Corporate sustainability reporting starts with a laudable goal: that measurement and reporting of a company’s social and environmental footprint would trigger the following positive chain reaction:
- Individual companies’ social and environmental performance would improve (because what gets measured gets managed).
- A link tying companies with better sustainability records to better equity returns would emerge.
- Investors and consumers would reward companies that had strong sustainability performance — and put pressure on the laggards.
- Ways to measure social and environmental impact would become more rigorous, accurate and widely accepted.
Over time, this virtuous cycle would result in a more sustainable form of capitalism.
Unfortunately, that hasn't come to pass. And I don't believe it will without deeper systemic changes.
That's the argument I make in an article that Harvard Business Review has just published, "Overselling Sustainability Reporting: Don’t Confuse Output with Impact.”
Research on the efficacy of measurement and the endless refinement of non-financial reporting are actually distractions from the much-needed work of systems change.
As I wrote, I was for many years an enthusiastic believer in this process myself. From 1992 to 2007, I worked at the footwear and apparel company Timberland, which prided itself on being a force for social and environmental good. Throughout my tenure (which concluded with seven years as chief operating officer), Timberland aimed to marry commerce with respect for human rights, responsible environmental stewardship and community service.
The management team's dedication to those values produced strong financial results and a powerful culture. However, we learned that it’s extremely difficult to change the rules of competition in an industry. Succeeding at that requires much more than individual action. Moreover, reporting on ESG performance does not ensure environmental and social improvement. Indeed, I fear that research on the efficacy of measurement and the endless refinement of non-financial reporting are actually distractions from the much-needed work of systems change.
A decade ago, Yvon Chouinard, amed CEO of Patagonia, predicted in HBR that sustainability would soon "simply be how business is done." He and his coauthors based their conclusion on improving quantification of ecosystem services, comparability enabled by value chain indices and research linking high ESG companies to high equity returns. Chouinard and his coauthors highlighted the many efforts to dollarize ecosystem services (including efforts by The Nature Conservancy plus PwC, the UN Millennium Ecosystem Assessment, The World Bank and Puma/Kering plus Trucost and their environmental profit and loss, or EP&L). These efforts, according to the article, would pave the way for companies to internalize their externalities.
Since publication of Chouinard's article, enthusiasm for measurement, reporting and ESG investing has grown. Sir Ronald Cohen, founder of private equity firm APAX, is funding a team at Harvard working on the Impacted Weighted Accounts project to advance the precision of non-financial accounting. Close to 90 percent of the S&P 500 now produce sustainability reports and a preponderance of academic research touts the link between ESG and equity returns. More than $25 trillion of global assets are invested "sustainably,” with projections for that number to double in just four years. Earlier this year, BlackRock CEO Larry Fink noted, "We’re going to see a vast change in the public company arena worldwide. They are going to move forward. We’re not going to need really governmental change or regulatory change."
And yet, notwithstanding all of the noted “progress” and optimism, social and environmental problems continue to mount.
For one, reporting is not a good proxy for progress. Sustainability reports are full of holes, inaccuracies and well-chosen case studies. Dollarization is a bootless errand, disconnected from operating practice, reliant on interpolation and unrelated to natural thresholds and allocations.
Twinkies and cheeseburgers
It is also not clear that precise and audited sustainability reporting would make a difference (it has not for executive compensation) as investors’ time horizons do not often account for long term or systemic risks. According to a fellow traveler and operator, Auden Schendler, SVP of Sustainability at Aspen Skiing Company, "Measurement and reporting have become ends to themselves, instead of a means to improve environmental or social outcomes. It’s as if a person committed to a diet and fanatically started counting calories but continued to eat the same number of Twinkies and cheeseburgers."
At the same time, what is billed as an ESG investment is exaggerated. Two-thirds of what is dubbed sustainable investment comprises negative-screen funds. Excluding tobacco from a fund will not have any impact on climate change. The final third of ESG investment also is wrought with classification challenges. According to the Wall Street Journal, eight of the largest 10 U.S. ESG funds were invested in oil and gas companies.
Finally, almost all academic research to date has been focused on establishing the link between ESG investment and equity returns, with very little inquiry into how ESG investing affects workers or the environment. A recent study by researchers at MIT found little evidence that ESG investment leads to improved social or environmental outcomes.
After decades of trying, it should be clear that measurement and the market will not ameliorate worsening social and environmental challenges. British economist Sir Paul Collier summed up the situation well when he said that capitalism "doesn’t work on autopilot. Periodically throughout its 250-year history, capitalism has derailed. And when that happens, it’s been up to public policy to get it back on the rails — public policy and the efforts of private citizens, of firms and families."
Integrating this wisdom means we would be well served by redirecting our energies toward civic engagement, policy advocacy and systems change.