July 12, 2024

Would “reframing” ESG restore its appeal?

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In this Comment from a Reuters magazine, the author attempts to rescue the underlying environmental, social and governance principles from the often disparaged term, “ESG.” ESG, he observes, was “[o]riginally conceived as a financial tool to frame how corporations disclose their impact and investment,” but has now become a term that is “fraught with debate, lacks a clear definition and is often misunderstood.” However, he contends, people actually associate many of the values and concepts underlying ESG with business success. Perhaps the term should be retired, he suggests, in favor of something less freighted. “Responsible business” might do the trick—especially “responsible business” that correlates with positive corporate performance.

In some circles, particularly conservative circles, the author observes, ESG has become almost synonymous with “woke capitalism”—a perspective that a “growing segment of American voters” rejects: those hostile to ESG and “seeking to influence the public debate on the role of business in society have used the vagueness of ESG as a weapon, effectively demonizing the term, along with the perceived ‘woke’ agenda. Since 2021, 318 anti-ESG bills have been introduced in 38 U.S. state legislatures, with dozens filed already this year. These bills range in severity from prohibiting state agencies and local towns from offering tax subsidies to a company that participates in an ESG scoring or rating system, to making it a felony punishable by up to 20 years in prison for an official to ‘knowingly’ make investment decisions using ESG criteria.”

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This article in Institutional Investor, based on a survey conducted by Pleiades Strategy, reports that state legislators have introduced hundreds of bills designed to deter or prohibit investments that take ESG factors into account in selecting investment targets. But the success rate has been declining. According to the article, “[i]n 2024, legislators wrote 161 bills and resolutions in 28 states for consideration, a high volume and continuation of a trend in recent years. Out of those proposed, including 58 that carried over from the 2023 legislative session, only six bills passed in 2024 (each in a different state). Five of those six have become law; one is awaiting a governor’s signature. The success rate is worsening. In 2023, 23 laws were passed and 6 resolutions resolved out of 198 total pieces of legislation.” The founder of Pleiades commented that one reason for the decline was pushback by “‘an extremely broad coalition.’” In its report, Pleiades suggested that “anti-ESG policies ‘remain deeply unpopular with diverse constituencies who don’t often see eye to eye on public policy, including business groups, financial officers, investors, labor unions, libertarians, taxpayer advocates, racial justice advocates, and environmentalists.’”

While proponents of the legislation would like to see these bills become law, even bills that are unlikely to pass “can still have a chilling effect and instill fear in companies and organizations.” The founder of Pleiades explained that “‘[b]oards understand that climate risk is financial risk. When legislators are hostile toward responsible investment, companies are more cautious in how they address these real risks. And their shareholders and investors pay the price, through lower returns and higher risks.’” That’s why a broad coalition has eschewed this type of legislation, “highlight[ing] the high costs and impacts of anti-ESG policies to businesses and constituents in formal testimonies, publicly and behind closed doors.” (See this PubCo post.)

Is the term “ESG” the villain here? The author cites interesting research by “language strategists” Maslansky + Partners supporting the idea that just avoiding the term “ESG” might go a long way: while voters might disparage the term “ESG,” they associate the phrase “responsible business” favorably with “business success”: the research found that the vast majority of both Democrats and Republicans agreed with the concept “that ‘companies have a responsibility beyond serving shareholders to make a positive impact on the world.’” To be sure, many of the principles and values underlying “successful and responsible business” align fairly closely with those underlying ESG. According to the article, when voters were asked to discuss the factors that contribute to a “successful and responsible business,” they

“focused on three areas:

How well do they treat their employees?

What is the impact on local communities? Does the company ‘look’ like the communities in which they operate?

Do they take care of the environment?

People generally understand the connection between responsible business practices and financial success, as well as the value of companies managing resources, supporting employees, and embracing diversity. These are business priorities for a 21st century executive, and core elements of an effective business strategy.”

