Why we need to simplify our approach to ES (G)


Achieving our environmental and social goals will be crucial for our survival as a species and for our democracies. Sergio Scandizzo analyzes “environmental, social and governance” (ESG) criteria and the difficulty of identifying what each component is supposed to measure. He suggests focusing on aligning with EU taxonomy and the amount of taxes paid, and removing “governance” from ES (G).

The fundamental problem of modern societies is how to limit our impact on the planet’s finite resources while maintaining social inequalities at an acceptable level. In fact, it seems reasonable to postulate that we are unlikely to survive as a species beyond a certain increase in average temperature and as a democratic society beyond a certain level of temperature. inequality. What these two levels are and how to measure them could be controversial, as we do not know to what extent the first is achievable and the second desirable.

Indeed, while most people would agree that the depletion of scarce natural resources (which include a liveable climate) should be contained, there is widespread disagreement over the level of environmental impact it is. possible to achieve given the current state of technology and current and desired levels. of economic development in the world. On the other hand, while almost everyone will agree that excessive social inequality – especially if it means that many people live in poverty – is undesirable, only a small minority are likely to advocate a perfectly even distribution of wealth. and income.

Since it is the scale and nature of our economic activities that cause both the degradation of our natural environment and the increase in inequality, only substantial changes in these activities can reduce and possibly reverse these trends. Moreover, as governments cannot mobilize, let alone provide on their own, all of the gigantic resources needed, it is reasonable to expect that only a substantial shift in investment between countries, sectors and institutions. companies can hope to achieve tangible results. While there are signs that governments are trying to foster such a reorientation through policy changes – with EU taxonomy being the most articulate example – the role of private enterprise in this collective effort remains ambiguous. . So now is the time to take a look at how businesses are helping to solve these problems.

The industry’s response to this challenge has been the birth of ESG rating agencies which are supposed to fulfill a role similar to that played by credit rating agencies: to provide an independent assessment of a company’s performance in the dimensions environmental, social and governance. However, it appears that the methodologies developed by these agencies are still evolving towards a common standard and that they are far from being able to capture all the relevant interactions between economic activities and environmental and social factors. While there is evidence that the ESG ratings produced by different agencies for the same companies can diverge considerably, as these methodologies are proprietary and largely undisclosed, it is also difficult to establish how theoretically and empirically robust they are.

However, the fundamental problem with ESG ratings is that it is far from clear what they are meant to measure. Not only do attempts to explain such evaluations strongly suggest an error of ambiguity, that a hypothetical construction is treated as real, but it is also questionable what such a hypothetical construction might be. Unlike credit risk ratings which aim to estimate an unobservable but well-defined quantity (the probability of default), ESG ratings claim to measure the “ESG performance” or “ESG risks” of companies, without providing an ontological basis for this. such concepts. The whole approach strongly suggests an IQ test, the ultimate goal of which is to estimate… an IQ.

I believe that companies are allowed to operate not only as long as they do no harm or at least control that harm and pay for it. They receive their charter, to use the original language of the sixteenth century, because they contribute to the common good through their lucrative activities, not despite this. Milton Friedman, in a now famous New York Times editorial, argued that this is the case by definition, but now we find this claim at best dogmatic and at worst blatantly contradicted by the evidence. Therefore, we need to assess, maintaining both objectivity and comparability of results, the quality and quantity of the impact of different types of economic activities on these objectives. In other words, rather than looking at how well a company complies with environmental or labor laws or cases of affirmative action in its hiring practices, measuring its environmental footprint or charitable giving, we should focus on its direct contribution to the stock of our environment resources and to the equity of our society.

I propose to note the contributions of companies according to two environmental and social indicators: the percentage of turnover of activities aligned with EU taxonomy and taxes paid as a percentage of company profits, the latter indicator being admittedly a shortcut. crass in the, hopefully, temporary absence of a European Social Taxonomy. In addition, by emphasizing the direct contribution of companies to environmental and social objectives, we will leave aside the governance dimension. Without neglecting the importance of governance for a healthy economic system, a ranking of companies based on the quality of their governance can be of great interest to regulators and stakeholders in general, but would likely pollute a quantification of their contribution. to our environmental and social environment. goals. In fact, a company can be a model of internal governance while being totally out of step with EU taxonomy and paying little or no corporate tax.

Over sixty years ago, in a now famous article, The Problem of Social Cost, the Nobel Prize winner Ronald Coase addressed “those actions of companies which have harmful effects on others”. Now is the time to focus on actions that benefit society as a whole.

Author disclaimer: The views expressed in this article are those of the author and do not necessarily represent those of the European Investment Bank.



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