How Do We Make ESG Sustainable?

by Diana Drake

It’s the acronym that has taken the business world by storm (and made its way into many teamsWharton Global High School Investment Competition portfolios — See Box). ESG, which refers to Environmental, Social and Governance factors, is the lens that people use to evaluate companies’ efforts to do more than make a profit – like contribute positively to the planet, practice inclusivity in the boardroom, and support social causes.

ESG considerations are reshaping corporate priorities. ESG fits into the broader landscape of accountable capitalism – a system in which stakeholders (people with an interest in a business, including owners, managers, board members, employees, customers and investors) hold organizations accountable for the externalities that they create (positive or negative outcomes of their business activities), and price them correctly in the market.

The ESG movement is driven in large part by investors, who are focused on opportunities to build company value and generate investment returns. In ESG investing, investors apply non-financial factors like environmental, social and governance to analyze a stock’s performance and long-term potential. By many accounts, investor demand for ESG has been growing robustly in the past 10 years.

Witold Henisz, vice dean and faculty director of the ESG Initiative at the Wharton School of the University of Pennsylvania, said, “We often hear statistics organized by institutions like the Global Sustainable Investment Alliance that tout $35 trillion or 36% of all globally professionally managed assets incorporate or demand ESG factors be included in their investment thesis… Bloomberg even reported that the expected demand for ESG investing was going to be $50 trillion as soon as 2025.”

Discussing the Possibilities

But not everyone embraces ESG – and not all data suggest that investor demand is that robust. For example, research by Wharton faculty members Luke Taylor and Bob Stambaugh concludes that the actual amount of ESG investing may be more like $2 or $3 trillion. What’s more, a countermovement challenges the efforts to value ESG factors and incorporate them into strategic initiatives, claiming that such efforts are being used to push political goals.

This friction point sparked the August 2023 LinkedIn Live conversation “ESG: Dispatch from the Front Lines of Accountable Capitalism,” organized by Wharton’s ESG Initiative and Wharton Executive Education.

Dr. Henisz moderated a virtual panel discussion with three leaders in ESG integration – across financial services, consulting and corporate – as well as a Wharton associate professor of business economics and public policy.

What’s next? asked Henisz. “Will we find better data, build better models and drive substantive change? Will we see less-lofty claims, but no changed effort in which companies avoid using the label ESG, but continue to pursue meaningful reform? Or will the current headwinds lead to delays and tactical retreats that reverse progress and taint the ESG movement as just another fad?”

The hour-long LinkedIn Live discussion is available HERE.

ESG Experts Express Policies and Purpose

Below are highlights from the panel of ESG leaders, as they pull from their professional experiences to suggest how companies, investors and policymakers can support the future strength of ESG.

How can we accelerate progress toward accountable capitalism? “We have to reshape our economy in so many ways. And we have to choose to put aside a bit of the noise, because there isn’t much space for that when data and everything is telling us the right direction,” said Viviana Alvarez, former head of sustainability and corporate strategy at Unilever North America, a consumer goods company and leader in the corporate ESG movement. “I think there’s going to be a lot of innovation and new industries, new jobs, new economies, going towards what we need to do in terms of [ESG] adaptation, and that is going to happen across all industries. So that is very exciting. How to demonstrate that to shareholders? Well, we have to stress-test a portfolio. Can you continue to produce your product or service at this pace in the next five to 10 years? We know the answer is no. A lot of procurement officers (people responsible for determining the best sources of supplies for a company) don’t really sleep at night, because they know their commodities depend on a lot of these fragilities — and we’re not talking five to 10 years from now, we’re talking three years from now. These things are going to accelerate very much-needed rapid change. And we will see which companies are reacting or being proactive.”

