The debate on the capital market surrounding ESG is complex, and not always comprehensible, even to the experts. One thing, however, is clear: ESG is not ethical valuation but about understanding and measuring material risks impacted through ESG for companies in every industry
Beginning around the start of the twenty-first century, caring capitalism, as a new and purportedly gentler model of the market, began to be promoted by key actors in the global economy. As a social project, caring capitalism heralds the capacity of compassionate companies to produce principal and principle at one and the same time. Firms can generate social and financial value through their business models, including how they source supplies, whom they employ and how they treat their workers, how they distribute their products, and/or what products they sell and to whom. Unlike the negative view of the market found in Chapters 4 and 5 of this book, advocates of caring capitalism champion the work of businesses as a solution to social problems. The third and last part of this book analyzes the implications of this rise of caring capitalism, which has taken a number of distinct fields, for the pursuit of social good. What happens to the meaning and measure of social value when caring capitalism is framed by market enthusiasts both as an answer to social inequities and as a new source of wealth creation?
As outlined in Chapter 1, scholarship in the social sciences offers us a number of competing expectations. One traditional prediction is that the movement of goods into the economy, where they will to be bought and sold as commodities, subjects them to the logic of the market. They will become evaluated solely in terms of their monetary worth for consumers and their capacity to generate economic gain for producers and investors. In this view, what gets to count as social value with caring capitalism should become determined not by actors’ values (their ideals concerning a just and equitable society) but by the criteria of value (the pursuit of profit). In result, social value as an order of worth (or, alternatively, as an institutional logic or repertoire of evaluation) should become restricted to those business practices that not only generate social good but that also generate return for investors, given that shareholder value has “become the privileged metric for assessing corporate success” (Krippner Reference Krippner2011:7).
A second prediction is that actors are able to draw from and integrate different orders of worth even when located in the private sector (Boltanski and Thévenot Reference Boltanski and Thévenot2006; Zelizer Reference Zelizer2009). Rather than the “hostile worlds” outcome, goods deemed sacred or moral in some way can be bought and sold as commodities without losing their ethical intent, through the careful use of relational work. Actors create social relationships around the market exchange of those entities, bounding them of as distinct from the trade of other goods. In the case of caring capitalism, we should expect to see proponents enact a social project as a moral market by ensuring the use of money as a medium of exchange and as a mode of valuation for goods that are heralded as a market-based solutions to social problems in ways that protect the social value of those commodities and limit the impact of a market logic.
In contrast, in Chapters 7 and 8, I find a range of valuation instruments present across different fields within the broader movement of caring capitalism, with contrasting implications for what gets to count as social value. To explain these differing outcomes in terms of the measure and so meaning of social value across these varying fields of caring capitalism is the task of this next chapter and the next. As I will show in Chapter 7, in some versions of this newer, purportedly kinder global economy, companies are judged for their social worth in and of itself and distinct from their financial performance. In another version of caring capitalism, as discussed in this chapter, the emerging measuring devices assign a dollar figure to companies’ societal contributions and gauge firms’ efforts based on the generation of shareholder return, with critical consequences for the meaning of social value.
Drawing from literature in economic sociology on the formation of markets, I show that the construction of measuring devices in the case of Responsible Investment (RI) served to address the “problem of value” for potential investors, in order to justify this new form of investment to key audiences. And, even here, the “marketization” of compassionate companies’ social worth by reference to their economic value has been neither automatic nor compulsory. Instead, facing resistance from the intended audience of mainstream investors who viewed social value and economic value as oppositional (and hence embodied social scientists’ “hostile worlds” perspective), value entrepreneurs in the field have had to exert sustained effort to deploy market indicators in order to assess firms’ social performance in ways deemed legitimate to those key stakeholders. Importantly, the consequence has been that of a marked disjuncture between what counts as social value in the envisioned social project at the core of RI and what counts in that field’s prevailing measuring devices.
The rise of caring capitalism
To understand the turn to compassionate companies as a new type of social purpose organization requires attention to broader changes in the global economy. To begin with, the occurrence of the financial crisis in 2007 through 2008 resulted in a systematic and sustained reconsideration – by not only long-standing critics (such as the proponents of SRI and CSR) but also by some champions of a neoliberal agenda – of the guiding principles of business’ responsibility to shareholders and to society. Through the 1980s and 1990s, shareholder capitalism had dominated the global economy, replacing the logic of managerial capitalism that had guided business’ social and economic activities in the US since the Second World War, as outlined in Chapter 4. Shareholder capitalism has been defined as a principle of corporate governance that privileges firms’ pursuit of short-term financial return to shareholders, as part of the broader financialization of the global economy. Shareholder capitalism originated in the declining economic performance of American firms facing international competition in the 1970s (Davis Reference 238Davis2009; Mizruchi Reference Mizruchi2013). It was further driven by the rise of the institutional investor and the creation of stock-based compensation for managers as a means to solve the principal-agency problem for shareholders, where stock price was employed as the measure of corporate performance (Jensen and Meckling Reference Jensen and Meckling1976). Managers could drive up the market value of a stock’s price by cutting labor costs and selling off physical assets. Business’ adoption of the shareholder value ideology both contributed to and was reinforced by the discourse and practices of neoliberalism. The dominance of shareholder capitalism possessed critical implications for firms’ understanding of their social responsibility. Proponents of shareholder capitalism have viewed the only responsibility of a firm as being profit maximization for its shareholders and corporations’ societal obligations as ending with its economic, technical, and legal responsibilities (Davis Reference 238Davis2009).1 Corporations, in this view, should externalize the social and environmental costs of their activities to government and the larger society, often in the name of the benefits of shareholders and at the expense of stakeholders. The economist, Milton Friedman, famously articulated this perspective in a 1970 article in Time magazine, stating “the social responsibility of business is to increase its profits.”
However, the market crash in 2001 and the global financial crisis of 2008, along with long-standing critiques of growing inequality in the global economy, led to a fundamental reexamination of the legitimacy of shareholder value as the orienting principle of the global economy (Davis Reference 238Davis2009; Krippner Reference Krippner2011). Several institutional actors, including finance professionals, government agencies, multilateral organizations, and civil society actors, have offered up solutions to correct the perceived flaws of shareholder capitalism (Martin Reference Martin2011; Stout Reference Stout2012). These efforts to correct the premises of global capitalism have taken three main forms. First, there has been a call for and move to increased government regulation over the economy (Financial Crisis Inquiry Commission 2011). Others have sought to implement increased shareholder control over firms through attention to their governance practices (Gourevitch and Shinn Reference Gourevitch and Shinn2005). Finally, a third group has offered up an assortment of new and improvized versions of the free market that allow actors, including investors and firms, to voluntarily work to correct for the errors implicit to a neoliberal, shareholder-centered configuration of the global economy.
I group this last assortment of strategies under the broad umbrella of caring capitalism, or what also has been called creative capitalism (Gates Reference Gates2008), conscious capitalism (Mackey Reference Mackey and Sisodia2013), and inclusive capitalism (Hart Reference Hart2005). Caring capitalism consists of the explicit and concerted efforts of a cluster of advocates, whom I call “market enthusiasts,” to promote a new imagined vision of business in which the pursuit of mission and money are viewed as mutually constitutive so as to produce a more just and sustainable global economy. To do so, proponents have developed a range of vehicles by which principal and principle can be achieved in the private sector. Their goal has been to encourage investors and firms, including both multinational corporations and local companies, to implement one or more of these models as a means to resuscitate the global financial economy. Theoretically, caring capitalism constitutes another case of private regulation, as discussed in Chapters 4 and 5, whereby market actors voluntarily work to engage in market-based social change without the necessity of additional government oversight and intervention.
