Reflection on the ESG wave: Does a company with excellent carbon reduction performance but harmful products comply with the ESG spirit?

Reflection on the ESG wave, The sweep of the epidemic, Huang Weixuan has buried a piece of news that deserves more attention- Phillip Morris , a cigarette company that sells 700 billion cigarettes a year, joined in November 2020 The Dow Jones Sustainability Index (DJSI) is the most indicative sustainability evaluation indicator. Why can a company whose products cause harm to the health of users join DJSI? The reason is simple. The threshold for becoming an excellent corporate citizen is not high, which greatly reduces the positive benefits of ESG (Environment environment, Social society, Governance corporate governance) investment.

After further exploration, the evaluation methods of some well-known ESG evaluation agencies such as MSCI and Sustainalytics urgently need to be adjusted.

Contrary to the imagination of most investors, the evaluation method is not to evaluate the performance of the company in the environment (E), society (S), and corporate governance (G), but to evaluate the economic value of a company in terms of ESG risks Degree. For example, if a company produces a large amount of carbon emissions, but the pollution is properly managed and does not affect the company’s financial performance, it can still achieve a satisfactory ESG score.

This is why Exxon , the largest publicly listed oil company in the United States by total market capitalization, and BP , the British oil company , can still get 3 B (BBB) ​​and an A (A) upper-middle score from MSCI respectively. This also explains why Phillip Morris can be squeezed into the DJSI roster. Phillip Morris recently announced that it will develop towards “smoke-free”. The rating agency believes that it will reduce government supervision, even if the company will still produce addictive and harmful electronic cigarettes and heated cigarettes in the future.

Another question concerns the scoring method of the 3 ESG items. The rating agency evaluates the performance of each company’s ESG sub-projects, and assigns the score proportion of each sub-project, which is combined to form a company’s overall ESG rating. One business might get 3 As’s in E, S, G while another gets 3 C’s. The comprehensive evaluation score provided by this third-party organization will then become the parameter basis for various extended investment products of the company. This approach seems reasonable and fair, but in essence there are still some doubts. The evaluation method still relies on human judgment, and different evaluators may give different evaluation scores due to inconsistent interviews. What needs to be more vigilant is that even if a company is harmful to stakeholders, it may still get a high score on the composite score.

Take PepsiCo and Coca-Cola for example, both companies have achieved satisfactory scores in the ESG evaluation. These two companies are usually one of the largest holdings of ESG funds because of their good performance in corporate governance and carbon emissions. However, the core product of their business involves the production and marketing of addictive foods that may pose risks of diabetes, obesity, and shortened lifespan. PepsiCo and Coca-Cola use their power to avoid taxes, prevent government regulation of their businesses, and divert attention from the health effects of their products by heavily funding research. Taking the United States alone as an example, the current cost of treating diabetes is as high as 300 billion US dollars, and the negative impact of these companies may be greater than their economic contribution.

Another example is technology companies Alphabet, Amazon, Facebook, etc., which are also the largest holding companies of ESG funds. These companies have good ESG scores due to low greenhouse gas emissions, but few would consider them good corporate citizens – Amazon doesn’t treat its employees well and undercuts prices; Facebook and Alphabet’s business models Algorithms involved in the creation of hate speech and the dissemination of misinformation, whose products may increase mental illness among young people. All three companies have been identified as market monopolies by academics, policymakers, business leaders and lawyers. If a company’s business model has caused so much damage, it shouldn’t be so simple to make up for the lack of other parameters through “good behavior”.

To complicate matters, there have been many recent academic studies analyzing ESG scores in an attempt to demonstrate that ESG performance is positively correlated with financial performance. The current broad conclusion is: “Companies that focus on ESG will be able to obtain higher profits.” However, there are several problems with this preliminary conclusion:

First, the degree of positive correlation between ESG performance and financial performance involves how and when profits are measured.

Second, even if it can be proven that ESG performance is highly correlated with financial performance, it does not mean that there is a causal relationship between the two. Aswath Damedaran, a professor of finance at NYU Stern School of Business, mentioned: “Is it a “successful” company that has added ESG points on the basis of its success, or is it a company that pays attention to ESG? performance and success?”

Third, the current ESG rating system does not have high standards for obtaining good scores. As mentioned in the above paragraph, many technology companies can achieve quite good scores in ESG evaluations, but the nature of their business models is harmful to society.

Facing the problems of global environmental destruction and social inequality, more and more investors hope that they can improve these problems through investment. To capitalize on this trend, large financial institutions such as Blackrock and Vanguard have launched hundreds of ESG funds, managing trillions of dollars. Dollar flows into these ESG funds accounted for 25% of total mutual fund net inflows, 10 times higher than in 2018.

For financial institutions, ESG funds can be lucrative – because of its novelty, it helps to charge higher management fees. For proponents of “conscious capitalism,” the rapid shift in capital flows is proof that business can be a force for good. But the current system is incomplete, allowing companies that are harmful to the environment and society to still benefit from it; and most CEOs and Wall Street executives are happy to see this lucrative movement that can improve the company’s public image continue to flourish.

To truly practice the spirit of ESG, a new evaluation system must be designed. Whether an enterprise creates a market monopoly, whether it generates external environmental costs, and labor rights all need to be considered. Under this evaluation system, if an enterprise does not perform well in any of the environmental, social, and corporate governance aspects, it will not be able to obtain an overall high score. For example, if a company produces food that is harmful to health, even if it performs well in corporate governance and environmental protection, it will not be able to score high in ESG ratings. If a company causes market failure, it will not be able to score high.

“Creating the highest shareholder value at any cost” – this thinking has been kidnapping business leaders for a long time, and now it’s time to change. The rise of the ESG concept has made companies face up to the importance of being a corporate citizen. To become a true ESG leader, companies need to pay their employees higher salaries, produce products that are not addictive to consumers, increase environmental protection budgets, and so on. In other words, they may have to sacrifice profits. Practicing ESG is not easy.