“It’s important for investors to look at each company and look at governance. There’s a lot of things we can observe from that.” –Jennifer Grancio, Engine No. 1

What does Effective ESG look like inside companies? “The companies that get this right do five things,” observed Monica Dimitracopoulos, corporate sustainability leader, EY Americas, a professional services organization within Ernst & Young. “They are deepening their understanding of stakeholder expectations…They are putting in place the right governance at the board and executive-leadership-team levels. They’re embedding this as a lens into how they think about their strategic priorities and growth agenda. They’re essentially moving toward operationalizing these initiatives and allocating the right amounts of capital. And they’re staying very connected to the market, to their stakeholders, transparently reporting on progress or lack thereof and generating quality data. I think that first point is the most important one, which is knowing your stakeholders, knowing their expectations, but importantly, not just those expectations, because they’re not all created equal, but those that matter the most for your organization’s future success. Thinking about how to prioritize those is what sets apart companies that are doing this well. As we look ahead, this is only going to become more important.”

How can we get asset owners to see the opportunities of ESG and accelerate change from the investor side? “When we think about the E and the S and the G, we know corporate governance always matters,” said Jennifer Grancio, CEO of Engine No. 1, a hedge fund that is part of a new breed of shareholder activists believing that social good is important to a company’s value and impacts the bottom line. Founded in 2020, Engine No. 1 is all about active ownership of the companies in which it invests. “I think we can be very disciplined, whether you’re an investor like we are, and we’re investing on behalf of others, how a company behaves. Tesla is a great example. They have built a beautiful engineering process that takes us down the [positive environmental impact] road very quickly and creates competition on battery electric vehicles. But, there are moments in time where if Elon Musk is running their company, you could give them a very negative grade on governance. And so, it’s important for investors to look at each company and look at governance. There’s a lot of things we can observe from that. And there’s a lot of research to back up what good and bad governance look like.”

What should people and policymakers understand about ESG factors? “I think it’s crucial for investors, consultants, strategists to really understand how climate risks affect prices and financial markets and might change long-term corporate strategies,” noted Arthur van Benthem, faculty co-director of the Wharton Climate Center. “I would say that climate-risk pricing is real. For example, take the housing market. There’s some really interesting research by my colleagues here at Wharton who studied the housing market in Florida. They show that houses that are in high flood risk areas transacted 19% less and sold for 5% less than very similar houses in low flood risk areas…Good strategists and leaders need to understand why and how financial markets respond and how to be prepared for that.”

When it comes to the sustainability of the ESG movement, Dr. Henisz summarized the panelists’ insights like this: “We need to experiment. We need to embed ESG into the core. We need more system-level thinking. We need people who have a sense of purpose that are willing to drive this experimentation and integration. And we all need to understand the role that externalities (side effects or consequences of commercial activities) play in this broader system that companies are embedded in.”

Grancio of Engine No. 1 echoed that ESG can’t be something we do on the side: “We need to assume that the E and S and G is data and material and push it into the core of how people think about things.”

 Click HERE to visit Global Youth’s ESG Mini-sites!

Conversation Starters

Dr. Witold Henisz asks, “What’s next? Will we find better data, build better models and drive substantive change? Will we see less-lofty claims, but no changed effort in which companies avoid using the label ESG, but continue to pursue meaningful reform? Or will the current headwinds lead to delays and tactical retreats that reverse progress and taint the ESG movement as just another fad?” Where do you think the ESG movement is headed and why do you hold those beliefs?

Panelist Viviana Alvarez says, “I think there’s going to be a lot of innovation and new industries, new jobs, new economies, going towards what we need to do in terms of [ESG] adaptation.” As a future business leader and employee in this evolving economy, how do you hope to contribute? What new job or innovation do you hope to see?

Lots of novice investors are enamored with Tesla because its electric cars are helping to lead the world away from carbon dependence. But what is Jennifer Grancio saying about the value of corporate governance, supported by the Tesla example? Why is this critical to the perspective we have and the decisions we make as stakeholders?

5 comments on “How Do We Make ESG Sustainable?

