ESG’s ‘Social License’ Will Endure Even If the Letters Don’t
McKinsey says the turbulence surrounding the concept’s components doesn’t
change the fact that it’s here to stay.
Climate activists from Extinction
Rebellion gather during their "Blood Money March" protest near
the Bank of England in London on Aug. 27, 2021.
Photographer: Hollie Adams/Bloomberg
August 10, 2022 at 6:23 AM EDT
It’s been a bumpy stretch for adherents of investment strategies based on
environmental, social and governance data.
Much has been written about how Vladimir Putin’s February invasion of Ukraine
questions about why ESG-focused funds were even invested in Russia.
Then markets tanked, with many huge ESG funds getting slammed for posting losses
worse than those suffered by benchmarks, thanks to their massive holdings in
beat-up tech stocks.
In a new paper entitled “Does
ESG Really Matter—and Why,” consultants from McKinsey & Co. run
through the many reasons why ESG has attracted such intense criticism of late.
But they ultimately conclude that, regardless of the current turbulence surrounding
its specific components, ESG’s underpinnings and the “social license” adherence
to them will remain important for companies far into the future.
Detractors complain ESG is often just public-relations cover rather than true
corporate belief, where greenwashing is
employed to profit off of unwitting environmentally and socially conscious
investors. The concept itself is also seen as an
odd bird, a weird combination of ill-defined elements whose focus
should mainly be on environmental sustainability.
The nebulous nature of ESG is clearly illustrated by the lack of agreement on
its meaning. For example, while credit ratings from Standard
& Poor’s and Moody’s
Investors Service are in sync about 99% of the time, ESG scores from
six of the most prominent ESG ratings providers are found to be comparable
closer to 54% of the time, according to a paper cited by McKinsey. And even when
ESG can be measured appropriately, there’s often no meaningful relationship with
a company’s financial performance. (Bloomberg LP, the parent of Bloomberg News,
also provides ESG data, analysis, indices and scores.)
But even with its inherent problems, what ESG represents at its base is critical
to modern corporate decision-making, McKinsey says.
“While acronyms will come and go, the substance of what matters long term to
companies and their stakeholders won’t change,” said Hamid Samandari, a senior
partner at McKinsey who was part of five-person group that co-authored the
Companies are increasingly going to be under pressure to ensure they can “build
purpose into their business models in a sustainable way and respond to their
stakeholders’ growing focus on the impact of the company’s actions on the
environment and society,” added Lucy Pérez, who’s also a senior partner and
The group examined the question of whether companies that show an improvement in
ESG ratings over several years exhibit higher shareholder returns, as has been
claimed by proponents. While they find some early indications of a correlation,
they contend that the numbers are inconclusive.
McKinsey instead says the main reason for a company to focus on ESG is to
maintain and enhance its so-called social license. Regardless of the current
debate, many companies are advancing on the sustainability front to improve
their long-term financial performance. More than 5,000 companies, for example,
have made net-zero commitments as part of the United Nations’ “Race
to Zero” campaign, and most businesses are being forced to adapt to
the climate crisis. Moreover, some 90% or more of companies in the S&P 500 now
publish ESG reports.
For the best outcome, companies should focus on ESG improvements that are
informed by and support the evolution of their business models, even if the
improvements don’t directly lead to higher ratings, the McKinsey authors wrote.
And there are tangible risks for companies that don’t take action.
“If companies, particularly those with significant externalities, such as
high-emitting industries, hold out for perfect data and a ‘flawless’ rating
process, they may not have a business in 20 to 30 years,” they warned.
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