April 23

Analysis: The Rise And Fall Of ESG

By Nives Dolsak and Aseem Prakash

This week we celebrate the 55th anniversary of Earth Day. Perhaps the most serious challenge facing the earth is climate change, which reflects the industrial economy’s reliance on fossil fuels. To decarbonize, governments have enacted a range of mandatory policies. Alongside there is a proliferation of voluntary business efforts. Probably the most well-recognized of business initiatives is ESG (Environmental-Social-Governance), a metric to assess firms’ performance holistically, as opposed to relying predominantly on profits.

The theory is that decarbonization requires substantial changes in how businesses function. Decarbonization policies, whether mandatory or voluntary, tend to impose short-term private costs on firms to produce the global public good of climate mitigation. If firms focus on short-term profit maximization, they will have fewer incentives to pursue decarbonization. The ESG metric is a game changer because it recognizes firms for their pro-environmental efforts. ESG also has social and governance dimensions which are expected to motivate managers to consider the interests of all stakeholders, not only shareholders. This is a big ask because financial markets are programmed to focus on profits.

Photo courtesy of geralt.

Source: Forbes (link opens in a new window)

climate change, corporate social responsibility, corporations, decarbonization, ESG, governance