  1. ESG is a crucial lens through which people like shareholders, consumers, and investors can see whether a company is concerned with making more than a profit and contributes to environmental, social, our governance causes or not. As soon as I read that term, I knew that it must be a very hot topic with a lot of research, but it is concerning for me to realize that while some data says that $36 trillion of all professionally managed assets demand ESG analysis, some other data done by professionals at Wharton suggest that that real amount of ESG investing is more like $2-$3 trillion, and other studies claim that it has been growing for the past 10 years. This information only causes preoccupation in myself on the lack of information on ESG investing and how this could also be affecting investors and how much are they concerned with investing in ESG or not. But one thing is for sure, future financial performance is going to be affected by ESG adherence, especially with our new generation of social entrepreneurs who are every time more and more concerned with contributing to the planet and our societies through their business models. I firmly believe that our economy will change along with changes in our industries and companies, as well as public interest in how businesses can implement social and environmental initiatives in their processes, and this is exciting.

    Companies will have to change their products and their ways of making products as ESG adaptation is happening, this is a change that is indeed needed for a constructive future of business, and in our current world, as Erick Orts said “every business has to have a climate imperative about its behavior” and with this is also important to realize that climate is greatly affecting our financial markets. Companies need the ESG lens to observe their strategies, understand what the market is demanding, and inform and educate shareholders. Then again, I am back to feeling concerned about the little information there is on ESG and its complexity, and how shareholders, and consumers, are also responsible for its adaptation, therefore, public education and information on this topic are very important. There is a responsibility from the investors’ side to make sure their assets include an ESG analysis that achieves its goal of investing in companies that are adapting to this lens. All the articles I had read about the environment and businesses’ responsibility always talked about how businesses and entrepreneurs were the main important people in creating change in our economy and the products being released. However, it is difficult to release a product that has an ESG approach when the market and the shareholders are not concerned with it and, therefore are not demanding it, much less willing to spend their money on it.

    As Dr. Henisz said, “We all need to understand the role that externalities play in this broader system that companies are embedded in”. If we can bring ESG into the spotlight more often, and inform the general public about ESG – a public that not only includes entrepreneurs, but also shareholders and consumers- then I can imagine a bright future for ESG investing, and seeing companies taking real action to change their processes to adapt to the needs of our world, but that is only if people are informed and demand it.

    • Thank you Isabella, for your thoughtful reflections on ESG principles and their impact on global business practices. It’s evident that ESG is not just a trend but a transformative lens through which we can evaluate the holistic impact of businesses on our planet and society.
      Isabella, your concerns about the discrepancies in data regarding ESG investing are valid and reflect broader challenges in the financial sector. The varying reports highlight the need for standardized metrics and greater transparency to ensure that ESG investments truly align with their intended goals. I recently read an article on the global top ESG ranking company, Morgan Stanley Capital International (MSCI)’s ESG ratings after taking the Wharton Global Youth Essentials of Finance Summer Program. MSCI uses a letter-grade scale from AAA (best) to CCC (worst) to rank companies on their ESG performance. The ratings assess companies across three key dimensions – environmental, social, and governance. Within these, MSCI evaluates various issues such as climate change impact, resource use, human capital, product safety, corporate governance, and business ethics. MSCI gathers data from corporate disclosures, financial reports, press releases, third-party media, NGOs, and governmental databases. Companies are scored from 0-10 on each ESG issue, with 0 indicating minimal exposure and 10 indicating high exposure. These scores are then aggregated and weighted to produce the final letter grade. The ratings are standardized within each industry sector, allowing for comparisons between companies in the same industry. MSCI has made its ESG ratings publicly available for over 2,900 companies. However, there are apparent flaws with MSCI ratings, such as inflated and biased ratings, changes to weightage, and misleading ratings. As you said, bringing more light to ESG will create a wave of investor sentiment that will, hopefully, pressure change for refining ESG metrics.
      I believe the ESG movement is at a critical juncture. While there’s significant momentum towards integrating ESG factors into business strategies, challenges like data integrity and varying stakeholder expectations remain. However, I am optimistic about the future of ESG investing. As awareness grows and stakeholders demand more accountability from companies, including insights from MSCI’s ESG rankings, we can expect to see greater emphasis on sustainable practices and societal impacts in corporate decision-making.