Caring capitalism perhaps has been most prominent in a new envisioning of the long-standing goal of poverty reduction in the project of international development. Poverty, in this view, is caused by individuals’ lack of access to the free market. This new model of international development, often called “inclusive development,” prioritizes the role of the private sector in poverty alleviation, based in part on companies’ capacity for scale and self-sufficiency, and de-prioritizes the historically dominant efforts of the public and nonprofit sectors to address poverty and other social problems. In all, the shared assumption of caring capitalism is that firms will pursue the same set of social goods as government and NGOs, just in a more effective and efficient manner (Stiglitz Reference Stiglitz1989; World Bank 1991, 2001; Department for Industrial Development 2006; Commission on Growth and Development 2008).
Caring capitalism takes a variety of investment and business forms, each premised on a faith that market actors can do well at doing good, as discussed in Chapter 1. Multinational corporations, for example, can produce social and economic value at one and the same time in several ways. They can pursue a double bottom line through the optimal organization of their production processes (via their just treatment of stakeholders, including employees, local communities, and supply chains) (Hebb Reference Hebb2012). Other MNCs pursue principal and principle by selling socially beneficial products to low-income consumers (those at the “Bottom of the Pyramid”) in new ways that still produce profit (Prahalad Reference Prahalad2004). And, in the developing world, local companies, often called “small and medium enterprises” or SMEs, facilitate social welfare in their community by expanding individuals’ access to the economy as employees, entrepreneurs, and suppliers (Ferranti and Ody Reference Ferranti and Ody2007). Finally, microfinance is a much-heralded strategy for providing financial services to individuals who previously have been unable to acquire the capital necessary to start or grow a small business from traditional banking institutions (Yunus Reference Yunus1999). In all of these cases, for-profit actors and entities in the private sector are heralded as possessing new and optimal means to make money while also making the world a better place.
The case of RI
This chapter focuses on the field of RI – a new and emerging view of financial capital that sees firms’ performance on environmental, social, and governance issues (what is often called “ESG”) as one critical source of shareholder value. In its formulation of the social obligations of business, proponents ground RI in the tenets of Corporate Social Responsibility (CSR), but now seek to make the business case for CSR and to create a new financial market around it. To do so, proponents of RI, including the United Nations, governments, consultants, and large finance institutions, have worked to integrate the use of ESG data into mainstream investment (United Nations Global Compact 2004; World Economic Forum 2005; International Finance Corporation 2012). However, the challenge for proponents of growing RI as a market has been that it challenges the traditional premises of stock valuation in the stock market. Typically, only financial data is employed by stock analysts to assess the worth of a company and corporations’ attention to society and the environment is perceived to violate a firm’s financial duty to shareholders. In result, many members of the mainstream investing community have responded to the concept of RI with skepticism and resistance. How then have proponents of RI sought to make the business case – to demonstrate the positive bottom line of firms’ non-financial ESG performance – for this new version of investing? How have they worked to create a market of RI? And what are the implications of RI for how social value is defined and assessed as a case of caring capitalism, compared to the pursuit of social value by social purpose organizations in other fields both in and out of the market?
Literature in economic sociology on the construction of markets provides one useful perspective for addressing these questions. An economic market is typically understood as a setting or field in which the repeated economic exchange of a commodity (a specific good or service) between buyers and sellers (either consumers or other businesses) takes place (Fligstein Reference Fligstein2001). The traditional view, typically found in neo-classical economics, is that the formation of a market is the natural and inevitable result of individuals’ desire to trade a particular good. Markets are self-regulating entities that arise spontaneously out of individuals’ rational pursuit of self-interest as buyers or sellers. As most famously espoused by Adam Smith (1776), the market is governed by a mechanism that ensures that the price of a good reflects the balance of demand and supply.
In contrast, economic sociologists emphasize that markets are socially constructed and require sustained effort by multiple actors, including suppliers, competitors, customers, government, and civil society actors, in order to emerge and to operate (Fligstein Reference Fligstein2001; White Reference White2002). For a market’s participant, it must make sense to buy and sell those objects rather than exchange them in other settings (such as the domestic sphere, the government, or the nonprofit sector) using an alternative basis of exchange, such as reciprocity or redistribution (Polanyi Reference Polanyi, Polanyi, Arensberg and Pearson1957). A successful market must be constructed “cognitively, structurally, and legally” (Levin Reference 250Levin2008:119) in order for the successful exchange of goods to occur (Abolafia Reference Abolafia1996; Carruthers and Stinchcombe Reference Carruthers and Stinchcombe1999). In this framework, a market is viable only when the objects to be exchanged are legitimately viewed as commodities, in that they can be assigned a price and that they are understood to produce profit for the company and value for the consumer. Actors in a market must be able to determine the economic value of competing commodities in order to make a judgment of worth, compare alternatives, and make a purchase or investment with an expectation of economic gain or competitive advantage (Callon Reference Callon1998; Espeland and Stevens Reference Espeland and Stevens1998). Among issues of coordination, this “value problem” (Beckert Reference Beckert2009) in a market can be resolved not only by the subjective estimations of market members, but also by the construction of institutions, conventions, and devices that can calculate the worth of goods for the market as a whole and its members (Callon Reference Callon1998; Callon and Muniesa Reference Callon and Muniesa2005; Karpik Reference Karpik2010). 2
The implication of this latter view is that the construction of a market around a good or service is not automatic. Further, the conversion of an object into a commodity is relatively straightforward in some cases but in other cases is more complicated and even unfeasible in yet others. Often goods that are considered “sacred” or “intimate” in society (items such as blood, eggs, cadavers, and organs) face the greatest challenge in being classified as a commodities that should be bought and sold for money (Anteby Reference Anteby2010; Almeling Reference Almeling2011; Chan Reference Chan2012). The move of a good from other societal spheres to the market is often fraught and requires thoughtful and concerned effort on the part of that new market’s proponents. How, for example, have advocates of the new global market of gestational surrogacy attempted to frame the sale of women’s reproductive capacities in ways that limit ethical concerns? (Spar Reference Spar2013) In such industries with “contested” goods (Radin Reference Radin2001), proponents struggle to create legitimacy and the necessary infrastructure for the market exchange of that good, sometimes meeting with mixed success (Levin Reference 250Levin2008; Turco Reference Turco2012).
How can this literature on the social construction of markets help us to understand how advocates of Responsible Investment sought to construct this new field? As we will see, the success of this new market, while still unfolding, has been dependent on the sustained efforts by proponents of the social project of RI to convince others that it is a legitimate form of financial investment. Here, contrary to the predictions of the “hostile worlds” perspective, resistance to the formation of this market came not from those actors committed to the moral value of firms’ treatment of stakeholders, but instead from mainstream investors committed to the traditional criteria and methods of stock valuation as a means to make money. To build a market of RI, value entrepreneurs worked to develop the appropriate measuring devices necessary to solve the “value problem” as an analytical case of justification as a communicative purpose, as outlined in Chapter 3. They sought to demonstrate the capacity of a firm’s ESG performance to generate shareholder value through the monetization of that array of a corporation’s non-financial characteristics. To construct suitable tools, proponents of RI drew from their expertise in traditional capital markets in order to extend and modify mainstream investing’s existing measurement devices to this new market. But, the consequence has been that what counts as social value has become restricted by the conventions and devices present in the broader quest for shareholder value in a finance economy.
Defining RI
Emerging in the early 2000s, RI, also called Sustainable Investment (World Economic Forum 2011), is a view of investing that incorporates a concern for firms’ ESG performance, alongside their financial performance, into the estimation of a stock’s value. ESG is an acronym for “Environmental Social Governance” and draws attention to how corporations negotiate their environmental impact, how they manage their social relationships with employees, suppliers, customers, and local communities, and the policies in place by which they are governed (United Nations Global Compact 2004; World Economic Forum 2005; Eccles and Vivier Reference Eccles and Viviers2011).3 Like SRI and CSR, RI consists of a set of expectations of good corporate behavior that extends beyond the traditional measure of financial performance to include additional policies and practices, including a concern for firms’ production of social value.
