{"id":334728,"date":"2024-06-26T16:48:10","date_gmt":"2024-06-26T14:48:10","guid":{"rendered":"https:\/\/climatescience.press\/?p=334728"},"modified":"2024-06-26T16:48:13","modified_gmt":"2024-06-26T14:48:13","slug":"esg-and-stakeholder-capitalism-a-necessary-deconstruction","status":"publish","type":"post","link":"https:\/\/climatescience.press\/?p=334728","title":{"rendered":"ESG and stakeholder capitalism: A necessary deconstruction"},"content":{"rendered":"\n
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From CFACT<\/a><\/p>\n\n\n\n

By Rupert Darwall<\/a><\/p>\n\n\n\n

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The Following is Book Reviews of:<\/strong><\/p>\n\n\n\n

The Case for Shareholder Capitalism: How the Pursuit of Profit Benefits All<\/em><\/strong>, by R. David McLean (Cato Institute, 2023)<\/strong><\/p>\n\n\n\n

The Race to Zero: How ESG Investing Will Crater the Global Financial System<\/em><\/strong>, by Paul H. Tice (Encounter Books, 2024)<\/strong><\/p>\n\n\n\n

May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases\u2014and What We Can Do About It<\/em><\/strong>, by Alex Edmans (Penguin Random House, 2024)<\/strong><\/p>\n\n\n\n

\u201cI\u2019m not going to use the word \u2018ESG\u2019 because it\u2019s been misused by the far left and the far right,\u201d Larry Fink, chairman and chief executive of BlackRock, declared<\/a> a year ago. The far left, Fink complained, wanted BlackRock to use other people\u2019s money to decarbonize the economy. As for what Fink presumably regards as the \u201cfar right,\u201d BlackRock had lost $4 billion in mandates as a result of the political debate on environmental, social, and governance (ESG) investing, which he called \u201c90% misinformation.\u201d<\/p>\n\n\n\n

The chief executive of the world\u2019s largest fund manager was speaking at the Aspen Ideas Festival to fellow billionaire David Rubenstein, co-chairman of the Carlyle Group, a private equity firm. At one point, Fink confessed to being ashamed of being part of the public conversation on ESG brought on by the annual letters that he writes to CEOs of BlackRock\u2019s investee companies. \u201cWhen I write these letters, it was never meant to be a political statement,\u201d Fink told Rubenstein. \u201cThey were written to identify long-term issues.\u201d<\/p>\n\n\n\n

Moments later, Fink backtracked. \u201cI write about stakeholder capitalism, and I\u2019m a big believer that you have to focus on all of your stakeholders,\u201d Fink said. \u201cSo there\u2019s nothing to be ashamed about. I just don\u2019t use the word \u2018ESG\u2019 anymore.\u201d Confused? You\u2019re meant to be. BlackRock has been put on the defensive by red-state blowback to the anti-fossil-fuel positions adopted by BlackRock in its embrace of stakeholder capitalism and ESG. The debate on stakeholder capitalism and ESG is too important to be left with BlackRock and its CEO\u2019s less than candid, but nonetheless revealing, attempt to find a way out of BlackRock\u2019s self-inflicted ESG difficulties.<\/p>\n\n\n\n

That\u2019s why the three books reviewed here are so important. Taken together, they constitute a comprehensive refutation of ESG and stakeholder capitalism. In The Case for Shareholder Capitalism<\/em><\/a>, R. David McLean takes the argument back to first principles\u2014indeed, back some 320,000 years and archaeological evidence that some of our earliest African ancestors engaged in trade. Moving to Europe, Homo sapiens outcompeted physically stronger Neanderthals because we traded and they did not. \u201cWhy would trading help us survive? Trade enables specialization,\u201d McLean writes. Trade also enabled the formation of towns and cities, i.e., civilization.<\/p>\n\n\n\n

People trade with other people only when both sides gain. This axiom of human behavior applies to shareholder capitalism: a corporation is a legal entity through which customers, suppliers, and employees trade with the business\u2019s shareholders. \u201cYou cannot expect businesses to keep trading with you unless the trading also makes the businesses\u2019 owners better off,\u201d McLean writes. \u201cProfits reflect the business owner\u2019s gain from trading.\u201d<\/p>\n\n\n\n

Profit\u2014the economic value accruing to shareholders\u2014also indicates whether a business makes an economic contribution to society. When a mature firm or product is chronically loss-making, \u201cit likely signals that the resources it is using could be put to better use elsewhere.\u201d It makes society, as well as shareholders, poorer because it consumes resources that could have gone to more valuable use elsewhere.<\/p>\n\n\n\n

