Defining Positive Environmental Behaviors in Business
Sam Weiser, a 2021-22 Environmental Ethics Fellow, and Brian Green, director, technology ethics, both at the Markkula Center for Applied Ethics. Views are their own.
Environmental, Social, and Governance (ESG) considerations have become an important topic in the business world in recent years as investors and financiers increasingly look to ESG criteria when making investing and underwriting decisions. The rise in ESG investing has been paralleled by steadily increasing consumer and shareholder demand for sustainable products as more and more people choose to back products and companies which share their values. There are a variety of ways to evaluate what constitutes positive environmental behavior in business and therein lies perhaps the biggest challenge; objectively and fairly implementing ESG as a governing principle for institutional and individual investors as well as for consumers.
This article will focus on the environmental component of ESG, providing examples of positive environmental behaviors from an ESG perspective. These behaviors include the reduction of negative externalities, a potential shift from shareholder to stakeholder primacy, supply chain improvements, and investments in natural capital.
A business deciding to ‘go green’ can mean many things, and different industries interface with the environment in radically different ways. For this reason, it would be difficult to apply the same set of standards to businesses across all sectors. This paper will explore ways to identify companies with strong environmental performance and also explain some of the broader challenges associated with evaluating environmental behavior through ESG. Due to the interconnectedness of the modern international economy and the rise in human caused global environmental threats, more people than ever before are directly impacted by the actions of individual firms. Businesses’ potential to produce externalities on a global scale requires a proportional increase in corporate responsibility to ensure that people and the environment are not unintentionally being harmed.
- Externalities and ESG
- Shareholders vs. Stakeholders
Despite the increased popularity of ESG and growing collection of proposed ESG standards, there is only partial consensus over what constitutes positive environmental behavior for a business or how heavily to weigh the costs of a business’s environmental damages compared to its potential benefits to the economy and society. The definition of sustainability in ESG has largely been left to the discretion of individual investors [1].
One potential model for assessing a company's environmental behavior involves using the economic concept of externality. A traditional example of a negative environmental externality is a factory polluting a river, thereby worsening the quality of water used by people downstream and likely harming that ecosystem. In popular economic theory, this form of market failure can be corrected through some mechanism which forces the value of external costs to be realized in the creation and/or transaction of this good or service; typically a tax or environmental regulation [2]. A simple way to assess a firm's environmental impacts could be to determine if their business practices are resulting in negative environmental externalities, or if they are taking actions to reduce environmental impacts. This type of analysis could also potentially improve the firm’s long-term viability since they will be insulated from any shocks associated with adapting to more stringent environmental regulations. The modern globalized economy, coupled with the threat of global climate change, has increased the scope and scale of potential environmental externalities. Assessing companies’ environmental impacts through ESG may be an important tool to help correct market failures on a global scale.
One way to consider the broader ESG movement is as a means of transitioning from a system of shareholder capitalism to stakeholder capitalism. Traditionally, corporations were beholden only to shareholders and to the approval of customers consuming their product. Under the stakeholder model, stakeholders may include customers, suppliers, employees, shareholders, and impacted communities [3]. Proponents of stakeholder capitalism suggest that serving the interests of all stakeholders as opposed to only shareholders is essential to the long-term success of a business [3]. Support for stakeholder primacy is increasingly popular amongst business elites. In a 2019 statement Jamie Dimon, chair and CEO of JP Morgan Chase and Co was quoted saying “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term”[4].
If companies are transitioning towards a stakeholder focused model, the next logical question is who to include as a stakeholder in the new model. Since stakeholders include those with an active interest in a firm's performance and actions [3], then people impacted by a firm's externalities are also stakeholders. But if these people are indeed stakeholders, how far does this go? If this were to include those impacted by the effects of climate change caused by greenhouse gas emissions then everybody on the planet would be a stakeholder. However, this becomes problematic because the CO2 emissions produced by firms also provide energy for the economy - manufacturing, heating, power, and transportation - that most people in the developed world rely on and benefit from daily. Additionally, placing blame for these emissions exclusively on energy extractors and producers of direct emissions doesn't place any responsibility on recipients of the energy produced. Any thoughtful assessment of environmental behavior in ESG should consider who is responsible for and affected by a firm's negative environmental impacts.
- Supply Chains and Natural Capital:
- How far should ESG Go?
Actively pursuing positive environmental behaviors and promoting sustainability can be in some cases as important as mitigating negative environmental impacts. Additionally, proactive environmental policies can, in many instances, be good for business. For example, redesigning supply chains to be more transparent, with fewer single points of failure, and greater insulation from external shocks, can result in decreased carbon emissions and foster environmental and social accountability through all parts of the supply chain. Simultaneously, businesses can benefit from decreased fuel costs and increased resilience during times of global instability. Resilience can turn into real world value [5]. Supply chain stability allows firms to outperform competitors during crisis periods, giving them a key advantage once the economy returns to business as usual [5]. Some additional actions which can insulate firms from supply chain mishaps while also promoting sustainability include, 1) emphasizing nearshore and onshore options which shorten and simplify supply chains, 2) running through various supply shock scenarios to ensure that supply chains are dynamic enough to mitigate risk, and 3) potentially increasing available inventories [6]. For ESG focused investors, firms which employ these strategies are stronger investment choices due to their sustainability and resilience against shocks in an unpredictable and rapidly changing world.
