A call for clearer thinking on sustainability
Alex Edmans never set out to be an academic specializing in sustainability. By his own account, the former investment banker was inspired to enter the field after his research suggested some sustainability factors can lead to long-term outperformance for investors and corporates alike.
Now the Professor of Finance at London Business School is driving the ESG debate into new territory. He is motivated by what he identifies as a lack of clear-headed thinking in this space.
On one hand, he says, some sustainability champions base their support on “flimsy data”. They may put the goal of addressing sustainable and societal issues above other performance markers: “Some of the pushback against ESG is actually well-founded, because some advocates pushed for advancing sustainability goals at the expense of long-term shareholder value”.
“But there is also a lack of rational thinking on the opposite side,” he adds. “There are skeptics who will argue that sustainability is, by definition, at the expense of financial performance.” At the extreme, he cites lawmakers in who are proposing criminal punishment for the consideration of ESG factors in investment decisions: “Why would you want to ban considering factors that can enhance your investment returns?”
A rational approach to value creation
Edmans’ solution is not designed to be a rebranding of ESG, but a fundamental shift in approach. It was guided, he says, by the practices of the best investors, and partly shaped by his role on the responsible investment advisory committee of Royal London Asset Management, chaired by Ben Yeoh of RBC.
“We will always try to look at different perspectives and recognize that an issue which is often perceived as black and white might well be more nuanced,” says Edmans of that committee.
Another inspiration was a discussion that arose in his advisory role with a real estate firm. The conversation focused on a strategy to buy a portfolio with green building certifications. The group questioned whether these assets were already fully priced and, despite the positive climate impacts, could potentially negatively impact the long-term returns of the firm.
“I said, this sounds like rational sustainability,” he says – a thought that led to a research paper with that title.
His definition is supported by ten features. “The first five focus on sustainability, which is the outcome: long-term value creation,” Edmans explains.
“Then the rational element describes how you get there, the approach – which is considering the evidence using not only quantitative factors but also qualitative ones, acknowledging the existence of trade-offs and diminishing returns”, which are equally applicable for sustainability issues as they are for financial factors.
Embedding strategy into corporate purpose
Those companies seeking to leverage their corporate purpose as a strategic enabler, not just a marketing tool, should ask themselves two questions, Edmans says. The first is how their purpose will change business decisions.
He cites Novo Nordisk, and their approach to allocate their limited stocks of obesity drugs to countries with the highest incident of disease, rather than where prices are highest, aligned with their overall mission. Strategic decisions such as that recognize that there are trade-offs to sustainability: companies make seek to prioritize certain outcomes and this may impact other ESG factors such as the carbon footprint of the product.
The second question for companies is whether they would still pursue their purpose if they could not communicate it. “This ensures you are doing something for the right reasons – you think it’s going to create long-term value.”
Edmans points to corporate diversity initiatives as an example: “You can certainly communicate the percentage of minorities within the workforce and on the board. You can’t communicate what you are doing to create a psychologically safe corporate culture that encourages different viewpoints – but that is the action that is going to improve long-term value.”
“When you are using your competitive advantage, you can achieve a lot of social impact.”
Alex Edmans, Professor of Finance, London Business School
Edmans advises businesses to leverage their own strengths when setting sustainability goals. He cites Vodafone’s use of its telecoms expertise to launch M-PESA, a mobile money service designed to deliver financial inclusion in Kenya.
“When you are using your competitive advantage, you have this magnifying effect, and you can achieve a lot of social impact” he adds.
How investors can unearth a sustainability advantage
From an investor viewpoint, one way to gain an edge is to seek out ESG data that is not mandated disclosure by the regulators, Edmans says. For example, if it is not mandatory to report on diversity of experience or socioeconomic background, but an investor knows that one company is hiring on this basis, it may lead to additional insights on the structure of the workforce and the corporate culture that others are not considering.
“If regulation is not causing companies to disclose information, investors can find other sources, such as Glassdoor employee reviews, to find out about corporate culture.”
“What I’m trying to promote is a more nuanced, more holistic approach to this complex issue, which has sometimes been reduced to a simple set of numbers.”
Alex Edmans, Professor of Finance, London Business School
Edmans is continuing to explore the field, with a new academic survey of over 500 portfolio managers that probes their objectives in sustainable investing. He believes this can yield deeper insights on the evolution of the practice as it moves toward Rational Sustainability, which in his view, has the potential to create long-term value for shareholders and society.