However, RI is distinct from CSR in two ways. First, RI draws attention to a different cluster of firm characteristics than CSR. While drawing from CSR’s long-standing concern for a firm’s environmental and social negative impacts, the concept of ESG also incorporates the concept of “corporate governance” (Paine et al. Reference Paine, Deshpandé, Margolis and Bettcher2005). Corporate governance concerns the procedures and processes according to which an organization is directed and controlled. It typically is focused on ensuring appropriate guidelines are in place to govern the behavior of a company’s board of directors, including its prescribed activities, composition, and compensation. This focused concern for corporate governance in the global economy emerged in the 1990s. It is traced to the growth of shareholder control of corporations, the rise of agency theory (which assumes a disjuncture between the interests of firms’ shareholders and managers), as well as an effort to implement corporate accountability following the notorious collapses of Enron and Worldcom (O’Sullivan Reference O’Sullivan2001; Gourevitch and Shinn Reference Gourevitch and Shinn2005).4
Secondly, RI’s attention to ESG represents a departure from CSR in that it is based on mainstream investors’ expectations of economic return, rather than on the normative concerns of market monitors as was the case with CSR, as outlined in the last chapter. With RI, proponents have offered a new justification for attention to a firm’s performance on ESG factors. As shown in Figure 6.1, ESG criteria are salient for financial, rather than moral, reasons (Kinder Reference Kinder2005; Hebb Reference Hebb2012). RI is about “value not values,” to quote from one senior executive that I spoke with at a mainstream investing firm who worked in its RI office. In RI, this attention to ESG issues is justified in the belief that firms that incorporate a concern for those non-financial matters will not only produce social value but also will have better, long-term financial results than their peers whom they outperform on these dimensions (United Nations Global Compact 2004; World Economic Forum 2005). As the United Nations, an early proponent of RI, asserted: “From asset managers, pension trustees and stock exchanges to project leaders and insurers, the investment community increasingly connects – ESG – performance to long-term viability and financial performance” (UN Global Compact Office 2007:12). One proponent of RI explained that firms’ ESG performance is “about risk management, not morality. Thus what ‘ought to be’ is not considered relevant.”5
Figure 6.1 Social and financial value in Responsible Investing
This economic rationale for attention to ESG performance draws from the fundamental assumptions of finance theory but alters it in key ways. One central premise of finance theory is that the valuation of a firm’s stock is based on its future price, in order for an investor to acquire profit by a stock’s price movement. Profit is earned by buying firms priced at less than their actual value and losses are avoided by selling stocks that are over-priced relative to their actual value. As I discussed in Chapter 4, to estimate the intrinsic value of a stock, analysts engage in “fundamental analysis” by examining a firm’s characteristics to determine its total discounted cash flows in the future. Historically, this estimation of a stock’s intrinsic value has been based on financial considerations, employing economic information about a company presented in various firm publications, including financial statements and annual reports. Typically, investors and analysts examine key characteristics including revenue, expenses, liabilities, and assets, among others, which they insert into well-established financial equations (such as a price to earnings ratio) to determine a stock’s intrinsic value. This quantitative data on a firm is then synthesized with further research on the industry, as well as a more in-depth analysis of the corporation itself. Research analysts draw from this mix of information in order to determine a stock’s intrinsic value and, in result, if the stock is underpriced or overpriced relative to its current value in the stock market (Graham Reference Graham2006).
Extending this perspective, proponents of RI argue that the incorporation of data on a firm’s ESG performance alongside financial data provides a more accurate picture of a stock’s intrinsic value and thus its potential for long-term financial return (Bassen and Kovacs Reference Bassen and Kovács2008). In contrast to the assumption of the efficient market hypothesis (that the price of a stock reflects all relevant information), the supposition of this valuation method is that analysts’ inclusion of ESG data in the valuation of a firm will create a better understanding of its future risk-adjusted return. In result, ESG performance, along with other “intangible assets,” is argued to be financially material. The integration of ESG data into the procedure of fundamental analysis should occur because it is understood to present financial risks and/or opportunities for a company in a complex, changing, and global economy. Risks consist of the costs incurred by a firm from an ESG issue, such as carbon emissions or the threat of a lawsuit, and opportunities include the creation of new markets, cost savings for firms, and brand enhancement with consumers and employees. Attention to a company’s ESG performance also matters because it is often perceived as a proxy for its quality of management. A firm that addresses its social and environmental impact, as well as possesses good governance practices, will also be more likely to produce shareholder value through its production and/or sale of its products. As one United Nations’ report (United Nations Environmental Programme Finance Initiative Asset Management Working Group 2006:8) concluded, “Well-managed companies generally do not abuse the planet, or unfairly exploit their workers, their suppliers, or their communities.” Finally, RI alters the premises of finance theory by changing the temporal orientation of shareholder return. Typically, financial analysis is attuned to a stock’s production of short-term value. It is expected that shareholders seek to acquire an immediate return on their investment. In contrast, the incorporation of ESG data into the estimation of a stock’s intrinsic value is understood only to create long-term future profit for the investor, given the nature of the risks and opportunities represented by a firm’s ESG performance (United Nations Global Compact 2004; Hebb Reference Hebb2012).
The origins of RI
The origins of RI can be traced to concerted efforts by an assortment of proponents, each with a distinct motivation for encouraging the growth of the field. The first set of RI advocates consisted of multilateral organizations that sought to respond to the global financial crashes of 2001 and again in 2007–2008 (World Economic Forum 2005). As discussed earlier, multiple solutions were proposed to prevent a recurrence of the financial crisis, including increased government intervention and regulation, greater shareholder control over firms’ governance practices, and caring capitalism as an effort to construct a more just and sustainable global economy.
As one strand of caring capitalism, RI attributes the financial crisis to mistakes in mainstream investing, particularly an over-emphasis on short-term financial return and the misspecification of stocks’ fundamental value. An assortment of actors, including multilateral organizations, governments, and civil society actors, have called for a reconfiguration of the finance market towards long-term shareholder value, and the integration of corporations’ social and environmental impacts into stock analysis, either through private efforts or government regulation, along with a greater emphasis on governance issues (Aspen Institute 2009; Stout Reference Stout2012).6 RI has been promoted as a means to a more durable and justifiable capital market. RI constitutes a private, non-governmental effort by market enthusiasts to institutionalize a new form of investment that recognizes and rewards corporations that produce goods in a socially and environmentally responsible manner while generating long-term economic return.
