ESG is fighting with each other.  According to a paper published by the American Institute for Economic Research, the environmental (“E”), social (“S”) and governance elements of ESG do not correlate with each other.  Often social criteria and environmental criteria undercut each other and the E and the S can be used to cover up significant issues with G.

The paper suggests E, S and G should be “disaggregated,” or, as Gwyneth Paltrow would say, have a conscious uncoupling.

ESG should be disaggregated and responsibility for social and political matters should be placed on public entities rather than businesses, Paul Meuller argues in a paper published yesterday.

Yesterday,  the American Institute for Economic Research (“AIER”) published a paper titled ‘The Incoherence of ESG: Why We Should Disaggregate the Environmental, Social, and Governance Label’.

Environmental, social and governance (“ESG”) is a method of scoring businesses on their practices and performance on various sustainability and ethical issues.  It is similar to a social credit score used to monitor people’s behaviour and trustworthiness but for businesses.

Further reading: ESG Social Credit Scores and the Threats They Pose to Freedom, The Heartland Institute, 27 October 2022

The E measures a company’s impact on the natural environment including climate change mitigation and adaptation, resource depletion and conservation, pollution prevention and control, and biodiversity conservation.

The S evaluates a company’s relationships with “stakeholders” including labour practices and human rights, community engagement and development, customer relations and satisfaction and supply chain management and ethics.

The G assesses a company’s leadership, executive compensation and board composition, including transparency and accountability, risk management and internal controls, shareholder rights and engagement, and executive compensation and diversity.

ESG investors seek to ensure the companies they fund are responsible stewards of the environment, good corporate citizens and led by accountable managers based on the criteria above.

Authored by Paul D. Mueller, AIER Senior Research Fellow, the paper argues that the ESG criteria lack logical cohesion and internal consistency.  Social criteria can undercut environmental criteria and vice versa and high environmental or social scores can hide significant governance issues, making the ESG label confusing.

Additionally, the ESG label is used by various groups to advance their agendas under the guise of “responsible” or “sustainable” investment.  Ideological priorities in ESG have little to do with successful business performance or high financial returns.

In his paper, Mueller argues that the three elements of ESG should be disaggregated.  Because disaggregating ESG into separate categories can lead to more efficient capital allocation and transparent engagement with societal problems.

Due to time constraints, we haven’t read the 20-page paper.  We have instead relied on an AI-generated summary of it to produce the yet further summarised version of it below.  As AI is imperfect, it is best to check the critical facts to the source for yourself.  You can read the full paper HERE.

Using ESG as a catch-all term conflates sound business practices with ideologically driven goals, offering no tangible benefits to company profitability or social issue resolution.  While ESG investing is promoted as a “must-have,” its costs and potential for unintended consequences are often overlooked.

The arbitrary grouping of these disparate elements under the ESG umbrella results in ambiguity, contradictions and inefficiencies.  Meuller particularly criticises the “social” category for prioritising progressive agendas over financial performance and hindering the advancement of environmental and governance objectives.

The social aspect of ESG, particularly diversity, equity, and inclusion (“DEI”) initiatives, can be inconsistently applied and may even result in discrimination against certain groups, as exemplified by the Supreme Court case Students for Fair Admissions v. Harvard. Pushing DEI priorities can reduce accountability in hiring practices, as subjective criteria may be used to justify personal preferences.

ESG policies, particularly those related to environmental regulations, lead to increased costs for businesses, which are then passed on to consumers in the form of higher prices for essential goods and services like electricity, hydrocarbon fuels and food.

Added to the increased costs, pressure to obtain high ESG scores to impress investors may lead to “greenwashing.”

High ESG scores are often correlated with the amount of voluntary disclosure a company provides, rather than the actual content of those disclosures. This suggests that companies may be focusing on appearing ESG-compliant rather than genuinely integrating ESG factors into their operations.

A paper by Gibson et al. published in Oxford Academic’s Review of Finance in September 2022, found rampant “greenwashing” in the US, where institutional investors signing onto ESG initiatives like the Principles for Responsible Investing (“PRI”) did not necessarily have higher ESG scores in their portfolios compared to non-signatories.

And the increasing embrace of ESG by business schools and consultants, Meuller argues, often creates more opportunities for research, consulting and career advancement rather than leading to substantive change.

ESG is often used as a way to justify business practices that prioritise social or political goals over shareholder interests, Meuller says.  ESG criteria often contradict each other and undermine shareholder primacy.  And while ESG advocates promote diversity on boards as beneficial, there is no guarantee that diverse boards make better decisions and such mandates can lead to discrimination against more qualified candidates.

ESG scoring involves subjective assessments, making it difficult to reconcile the “E,” “S,” and “G” components, as exemplified by the inconsistent ratings of companies like PepsiCo, Coca-Cola, Exxon Mobil and Tesla by different ESG rating firms.

Furthermore, Tesla was excluded from the S&P 500 ESG Index despite its positive environmental performance, while companies with questionable governance practices but strong DEI stances receive favourable ESG scores.

The widespread adoption of criteria is flawed, particularly the social category which lacks a clear connection to profitability.  Mueller suggests that ESG advocates should abandon the social category entirely to focus on environmental and governance issues, which hold more relevance to business operations. ESG should be disaggregated and responsibility for social and political matters should be placed on public entities rather than businesses, he says.