McLean\u2019s reasoning leads to two powerful insights. The first involves what he calls the \u201cstakeholder fallacy,\u201d which says that shareholders should be put on an equal footing with other stakeholders: \u201cThis overlooks the fact that they already are on an equal footing. If a customer or an employee in a capitalist economy doesn\u2019t find it beneficial to transact with a firm, then she isn\u2019t required to do so. By the same token, if a transaction doesn\u2019t benefit the firm\u2019s shareholders, then the firm shouldn\u2019t engage in the transaction. That is all shareholder capitalism requires.\u201d<\/p>\n\n\n\n

This links to the second insight. When a manager spends the corporation\u2019s money on things that cannot reasonably be expected to create shareholder value, the manager is expropriating the corporation\u2019s assets. Either corporate spending is undertaken with the intention of increasing shareholder value, or it expropriates the firm\u2019s resources. \u201cThere is no third category.\u201d Whether spending in the second category is labeled \u201csocially responsible\u201d or to improve an ESG rating is entirely subjective, McLean argues: \u201cLabels reflect what the labelers like or dislike. That is all. They have no higher meaning. Labeling an expropriation \u2018socially responsible\u2019 does not change the fact that it is an expropriation.\u201d<\/p>\n\n\n\n

McLean is a professor of finance at Georgetown University. His writing has the virtue of bringing crystalline brilliance to a subject distorted by willful obfuscation and misleading claims. Paul H. Tice, author of The Race to Zero<\/em>, spent 40 years on Wall Street, including spells at J. P. Morgan, Lehman Brothers, and BlackRock. Tice\u2019s practitioner experience and the granularity of the evidence that he presents make for a perfect complement to McLean\u2019s more theoretical treatment.<\/p>\n\n\n\n

Like McLean, Tice is unsparing in his criticism. ESG, he writes, is the latest fraud being perpetrated on the financial markets, and sustainable investment is a scam that aims to determine the allocation of capital in the economy: \u201c[I]t is socialism disguised as a new form of capitalism.\u201d As a former Wall Streeter, Tice follows in the footsteps of Terrence Keeley and his pathbreaking 2022 book Sustainable: Moving Beyond ESG to Impact Investing<\/em><\/a>, for which Keeley sacrificed his senior role at BlackRock. Like Keeley, Tice advocates segregating ESG funds, or impact funds, as Keeley calls them, and takes the case against ESG several stages further.<\/p>\n\n\n\n

Tice writes of how Wall Street bosses embraced ESG as a path back to social acceptability after the financial crisis. Despite empirical studies demonstrating a tenuous link, at best, between ESG factors and corporate performance, Wall Street\u2019s analytical defenses were dulled by the Fed-induced trance of near-zero interest rates. Tice contrasts the objectivity and reproducibility of credit ratings with the subjectivity and non-comparability of ESG ratings, as different ESG raters have their own methodologies delivering vastly different results on the same company. According to Michael Jantzi, founder of ESG rater Sustainalytics (now owned by Morningstar), the diversity of ESG ratings is a sign of a healthy market. This is like saying that schizophrenia and multiple personality disorder are \u201csigns of a healthy mind,\u201d Tice comments.<\/p>\n\n\n\n

ESG is fundamentally about getting capital providers (debt and equity) to use their financial leverage and institutional power to frog-march the corporate sector into the front line of the war against climate change. As Tice notes, apart from climate change, ESG is \u201cjust a ragtag collection of liberal policy wants\u201d sponsored by the United Nations\u2014diversity, union power, gender pay equality, executive compensation, and \u201cfair\u201d corporate taxes. The UN attempts to justify<\/a> the prioritization of climate change over the other 16 of its sustainable development goals (the first of which is ending world poverty) on the spurious grounds that tackling climate change drives attainment of all the rest. In the world according to the UN, there are no costs or trade-offs when it comes to cutting greenhouse gas emissions.<\/p>\n\n\n\n

When companies set net zero targets, they expropriate value from their shareholders. Where does this shareholder wealth go? The recent scandal at Science Based Targets initiative (SBTi), which companies use to validate corporate net zero targets, illustrates the truth of McLean\u2019s proposition on shareholder expropriation. Under pressure<\/a> from John Kerry and lubricated<\/a> by a large donation from the Bezos Earth Fund, SBTi decided to support the use of carbon credits to finance the energy transition in the Global South. Thus, net zero targets are a non-legislated tax on shareholders to fund the goals of the Paris climate agreement. This was too much for many of SBTi\u2019s staff and advisers, one of whom denounced carbon credits as \u201cscientifically, socially and from a climate perspective a hoax.\u201d<\/p>\n\n\n\n

