What is ESG#
McKinsey has done an excellent job defining ESG in my view. According to their report referenced at the end,
| Area | Criteria / Conent |
|---|---|
| Environmental | Environmental criteria include
|
| Social | Social criteria address:
|
| Governance | Governance is the internal system of practices, controls, and procedures a company adopts in order to govern itself,make effective decisions, comply with the law, and meet the needs of external stakeholders |
Five Ways ESG Creates Value (McKinsey)#
ESG may link to cash flow in five important ways: facilitating revenue growth, reducing costs, minimizing regulatory and legal interventions, increasing employee productivity, and optimizing investment and capital expenditures.
| Areas | Mechanism |
|---|---|
| Revenue Growth | 1. A strong ESG proposition helps companies tap new markets and expand in existing ones. 2. When governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford fresh opportunities for growth 3. ESG can also drive consumer preference. - price premium |
| Cost Reductions | Recognizing the opportunities to save and reduce waste |
| Reduced regulatory and legal interventions | A lot of industries are heavily rely on government support to survive. (value at risk) |
| Employee Productivity uplift | 1. help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Employee satisfaction is positively corre lated with shareholder returns. 2. The stronger an employee’s perception of impact on the beneficiaries of their work, the greater the employee’s motivation to act in a “prosocial” way. 3. positive social impact correlates with higher job satisfaction, and field experiments suggest that when companies “give back,” employees react with enthusiasm. |
| Investment and asset optimization | Can enhance investment returns by allocating capital to more promising and more sustainable opportunities (for example, renewables, waste reduction, and scrubbers). |
Reference:
Mind the False Reasoning Trap (Damodaran)#
In Damodaran’s post and video session about ESG, he often highlights the causation between being “good” (practicing strong ESG principles) and being “profitable.” It is true that many articles claim companies with good ESG practices are more likely to achieve superior profitability. However, the causation direction may be different. It could be that companies with higher profitability simply have more resources to brush up their ESG marketing and practices.
This perspective raises the classic statistical pitfall of reverse causation or endogeneity, where it’s unclear if ESG practices lead to profitability or if profitability enables stronger ESG initiatives.
Reference:
