ESG Investing, Versus Those Who Would Ban It

The popular ESG movement advocates judging firms, not just by what they generate for shareholders in short-term profits, but by their emphasis on environmental, social, and governance goals.  The movement has its detractors, particularly in the United States.  A counter-movement is gathering steam. It would prohibit some financial institutions from investing in firms that follow ESG practices.

To be sure, ESG does warrant some skepticism.  Often, corporate commitments are essentially mere exercises in public relations.  But those who, in the name of economic freedom, would ban private investors from pursuing ESG goals are logically confused.

1. The campaign to ban ESG investing

Leading the charge, Florida Governor Ron DeSantis said last July:
“From Wall Street banks to massive asset managers and big tech companies, we have seen the corporate elite use their economic power to impose policies on the country that they could not achieve at the ballot box. Through the actions I announced today, we are protecting Floridians from woke capital…”

The anti-ESG forces are especially anxious that investors not be allowed to discriminate against gun manufacturers or fossil fuel companies.

In the first five weeks of 2023 alone, Republican state lawmakers proposed up to 49 laws to prevent banks and other institutions from paying attention to ESG criteria in their decisions over which corporations to invest in. In other states, such bills were proposed last year, and some have voted them into law.  States that have taken actions restricting ESG investing include Arizona, Florida, Idaho, Indiana, Kentucky, Louisiana, Mississippi, Missouri, North Dakota and Utah.

At the federal level as well, conservatives in the Senate and House are considering  anti-ESG legislation.  The Biden administration in November decided that it is appropriate for fiduciaries to rely on risk-return analysis that considers environmental, social, and corporate governance factors. The Labor Department ruling permits retirement plans, as of January 30, to take considerations of “social responsibility“ into account on behalf of plan participants (thereby reversing a Trump policy).  Senator Mike Braun (R-Ind.) has put forth a resolution to overturn the rule and has garnered the support of every Republican senator, and thereby to ban retirement plans from “socially responsible” investing.

Many actions at the state level prohibit only public pension funds from investing along ESG lines.  That may be the legal right of a state government.  But the campaign also takes aim at private banks and institutional investors. BlackRock, the world’s largest asset manager, is a favorite target.

There should no longer be any doubt that today’s “conservatives” are not crusading for economic freedom, but rather are fighting culture wars.  DeSantis is the same governor who in 2021 used the power of the Florida state government to prevent privately owned cruise lines from running cruises on which Covid19-vaccinated vacationers could choose to be in each other’s company.  To anyone sincerely interested in free markets, the Governor appears unclear on the concept.

2. The debate

These issues are not new.  The debate over the social responsibility of corporations can be traced back to 1932, when New Deal architect A.A. Berle and law professor Merrick Dodd debated the issue in the Harvard Law Review.  In a famous 1970 New York Times Magazine essay, “The Social Responsibility of Business is to Increase Profits,” the free-market economist Milton Friedman argued that a government chosen by the political process is the proper venue to address social goals and that the duty of a corporation is simply to maximize returns to shareholders, within the constraints of ethical custom and the laws enacted by that government.  If society wants to accelerate the energy transition, for example, it should enact policies like taxes on carbon or subsidies to renewable energy, and then let firms respond to the incentives.  This is a more serious approach than appealing to executives’ consciences and then crying “greenwashing” when the ultimate results are inadequate.  For almost 50 years, the Friedman doctrine reigned.

Then along came ESG.  Proponents make two sorts of arguments.  One is that corporations should, on moral grounds, look beyond the economic interests of their shareholders.  It is for ethicists to adjudicate the moral argument. The second claim is that workers, customers, and investors will respond to good corporate behavior, and that enthusiastic consumers and motivated employees will benefit the firm’s bottom line in the long run.

Some evidence suggests that reforms in the area of corporate governance (the “G” in the acronym) can indeed be financially rewarding.  Note that the interests of top managers and the interests of shareholders often diverge.  Studies in a variety of countries have shown that corporations have higher returns and higher share prices if they constrain executive compensation by such good governance practices as requiring outside directors to sit on compensation committees and stock-holders to get a “say on pay.”

Scholarly findings are less favorable when it comes to “sustainable investing” more broadly. Turning to the “E,” it is not clear that acting to protect the environment above and beyond what is required or incentivized by the government, however praiseworthy, will necessarily help a company’s long run profits. As a general rule, that is.  Clearly there are big potential rewards for being the fastest or the best in, for example, the markets for EVs or renewable energy.

3. Who should decide?

The case for “doing well by doing good” is for private markets to evaluate.  Customers can decide for themselves whether they want to buy the products of environmentally conscious firms.  Workers can decide for themselves whether they want to work harder for socially minded employers.  Investors can decide for themselves whether they think that following good governance practices is indeed profitable in the long run.

ESM is no substitute for intelligently-designed politically supported government regulation.  In this respect, Milton Friedman was right.  On the other hand, if a private company thinks it can do better by pursuing ESM goals, and makes the case to shareholders, it is not the place of governors or congressmen to interfere.  Milton Friedman would agree with that too.