Why Aswath Damodaran Is Mistaken On ESG Criticism

Concerned ESG activists

The critique of ESG investing by Aswath Damodaran, finance professor at the Stern School of Business in the FT, offers a scathing view that questions the framework’s value and effectiveness. While criticisms should be acknowledged for any nuanced understanding of the subject, the points raised in the critique often misrepresent or oversimplify the complexities of ESG.

Firstly, it is essential to recognize that evolving objectives are common in emerging fields. The article argues that ESG has moved from a measure of”goodness” to an instrument for higher returns and lower risk. However, geopolitical events like the Russian invasion of Ukraine are not a sweeping indictment against ESG but a specific context affecting all investing forms.

One of the major arguments presented is the supposed ambiguity in ESG definitions. The critique argues that ESG measures “everything and therefore nothing,” oversimplifying a complex issue. ESG metrics range from carbon emissions to employee welfare, offering a comprehensive approach to responsible investing. This diversity allows for adaptability and refinement as best practices emerge.

Another issue raised is the impact of ESG on value and returns. While the critic argues that ESG can both positively and negatively affect companies, empirical studies have indicated that companies with strong ESG practices often outperform their counterparts in the long run. It’s a misstep to state that ESG’s varied impact on individual companies negates its overall positive effect on long-term value.

Aswath Damodaran also highlights what they perceive as a risks and returns paradox in ESG investing. The notion that less risky assets should offer lower expected returns is a foundational financial principle, but it doesn’t automatically negate the value proposition of ESG. The market’s growing emphasis on sustainable practices suggests that ESG portfolios can offer risk mitigation and potentially higher returns.

Another point made in the critique is the selective application of ESG scores. While it’s true that the pressures of ESG are applied unevenly, this doesn’t debunk the ESG approach but highlights areas where it can grow to make a broader impact. For instance, the role of private equity in fossil fuels is an implementation challenge rather than a fundamental flaw in the ESG concept.

As a component of ESG, governance is also questioned in the critique. He posits that managerial accountability becomes diluted when expanded to multiple stakeholders. However, this broader accountability can be a strength, offering a more holistic view of corporate responsibility. If corporate executives were better at managing labour relations, they would not have to work record levels of strike action in the USA.

Lastly, the critic argues that ESG will fail in its societal objectives, overlooking the documented successes in driving positive social and environmental changes. While not a silver bullet for all societal issues, ESG remains a valuable tool for influencing corporate behaviour towards more sustainable and equitable practices. The issues of greenwashing and greenhushing will increasingly be managed through regulation and asset owner expectations.

In conclusion, while it’s essential to critically examine ESG investing, the critique under consideration fails to appreciate its complexities and potential benefits. ESG is a complex and evolving field that merits a nuanced analysis rather than broad-stroke criticism. Dismissing it entirely would be overlooking its positive impacts and future potential. Even one of the best finance professors in the world can get it wrong.

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