    • Hi Isabella,

      Like you, I’m excited to see the role of companies in creating a more equitable and environmentally sustainable world. I agree with your assessment that a crucial step in achieving this future is increasing awareness of the three pillars of ESG. As you state, if consumers are not aware of the merits of ESG adherence, it would be more difficult for a company centered around doing good for society to be competitive.

      However, something I’d like to challenge is the notion that ESG is about doing more than making a profit. This distinction makes ESG adherence seem like an extra cost incurred purely for charity. In my view, the purpose of incorporating ESG factors into financial analysis is perfectly summarized by Diana Drake in the Global Youth Business Journal article “How the Next Generation Can Add Value to ESG Investing,” where she writes that it aims “to improve their traditional financial analysis of potential investments and to identify risks and opportunities.”

      With this in mind, here’s how I’d approach the three pillars of ESG:

      Environment – There’s no denying that climate change will change the earth and how we interact with it. Given this future, isn’t it a risk to invest in companies that will have to make significant, potentially disastrous adjustments to their business structure to accommodate for the inevitable environmental regulations of the future? As you quote from Erick Orts, “every business has to have a climate imperative about its behavior.” And on the flip side, isn’t it an opportunity to invest in companies in industries that are positioned to expand as we adjust to a new world? A prime example of this is the burgeoning EV market.

      Social – One aspect of this pillar that I’d like to emphasize is inclusion. A little over a hundred years ago, women were excluded from participation in orchestras, but today, it would likely be impossible to find an orchestra without women, and many of the world’s leading musicians are women. If orchestras still excluded women, they’d deprive themselves of an enormous amount of talent. With this example in mind, isn’t it advantageous for companies to promote inclusion?

      Governance – As you note, newer generations tend to be more concerned about social issues and the environment. This is reflective of a broad truth that as humanity progresses through time, the wants and needs of society change. As a result, companies must adapt to ever-changing consumer demands. This usually starts at the top. Thus, evaluating a company’s leadership may provide valuable insight into how a company may change over time.

      While it would be nice for all companies to make a complete switch to eco-friendly practices, actively address social issues, and maintain honest and receptive boards, these ideals are exceptionally rare to find in practice. Plus, at the end of the day, investing is about making money–and money talks. Thus, I believe that the most effective way to make ESG investing sustainable is to view it from the lens of an investor (and hopefully do some good along the way).

      Ultimately, the differences between our interpretations of how investors should approach ESG reflect the reality that ESG investing is still a relatively new idea. Thus, as you emphasize, we as a society must continue to think critically about what ESG means and how we may address each of its three pillars. By doing so, we can achieve a brighter future.

  2. I remember walking along the edge of the Cengkareng Drain in Western Jakarta, the sun beating down my neck and mosquitos circling my head. I saw a winding river leading down an endless row of uniquely built houses downstream. My young mind had taken pleasure in regularly heading to nearby parks and rivers to spend time away from our apartment in the city center. However, the stream’s beauty was hindered by the pieces of trash scattered across the surface of the water. At the time, I never understood how the trash got there, or why people wouldn’t just pick up after themselves. Years later, I came to realize that this was not the fault of the people living along the river, rather it was the fault of systemic issues in waste management in Jakarta, with much of the garbage being left to float across the beautiful river due to inadequate infrastructure and a lack of public waste disposal facilities. Many years later, I visited Jakarta again and returned to my place along the Cengkareng Drain. However, this time, there was nearly no garbage or waste. I found out that small Jakartan businesses had pooled together money to fix this pollution problem, with NPOs such as The Ocean Cleanup employed to fix the issue. However, their efforts are not complete, the river is still one of the most polluted in the world and will require many more years of effort to become clean. This initiative is a testament to the power of small businesses and grassroots.