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Many companies seem to have caught on. As discussed in this January 2024 article from the WSJ, The Latest Dirty Word in Corporate America: ESG, ESG backlash is driving many company executives to drop any reference to “ESG” and instead use terms like “sustainability” or “responsible business,” or opt for “green hushing” altogether. Citing an analysis from FactSet, the WSJ reported that, on “earnings calls, mentions of ESG rose steadily until 2021 and have declined since…. In the fourth quarter of 2021, 155 companies in the S&P 500 mentioned ESG initiatives; by the second quarter of 2023, that had fallen to 61 mentions.”

The author reports that, while ESG backlash has led many major corporations to discontinue use of the term “ESG,” but it hasn’t caused them to give up on sustainability. He cites a recent global survey conducted by KPMG which showed that the vast majority of global organizations plan to increase spending on sustainability initiatives over the next three years. (As discussed in this PubCo post, in the KPMG survey of 550 company directors and members of management, 90% of respondents reported that they expected to increase their ESG investments over the next three years, with 43% increasing expenditures on dedicated ESG personnel, 40% on ESG-specific software, 38% on employee training and education and 37% on data collection and management tools. About 32% planned to invest in external consulting or advisory services.) The author also points to support from a 2024 EY survey, which found U.S. respondents “were the most likely to report that sustainability has become a higher priority, and the least likely to report de-prioritization, compared with companies in other countries.”

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However, this recent report by the advisory firm Teneo suggests that there’s more to it than just soft-pedaling of terminology—there might also be some back-pedaling on programs. The report indicates that the “recent politicization of ESG” is having an effect: in a survey of 260 global CEOs representing $3.4 trillion of combined company and portfolio value, results showed that “72% of CEOs polled are making one or more changes in how they operate in response to the shifting environment.” In the survey, 8% responded that they have ramped down some of their ESG-related programs; 28% said that they had become “more cautious” in their selection of ESG topics for engagement; another 28% reported that they were allocating more time and attention to ascertain which ESG topics were important to employees and customers; and 45% said that they were continuing to do what was right according to their beliefs, but discussing it less outside of the business.

In the U.S., one area that has been subject to increasing scrutiny has been DEI—diversity, equity and inclusion—particularly in light of the recent SCOTUS decision on affirmative action in universities, Students for Fair Admissions, Inc. v. President and Fellows of Harvard College, as well as challenges from conservative activists. (See this article in the WSJ.) The survey from Teneo showed that CEOs were divided on DEI programs, with 20% increasing their DEI recruiting and retention efforts, 30% continuing their efforts, 35% reporting that they were scaling back their programs, 5% terminating their programs and 10% pausing to re-evaluate their programs. Although the SCOTUS decision concerned university programs, not corporate programs, in light of the upcoming election and the concern expressed by some candidates about perceived “woke” corporations, the issues surrounding DEI may have been invigorated. Teneo speculates that “[t]hose pausing or re-evaluating are likely adapting messaging to minimize risk and are cautiously monitoring the environment. It will be critical for companies to include legal perspectives alongside the business risks of slowing down or scaling back their DE&I programs.”

These shifts in ESG programs notwithstanding, according to Teneo, “a vast majority of CEOs continue to believe that certain ESG issues are critical to their business and to their stakeholders,” and 92% of CEOs said they were “standing by their ESG-related programs”; only a small proportion of companies reported actually curtailing their ESG-related projects “in response to these political headwinds.” (See this PubCo post.)

The author advises that the answer lies in properly “framing these actions to emphasize the link between responsible business practices and financial prosperity, underscoring the need for comprehensive frameworks for measuring and reporting corporate performance. Demand for increased accountability and transparency on these matters will continue to rise, and improving corporate performance and accountability is essential for long-term corporate value and business success….To make this shift, companies need to prioritize authenticity, align materiality and their messaging with their brand values and consumer expectations, and demonstrate tangible business benefits.”

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.