Evaluate E, S, and G separately: Financial Express 27th November 2023

ESG (environmental, social, and governance) is the latest buzzword in the corporate world, and all companies worth their salt are trying to do well on environment, social responsibility and governance. There are several pages dedicated in the annual reports elucidating what is being done on all three fronts by them. Hence, going paper-less, using less power, growing trees are some manifestations mentioned in the Directors’ Reports. Similarly, donating water coolers to schools is depicted as companies doing social good; and, of course, there are best governance practices reiterated over a few more pages. Hence, all companies do tend to show they are ESG-conscious.

Regulators over the world are also trying to put in place systems to grade companies on ESG performance and, hence, there is a lot of work going on here. The idea is to score companies regularly on ESG so that the progress can be gauged. This is useful for various investors who believe in funding ventures that are ESG compliant. Hence, getting good ESG scores have become a must for companies in order to catch interest of these investors, many of whom have set up dedicated funds. This is one reason why companies are striving to score on these issues. But, does this concept really make sense?

While the three concepts are relevant and, without doubt, need to be pursued by the companies, they capture three different facets of a business’s running which are not related to one another. Protecting the environment is a tricky concept considering that progress made by a country involves negative externalities for the environment. Highway projects, for example, involve cutting of trees and other vegetation and changing patterns of land use, be it farm land or even mountains, to make travel easier. This has no doubt enabled commerce, but the recent episodes of crumbling hills in Himachal and Uttarakhand highlight the broader issue of whether we are doing the right thing in these vulnerable geographies. The Mumbai metro-rail, which will ease a lot of traffic congestion, has already led to the cutting of thousands of trees and can have a deleterious impact on the city in terms of flooding at some point of time.

Then, there are some industries that are inherently environment-unfriendly (a rather obvious instance of this would be the entire petrochemical chain). The question that arises here is whether, by pursuing an activity that is dangerous in the long run and planting trees to offset this impact and become ‘net zero’ by a certain timeline, amends can be considered to have been made. It is worth recollecting that when the wide-scale use of paper gave way to plastics, it was considered to be a major paradigm shift in the way in which society operated, as it meant “saving trees”. But, the proliferation in use of plastics has created a new problem for civic administration in terms of disposal. One never can tell what the sudden shift to EVs can mean in the medium term in terms of negative effects. That said, these issues are completely different from social responsibility, which the government has addressed already by making companies spend a certain portion of profit on CSR (corporate social responsibility).

This has no linkage with what a company does to the environment. Hence companies can be polluting the lakes or rivers with effluents on the one hand but contributing significantly to schools, hospitals, orphanages, etc. Therefore, while finalising any score or rating, can one really put the two on the same plane? The answer is no as the objectives are very different. Further, often only a formal obeisance is paid to such expenses and there may be no real commitment, as companies end up spending exactly 2% of the net profit that is mandated.

The third concept,, that of (corporate) governance, is more of an internal issue where companies are to adhere to rules laid down by regulation. Hence, they need to have a certain number of directors, and a certain number of these directors have to be independent members of the board and there have to be an obligatory female members. A quorum (minimum attendance) of the directors have to met for the Board meetings and there have to be committees to address different issues. These could just mean ticking all the boxes, given how rarely there are deviations from the prescriptions. But, it is well understood that governance cannot be linked with either environment or social responsibility, though companies often have a special committee that looks at the same.

Given this backdrop, it is pertinent to ask if the three can be clubbed together when assigning ratings or scores. Will the three aspects have equal weights or will they vary? A very good score on one of these objectives can go with a low one on the other. Quite clearly, this has become a jumble, because the issues are so different.

While having green bonds make sense as they target just one aspect of ESG, combining the three for any purpose makes the concept fuzzy. It can be argued that environment affects the society at large, but social responsibility is more of doing good for humanity. Here, too, companies that espouse CSR may see nothing amiss in laying off workers on grounds of protecting shareholder value while at the same time spending on social good, quite like what happened during the Covid times. Governance is more of a mandatory compliance that has to be followed, and hence almost all large companies would be fully complaint.

An important question to ask here is how would investors who take decisions based on ESG scores evaluate this puzzle. Ideally, the three issues need to be evaluated on a standalone basis so that it can be seen as to how the company fares on these parameters. Besides, while environment is certainly a national and global issue, social responsibility is more in the realm of ethics, and, ideally, can’t be merely related to any economic activity undertaken. Lastly, governance is again a habit of the boardroom that gets reflected in neither of the other two objectives.