The embrace of RI by these actors also has been supported by other changes in the global economy. The growth of knowledge-based industries has increased the perceived importance of “intangible assets” such as intellectual capital, alongside the traditional emphasis on “tangible assets” such as physical and financial assets (Bassen and Kovacs Reference Bassen and Kovács2008; International Integrated Reporting Committee 2011). In addition, as was the case with the earlier sustainability movement, the growing awareness of corporations’ impact on the environment, and their economic repercussions for the firms’ bottom line, has been critical to the growth of RI. Globally, companies were increasingly forced to consider the effect of their carbon emissions given consumer pressure and recent regulatory requirements in the United States and elsewhere (UNEP FI 2004; United States Securities and Exchange Commission 2012).7
In response, several global actors have sought to grow the market for RI, motivated by both political and economic interests. Most importantly, the United Nations, drawing from its earlier sustainability initiatives, became a proponent of this new strategy of investment as a means of private regulation of the capital market. Investors would serve as the vehicle of corporate governance (Ho Reference 246Ho2010). In 2005, ex-UN president Kofi Annan, launched the United Nations Principles for Responsible Investment (now called the “Principles for Responsible Investment” or PRI). The PRI is an investor-led collaboration, in partnership with the UN Environment Programme Finance Initiative (UNEPFI) and the UN Global Compact, to encourage institutional investors to incorporate ESG principles into their investment analysis and decision-making and to encourage the growth of the field (PRI 2014).8
To facilitate the formation of a market of RI, the UNEP FI, along with other advocates, sought to demonstrate the economic viability of RI. First, advocates published a series of papers that demonstrated either a neutral or positive relationship between firms’ ESG performance and their rate of shareholder return (United Nations Environmental Programme Finance Initiative Asset Management Working Group 2004, 2006; Sustainability Asset Management 2008). This effort to demonstrate the financial, rather than solely the normative, value of ESG was also based on a line of academic research demonstrating the positive effects of SRI and CSR performance for firms’ financial performance, as discussed in the last two chapters (Waddock and Graves Reference Sandra and Graves1997; Margolis and Walsh Reference Margolis and Walsh2003; Capelle-Blancard and Monjon Reference Capelle‐Blancard and Monjon2012).
Secondly, the UNEPFI co-sponsored an influential publication on the implications of RI for the enactment of fiduciary duty (UNEPFI and Freshfields Bruckhaus Deringer 2005). Under US law, a fiduciary is any actor who is delegated (usually in the role of a trustee or a money manager) to manage resources for another – they are legally obligated to manage those goods in the others’ best financial interests via the exercise of due care and prudence. Many critics had long expressed concern that investments based on non-financial considerations (such as Socially Responsible Investing and CSR) would violate the fiduciary duty of institutional investors by having a negative effect on the generation of financial return (see, e.g., Langbein and Posner Reference Langbein and Posner1980). Yet, based on a review of academic and practitioner research showing the positive financial benefit of firm’s ESG performance, the UN’s commissioned report asserted that fiduciaries’ duty necessitated inclusion of ESG issues in their management decisions.
In addition, a small but growing number of investors and financial intermediaries were engaging in RI – using ESG data and financial data together in their evaluations of firms and estimates of a stock’s value (Tullis Reference Tullis2011). Some of these actors, like Pax World Investments, were motivated not only by economic interest but also by an ongoing political concern for corporations’ non-financial performance. They have extended their original involvement in the fields of SRI and then CSR to now espouse RI for both normative and material reasons (Wood and Hoff Reference Wood and Hoff2007; Social Investment Forum 2010). As first noted in Chapter 4, leaders of the United Methodist Church formed Pax World in 1971 as a mutual fund with an anti-war mission. Today, however, Pax World Investments offers a notably distinct, albeit related, set of financial services to investors by “fully integrating ESG factors into investment analysis and decision making” (Pax World Investments 2014).
Other long-term participants in the move to include non-financial criteria in the capital market were institutional investors with an extended engagement with socially responsible investment. CalPERS (the California Public Employees’ Retirement System) – one of the nation’s largest and earliest socially responsible institutional investors – decided in 2008 to alter its investment strategy, shifting from the guidelines of Socially Responsible Investment to employing ESG criteria (Eccles and Sesia Reference Eccles and Sesia2009). Yet other advocates of RI were members of the mainstream investment industry who now were taking up the criteria of ESG, seeing this form of investment as a potentially new source of revenue through the offering of new products to new customers (Cui Reference Cui2007). Several large investment firms, including Goldman Sachs, UBS, Merrill Lynch, and Credit Suisse, have created divisions that focus on RI (Tullis Reference Tullis2011). Their work has been facilitated by the growing provision of ESG data to investors and investment advisors by large data providers and research firms, including Thomson Reuters, Sustain Analytics, Bloomberg, and MSCI. To do so, these research and ratings agencies often bought out ESG-only analysts, such as MSCI’s purchase of KLD (an organization that began with the production of SRI and then CSR ratings, as detailed in Chapter 4) (Bendel Reference Bendel2011). Similarly, to tap into this new market, stock market indices that use ESG criteria have appeared, including the Thomson Reuters Corporate Responsibility Indices, FTSE4GOOD, and the Dow Jones Sustainability Index (FTSE 2011; Sustainable Asset Management 2012; Thomson Reuters Reference Thomson2014). By 2013, over 1200 organizations, including asset owners, investment managers, and professional service partners, had signed on to the United Nation’s Principles for Responsible Investment, which asks investors to pledge to integrate ESG criteria into their stock market decisions (PRI 2013).9
Valuing the social in RI
Despite this embrace of RI by multilateral organizations and some actors in the capital market, many mainstream institutional investors and asset managers, particularly in the United States, have not readily taken to the inclusion of ESG as a new principle to guide financial investment. Notably, of the twenty-one American asset owners who have signed the United Nations’ Principles for Responsible Investment, the vast majority consists of pension funds and nonprofit organizations (which invest their endowments according to the PRI guidelines), with the one exception being the International Finance Corporation, a quasi-governmental organization affiliated with the World Bank (PRI 2013). Similarly, despite the growth of actors embracing RI, it was estimated that only seven percent of all assets under management involved ESG criteria in 2010 (PRI 2011).10 And a 2012 study found that only a quarter of top investment consulting firms (advising more than 95% of the assets held by all institutional investors) incorporated a concern for ESG into their analysis and recommendations (Ceres 2012).
In one interview that I conducted, a senior executive at a relatively new institutional equity manager that employs ESG data recounted his experience in trying to find clients. He explained:
I initially approached institutional investors who were signatories of the Principles for Responsible Investment, basically saying to them that you need me because I’m going to provide you with an opportunity to do what you say you want to do. No success with that, absolutely none. So, now instead I use our track record – the fact that we have had a higher return rate than traditional comparison benchmarks. They listen to that; it’s the oldest saying in the world but it’s true – money talks. ESG has to be a means to make money for [this market] to take off.
Thus, despite a growing proclamation of interest in RI, many mainstream financial intermediaries and investors were not convinced of the merits of this new market. Drawing from interviews with respondents in this field and reports by proponents of the field, advocates attributed this skepticism to multiple causes. Many remained committed to the premises of the efficient market hypothesis, where the price of a stock reflects its fair value, and so they argued that if ESG factors were indeed material, they would already be integrated into the price of a stock. Others saw a company’s concern for ESG issues as generating additional costs not born by industry competitors, hence limiting their economic performance. Another group understood the financial merit of the consideration of these “intangibles” but was not sure how to integrate ESG data into their decision-making. Finally, some analysts did not trust the quality of ESG data currently made available by firms, claiming it lacked rigor and commensurability compared to data on financial characteristics (World Economic Forum 2011; Commonfund Institute 2013).
To promote the growth of RI, advocates of this new financial market sought to address these sources of resistance by creating new valuation instruments. These valuation entrepreneurs consist of two distinct groups: those actors who work to promote RI’s use by others in the field and those actors who sell financial products based on ESG integration. The first group consisted of the PRI (initially sponsored by the United Nations), the World Business Council for Sustainable Development (a coalition of multinational corporations interested in CSR issues), and Business for Social Responsibility (a membership-based business association for socially responsible businesses), among others. The latter group consists of a small but growing assortment of financial information providers – either “sell-side” members of the finance industry (those who create and advise on the sale of stock products to those who advise or buy investment services) or in-house analysts for buy-side actors, such as asset managers, who seek to promote the use of ESG data (World Economic Forum 2011). Many were early adopters of Responsible Investment, including the ESG/RI offices of mainstream investment firms (including Goldman Sachs, UBS, Merrill Lynch, and Credit Suisse), established data providers and research firms that expanded to include RI services (including Thomson Reuters Asset4, MSCI ESG Research, and Bloomberg), accounting professionals (such as the AICPA’s Enhanced Business Reporting Consortium), and new sustainability stock market indices (such as the Dow Jones Sustainability Index).
The task of these advocates of RI has been to facilitate the incorporation of ESG data into mainstream investing. The ultimate goal has been to encourage those analysts and investors who currently employ only financial data to determine a stock’s value to also employ ESG data. In this project of promoting RI, the task of valuation is critical and is two-fold (Enhanced Analytics Initiative 2008; Ho Reference 246Ho2010). First, proponents have sought to make the business case for this type of investing. Showing that the use of ESG data is “just good business” (to quote from one respondent) involves the pragmatic challenge of creating measurement devices that could determine and demonstrate the shareholder value of companies’ ESG performance to date, at the firm level or the industry level. As one major organizational proponent of RI, Business for Social Responsibility (2008:3), observed in a report on the state of mainstream investing, “investors are waiting for vetted proof of long-term materiality before fully incorporating the criteria.”
Secondly, these advocates of RI have worked to have ESG data included in the task of fundamental analysis itself (what is called “integrated analysis”). Recall from Chapter 4 that stock valuation has traditionally relied on only financial information about a company to estimate the intrinsic value of a stock. The goal now is to render firms’ ESG performance “calculable for profit” – to be able to assign a monetary worth to those salient policies and practices in terms of a stock’s intrinsic value (Amaeshi Reference Amaeshi2010). The problem of RI, as communicated to me by one long-time proponent, is that investors and analysts “often feel and tell us that ‘we don’t know how to use sustainability information because it doesn’t fit into our models.” Value entrepreneurs have worked to create the measurement devices needed for participants to be able to estimate the value of an individual stock using both financial and non-financial criteria. As with any other market, as outlined above, the challenge of RI was to solve the value problem, thus allowing for commensurability – the ability of market members to determine the value of different products using ESG data and to compare them for the purpose of investment. To do so, as outlined later, they have transposed conventions and devices taken from their valuation repertoire, as made possible by their professional backgrounds in the finance industry, based on an explicit belief that mainstream investors would be most likely to adopt this new method of stock valuation if they could use familiar and accepted conventions and devices to do so.
Measuring the social in ESG
These value entrepreneurs have worked to address these two challenges of valuation for the market of RI through three distinct strategies: the use of ESG ratings, the development of “integrated reporting,” and the monetization of ESG data via fundamental financial analysis, with consequences for the meaning of social value. Most importantly, the ensuing definition of the “social” in the field’s measuring devices looks markedly narrower than that espoused in the field’s social project, as driven by the mimicry of the conventions of the finance industry and as structured by the assignment of monetary value and the employment of the criteria of shareholder return to the gauge of firms’ social performance.
ESG ratings and materiality
When proponents of RI sought to establish and grow the field, one of their first tasks was to generate the ratings of stocks that incorporated ESG data. In the case of RI, ESG ratings were produced by a number of value entrepreneurs in this field, including the RI/ESG offices of mainstream investment firms (including Goldman Sachs, UBS, Merrill Lynch, and Credit Suisse), established data providers and research firms that include ESG services (including EIRIS, Thomson Reuters Asset4, MSCI ESG Research, and Bloomberg), and the key sustainability/ESG stock market indices (FTSE4GOOD and the Dow Jones Sustainability Index).11 For these value entrepreneurs, firms’ ESG ratings served two purposes: they facilitated investors’ use of ESG data in their selection of stocks and ratings could demonstrate the positive financial impact of firms’ ESG performance for the generation of shareholder return.
As detailed in Chapter 4, the use of stock ratings to evaluate firm’s non-financial performance certainly was not new. In the case of Socially Responsible Investing, value entrepreneurs’ generation of ratings was a central tactic to the growth of the field. Firms were rated based on their financial performance and on a negative screening in terms of their products, place, and policies, as contingent upon a subjective understanding of social good. With the growth of CSR in the 1990s, both SRI activists and mainstream investment actors also began to offer ratings of firms based on their sustainability performance for interested investors. These actors, such as KLD and Innovest, gathered data via surveys or by examining company reports in order to assess a firm’s CSR performance. A firm’s commitment to each dimension of CSR was counted by the presence of a specific policy (e.g., whether a corporation has a policy guaranteeing employees the freedom of association) and/or by a count of a firm’s outputs (e.g., a tally of a company’s average annual employee training hours) (Bendel Reference Bendel2011).12 These analysts either rated companies based on an aggregate CSR score or ranked them as “best-in-class” in their industry. As with the case of Socially Responsible Investing, CSR ratings included an initial screen based on a firms’ financial performance. The goal for these information intermediaries was for morally oriented investors to use the CSR rating to make their investment decisions (Eccles and Vivier Reference Eccles and Viviers2011).
With the growth of RI, however, the worth of firms’ ratings became re-framed by actors in the finance industry around the financial goals of mainstream investors whose primary focus was on the production of economic return (albeit only for those investors with a long-term value orientation). In consequence, the content and methods of the ESG ratings produced by financial information providers then departed from those prior SRI and CSR ratings. Not only was an attention to CSR criteria replaced by a concern for ESG criteria, but and perhaps more importantly, the selection of the relevant ESG factors for inclusion in firms’ ratings was based on a financial, rather than a normative, criterion.
Historically, fields with social purpose organizations – including nonprofits, social enterprises, SRI, and CSR – have based the institutionalized definition of social value on actors’ own beliefs about the nature of social value. What counts, at least as articulated as the guiding premise of each field, is determined by what proponents (as articulated in the field’s social project) believe is normatively required to address social inequities. In the case of SRI, for example, proponents emphasized the extra-regulatory obligations of US corporations regarding their products, their place of production, and their policies. The field of CSR was premised on the private regulation of multinational corporations in terms of the social and environmental implications of the production processes of their supply chains in developing nations. In contrast, with RI, the determination of what counted as the “social” for a company in the generation of ESG ratings looked quite different. Here, claims about the normative nature of social good were indeed made by ESG advocates, largely as extended from the field of CSR. But, they were then filtered through the additional criterion of their financial value – a consideration of their “materiality” (Eccles et al. Reference Eccles and Viviers2011). Taken from the concept of financial materiality in accounting, materiality technically refers to the “magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement” (Financial Accounting Standards Board 1980:132). In mainstream investing, the analysis of a corporation’s financial performance requires the reporting of only those issues that would be deemed salient or “material” for a mainstream investor, who is concerned only with the pursuit of shareholder return, to make an informed decision about a firm.
When applied to the estimation of a firm’s ESG performance, financial materiality required the evaluation of ESG issues in terms of their relevance for a firm’s creation of long-term business value for shareholders (Kinder Reference Kinder2005). For instance, Business for Social Responsibility (2010:1), a membership association and consulting firm for socially responsible businesses, defines materiality as “rather than trying to address every sustainability risk and potential opportunity, leading companies focus their reports on areas that deliver the greatest value to their business and to their most important stakeholders.” The “materiality test” included such issues as financial impact/risks, legal/regulatory/policy drivers, peer-based norms, stakeholder concerns and societal trends, and opportunity for innovation (Lydenburg, Rogers, and Wood Reference Lydenberg, Rogers and Wood2010).