The first step in getting companies to set decarbonization targets is forcing them to report their greenhouse gas emissions. Three years ago, Follow This<\/a>, a Dutch nonprofit\u2014more accurately, an anti-profit\u2014tabled a shareholder resolution that would require Chevron to reduce its Scope 3 emissions, defined as those emitted across the company\u2019s entire value chain. As McLean writes, \u201cChevron is an oil company. It can reduce its customers\u2019 CO2<\/sub> emissions only by getting its customers to use less oil. The purpose of this resolution, therefore, was to get Chevron to destroy itself.\u201d<\/p>\n\n\n\n

A majority of Chevron\u2019s shareholders voted for the resolution, including the Big Three index providers: BlackRock, State Street, and Vanguard. The Chevron resolution is a clear example of investment managers using other people\u2019s money to destroy the value of their investments. On Larry Fink\u2019s own definition, this puts BlackRock and the other two index providers on the far left of American politics.<\/p>\n\n\n\n

Shareholder capitalism depends on a chain of principal-agent relationships that runs from savers, investors, and pension plan beneficiaries through investment managers to corporate boards and CEOs. The first-round principal-agent relationship is generally governed by the legal duties that investment managers, as fiduciaries, owe their clients because, as Fink puts it, they\u2019re managing other people\u2019s money and shouldn\u2019t pursue other objectives. ESG advocates try to square the circle by claiming that investing according to ESG precepts boosts\u2014or, at minimum, does not sacrifice\u2014investor returns (\u201cdoing well by doing good\u201d). This won\u2019t wash. McLean quotes Cliff Asness, co-founder and chief investment officer of AQR Capital Management, who points out that if one investor mandates an investment to maximize return for the risk taken, and a second says to do that, subject to the following constraints, \u201cit is simply false and irresponsible for the asset manager to assert that the second investor should expect to do as well as the first, except in the case where those constraints are non-binding (and therefore not relevant).\u201d<\/p>\n\n\n\n

Evidence that advocates of ESG investing don\u2019t believe their own arguments for ESG boosting risk-adjusted returns is shown by their campaign to destroy fiduciary duty as a binding constraint on investment managers. Tice is superb on this, writing that rules on the duties of fiduciaries are being rewritten to \u201cnot just allow but require an ESG approach by fund managers.\u201d Thus, the UN-sponsored Principles for Responsible Investment (PRI) states<\/a> that fiduciary duty exists to ensure that those managing other people\u2019s money act in the interests of beneficiaries\u2014the omission of \u201csole\u201d pointing to PRI\u2019s sleight of hand, which comes next\u2014requiring \u201cinvestors to incorporate all value drivers, including environmental, social, and governance (ESG) factors, in investment decision making.\u201d<\/p>\n\n\n\n

Tice charts how PRI, together with its sibling, the United Nations Environment Programme Finance Initiative (UNEP FI), have become increasingly prescriptive. In 2015, PRI and UNEP FI published Fiduciary Duty in the 21st<\/sup> Century<\/em><\/a> (foreword by Al Gore and his investment partner David Blood), with the intent of eviscerating fiduciary duty as a constraint on investment managers by, as Tice puts it, requiring fiduciaries to \u201cconsider the long-term interests of their beneficiaries, both financial and non-financial, whether known to them or not.\u201d With its detailed demands addressed to individual financial regulators around the world to write its proposals into law and regulation, PRI\u2019s Fiduciary Duty in the 21st<\/sup> Century<\/em> is a lobbying manual to end fiduciary duty in the 21st<\/sup> century.<\/p>\n\n\n\n

PRI\u2019s 5,336 signatories<\/a> include BlackRock, which signed on October 7, 2008, State Street (May 2012), and Vanguard (November 2014). BlackRock states<\/a> that it is committed to supporting PRI\u2019s principles \u201cwhere consistent with our fiduciary duties.\u201d This is thoroughly disingenuous, as PRI continues its campaign to weaken and ultimately destroy the fiduciary duties that BlackRock professes to maintain. Fink\u2019s protestations that BlackRock does not seek to play politics with other people\u2019s money have little credibility for as long as BlackRock remains a PRI signatory.<\/p>\n\n\n\n

