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How Much Influence Does ESG Investing Really Have?

Purchasing a way out of an unpleasant or unwanted situation has a long and storied history – be it paying for a substitute to take someone’s place in a military draft or paying the church for forgiveness of sins. In the 16th century, a friar named Johann Tetzel roamed Germany, selling indulgences for the dead, who neither sought forgiveness nor were able to express contrition but whose relatives could contribute to the Church’s coffers.

Even longer ago, beginning in the 11th century, the Catholic Church sold indulgences to people who sought forgiveness for their sinful ways and had expressed repentance for those sins. In the 16th century, a friar named Johann Tetzel roamed Germany, selling indulgences for the dead who neither sought forgiveness nor were able to express remorse but whose relatives could contribute to the Church’s coffers.

In the fourth installment of his multi-part “Secret Diary of a Sustainable Investor,” Tariq Fancy, former BlackRock chief investment officer for sustainable investing, discusses Tetzel’s “financial innovation. He considers Tetzel as someone who could make “potential buyers feel guilty for not seizing the opportunity to aid their dead relatives, who he assured them were ‘clamoring for help’ as they awaited a generous payment from us in the here-and-now to unlock their ascent to Heaven in the hereafter.” In the book, Fancy echoes many concerns about ESG investing expressed by The Corporate Citizenship Project, a think-tank focused on a data-driven look at corporate governance issues.

“Many of the world’s richest people, both then and now, are searching for the meaning behind their wealth,” said Bryan Junus, Chief Analyst for The Corporate Citizenship Project.

“They feel guilty about their wealth and lifestyle and are searching for a means to assuage that guilt while not sacrificing any of their money. That leaves them open to being pitched by opportunists. From unscrupulous priests in the Renaissance to proxy advisors and so-called ESG consultants today, there is no shortage of actors ready to take a fee to assure the wealthy that their money is pure. Like ISS ESG, the unscrupulous priests had many conflicting interests. Moreover, these same opportunists rarely give any of their fees to the truly needy.”

If Tetzel were alive today, writes Fancy, “[H]e would almost certainly have figured out social media well enough to hock IndulgenceCoin, the latest new and worthless cryptocurrency.” Tetzel’s innovation would be “classified as an ‘impact investment’ with strong social virtue attached, a high environmental, social and governance (ESG) score, and glossy marketing materials that target those looking for more ‘purpose’ in their everyday lives and commercial transactions.”

For Fancy and companies like BlackRock, there is a fundamental question: “[W]hether being a responsible and good corporate citizen truly helps profits or not?” Does better ESG performance lead to better returns? When all is said and done, CEO Larry Fink and BlackRock have a legal responsibility to make a profit for shareholders. Adding any other value is incidental.

In the third part of his secret diary, Fancy cites a 2020 paper, “The Illusory Promise of Stakeholder Governance,” that examines a “governance model that encourages and relies on corporate leaders to serve the interests of stakeholders and not only those of shareholders.” The authors, Lucian A. Bebchuk and Roberto Tallarita of Harvard Law School’s Program on Corporate Governance, call this “stakeholderism” and conclude that it is “an inadequate and substantially counterproductive approach to addressing stakeholder concerns.” They go on:

“Our analysis indicates that, because corporate leaders have strong incentives not to protect stakeholders beyond what would serve shareholder value, acceptance of stakeholderism should not be expected to produce material benefits for stakeholders.”

Junus, from The Corporate Citizenship Project, shares these concerns. “The challenge with so-called stakeholder-ism is that it is difficult to designate who is a stakeholder of any particular company. For example, is everyone who uses the Google Search Engine a stakeholder of Google? If so, Google has over 4 Billion stakeholders. How on earth are they supposed to serve the conflicting interests of all 4 Billion people? Conversely, shareholders’ interests are generally aligned since they all seek to maximize returns.”

In his  fourth installment of his “Secret Diary,” Fancypoints to the “fake debate” between ESG proponents like Fink and anti-woke capitalists like Peter Thiel, citing economist Mariana Mazzucato who wrote that Fink’s version of stakeholder capitalism is based on “conceptual sleight of hand.”

Fancy explains that managing climate risks in investors’ portfolios is not the same as fighting climate change. Investment management firms, banks, and proxy advisors benefit from this confusion. They are, in Fancy’s words, “selling fire insurance rather than helping to stop the fire; and even worse … exaggerating their work publicly runs the risk of crowding out government regulation that could actually fight the fire.” The fire, of course, is climate change.

Junus, of The Corporate Citizenship Project, adds, “Many companies make long-term environmental policy promises that make great headlines today but rarely come to fruition. When a company states they are going carbon neutral by 2035, who will remember that promise 13 years from now? Yet, as we understand it, by making these promises, they can effectively ‘game’ the ESG rating system, thereby earning better ESG scores from ISS and others. Meanwhile, companies who are more conservative with their environmental promises but stick true to them are disadvantaged for their honesty.”

As an example of selling insurance while the house is burning, Bebchuk and Tallarita in their paper, considered the current practice of compensating company directors with restricted or deferred stock (part of the governance aspect of ESG investing). Both major investor proxy advisory firms, Institutional Shareholders Service and Glass Lewis, support aligning the interests of directors with those of shareholders and think that director stock ownership is a good way to achieve that alignment.

There is, however, no alignment with stakeholder interests: “This aspect of director compensation practices is supported by ISS and Glass Lewis, which do not even mention stakeholder welfare in their compensation guidelines.”

Like Friar Tetzel, investment management firms and proxy advisors are making claims to deliver virtue in addition to profit. Those claims are dubious at best.