Another example of a practice which can be environmentally beneficial, and can bolster a company’s long-term success, involves accounting for that entity’s relationship to, and reliance on, natural capital. Natural capital is defined by the Convention on Biological Diversity as “world’s stocks of natural assets which include geology, soil, air, water and all living things” [7]. Natural assets provide critical resources as well as ecosystem services which, in some cases, act as the foundation for entire industries. To ensure their own long-term viability, firms have a vested interest in protecting any sources of natural capital which they depend on. For example, some studies have shown that wild pollinators provide between $937 million and $2.4 billion in economic benefit to California farmers annually, and therefore should work to protect those pollinators [8]. Another example of increasingly important natural capital is erosion control. Coastal Mangroves can provide erosion control and act as a natural buffer for flooding and wave action which impact low-lying tropical areas during storms [9]. If sea level rises and storms intensify due to climate change, the health of mangroves will be increasingly important to the continued economic productivity of impacted regions; specifically Southeast Asian manufacturing and textile hubs as well as fisheries [10]. Organizations which depend upon these trees to protect their land should be motivated to protect them. As an investor or business owner examining business practices, supply chains, and the stock of natural capital used, it may be beneficial to think about how the business would operate without oil with only a few weeks’ notice, if the lights didn’t turn on tomorrow, if energy prices skyrocketed, or a key supplier can no longer perform because their factory and community were flooded [11]. Positive environmental behaviors in a business should minimize risk by ensuring the long-term viability and sustainability of energy resources and physical inputs. Any firm interested in their long-term success should be aware of their dependence on various forms of natural capital and take actions which ensure the continued abundance of these resources.
The examples above are only a few of a wide variety of ways companies can improve their environmental practices while still creating value for their business. Currently, the definition of positive environmental behavior varies amongst different businesses, investors, and accrediting firms. Positive environmental behavior becomes even more difficult to quantify in conjunction with other ESG principles. The ESG ratings of electric car manufacturer Tesla exemplifies this subjectivity. When assessed by 3 major ESG accreditors - FTSE Russell, MSCI, and Sustainalytics - Tesla achieved wildly different ratings. MSCI ranks Tesla at the top of the industry, Sustainalytics gave them an average rating, and FTSE rated them as the worst car maker globally on ESG issues [12]. Differences come down to what themes are given priority and what is included in quantifying environmental performance. For example, part of the reason that FTSE gives Tesla a zero on the environment is because its rating system doesn’t include vehicle emissions in its accounting [12].
Differences in ESG ratings are very concerning due to the volume of capital invested based on these ratings. If private investors and managers of ESG focused mutual funds blindly follow the guidance of specific scoring systems, there could be major consequences for firms unfairly included or excluded from ESG capital resulting in rewarding companies that harm the environment and harming firms which could play a key role in solving the world’s most pressing environmental issues. Additionally, if different ESG ratings inform high volumes of investment decisions, accrediting organizations with vested interests in certain firms could participate in non-competitive behavior by adjusting scoring criteria to help the score of preferred firms and reducing the score of rival firms. ESG investors should make every effort to identify and utilize impartial rating systems but should also conduct their own investigation into a company’s business practices and environmental impacts when assessing whether or not the organization is aligned with their values.
So, “How far should ESG go?” The answer is that evaluations should be comprehensive, industry specific, and should not only address negative environmental impacts but also incorporate a cost-benefit analysis in terms of the value a company’s goods or services provide to society and the environment. It is critical that investors or businesses have access to accurate, unbiased information, so that they have the tools necessary to decide how much weight to give ESG in influencing business decisions. In any case, individuals, not governments or accrediting groups, should be the final decision makers when it comes to picking winners and losers on the ESG playing field.
Conclusion
ESG offers an opportunity for more business accountability and in many ways marks a significant shift away from shareholder primacy towards a more stakeholder-oriented model. One of a business’ primary goals under a stakeholder model is to minimize negative externalities. Who is included as a stakeholder is an important question which will, in part, determine the extent to which ESG firms assign value to other goals besides generating profit. For investors who are currently exploring different companies' environmental impacts, some positive behaviors might include reducing negative externalities, embracing a stakeholder model, developing transparent and optimized supply chains, and investing in sources of natural capital. If correctly implemented, these behaviors can be beneficial to a firm’s long-term success by improving risk management and providing resilience from a variety of market disruptions. The rise of ESG doesn’t come without its own risks. The inconsistency of ratings means ESG needs to mature as a field and become more comprehensive and coherent in its ratings. If too much authority is wrongly given to an unscrupulous or shoddy accrediting body it may unfairly harm businesses and the entire free and open market. Due diligence on the part of businesses and investors will be increasingly important to ensure ESG under false pretenses does not result in market manipulation. If investors and businesses are cognizant of the potential pitfalls of ESG, and take steps to avoid them, hopefully ESG will improve the relationship between businesses, the environment, and people around the world. Ideally, ESG will continue to encourage businesses and investors to make thoughtful long-term decisions which help not only the environment, but all of humankind.
Works Cited
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