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Defining Terms and Exploring the Sustainability/Financial Value Link

EVEN IN OUR brief introductory statement, we used both the terms sustainability and ESG. This might suggest they are synonyms with nearly identical meanings, but that is not the case. Sustainability is a broad principle that is concerned with balancing environmental, social and economic needs for the long-term benefit of both current and future generations. ESG, on the other hand, is a specific framework used to assess and measure a company's performance against environmental, social and governance factors. What both terms do have in common is that they have come to mean so many different things to so many different people. And by doing so, they risk becoming both essentially meaningless and highly contentious.

Fortunately, this is not a book about definitions, but rather about financial outcomes. However, it is helpful to provide some context to understand how we arrived at our current state in terms of both sustainability and ESG.

So, in our first section, we examine the history of sustainability in all its forms, followed by an overview of the rise of ESG.

In our second section, we take our first steps into exploring the link between sustainability, ESG and financial value.

Thirdly, we examine the recent backlash against ESG and assess its impact on financial value.

A Brief History of Sustainability

Please forgive us for a quick foray into ancient history. If we consider sustainability to revolve around the ability of people and nature to coexist successfully over time, then the concept not only dates back a very long way but has value at its centre. As hunter-gatherers, we lived in a largely harmonious relationship with our environment. Following the agricultural revolution approximately 12,000 years ago, we became farmers, controlling and extracting value from the natural world. The Industrial Revolution, which took place between 1750 and 1900, witnessed both the unprecedented destruction of nature and the unprecedented creation of financial value. Now, we are seeking to reestablish our connection with nature through the development of innovative green technologies. If that is to be the case, there can be little doubt that such technologies will only succeed if they offer the promise of financial value to those who invest in and deliver them.

In other words, the search for value, whether through farming land or harnessing new technologies, is at the heart of the human story, past, present and future. It may even be responsible for the words you are now reading. In his groundbreaking international multi-million-selling book, Sapiens: A Brief History of Mankind (Harari, 2015), author Yuval Noah Harari explains how homo sapiens invented the written word some 5,500 years ago to record the ownership of animals and crops. On this basis, Harari believes it is likely that 'the first recorded name in history belongs to an accountant, rather than a prophet, a poet, or a great conqueror'. In this spirit, we will continue our journey to explore financial value and sustainability.

The Modern History of Sustainability

In more modern terms, the history of sustainability can be traced back to the 1950s, with the publication of Howard Bowen's book, Social Responsibilities of the Businessman (Bowen, 1953). Essentially, Bowen's focus is on how an individual business impacts the society in which it operates and how it can take action to reduce harmful aspects and increase positive ones. In the 1960s, anti-Vietnam War activists influenced the investment choices of university endowment funds, leading to the creation of ethical funds, such as the Pax Fund. Pax Fund was the first publicly available US mutual fund to consider social and environmental factors in investment decisions, laying the groundwork for the future of ESG investing. Such funds played a crucial role in assessing the ethical, social and ecological value of their investments and linking these factors to their performance.

Similarly, the anti-apartheid movement's divestment campaigns compelled investors and some companies to sever ties with South Africa, prompting consumers to reconsider the ethics of their purchases. For those old enough to remember, purchasing a South African orange in a UK supermarket became a politically charged act. This early example shows how sustainability-related issues can influence a product's desirability and price point. On the right side of public perception, more significant volumes can be sold at higher prices, adding value. On the wrong side, shunned oranges rot on the shelves at almost any cost, losing value by the hour.

In the 1970s, the focus shifted to the environment, with US Senator Gaylord Nelson organising the world's first Earth Day in 1970. How did he mobilise nearly 10% of the country to attend events nationwide? Due to growing public concern over pollution, environmental damage and health issues resulting from industrial activities, there is a need for action. Public concern may have risen to such levels because of the lack of regulation. It was not until 1972 that the Clean Water Act (CWA) established the basic structure for regulating discharges of pollutants into the waters of the United States and regulating quality standards for surface waters. Until then, there was little to stop factories from discharging toxins into rivers. A decade earlier, the Clean Air Act of 1963 implemented measures to control national air pollution.

It would be wrong to suggest that it was all one-way traffic. Many in the business world, including renowned economist Milton Friedman, challenged the idea of corporate accountability and responsible investment. In his book Capitalism and Freedom (Friedman, 1962), he argued that 'there is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits'. This idea, known as shareholder primacy, deserves careful consideration.

Shareholder Primacy Versus Stakeholder Capitalism Milton Friedman's faith in shareholder primacy meant he believed that a business executive spending the corporation's money on social causes was essentially operating against the company's interests. Friedman believed that if an executive wanted to make a difference in society and/or the environment, they should do so privately and using their own funds. His argument was financial rather than ethical or political. He believed businesses should focus on their strengths, maximising profits for their shareholders.

The opposing view, most famously espoused much later at the 1987 World Economic Forum's Business Roundtable, is that a business should prioritise the interests of all stakeholders - employees, customers, suppliers, communities and shareholders. The company should ensure it delivers value to all stakeholders, meeting their needs and protecting their interests. Crucially, most exponents of stakeholder capitalism believe that such a stance will not only benefit these individual stakeholders but also ultimately benefit the whole organisation and make it more financially successful. This view is based on the concept of interconnection. Let us take the example of a retailer acting in the best interest of its local community during the COVID-19 pandemic by making free food deliveries to local pensioners. These extra efforts may not appear to be in the direct interest of its shareholders. Still, the stakeholder capitalist would argue that doing so enhances the company's reputation within the community and, through the loyalty and allegiance it fosters, ultimately benefits the company and its shareholders. Note that in this example, the stakeholder capitalist is, in some ways at least, wanting to have their cake and eat it, too. Doing good is not enough. They also aim to establish a connection between doing good and, in the long term, at least, generating financial value.

Just as the opponents of shareholder primacy believe that stakeholder capitalism can ultimately deliver financial value to all stakeholders, Milton Friedman did, in a way, also acknowledge the value of providing value to all stakeholders, writing that, 'it may well be in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects' (Friedman, 1970). The problem, as we will discover throughout this book, is in measuring the actual financial value of such actions. Consider the example of a company that offers its employees an on-site gym. We could agree on those benefits, such as reduced time off sick and an increased ability to attract and retain talent. We may also see broader social benefits, including healthier populations, reduced need for medical intervention and increased longevity. However, calculating and agreeing on a specific value is a challenge and not always straightforward.

The 1980s and Beyond During this period, multilateral organisations picked up the sustainability baton.

In 1983, the United Nations established an autonomous body to investigate the relationship between human activity and the environment and consider its economic and environmental policy implications.

In 1987, the Brundtland Report 'Our Common...