There is no doubt that ESG both as a concept and as a social, political, and litigation phenomenon has changed over time. Due to political backlash and changing investor priorities, ESG and ESG-related issues recently have featured less prominently in general economic and business dialog than even just a short time ago. An interesting and thought-provoking May 2, 2024, article (here) from the Rock Center for Corporate Governance asks the question whether the circumstances surrounding ESG are changing because ESG “is a luxury good”? (Hat Tip to Cydney Posner’s May 13, 2024, post on the Cooley law firm PubCo blog, here). The article raises some interesting questions and reflects interesting data and observations.

The article begins with the authors’ comment that “enthusiasm for ESG has waned.” As evidence of the declining prominence of ESG as an issue, the authors cite a number of items: the significant outflow from sustainability funds; the decline in investor support for environmental- and social-related proxy proposals; and the decline in the number of companies discussing ESG in quarterly conference calls. The article also notes that more than 20 states have enacted laws and regulations to limit the use of ESG criteria in investment selection. The authors observe that “whether ESG has hit a cyclical peak or is in permanent decline is not known.”

The authors then go on to observe that to date, “many boards have viewed investment in ESG as economically – or at least socially — beneficial.” However, because there has been little research by researchers that have no preferred outcome, the economic consequences of ESG “have never been rigorously demonstrated.” In the absence of this kind of evidence, and with “demand for ESG in reverse,” boards now must face the question of what changes, if any, to make to their companies’ ESG-related initiatives. In order for boards to make this assessment, “it bears considering,” the authors assert, “how investors view the ESG characteristics of firms in their portfolio.”

The authors then consider the possibility that ESG is a “luxury good” – that is, “an item whose demand increases with price.” Think of brands like Rolls Royce or Tiffany, which can command a premium for their products.  Demand for these kinds of goods changes not with respect to the raising or lowering of the price of the goods, but rather with the economy: “When consumers are feeling flush, they are more likely to purchase a luxury good; when their wealth falls, demand for these specific types of good also falls.”

In support of their proposition that ESG is a luxury good, the authors note that the rise in ESG initially took place when “there was rising economic prosperity, low inflation, and a strong bull market.” However, now “economic headwinds” – such as rising interest rates, higher inflation, and economic pessimism, “there is,” as noted above, “evidence that investors’ taste for environmental and social advocacy has waned.”

In support of their theory that ESG interest has declined with the economy, the authors cite Stanford University Research showing that whereas in the past young investors were willing to forfeit up from 6 to 10 percent of their investment savings in order to support sustainability issues, today, the same investors say they would give up only 1 to 5 percent. By the same token, many fewer of these same investors report owing an ESG fund or ETF than in the past. Similarly, “institutional investors have backed off their commitment to ESG,” with many fewer institutional investors explicitly considering ESG factors as “central to their investment thesis.”

In light of these considerations, and if, as the authors postulate, ESG is luxury good, then boards “will want to rethink how they plan, prioritize, and invest in ESG,” particularly “if demand of ESG follows the economic pattern of a luxury good rather than a basic necessity.” In particular, the authors suggest, boards will want to “be more deliberate about the initiatives they support, prioritizing those with a clear link to the companies’ business model.” Management should be asked to justify “how each contributes to the financial performance or risk reduction of the firm.”

In prosperous times, companies might well choose to increase investment in broader set of initiatives but expect to decrease these when times change. Nevertheless, “boards will want to maintain investment in the core set of ESG initiatives through the business cycle.” When times are tough and stakeholder pressure is higher, “the board will want to be able to point to the long-term investment it made and explain how these served the dual-purpose that ESG always purported to support, increasing both profit and social welfare.”

Discussion

The authors make several interesting observations. I should add that the authors’ paper contains quite a bit of quantitative information documenting declining prominence of ESG as an issue, and for that reason I recommend a full reading of the authors’ paper.

The authors’ premise, that ESG should be understood as a luxury good, is interesting. I am concerned that the paper may understate and perhaps even underestimate the extent to which ESG-related issues have, at least in the U.S., gotten caught up in the larger social wars that so regrettably has come to divide the country on so many issues, and that this development explains in significant part the waning of ESG. Pressures from these kinds of political developments clearly explain at least in part the declining prominence of ESG as an item of corporate or business dialog — companies are self-censoring themselves away from potentially controversial issues by avoiding talking about ESG at all, a practice that has come to be known as “greenhushing.”

In a prior post, I noted the ways in which many companies, seeking to avoid controversy, have elected to change their vocabulary, now referring to initiatives that in the past were ESG-related as “responsible business” or by other similar euphemisms. The interesting point is that the initiatives themselves have not necessarily been discontinued, but the way in which companies refer to them has changed (which may explain at least in part the way that ESG as an issue has, as the authors note, appeared to be waning).

Where I think the authors’ analysis is particularly interesting is in their discussion of the way companies should conduct themselves if, as the authors postulate, ESG is in fact a luxury good. First of all, as the authors note, if ESG is a luxury good that investors appreciate most at various points in the business cycle, then “the board will want to maintain investment in its core set of ESG initiatives through the business cycle.” Perhaps more importantly, in order to justify this continued commitment through the phases of the business cycle, the board should be prepared to show how “each initiative contributes to the financial performance or risk reduction of the firm,” and explain how these initiatives serve “the dual-purpose that ESG always purported to support, increasing both profits and social welfare.”

From my perspective, the authors’ prescriptions of how boards should proceed have an added virtue, in that their proposed approach could insulate the company and the board from at least some kinds of ESG-related corporate and securities litigation. Certainly, an ESG-related approach built around the long-term interests of the company could help insulate the company from the kind of backlash litigation that has characterized so much of the ESG-related litigation. To be sure, a company-focused approach to ESG might still leave companies vulnerable to advocacy-group litigation accusing companies of failing to insufficient ESG-related action, but so far at least there has been relatively little of this kind of litigation.

Perhaps the most important point here is one that should not be overlooked. That is, the ESG as a social, economic, and political issue has evolved over time. Not that long ago, ESG was THE hot button issue, but it has faded while other issues have become more prominent. But ESG has not and will not go away, even if the role it plays has changed. The continued relevance and changing importance of ESG has many implications, not least among them the likely direction of future corporate and securities litigation involving ESG-related issues. Whether or not ESG is, as the authors suggest, a “luxury good,” the adaptive measure the authors suggest may serve many boards well in the evolving environment with respect to ESG issues.

About the State ESG Backlash Legislation: Readers interested in the impact of the anti-ESG legislation that many states have adopted will want to read the recent paper from the Wharton School discussing the effect of legislation adopted by the Texas legislature. The legislature prohibited the state from doing business with banks that had adopted ESG policies. As a result, several of the large bond underwriters left the state. By decreasing competition, the legislation increased the state’s borrowing costs. The research estimated that in the “first eight months following effectiveness of the legislation, the cities in that state will pay an additional $303 million to $532 million in interest on $32 billion in bonds.”