In this procedure, a financial intermediary who engages in the evaluation of a firm’s ESG performance, including actors like MSCI, GS Sustain, Robeco and SAM, would begin by identifying the universe of potential ESG issues. In regard to the meaning of the Social in ESG, the list of possible indicators was markedly similar to conception of the social found in CSR’s normatively guided emphasis on the impact of a firm’s production processes on stakeholders. With some exceptions, the social here incorporated corporations’ treatment of employees (the issues of fair compensation, health and safety, diversity, and human rights), the composition of their supply chain (extending the rights of employees to those of their suppliers), and engagement with the local community (community investment and business ethics).13 This marked overlap of the definition of social value for RI and CSR resulted from the historical trajectory of the ESG industry – its emergence out of CSR and the codification of CSR’s notion of firms’ social responsibility in the UN’s Global Compact and the Global Reporting Initiative – and the continued role of many of the same investment analysts and ratings agencies involved in both arenas, including KLD and Innovest. Yet, while the field of RI shared with CSR a definition of social good based on how goods are produced, its concern for financial materiality ultimately determined which social criteria (and, similarly, which environmental and governance criteria) actually got to be included in a firm’s ESG rating.
Most commonly, value entrepreneurs made decisions about the materiality of ESG issues based on the economic sector in which a company was located (United Nations Global Compact 2004; Eccles, Krzus, Rogers, and Serafeim Reference Eccles, Krzus, Rogers and Serafeim2012). The industry of the company mattered because it presented a distinct set of long-term challenges for those member corporations – a set of risks and opportunities that required attention to the relevant ESG indicators as signals of a company’s capacity to manage those sector-specific difficulties. The result was that the indicators used to measure a firm’s performance on each dimension varied by industry, as did the balance given to each of the three dimensions of ESG.14 In short, the determination of the “social” in ESG has become dependent in RI on which labor-related factors will increase shareholder value through limiting risks and increasing opportunities on a sector-by-sector basis.
In one instance, I spoke with the head of ESG investment for an international investment firm. I asked her how her company (and their analysts) decides on what counted as the “Social” in ESG. She replied in a way that emphasized the criteria of materiality as central to the process.
The S is sector specific and depends on the type of work being done in that industry. Take the case of how employers treat their employees. In service industries, we’re interested in what benefits a company offers to workers because then they can attract the best and the brightest, which we see as increasing a firm’s profit over the long run. In contrast, in sectors like manufacturing, we are interested in whether or not the company monitors the human rights of workers in their supply chain. And in the case of mining, we consider the rate of workplace accidents, which could lead to higher employee replacement costs and perhaps also more regulatory scrutiny by the local government or maybe even international NGOs. So in each case, or rather sector, it differs but it’s always all about whether or not the S provides either a risk or an opportunity for firms.
Similarly, take the case of GS Sustain, the long-term investment strategy of Goldman Sachs’ Global Investment Research division. First conducted in 2007, GS Sustain generates a focus list of companies by industry that are expected to provide superior, long-term economic return for shareholders, based on an integration of their financial performance, industry positioning, and ESG performance (what GS Sustain views as a proxy for management quality). Drawing from companies’ public reports, GS Sustain collects a large number of verified data points on each firm, which are combined into twenty to twenty-five ESG indicators, and companies are assigned a score for their performance on each indicator. While about two-thirds of indicators are universal, the remainder of the key indicators is selected based on the company’s industry location. In the pharmaceuticals industry, for example, the social performance of a firm counts for 58% of its total score, while it counts for just 48% in the food and beverages industry. And industries also vary in terms of which indicators of the social matter. In the case of sector of Global Energy, GS Sustain selects the social indicators of fatality rate, lost time injuries, total recordable injuries, and business ethics and human rights as relevant for that industry, from a longer list of possible social indicators (taken from the UN Global Compact) which also includes gender diversity, employee training and health management, and employee compensation, among others (GS Sustain Reference Sustain2009).
As these two examples show, the introduction of materiality into the valuation of firms’ ESG performance results in the inclusion of those ESG factors that have a theorized causal impact on a firm’s investment value, rather than selection based only on normative concerns about firms’ social responsibilities to society (Kinder Reference Kinder2005).15 For example, the World Intellectual Capital Initiative (2010:3), a public-private sector collaboration intended to generate a standard reporting framework for a firms non-financial performance, concluded that their proposed indicators of ESG “have different attributes from those indicators required by civil society to achieve its own objectives and purposes.” The implication of a concern for materiality in the field of ESG was that the meaning of the social was not driven by moral concerns or shared norms about corporations’ effects on society. Instead, the selection of salient social factors was selected from the broader list, as historically originating in moral concerns, but as dependent on the specific economic issues faced by a firm’s industry as they generated financial value for shareholders.
Integrated reporting and parsimony
A second strategy used by advocates of RI to grow this financial market has been to press for firms’ employment of “integrated reporting” – the incorporation of systematic ESG data into their traditional reporting of only financial data (Eccles and Krzus Reference Eccles and Krzus2010; Lydenberg, Rogers and Wood Reference Lydenberg, Rogers and Wood2010; International Integrated Reporting Committee 2011).16 Integrated reporting consists of a “more-comprehensive model that encompasses significant elements of traditional financial reporting and ESG reporting within a single presentation” (Deloitte 2011:3). It was meant to replace corporations’ use of stand-alone ESG or sustainability reports that exist alongside and distinct from their financial reporting.17 The purpose of integrated reporting was to make firms’ non-financial behavior as transparent as financial data but also to show the “interdependencies,” to quote from one respondent, between a firm’s ESG data and its financial performance for investors and analysts.
Integrated reporting entails a firm’s selection of which ESG issues are most germane to the creation of long-term shareholder value, the measurement of a firm’s performance on each issue, and – at least ideally – the demonstration of the financial value of the company’s performance on each ESG dimension.18 In 2012, as one example, Deutsche Bank published a report on the state of Responsible Investment. The authors concluded that corporations’ growing use of integrated reporting was facilitating the growth of the field. They described an integrated report as one in which “financial information is combined with non-financial information in such a way that shows their quantified impact on each other using established guidelines, standards and key performance indicators (KPI)” (Fulton, Kahn, and Sharples Reference Fulton, Kahn and Sharples2012:26).
A range of accounting bodies, ESG standard bearers, academics, and consultants have worked both to demonstrate the value of integrated reporting and to establish guidelines for integrated reporting as a suggested measuring device for investors. These include the International Integrated Reporting Council (formed in 2010 by the Global Reporting Initiative and Accounting for Sustainability), One Report, the Sustainability Accounting Standards Board (SASB), and the joint effort by the European Federation of Financial Analysts Societies and the Germany’s Society of Investment Professionals (DVFA 2008; Eccles and Krzuz Reference Eccles and Krzus2010; Lydenberg, Rogers, and Wood Reference Lydenberg, Rogers and Wood2010; International Integrated Reporting Committee 2011; Warren and Thomsen Reference Warren and Thomsen2012). Integrated reporting also has been promoted by a number of mainstream financial and accounting professionals including Deloitte, KPMG, PWC, and UBS (Deloitte 2011; Hudson, Jeaneau, and Zlotnicka Reference Hudson, Jeaneau and Zlotnicka2012; PWC 2013).
The rationale for developing integrating reporting was premised on a belief in investors’ growing interest in non-financial data (Eccles, Serafeim, and Krzus Reference Eccles, Serafeim and Krzus2011). Integrated reporting matters because it serves as a type of measuring device – it facilitates investors’ use of ESG data in their financial analysis by making both non-financial and financial data transparent, commensurable, and connected both within a firm and across firms. As one proponent has argued: “Companies, investors and governments are beginning to recognize that long-term sustainable performance relies on an understanding of the interdependency between financial, social and environmental factors. However, this recognition is far from main stream and action is needed to drive change such that sustainability becomes embedded in organizations’ strategy, operations and reporting” (Accountability for Sustainability 2013).