PRI has conquered Europe and the UK, which together account for about 75% of the 868 pro-ESG regulations tracked by PRI. In Britain, shareholder capitalism perished under a nominally Conservative government. At the COP26 Glasgow climate conference in 2021, Rishi Sunak, as Chancellor of the Exchequer, spoke<\/a> of a $130 trillion wall of capital\u2014the amount of other people\u2019s money managed by the members of the Glasgow Financial Alliance for Net Zero\u2014to be deployed to finance the net zero transition. Sunak went on to say that the entire global financial system needed to be rewired for net zero. \u201cInvestors need to have as much clarity and confidence in the climate impact of their investments as they do in the traditional financial metrics of profit and loss,\u201d Sunak told the COP. As a result, the UK is the first country in the world to have incorporated the framework drawn up by Michael Bloomberg\u2019s Task Force on Climate-Related Financial Disclosures into its disclosure requirements for listed companies and large asset managers.<\/p>\n\n\n\n

Britain formally left the EU in January 2020. In practical terms, it remains fully aligned with the EU on ESG and sustainability. Eight months after Brexit, the City minister, John Glen, told<\/a> an ESG conference that Britain would, at the very least, match the EU\u2019s Sustainable Finance Action Plan. \u201cWe are working hard to support the sustainability and responsible investing agenda,\u201d Glen said. These were not empty words. That year, the Financial Reporting Council (FRC), the regulator overseeing corporate governance, reporting, and auditing, issued a revision of its investment managers\u2019 stewardship code<\/a>.<\/p>\n\n\n\n

Tice observes that the revised code has the PRI\u2019s fingerprints all over it. All 12 of the FRC\u2019s \u201cstewardship\u201d (a word that has been twisted to mean the opposite of what it should) principles embed a sustainable approach to investing, requiring investors to identify and respond to supposed systemic risks, including climate change and to integrate ESG and climate change into their investment processes. UK-listed companies operating mainly in the UK are required to produce net zero transition plans that are to be vetted by a Transition Plan Taskforce<\/a>, cochaired by the CEO of one of Britain\u2019s largest insurers and a Treasury minister.<\/p>\n\n\n\n

While Britain killed off shareholder capitalism through regulatory fiat, minimal legislative change, and no public debate, at least the EU\u2019s effort involved legislative change and due consideration by the European Parliament. Under the 2020 Taxonomy Regulation<\/a>, large publicly listed companies and all financial-market participants must report the proportion of their activities that meet the standards of environmental sustainability set out in the regulation and further the goals of the European Green Deal and those that do not. The 2022 Corporate Sustainability Reporting Directive<\/a> requires, among other things, sustainability to be embedded into companies\u2019 long-term strategic planning. The Sustainable Finance Disclosure Regulation<\/a> of the same year penetrates deeply into how investment managers should consider and disclose sustainability risks and creates three classes of investment funds: Article 6 for non-ESG funds; Article 8\u2014funds integrating ESG and sustainability; and Article 9 funds\u2014those with sustainable investment as their core objective.<\/p>\n\n\n\n

The sustainability regimes adopted by Britain and the EU are more than a license for shareholder expropriation; they are instructions for systematic shareholder expropriation. It shows that the \u201cS\u201d in ESG really stands for socialization of people\u2019s savings, to be deployed to meet governmental objectives denoted by \u201cE,\u201d principally decarbonization, thereby exposing \u201cG,\u201d notionally about protecting shareholders, as a sham designed to con institutional shareholders into wholesale adoption of ESG. However, neither Britain nor the EU took on board the adverse macroeconomic consequences of transitioning from shareholder to stakeholder capitalism. Asness\u2019s logic shows why savings earn a lower return under ESG. Lower returns require a higher quantum of savings to generate the same future income stream. Having to save more means lower consumption and living standards today and in the future.<\/p>\n\n\n\n

Asness\u2019s logic on the outperformance of the unconstrained versus the constrained investor also applies to economies. An economy constrained by a net zero mandate has fewer choices than an unconstrained one; in particular, it is precluded from using the most efficient sources of energy. Given the high transitional costs of net zero, it is condemned to perform worse than it would without the net zero constraint. (For this reason, the UN\u2019s claim that net zero promotes achievement of other sustainable development goals, including poverty eradication, is not just illogical; it is immoral.) By directing capital into less productive assets, the economy produces less. Lower returns on productive assets imply lower stock-market valuations and reduced returns on new investment cascade through the economy into weaker economic growth.<\/p>\n\n\n\n

