Is ESG a ‘Protection Racket’ or Long-Term Value Contributor?

A backlash against ESG investing fills the headlines of The Wall Street Journal and certain other business publications. The harshest critics characterize ESG-informed investing and corporate ESG programs as great destroyers of shareholder value, undertaken for political reasons, and without resulting in any benefit to society. The ESG movement has been condemned by some state attorneys general as being rife with “destructive, illegal business practices” that politicize financial decisions. One recent editorial characterized ESG stakeholder engagement as a “protection racket.” Given the hyperbole, a serious look at the at these charges is warranted.

Certainly, the ESG movement has suffered growing pains. Those include persistent challenges, such as the difficulty and expense of measuring progress on ESG goals, and the incoherent multiplicity of disclosure frameworks, raters, and rankers in the space. Some of the backlash is also a reaction to bad behavior: greenwashing, ESG marketing ploys, and activist pressure on narrow issues unrelated to a company’s business.

But a protection racket involves pressure on businesses to pay for something they are already entitled to receive. Pressure to disclose ESG data is different. No company is entitled to quiet investors single-mindedly focused on the next quarter’s financial results. No company is entitled to consumer confidence or stakeholder trust. Spending corporate resources to build the trust of those stakeholders is hardly an anti-capitalistic strategy. Fundamentally, I believe in the efficiencies of the marketplace, including the marketplace of ideas. And ESG is winning in the market.

Let the market speak

ESG investment has gone mainstream. One recent study from Bloomberg Intelligence projects more than one-third of all globally managed assets could carry explicit ESG labels by 2025. Given the scale of the movement of assets into ESG-screened funds, the suggestions that ESG is all about politics seems far-fetched. Investor perceptions of risk and potential return and the preferences of their own clients deserve respect. A preference for investments in firms deemed socially responsible companies is no less valid or inherently political than a preference around a firm’s R&D strategy. Is it really credible that many of the largest and most sophisticated investment managers in the world have been pressured into pursuing strategies at odds with their clients’ interests?

Investors have also spoken with their votes. During the 2022 proxy season, companies were presented with no shortage of “anti-ESG” shareholder proposals. The average level of shareholder support was just 3%. That kind of consensus is a powerful signal.

But if many investors truly value sustainability, and if companies have an economic incentive to demonstrate social responsibility, then why does ESG arouse such passion? One answer is information—or more precisely, the lack of good data. Transparency is the foundation of any serious ESG strategy, but much ESG data is expensive to discover and provide. ESG is also complicated. Jumbling E, S and G performance scores into one consolidated rating of a company’s social responsibility is nearly meaningless—which may explain why different raters so rarely agree on the top companies. In addition, there is simply no political consensus around strategies to address environmental sustainability, gender and racial equity, and other issues. And most politicians are notoriously short-term oriented. Especially in areas where hard trade-offs must be made, is it any wonder that they would be frustrated by long-term investing strategies that drive changes unaligned to their own priorities? The furor over ESG reflects the divisions that already exist in our society.

The controversy surrounding ESG does not mean that it is time for the government to step in. Regulators properly insist that company disclosures are truthful, but there is little reason for them to dictate what investors and customers want to know. ESG factors are too numerous, complex, and variable across industries for a one-size-fits-all disclosure scheme. Voluntary disclosure can be better tailored to companies’ circumstances and the interests of their shareholders.

The future: More noise, and that’s OK

The growing noise around ESG is evidence of its increasing maturity and entry into the mainstream. Especially in a highly regulated and publicly sensitive sector like healthcare, leaders should welcome the scrutiny of ESG critics, but they should also resist any urge to take comfort in it or step back from well-considered ESG initiatives. On the contrary, we should instead redouble efforts to ensure that ESG factors are incorporated into corporate decision-making in a way that is truly aligned with the long-term sustainability of the firm.

Geralyn Ritter, head of external affairs and ESG at Organon and author of Bone by Bone. In this role, she focuses on guiding and shaping how the company interacts with key stakeholders and the environment.