Wayne WinegardenEditor’s note: This has been excerpted with permission from the Pacific Research Institute. To read the entire report, click here.
The concepts behind Environmental, Social, and Governance (ESG) investing and management are the latest theory trying to address a long-standing question: What is the appropriate social function of a business? This question predates Milton Friedman’s 1970 New York Times piece “The Social Responsibility of Business Is to Increase Its Profits,” but this article provides a useful benchmark for examining whether ESG adds value. According to Friedman,
there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.
A great deal of confusion surrounds this so-called Friedman Doctrine. It is not a paean to corporate greed, nor does it claim that “greed is good” – that framing is an inaccurate Hollywood caricature. Instead, the position recognizes that businesses fulfill an essential social role in society by ensuring that individuals and families have access to the goods and services they need or desire in the manner they want it produced. Performing this social function well is the key to prosperity, and profits are essential for performing this function efficiently.
For instance, the McKinsey Global Institute conducted a study of 13 nations that documented the importance of consumer-oriented businesses in practice. The study found that prosperous nations were more productive than poorer nations, which is a well-documented phenomenon. Interestingly, the nations with the most undistorted competition in product markets, such as the United States, were the ones with the highest levels of productivity.
Put differently, businesses operating in competitive markets and adhering to the Friedman Doctrine will consistently strive to improve their products, streamline their production processes, and find better ways to serve their customers. The historical record demonstrates that this profit maximizing competitive process is the most efficient way to provide the social good of widely shared prosperity.
If generating prosperity is the core social role of businesses, then ESG adds value – either as an investment strategy or a management philosophy – depending on whether it enhances or detracts from businesses’ ability to fulfill this primary social function. The evidence clearly demonstrates that ESG detracts from businesses ability to serve this primary social function.
ESG Investing Creates Additional Risks And Underperforms Comparable Non-ESG Alternatives
Many studies examining ESG’s impact on investment corporate profitability document that ESG investments underperform, and ESG-related proxy measures often harm financial returns.
A 2002 study by Tracie Woidtke in the Journal of Financial Economics examined the impact from activist public pension funds on the market values of a sample of Fortune 500 companies. Her results illustrate that increased shareholder activism by public pension funds is negatively correlated with stock returns.
To continue reading, click here.
Big Companies are run mostly by managers. However, this observation applies to the CEO and COO also.
These managers look to the gauge they are told is most important. It use to be “the bottom line”, ie, the net profit of the corporation, that they work for.
However, today the Board and the managers above them see ESG as being as-and perhaps even more important-than the bottom line.
Thus, the Company is now being run in a subjective, political way and not anymore in an objective, accounting and financial way.
It is much easier to run the company by pointing out what you have done to improve-not the bottom line-but the ESG rating of the Corporation.
Increasing net profits of the Company is difficult, mainly because of the outside competition that is faced.
However, if other Companies are also ESG oriented, then everyone will leave analyzing net profits and go towards ESG- analyses. That will now become the most important number-and the easiest to rationalize.
It’s like the water from a leak which will travel the easiest way it can.
Why does the Company let these managers get away with this? Why aren’t the managers evaluated on how successful their departments are in improving the bottom line.
Because woke-politics have been injected into the Companies veins, and-like the COVID vax-the injection of these foolish ESG policies are going to have side effects for years to come.
If it’s a Corporation (where stocks are involved), it’s just a shame that the little investor will be the recipient of this new way of analysis.