How does the growth of integrated reporting affect the meaning and measure of social value? Most importantly, the inclusion of non-financial data in integrated reporting must be governed by the principle of materiality and must be presented in a form comparable to how the equivalent financial data was presented in the report, often through the use of KPI. As with any effort to quantify the social world (Espeland and Stevens Reference Espeland and Stevens1998), the result has been a move to parsimony – a narrowing of the meaning of the “social” in ESG to only those dimensions that fit with the conventions of mainstream finance in both content and form, thus rendering invisible other dimensions.19 First, as with ESG ratings, integrated reporting results in a constriction of social value based on the principle of materiality. As before, materiality necessitates the inclusion of only those ESG issues in an integrated report that are critical for a firm’s production of shareholder value – they are deemed germane for an investment decision. As detailed in Chapter 6, the Global Reporting Initiative began in 1997 as a means to ensure comparability of corporate reporting on sustainability issues in the field of CSR. It has since become oriented around ESG issues and framed around the criteria of materiality, moving towards the endorsement of integrated reporting (Etzion and Ferraro Reference Etzion and Ferraro2010). In one recent report, the organization concluded that: “The emphasis on what is material encourages organizations to provide only information that is critical to their business and stakeholders. This means organizations and report users can concentrate on the sustainability impacts that matter, resulting in reports that are more strategic, more focused, more credible, and easier for stakeholders to navigate” (Global Reporting Initiative 2013).
Who decides what dimensions or indicators of the social count as material in integrated reporting? For some proponents of integrated reporting, a company must make its own decisions as to which ESG issues are financially material (International Integrated Reporting Committee 2011). For others who seek to generate universal standards, including the Global Reporting Initiative and the Sustainability Accounting Standards Board (2013), materiality typically was contingent upon the specification of a universal list of considerations as mediated by a firm’s industry, as was the case with many ESG ratings. In the case of the SASB, for instance, materiality was driven by: “(a) Financial disclosure (issues that may have a financial impact or may pose a risk to the industry in the short-, medium-, or long-term; (b) Legal drivers (Issues that are being shaped by emerging or evolving government policy and regulation; (c) Industry norms (Issues that companies in specific industries tend to report on and recognize as important drivers in their line of business); (d) Stakeholder concerns (Issues that are of high importance to stakeholders, including communities, NGOs and the general public, or reflect social and consumer trends, and which rise to the level of interest to investors when they have economic implications); and (e) Innovation opportunity (Competitive advantage created from potential innovative solutions that benefit the environment, customers, and other stakeholders)” (SASB 2013:15).
For proponents of integrated reporting, secondly, the inclusion of non-financial performance should be driven not only by the selection of materially pressing ESG issues but also by the standards of typical financial reporting. The goal of these advocates was to develop integrated reporting guidelines that would deliver ESG data to investment professionals in a familiar form, one that helps them to identify a stock’s fundamental value – to do so “data is quantified, comparable, and benchmarkable” (DVFA 2008:6). Here, some advocates of integrated reporting have proposed the use of KPIs, a long-standing component of financial reporting (Lydenberg, Rogers, and Wood Reference Lydenberg, Rogers and Wood2010; Eccles et al. Reference Eccles, Krzus, Rogers and Serafeim2012). In 2008, for example, the United States Securities and Exchange Commission published a report encouraging the development of a standardized list of KPIs for companies’ non-financial characteristics, so that investors could have a full understanding of corporate performance.
As a measuring device, KPI have been common in firms’ traditional reporting of financial performance. They consist of the identification of a short list of salient measures of a company’s status. Each resulting KPI is a numerical measure of how well a firm is performing relevant to a goal deemed critical for its success (Parmenter Reference Parmenter2011). In mainstream investing, KPIs provide companies and its shareholders with a set of clear, quantified, and quickly understandable metrics of performance that are considered indicators of economic success and so producers of shareholder value. Similarly, for advocates of integrated reporting, the goal has been to select KPIs that capture the critical material dimensions of ESG performance for each sector. Corporations are then expected to report their performance on these KPIs, to facilitate investors’ employment of this data in integrated analysis. “Unlike qualitative information, performance indicators, especially if reduced to key figures, have the advantage that given their numeric character they offer a fast, condensed overview of a business’s actual performance on extra-financial matters” (Bassen and Kovacs Reference Bassen and Kovács2008:186).
For some RI proponents, KPIs are encouraged for use by firms, and they should be tailored to each company’s situation (International Integrated Reporting Committee 2013). Take the case of an international communications services corporation that is considered to be at the forefront of integrated reporting in this field. At one conference on corporate sustainability that I attended, a senior CSR executive at the firm outlined the company’s reporting practices in the United States. The company had identified twelve KPIs as the core dimensions of its “non-financial” ESG performance. In an example of how the corporation was moving towards integrated reporting, a Powerpoint slide was posted overhead. For each ESG KPI listed on the slide, a quantified measure of the firm’s performance in that regard was listed alongside, followed by the source and dollar amount of each ESG KPI’s financial value, either in the form of costs or revenue for the corporation. For example, the company’s engagement to keeping employers healthy was measured as “number of sick days” and assigned a monetary value based on the company’s “sick pay costs.” As the speaker put up the slide, he provided a background on the company’s use of ESG KPIs in their annual report. He noted, “We use KPIs because we think they will help us to become a truly sustainable business – they tell us where we are and where we need to go. But I have to tell you that many investors don’t get it. And, as you all know, they are hard to convince. But it’s the best we can do.” At this point, there is general laughter (what strikes me as nervous laughter) from the other presenters on the panel and from the audience, all of who were proponents of RI. This anecdote makes clear that the use of KPIs to calculate the economic value of a firm’s ESG performance is sometimes only a precarious extension of corporations’ traditional use of financial data to convey this purported new source of shareholder value.
Alternatively, other proponents of integrated reporting have drawn from their valuation repertoire to generate standardized KPIs that vary not by firm but by sector (DVFA 2008; Global Reporting Initiative 2013; SASB 2013). It is here that the criterion of parsimony is particularly notable – an effort to identify KPIs based on the criterion of brevity. Take the case of the SASB, a nonprofit that seeks to hold a parallel function to the Financial Accounting Standards Board. It is working towards providing sector guidelines on materiality by sector, along with accompanying standardized performance metrics, which can then be used by corporations. In one recent report, the organization clearly specifies the basis for its selection of KPIs. “In developing such metrics, SASB will default to the minimum information that is still decision-useful (i.e., it presents a relative view of performance by which peers can be compared), rather than a complete accounting that may be necessary for public policy – or government target-settings” (SASB 2013:11). Similarly, the German Society of Investment Professionals’ (DVFA) and the European Federation of Financial Analysts Societies together produced a highly cited list of general and industry-specific KPIs. Their goal was to formulate a comprehensive list of “useable” ESG KPIs based on the criteria that they “should be manageable in dimension (‘Key’), e.g. small set of 30 KPIs max” (DVFA 2008:6). The result is that companies are required to disclose only 10 specified KPIs to capture ESG performance, contingent upon subsector (Garz, Schnella and Frank Reference Garz, Schnella and Frank2010).
In short, value entrepreneurs’ design and diffusion of integrated reporting has had critical implications for the meaning of social value in the field of Responsible Investment. For these proponents, integrated reporting was premised on a belief that the linking of firm’s non-financial and financial behavior in a single report would facilitate financial professionals’ use of integrated analysis. The result has been that what counts as social value (as one component of a firm’s ESG performance) is delimited not only by the criteria of financial materiality but then again narrowed down by the need to present that data in a format similar to the conveyance of financial data, using a parsimonious list of quantified performance indicators. The inclusion of KPIs in integrated reporting has a dual effect. It increases the likelihood that a mainstream investor will consider a firm’s social performance in the valuation of a stock. At the same time, the use of KPIs curtails the number of dimensions of social value that can be incorporated in that measuring device, in the estimation of a firm’s performance, and in terms of what counts as social value in the field of Responsible Investment.