Empirical data on Britain\u2019s efforts to decarbonize power generation with heavy investment in wind and solar capacity bear this out. In my 2023 RealClearFoundation report<\/a> \u201cThe Folly of Climate Leadership: Net Zero and Britain\u2019s Disastrous Energy Policies,\u201d I show that between 2009 and 2020, a 15.5% increase in nameplate electrical generating capacity produced 17.1% less electricity, caused by a 28.3% decline in output per unit of generating capacity over those 11 years.<\/p>\n\n\n\n

The negative microeconomic impacts of the transition from shareholder to stakeholder capitalism aggregating into anemic macroeconomic performance bring to mind Fr\u00e9d\u00e9ric Bastiat\u2019s warning in That Which Is Seen, and That Which Is Not Seen<\/em>: \u201cIt often happens that the sweeter the first fruit of a habit is, the more bitter are the consequences.\u201d Conservative ministers appear perplexed that they adopt antigrowth policies like net zero and mandatory ESG and then find themselves presiding over an ex-growth economy and cruising towards a catastrophic defeat at the general election on July 4.<\/p>\n\n\n\n

Although shareholder capitalism has come under sustained attack from the Biden administration, so far, the US has escaped the fate of Britain and Europe. The Department of Labor\u2019s 2022 ERISA \u201cPrudence and Loyalty<\/a>\u201d rule attempts to force pension fiduciaries to incorporate ESG factors into investment decision-making. The SEC\u2019s recently finalized climate disclosure rule<\/a> aims to inculcate climate-consciousness into corporate decision-making and requires companies to make standardized emissions disclosures so that climate activists can compare and then coerce them into adopting costly decarbonization targets, notwithstanding the fact that, regarding climate disclosures and materiality, the SEC had fulfilled its legislative mandate with its February 2010 guidance<\/a> on climate disclosures.<\/p>\n\n\n\n

Litigation fears likely led the SEC to drop mandatory Scope 3 emissions disclosures, and the withdrawal of some heavyweight financial institutions from net zero investment groups likely reflects fear of potential suits alleging infringement of antitrust law. However, the most effective opposition to ESG has been at the state level, where red states have pushed back against ESG by legislative and legal action as well as by simply taking their business elsewhere.<\/p>\n\n\n\n

This resistance has led the executive branch, in league with its allies on Wall Street, to greater reliance on informal or soft power to bring about the transition from shareholder to stakeholder capitalism: create the impression of the inevitable triumph of net zero, harness market momentum from the Big Three index providers and massive blue-state pension funds to provoke investor herding; and, with the help of an ideologically aligned media, foster a pro\u2013net zero climate of opinion, in which dissenting opinions and contrary narratives are not tolerated\u2014in short, the weaponization of information.<\/p>\n\n\n\n

It is on this battlefield that the third in the trio of books reviewed here is so valuable. Rather than directly confronting ESG and stakeholder capitalism head-on, in May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases\u2014and What We Can Do About It<\/em><\/a>, Alex Edmans provides the tools and, perhaps more importantly, the skeptical mindset to unpick common ESG claims. Edmans, a professor of finance at London Business School, recently wrote two important papers on ESG: \u201cThe End of ESG<\/a>\u201d (2022) and \u201cApplying Economics\u2014Not Gut Feel\u2014to ESG<\/a>\u201d (2023), which overturn conventional thinking on ten key ESG issues.<\/p>\n\n\n\n

Edmans reviewed an early draft of McLean\u2019s book. \u201cWhat better person to get feedback from?\u201d McLean asks. Yet, they are on different sides when it comes to sustainability. All businesses in a capitalist economy are subject to Schumpeter\u2019s perennial gale of creative destruction: \u201cWe can have sustainable economic growth<\/em>, but if we do, then nothing is sustainable at the level of the individual business,\u201d McLean writes. On the other hand, Edmans is a self-described sustainability advocate. Far from blinding him to problems arising out of the concept of sustainability, Edmans says that he seeks out well-informed critiques and views disagreement as valuable.<\/p>\n\n\n\n

Twenty years of research have taught Edmans the lesson of rigorously testing claims. May Contain Lies<\/em> is elegantly structured around an ascent up the ladder of \u201cmisinference,\u201d an ideologically neutral term that does not give off the stench of censorship that often accompanies the usage of misinformation and, especially, disinformation:<\/p>\n\n\n\n