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Kenan Institute 2022 Annual Theme: Stakeholder Capitalism
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Market-Based Solutions to Vital Economic Issues
Kenan Insight
Feb 17, 2022

ESG Measurement: A Surprisingly Complex Issue

Part of our series on: Stakeholder Capitalism

In her recent book, “Reimaging Capitalism in a World on Fire,” Rebecca Henderson posits that capitalism should be reimagined so that companies “embrac[e] a pro-social purpose beyond profit maximization and tak[e] responsibility for the health of the natural and social systems.” She also states, “[I]t took me a surprisingly long time to embrace the idea that accountants hold the key to saving civilization. Even tiny changes in accounting rules can change behavior in profound ways.”

Our deep dive into stakeholder capitalism has exposed shortcomings in a key building block – ESG measurement. As a result, we propose ways of refining these measures to produce structures that could potentially meet the needs of multiple stakeholders; designing reporting that is free from political influence and agendas; and illustrating the promise and risks of impact accounting.

The Crucial Role of Performance Measurement in Legitimizing ESG Strategies

Long-running literatures in accounting, economics, finance and business practice examine the powerful role that performance measurement plays in shaping behavior – as well as the potentially deleterious effects caused by schemes that measure the wrong things, miss important factors, or specify performance measures that poorly map to the underlying factors of interest. Given that, it is useful to consider ESG measurement in the context of performance measurement systems more generally. Such systems include accounting standards developed by the Financial Accounting Standards Board (FASB) and International Financial Reporting Standards (IFRS), innovative costing methodologies like activity-based costing, and a wide range of non-financial performance measures directly used in compensation contracts as well as strategic tools such as balanced scorecards.

The corporate organizational form has benefited from these standards and proven to be a powerful and dynamic mechanism for driving economic growth and prosperity. Well-designed performance measurement and disclosure systems play a central role in this success. Characterized by a separation of decision-makers from suppliers of finance, the success of the corporate form relies on the presence of effective incentives that deter managers from cheating investors out of the value of their investments, and that motivates managers to maximize firm value instead of pursuing personal objectives. Audited financial statements and related disclosures support the existence of vibrant capital markets and form the foundation of the firm-specific information set available to investors, boards, internal corporate managers, and other stakeholders to monitor and discipline the actions and statements of insiders.

The Ideological Struggle Behind the ESG Debate for Standardized Measurements

As we move forward to create standardized measures, it is paramount to consider the ultimate objectives of ESG measurement and how such measurement could optimally fit into the existing corporate order and information regime. The challenge is that ESG measurement is inextricably tied to diametrically opposed views on the purpose of the corporation, and directly related to debates about whether shareholder primacy or stakeholder governance should prevail.1 This debate is reflected in the evolving demand for ESG information from clienteles with diverse objectives and incentives, including:

  • Corporate executives managing internal capital allocation decisions and dealing with pressure from investors and myriad stakeholder groups.
  • Investors seeking ESG information to enhance the risk-adjusted returns of their investments, or to incorporate their social and environmental preferences into their investment portfolios, even if it lowers return performance.
  • Billionaires, regulators, activists, NGOs and others seeking to transform existing economic and political institutions and/or implement political objectives outside of normal political channels.2
  • Financial service firms, rating agencies, proxy advisors, accounting and consulting firms, and academics seeking to benefit from providing ratings and investment products, consulting on ESG issues, and attesting to ESG disclosures.3

Clearly, a single ESG measurement structure cannot satisfy such diverse objectives. Moreover, it is not clear that all of these objectives are desirable. Because of this, developing a neutral set of standards is critical to create a basis to understand the value created by different stakeholders and, therefore, to allow an unbiased perspective to help managers make difficult trade-offs across the interests of various stakeholder groups

Are Companies Either Good or Bad?

Much of the discussion surrounding ESG is couched in terms of differentiating between “good” and “bad” companies, but there is unlikely to be agreement on which companies fall into which category. Further, such a stark good-versus-evil view of the world can have unintended consequences. For example, a recent a recent paper examines ESG investing in the context of green patent production (e.g., patents with the potential to contribute to mitigating environmental problems).4 The authors find that find that oil, gas and energy-producing firms are key innovators in the green patent landscape. However, these firms are explicitly excluded from many ESG funds and are often the targets of divestiture campaigns focused on stimulating green energy innovation – campaigns which may actually discourage green innovation.

Our perspective on corporations is exacerbated by the current state of the ESG reporting landscape, which is characterized by many ESG ratings firms, idiosyncratic voluntary disclosures by corporations and mandatory reporting requirements that vary by jurisdiction. A recent study reveals this complexity by analyzing ESG rating data from six prominent ESG ratings agencies.5 The study finds that such ratings from different providers disagree substantially, with correlations between the ratings ranging from 0.38 to 0.71. Digging deeper, they find that the six agencies combined report 709 individual ESG indicators, where the indicators used vary substantially. Such divergence makes it difficult for investors and other stakeholders to evaluate the ESG performance of companies. This also imposes significant challenges for companies managing competing pressures from various stakeholder groups. How does a firm make inevitable trade-offs across categories that are valued differently by different clienteles?  Do managers view ESG scores as a problem to be managed rather than as tool to solve social issues and mitigate climate change?

Refining the Objectives of ESG Measures

Instead of the multi-stakeholder focus of current ESG ratings and disclosures, perhaps it makes sense to create narrower versions of ESG that focus on specific clienteles. Consider the demand for information by investors for value-relevant information about firms. This demand is supported by mandated public reporting, securities laws and enforcement mechanisms that prohibit false and misleading information, highly developed accounting standards and sophisticated financial intermediaries. Current ESG reporting embeds information that is immaterial from an investor standpoint, but still important to other stakeholders. Our idea would be to tailor ESG reporting to financially material sustainability information. Alternative measurement structures could then be designed to meet the needs of other stakeholders.

