firms that commit to ESG goals are more likely to commit violations related to ESG.  The results should be a clarion call for better policy and governance in this emerging field.

In the US, companies that care to signal their ESG attributes sign on to the Business Roundtable (BRT). Importantly firms that sign on to the BRT commit themselves to delivering value for all stakeholders and not just their own shareholders.

In their study the two professors compared 118 companies that have signed on to the BRT with those that had not signed on but were under similar administration. The authors found that compared to their industry peers, BRT signatories are:

  • More than likely to be involved in environmental and labour related violations (and pay more in compliance penalties);
  • spend more on lobbying policymakers and get more government subsidies;
  • BRT CEOs are more likely to have abnormal compensation and their independent directors have less power on the board.

Money talks

It is then important to consider why ESG firms are doing better financially. Indeed experts in recent articles in the Financial Times and in an article by the Asian Infrastructure Investment Bank (AIIB) headquartered in Beijing, argue that bigger companies are more likely to flout rules while at the same time showing higher returns. It is unclear whether flouting rules is leading to greater returns or whether the causality is the reverse but it is clear that firms claiming to do more on ESG are also flouting those norms.

What can India do? And developing countries particularly?

In India companies don’t have standards to adhere to and generally haven’t made ESG commitments. Yet it is critical that all companies generate public goods as well as their primary goods, because these have deep implications on the people and the country’s ability to adapt to changes (financial, climatic and others). Thus companies must aim to generate social and environmental benefits along with financial ones. Currently companies that are signing on to ESG goals continue to violate environment and labour laws.

Governments in India and other developing countries need to step in much more saliently. Three things are specifically important:

  • Good rules and standards for what ESG means so that this does not lead to green washing or impact washing.
  • Setting up the right kind of meta-governance structures that allow verification by independent third parties.
  • Focus on producing high quality data from satellites and mobile phones that can enable tracking and monitoring.

Independent financial accounting became an important element of reporting by companies in the United States after the great crash in 2008, so there would be credible understanding of the health of companies. We are at the point where we have another crisis on our hands. That is the climate crisis and this calls for another overhaul of reporting.

This article was first posted on The Third Pole.

This work is under Creative Commons’ Attribution-NonCommercial-NoDerivs 2.0 England & Wales License.