Applying economics – not gut feel – to ESG

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Here’s a note from Alex Edmans about his paper:

The urgency of ESG leads us to apply gut feel to some of the world’s most pressing issues, since we can’t wait for academic research to be peer reviewed and published.

But, as I argued in “The End of ESG”, ESG is “extremely important and nothing special”. It’s no different from any other investment that creates long-term financial and social value, and there’s decades of rigorous research on this (e.g. corporate finance studies financial value, welfare economics studies externalties). This new paper “Applying Economics – Not Gut Feel – To ESG Issues“, applies the insights of economics to ten ESG topics and shows how we draw quite different, and much more nuanced, conclusions than if we apply gut feel. These are:

1. Shareholder Value is Short-Termist (No, shareholder value is a long-term concept).
2. Shareholder Primacy Leads to an Exclusive Focus on Shareholder Value (No, shareholders have objectives other than shareholder value).
3. Sustainability Risks Increase the Cost of Capital (No, sustainability risks lower expected cash flows).
4. Sustainable Stocks Earn Higher Returns (No, sustainability may be priced in; tastes for sustainable stocks lead to lower returns).
5. Climate Risk is Investment Risk (No, climate risk is an unpriced externality).
6. A Company’s ESG Metrics Capture Its Impact on Society (No, partial equilibrium differs from general equilibrium).
7. More ESG Is Always Better (No, ESG exhibits diminishing returns and trade-offs exist).
8. More Investor Engagement Is Always Better (No, investors may be uninformed or undermine managerial initiative).
9. You Improve ESG Performance By Paying For ESG Performance (No, paying for some ESG dimensions will cause firms to underweight others).
10. Market Failures Justify Regulatory Intervention (No, regulatory intervention is only justified when market failure exceeds regulatory failure).

Comments and critiques welcome (either here or via email); please read the article before commenting.