    After living in Indonesia for many years, I moved to Bangkok, Thailand. It was a large culture shock leaving the land I had called home for much of my life. Living there, it was not uncommon to see men wearing women’s clothing and deviating from traditional male norms, a group of people locally referred to as Kathoey or Ladybody (although these terms are considered offensive, they are still used by locals, but I will not use them going forward). They were largely treated as equal members of society at a time when being transgender or feminine was seen as morally wrong in much of the world. Many businesses would hire them, indiscriminate to their sexual orientation, with my father knowing some at his workplace. This accepting nature allowed a group of people to find comfort both in and out of the workplace, with their practices being more socially accepted over time. While, they still face discrimination in Thailand, with some institutions choosing not to hire them at all, Thailand is considered one of the most accepting countries in the world for transgender people and continues to strive for equality through socially responsible businesses.

    While I enjoyed my time in Thailand, it came to an end when I moved to Tokyo, Japan. Living in the heart of the city, it was a surprise to see so many senior citizens continuing to work well into their 70s and 80s. This was an accepted practice in Japan, with the government providing many social services to make it easier for them to work. This mindset reflects a deeply seeded respect for the elderly and a recognition of their continued contribution to society, values enshrined in Japanese traditions and beliefs. This has allowed the nation to implement a model of inclusive governance that values all age groups and ensures that senior citizens remain an active and integrated part of the workforce, with companies treating older employees equal to their younger counterparts.
    After Japan, I moved to the US, where I conducted research to combat Tuberculosis (TB) in my home country of India. I integrate these ESG principles, deep learning, and game theory to create a multifaceted approach finding the optimal allocation of resources to combat TB in the country. My models reflect the environmental aspects (E) of ESG by promoting sustainable health practices through efficient resource allocation. They reflect the social component (S) by ensuring equal treatment for all TB patients, recognizing and addressing their diverse needs. Lastly, they reflect the governance component (G) through the involvement of ESG-friendly companies that adhere to high standards of corporate responsibility.

    My journey through various environments has shaped my understanding of ESG principles. In Indonesia, the environmental challenges I observed along the Cengkareng Drain highlighted the ability of small businesses to come together to better the environment around them. My time in Thailand exposed me to the importance of social inclusion, where businesses’ acceptance of transgender people was a step in the direction of progress. Living in Japan taught me the value of equality in the workforce, by welcoming people, regardless of age group. These experiences in my foundational years drove me to apply these ESG principles in my research. Only through collective action, can we empower businesses to build a future that reflects the needs of today.

    • Jai, your journey through different cultures really highlights how ESG principles play out in real life. Seeing grassroots efforts along the Cengkareng Drain in Jakarta and witnessing inclusive practices in Thailand and Japan underscores how powerful ESG can be in different settings. Integrating ESG principles into your research on combating Tuberculosis in India is a great example of how these principles can tackle tough societal challenges with sustainable solutions. I once interviewed an MIT student for my podcast “Sustainable Cents.” She majors in Economics and Sustainable Urban Development. Her raw and comprehensive experiences were mind-opening to see what options and challenges were encountered when she spoke to indigenous communities about sustainable development. She is currently advancing her studies in the UK as a Marshall Scholar now.

      I believe the ESG movement is at a critical juncture. While there’s significant momentum towards integrating ESG factors into business strategies, challenges like data integrity and varying stakeholder expectations remain. However, I am optimistic about the future of ESG investing. As awareness grows and stakeholders demand more accountability from companies, including insights from MSCI’s ESG rankings, we can expect to see greater emphasis on sustainable practices and societal impacts in corporate decision-making.

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