This is indeed the approach that the Sustainability Accounting Standards Board (SASB) has taken in defining material issues with evidence of both financial impact and wide interest from a variety of user groups. The SASB materiality criteria can be used to create tailored sustainability measures or be overlaid on existing ESG ratings reports to separate financially material and immaterial measures. This focus provides an opportunity for researchers and others to evaluate the efficacy of measures with respect to their valuation consequences. Research to date has yielded mixed results.6 But, it has been limited by the fact that much sustainably reporting is voluntary, and thus suffers from self-selection issues, the difficulty in distinguishing the measures from the underlying real behavior of firms, and the necessity of relying on third party ratings that, as discussed above, are far from perfect.7 Moreover, until there is widespread acceptance by accounting standard boards and government agencies, there will be questions about whether SASB is an unbiased measure.

Designing ESG Reporting Free from Political Influence and Agendas

We believe ESG reporting requirements should be managed more like the process of accounting standard setting. Accounting standards are the product of well-defined objectives and a transparent process designed to mitigate the influence of political pressure and achieve widespread acceptance. Standard setters like the FASB solicit input from business leaders, academic researchers and regulators around the world. Comment letters to the board are made publicly available and many board meetings are publicly broadcast.

It is also imperative that accounting standards adopt the principle of neutrality, where standard setters view themselves as providers of unbiased information to facilitate social and economic activity by others, rather than as agents to promote (or discourage) social and economic change.8 In order to create neutral ESG reporting standards, it is paramount that the funding structures of the standards be transparent, and the standard setters themselves be chosen and compensated in a manner than minimizes capture by outside interests.

Converting ESG Measures into Monetary Units: Impact Accounting

Given the importance of accounting on economic behavior, a growing movement proposes that better accounting practices can help transform and redirect capitalism onto a more sustainable track. The concept, known as “impact accounting,” seeks to comprehensively measure how individual companies impact stakeholder welfare, and then translate these financial, social and environmental impacts into monetary values that can be integrated into the current accounting framework.9 Instead of focusing on financial wealth creation as measured by profits, the new bottom line aims to reflect the total impact.

The tremendous ambition of impact accounting holds the promise of changing capitalism, but also poses great risk for existing economic arrangements that have delivered enormous prosperity. Despite decades of research, discussion and debates, accountants have still not resolved how to reliably measure important economic constructs, such as brand value, R&D intangibles, human and organizational capital, and marginal cost. Yet, impact accounting seeks to put a monetary value on the impact of products and operations on people, the environment and the planet, and then add or subtract it from companies’ profits.10 The level of judgment and the potential for ideological bias in determining these monetary values is enormous. What is the monetary value that credit card companies should bear for consumer depression due to credit card debt, or airlines for flight cancellations, or food producers for obesity? To be complete, this system would also have to overcome the difficult task of measuring the consumer surplus that is derived from every product, service, and policy at every company.11

There is a clearly a lot of work yet to be done in the areas of ESG measurement and impact accounting. These endeavors hold great promise, but pose significant challenges in balancing economic prosperity with the solutions to the many complex issues facing our global population.


1 For further discussion, see https://kenaninstitute.unc.edu/kenan-insight/is-money-left-on-the-table-when-we-dont-listen-to-stakeholders/.

2 Some argue that the ESG movement represents a libertarian response based on the view that government lacks credibility and is not a likely source of solutions to broad societal problems like social injustice and protecting the environment (e.g., Macey, 2021).

3 The potential for conflicts of interest when a firm both provides ESG ratings and consults on how to raise ESG ratings was highlighted in a recent Wall Street Journal article.

4 Cohen, L., Gurun, U.G., & Nguyen, Q. (2021). The ESG - Innovation Disconnect: Evidence from Green Patenting (European Corporate Governance Institute – Finance Working Paper No. 744/2021). SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3718682

5 Berg, F., Kölbel, J., & Rigobon, R. (2019). Aggregate Confusion: The Divergence of ESG Ratings (Working Paper). SSRN.

6 This includes papers that specifically examine valuation implications of the SASB materiality criteria (e.g., Kahn et al., 2016; Berchicci and King, 2021; Grewal et al., 2020), and carbon disclosures (e.g., Bolton and Kacperczyk, 2021a, 2021b; Aswani and Rajgapol, 2021).

7 Christensen, H.B., Hail, L., & Leuz, C. (2021). Mandatory CSR and Sustainability Reporting: Economic Analysis and Literature Review (European Corporate Governance Institute - Finance Working Paper No. 623/2019). SSRN. https://ssrn.com/abstract=3427748

8 Solomons, D. (1991). Accounting and social change: A neutralist view. Accounting, Organizations and Society, 16(3), 287-295. https://doi.org/10.1016/0361-3682(91)90005-Y

9 Serafeim, S. & Trinh, K. (2020). A Framework for Product Impact-Weighted Accounts (Harvard Business School Working Paper Series 20-076). Harvard Business School. https://www.hbs.edu/impact-weighted-accounts/Documents/Preliminary-Framework-for-Product-Impact-Weighted-Accounts.pdf

10 Stuttaford, A. (2020, December 11). Counting the Shareholder Out: When the Ruling Class Changes the Rules. National Review. https://www.nationalreview.com/2020/12/counting-the-shareholder-out-when-the-ruling-class-changes-the-rules/

11 King, A.A. & Pucker, K.P. (2021, September 21). Heroic Accounting. Stanford Social Innovation Review. https://ssir.org/articles/entry/heroic_accounting#


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