ESG has become a contentious corporate and political battleground.
In late September, Republican senators in the United States warned bank CEOs to steer clear of ESG (environmental, social and governance) issues. Pennsylvania’s Pat Toomey, a member of the Senate Banking Committee, noted, “I can’t help but observe that when banks do weigh in on highly charged social and political issues, they seem to always come down on the liberal side.” And in May, former U.S. vice-president Mike Pence claimed that ESG is “injecting left-wing politics into business.”
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These are strong words for a concept focused on disclosing a company’s ESG performance, Muhammad Asif of Plymouth State University and Cory Searcy of Toronto Metropolitan University wrote earlier this fall for Corporate Knights. The answer, however, is not to drop ESG disclosure; it is to make it mandatory.
ESG disclosure is largely voluntary in many countries, including the U.S. and Canada. Reporting on a company’s carbon footprint, working conditions in its supply chain, and board composition are just a few of the many issues disclosed under the ESG umbrella. These disclosures are often made in response to pressure from investors, customers, employees, and other stakeholders under the belief that public reporting may encourage improved performance.
Unfortunately, numerous instances of gross social and environmental malpractice show the limits to voluntary activities. The key problem with voluntary ESG reporting is the gap between corporate claims and actual practices.
Perhaps the most infamous case from the past decade is Volkswagen, perpetrator of the “Dieselgate” emissions scandal, despite previously being lauded as a model of voluntary ESG disclosure. More recently, Deutsche Bank’s offices were raided this past May to investigate greenwashing charges in its asset management unit, DWS. The key allegation is that DWS was misrepresenting financial products as green and sustainable. In June, the U.S. Securities and Exchange Commission (SEC) announced it was probing Goldman Sachs’ ESG funds.
These examples represent just the tip of the iceberg. The continuing emergence of ESG scandals and false disclosures indicate the ongoing seriousness of the disconnect between stated and actual performance.
There is some movement toward mandatory ESG reporting in the United States and elsewhere. The SEC is currently working to make disclosure mandatory. Climate-related financial disclosures are already required for UK registered companies and financial institutions. Other mandatory disclosure requirements focus on working conditions in supply chains.
The California Transparency in Supply Chains Act, for example, is aims to prevent human trafficking in supply chains. The International Sustainability Standards Board is developing an ESG reporting standard that will be mandatory for UK companies by 2025 or earlier.
Mandatory ESG reporting is not a panacea and does not guarantee excellent environmental, social and governance performance. There will still be possibilities for errors, misrepresentation, and outright fraud. Some companies may choose to accurately report poor performance and take no action to remedy it.
Mandatory ESG reporting does, however, build an expectation for corporate accountability and is likely to increase the authenticity of public disclosures. Most voluntary disclosures are unaudited, and mandatory reporting will invite greater scrutiny and assurance of ESG data. Mandatory disclosure will also signal that ESG is a strategic concern and will discourage practices that decouple stated and actual performance, such as greenwashing.
To be sure, regulators should remember that companies have many positive impacts on society. While many disclosures undoubtedly focus on mitigating negative impacts, disclosures of a company’s positive contributions should be encouraged. This could potentially be grounded in the United Nations’ Sustainable Development Goals, such as the provision of decent work and promoting responsible consumption.
Regulators must also guard against imposing overly burdensome requirements that companies cannot realistically be expected to meet. Mandatory ESG disclosure should be restricted to core issues of greatest interest to investors, consumers, and broader society. For example, The Economist recently argued that ESG fundamentally comes down to emissions. Some mandatory requirements could also differ by industry.
ESG is too important to become a partisan political issue. ESG is not about imposing “woke capitalism” or establishing a “climate cartel.” Rather, it is about building better businesses and a stronger society. Mandatory ESG reporting will help guard against unsustainable and unethical corporate practices while also highlighting the positive contributions business makes to broader society.
There is room for debate about what mandatory disclosures should be, Asif and Searcy said. But the time to establish and strengthen mandatory ESG disclosure requirements is now.
Muhammad Asif is an associate professor of management sciences at Plymouth State University.
Cory Searcy is a professor and the vice-provost & dean of the Yeates School of Graduate Studies at Toronto Metropolitan University.
This post was first published by Corporate Knights on October 26, 2022. Republished with permission.