Assigning financial value to firms’ ESG performance
Finally, the construction of a market for RI has entailed the construction of new types of measurement devices that assign a monetary value to firms’ ESG performance in relationship to its generation of shareholder return. Initially in this field, firms’ ratings held a dual purpose – they not only served as a judgment device for investors’ but proponents also employed them to demonstrate the long-term, financial value of firms’ ESG performance. A company’s ESG rating was intended to measure, alongside the traditional measure of their financial performance, one critical dimension of a company’s intangible performance for the purpose of investors. These “intangibles” include management’s ability to negotiate risks (e.g., carbon emissions cost or the threat of lawsuits) and/or to generate opportunities (brand enhancement, employee appeal) present in their environment. A better ESG performance was postulated to have beneficial consequences for the stock’s generation of long-term financial return through cost savings or improved revenue. Proponents of Responsible Investment supported these claims either by reference to relevant research findings that linked initial ESG ratings to a later rate of shareholder return or by showing the historical outperformance of a selection of top-ESG rated corporations compared to industry peers (UNEPFI 2007; Fulton, Kahn, and Sharples Reference Fulton, Kahn and Sharples2012).
The use of ratings as a means to demonstrate the long-term financial value of firms’ ESG performance, however, had its critics. The difficulty was that ESG ratings, as either a measure of firms’ ESG performance or as a signal of that behavior’s generation of long-term shareholder value, kept distinct the gauges of a stock’s non-financial and financial performance. Practically speaking, as with the case of GS Sustain previously, different groups of research analysts engage in the two assessments, employing two distinct sets of criteria. The financial and non-financial performance of a firm was then aggregated to produce a best-in-class ESG ranking of corporations by industry. In result, these ratings did not calculate the financial value of a firm’s ESG performance. For proponents of Responsible Investing, the use of ESG ratings to convey shareholder value then departed from the traditional estimation of a stock’s current value in mainstream investing, where all data is presented using the metric of money and as a measure of financial value.
This disjuncture between how value should be represented and how value was present in early ESG ratings was felt by some in the field to have impeded the incorporation of ESG data into stock analysis (PRI 2013a, 2013b). In result, some value entrepreneurs worked (and are still working) to create new measuring devices that incorporate a firm’s ESG performance into the process of fundamental equity valuation itself. The goal is to put a “price” on ESG activity. As outlined in Chapter 4, fundamental equity valuation examines the characteristics of a company, besides its trading history, that are considered germane to a determination of its stock’s intrinsic value. In the case of a firm’s equity valuation, analysts seek to determine the economic well-being of the firm by review of its financial statements. They employ a number of established financial formulas, including the discounted cash flow rate or the dividend discount model, which incorporate a firm’s income (calculated as the balance of revenue and expenses) to identify its future financial performance and to determine a stock’s intrinsic value.
Recall that the premise of RI is that a company with a strong ESG performance will provide a superior long-time financial return for a shareholder than a peer with a weaker ESG performance. The goal of these new and emerging measurement devices, part of what is sometimes called “integrated analysis” or “enhanced analysis,” is to identify the monetary value of a firm’s ESG performance following the lines of traditional fundamental analysis and to integrate that value into the calculation of one of those formulas that typically have governed the fundamental equity valuation of a firm (World Economic Forum 2011). At its most basic, integrated analysis requires ESG data to be monetized either as a source of revenue or as an expense to be incorporated into fundamental valuation. In one instance, I spoke with Sarah, a representative from a recently formed investment firm that touts its use of Responsible Investing. When I asked about how the company incorporates ESG into its estimation of a stock’s value, she responded:
First, our analysts determine what E, S, and G factors are relevant by sector. Then, they would look at an individual company and – relying both on data provided by the company to us and using other existing data out there as well – they try and determine the financial and non-financial performance of the company. To estimate the value of ESG performance, they also then ask the company to provide the monetary value of an indicator, which usually get estimated as cost savings or revenue generation.
One well-cited and relatively long-standing example of this incorporation of ESG data into fundamental equity valuation is RobecoSAM’s Equity Valuation Model. Formed in 1995, RobecoSAM is an asset management firm, located in Switzerland, that focuses exclusively on Responsible Investment. It was one of the first companies to generate ratings to assess firms’ sustainability performance, which then have become employed in the Dow Jones Sustainability Index. In its capacity as an asset manager, the company uses ESG data on firms to calculate the “fair value” of a company, based on its discounted cash flow – a long-standing formula in mainstream investing to estimate the value of a company or stock by estimating the current value of future cash flow projections. To do so, SAM employs ESG data to adjust the value on two critical inputs into the formulation of a company’s fair value: the cost of capital and return on invested capital. For SAM, companies that perform well on industry-specific ESG factors possess two advantages: first, they are deemed to be better able to manage risks and thus benefit from a lower “weighted average cost of capital” and, secondly, their ESG performance generates competitive advantages that lead to greater operational efficiency, leading to a positive impact on the company’s “return on invested capital” (RobecoSAM 2012, as cited in PRI 2013b). The result is the assignment of a SAM Fair Value score to each company, allowing for investment decisions based on exploitation of discrepancies between a stock’s fair value (which was now argued to be more accurately estimated due to the inclusion of ESG data) and its market value.
Another example is the work of Bloomberg, a company that historically has provided comprehensive, real-time market financial data to subscribers in the finance industry. Bloomberg added data on firms’ ESG performance to its service in 2009, providing data on a set of ESG indicators. And, in 2011, Bloomberg announced the launch of the ESG Earnings Valuation Tool, which provides an estimation of the future revenue and costs generated out of a company’s ESG performance in order to identify its financial impact on a company’s share price. The tool converts the value of a firm’s ESG indicators into monetized profits or losses by applying standardized pricing procedures, such as measures of carbon and oil prices, waste treatment costs, and paper costs. For example, Bloomberg identifies “accident severity rate” as one key social issue in a company’s ESG performance. Based on firm-level data gathered on that indicator, Bloomberg then prices the amount of lost labor time – as an additional company cost – that is generated by a firm’s performance by reference to the standardized measure of “employee salary.” By aggregating the economic impact of thirteen different ESG indicators, the company claims the tool is able to more accurately calculate a company’s future earnings before interest and tax as a ratio to its share price (Elders and Evans Reference Elders and Evans2011; International Federation of Accountants 2012).
As apparent in these examples, the question of social value in RI in integrated analysis is fundamentally driven by these value entrepreneurs’ efforts to refashion the measuring devices used in mainstream finance in order to solve the value problem in this new market for traditional investors. Despite its origins in the morally oriented frame of CSR, the rationale for investors’ use of ESG to assess stock value has meant that social value is now framed within the imperative of shareholder return. First, what counts as the “social” of ESG is determined by the criteria of materiality. Notwithstanding its shared concern with CSR for the effect of big businesses’ production processes on stakeholders, including employees, suppliers, community, and customers, value entrepreneurs in the field of RI only count those dimensions of a firm’s social behavior that are germane to reducing risk and increasing return within the firm’s industry. Secondly, the need to have ESG data equivalent in form and amount to that of financial data in mainstream investment analysis has resulted in a reduction of the number of aspects of a firm’s social behavior that are counted in public reports and so deemed relevant. Finally, a new measure of a firm’s ESG performance calculates its dollar worth in the estimation of a stock’s fundamental value, yet further delimiting what counts as social value by valorizing only those ESG measures that can be assigned a dollar value. In all, the consequence of Responsible Investing for social value is that the evaluation of firms’ social performance will be driven less by actors’ moral understanding of a “good society” and more by the pursuit of economic gain.
