“ESG is the devil” – Elon Musk

“ESG is a threat to the American economy” – Florida Governor Ron DeSantis

No Elon, ESG is not the devil. And I’m sorry Governor DeSantis, ESG is not a threat to the American economy. However, just like the devil, ESG is in the details.

The anti-ESG movement seems to come in waves. Anytime an article appears with a slandering view of ESG, the community rallies around it, shares their disbelief, decries the woke left, then the murmuring fades until the next piece of misguided information emerges.

The most recent wave of criticism was ignited by an article that pointed out that some tobacco companies had better ESG scores than Tesla. This seemed to summon all of the ESG haters to their quarterly meeting. “How can Big Tobacco be more ethical than Tesla?” “There’s no way that Tesla is worse for the environment than smoking.” “ESG is a scam.” “ESG is what’s wrong with America.”

If ESG was a measure of the most ethical companies, or the most environmentally friendly companies, or even the most diverse companies, then I’d jump right on board with those arguments and be shouting from the rooftops that ESG is a scam.

But that’s not what ESG is, and that’s where almost everyone in the anti-ESG movement has it all wrong. It’s a complex topic so I don’t blame anyone for not understanding, but decrying something that you don’t understand — that’s blameworthy.

“So, Andrew, if ESG isn’t about being environmentally friendly, ethical, woke, or whatever other phrase you want to give it, what is it about?”

When you boil it all down, ESG is about investment risk. That’s it. A company’s ESG score signals to investors how safe from environmental, social, and governance (ESG) risks a company is.

“Okay. So it is about the environment then. I thought you said it wasn’t about being environmentally friendly.”

True, it is about the environment, but not in the way that you’re thinking. It’s not about how many trees a company hugs, it’s about how well a company is managing its material environmental risks. Like it or not, legislation is changing and regulations are coming that will mandate companies to lower their greenhouse gas (GHG) emissions. If a company is not prepared for this reality, they run the risk of incurring fines, disruptions in production, or even foreclosure. Those are things that investors want to know about before sinking their money into a company. ESG analyzes how well a company is managing their exposure to environmental risks like the changing regulatory landscape.

“Alright, but Tesla is a good environmental company. Their cars have no emissions. How could they score less than a tobacco company?”

That’s a good question. Now we’re having a real ESG conversation. Tesla cars might not produce any emissions when you drive them, but producing the steel, aluminum, and other materials that make the parts of a Tesla car does create emissions. As well, you have to factor in where the electricity comes from that charges the electric vehicles — are there any emissions involved in that?

To keep things simple, however, let’s say that Tesla produces zero emissions, or negligible emissions. (Side note: there are more factors that make up the “E” part of ESG than just GHG emissions, but let’s keep it simple for now.) There are also the social and governance risks to factor in, and that’s where Tesla typically doesn’t score well on the ESG ratings.

“What are social and governance risks?”

They come in different forms and admittedly are less straight-forward to measure than the environmental risks. However, under the “S” they typically measure things like employee satisfaction and working conditions, community relations, and supply chain issues like human rights abuses.

The “G” concerns itself with corporate governance. Are there conflicts of interest on the board of directors? Does the company conduct itself professionally and abide by the laws in the countries where it operates? Do they have a history of giving or receiving bribes? Do they have internal processes to ensure that they are responsibly managing their ESG risks?

Everything about ESG is really designed to protect the investor from unforeseen risks.

“So tobacco companies have less risks than Tesla?”

It’s not necessarily that they have less risks, but rather that the ratings company decided that the tobacco company is managing its risks better than Tesla. That’s what the better ESG score means.

“Okay, I think I get it. But I still have all this built-up ESG hate.”

Haha that’s fine. You don’t have to like it. But if you’re going to invest in a company, it might be worthwhile to find out how they are managing their ESG risks.

And you know what? Since you stuck with me until the end, I’ll give you some better guided criticism if you still want to be in the anti-ESG group. Don’t just call it the devil, or a scam, or evil, because that’s laughable to those of us who work in and understand ESG. However, each ESG rating company has a slightly different formula for how they determine ESG scores and what factors into the E, S, and G. This lack of standardization is actually one of the major critiques of ESG and the main thing that companies dislike about it. So next time you want to talk about what you don’t like about ESG, talk about the lack of standardization and how it takes companies a lot of time and resources to understand what they’re supposed to submit to the different rating agencies, rather than just saying ESG is what’s wrong with America.

I hope this helped. Have a great day.

Image by Mohamed Hassan from Pixabay