Is ESG Already Over?

It may not seem unusual that a corporate CEO would want to focus on increasing shareholder value, but in October this was treated as big news. A Financial Times headline announced that "Unilever's new chief says corporate purpose can be 'unwelcome distraction.'" That new CEO, Hein Schumacher, went on to explain that he rejected the idea that "every brand should have a social or environmental purpose." He intended, he said, to build a "performance culture" instead.

Why would it be newsworthy for a CEO to be focused on corporate performance? Not long ago, that was simply assumed. What changed?

The change is summed up by three letters of corporate jargon: ESG. The initials stand for environmental, social, and governance factors, and the term dates back two decades. Early ESG documents—such as the 2004 report "Who Cares Wins," produced under the auspices of the United Nations (U.N.)—suggest an effort to globally coordinate private and public sector activity toward a shared set of social objectives. This was a departure from previous efforts at injecting political and moral values into business (such as corporate social responsibility, socially responsible investing, impact investing, and so on) in that it pointed to a future of uniform ESG standards, enforced and encouraged by governments around the world.

The rise of ESG has further blurred the lines between the government and the corporate world. Under an ESG regime, the government is called to advance goals in the private sector and the private sector is called to support the government's policies. The public-private distinction has been foundational to both classical liberal principles and constitutional government, but the line is becoming increasingly difficult to find.

Unilever's history is a microcosm both of the rise of ESG and of the challenges the ESG agenda is now facing. The British consumer packaged goods corporation owns several successful brands, including Ben & Jerry's, Dove, and Magnum. It has prided itself on its ESG credentials, particularly under Paul Polman, Unilever's CEO from 2009 to 2019.

Under Polman's leadership, the company made a series of corporate commitments to environmental and social causes. It supported sustainable agriculture at the World Economic Forum. It helped create the United Nations' "sustainable development goals." It "made a stand to #unstereotype the way men and women are portrayed in marketing." Again and again, it filtered its corporate purpose through a progressive worldview.

While it is now common for brands to advertise their commitments to such causes, Unilever took the lead in incorporating "purpose" into virtually everything it did. Polman often called for CEOs to focus on creating value for a wider group of "stakeholders," as opposed to narrowly focusing on shareholders; he also campaigned for government efforts to fight climate change.

At first, Polman's play worked. In his decade atop the company, Unilever's stock price rose by about 150 percent—"well ahead of the FTSE [Financial Times Stock Exchange] 100 average," The Guardian notes—and it reported decreasing emissions from its factories by 47 percent from 2008 to 2018. Perhaps it indeed was possible to achieve both purpose and profits, to serve both "stakeholders" and shareholders at once.

Toward the end of his term, though, signs of trouble appeared. Kraft Heinz, a firm closely associated with Warren Buffett and his holding company Berkshire Hathaway, made a bid for control of Unilever in 2017. The company rejected the offer. This event carried symbolic meaning, as Buffett has a long history of favoring profits over "purpose." In the fallout, investors increasingly put pressure on Unilever to cut bureaucratic overhead.

After Polman left the company in 2019, his replacement Alan Jope eagerly picked up the ESG mantle. A 2021 Unilever blog post declared that there was "No trade-off between purpose and performance." In 2022, after a backlash against ESG had begun, Jope declared at a Clinton Global Initiative event that Unilever "will not back down on this agenda despite these populist accusations."

Indeed, the populists did not prompt Unilever to back down from ESG. After all, Unilever is a British company, and in Britain, even conservative politicians have embraced aspects of the ESG agenda. Market forces, on the other hand, have had an impact. Investor Terry Smith repeatedly ridiculed Unilever's "virtue-signaling," calling on the company to focus on fundamentals. Why did Hellmann's mayonnaise need a purpose? Didn't it already have one, as a salad and sandwich condiment? Nor was Smith the only investor concerned with Unilever's flagging performance.

Within months of his promise not to back down, Jope announced that he was stepping down as CEO. His replacement, Schumacher, is the one who called the focus on ESG goals a "distraction."

Schumacher had good reasons for a change in course. In the U.S., for example, a poll conducted by Todd Rose at Populace suggests, as Axios put it, that "an astonishing four times as many Democrats say CEOs should take a public stand on social issues (44%) than actually care (11%)." Gallup has found that support for large corporations plummeted among Republican voters during the same period that businesses most loudly proclaimed their environmental and social commitments.

Schumacher's shift in focus is not guaranteed to pay off. Plenty of companies focus on performance and still fail. But that's the point. Business is hard enough without extraneous political objectives. If you chase two objectives at once, you risk falling behind those with a singular focus.

Some advocates have argued that ESG is just good business. ESG, they say, is simply about managing the risks that environmental and social factors pose to businesses. But that understates the extent of the policies that ESG imposes. In the words of Reuters' Corporate Sustainability Reporting Directive Playbook, "the aim of these changes" is "to affect the whole business model of the Organization." A company's ESG reports, it declares, should disclose how its negative impacts are being mitigated "in relation to the U.N. Sustainable Development Goals."

Why exactly should a business concern itself with U.N. goals?

ESG efforts have been on the retreat recently. The financial firm Vanguard announced in 2022 that it was withdrawing from the Net Zero Asset Managers initiative, and Blackrock CEO Larry Fink said in June that he was moving away from the term ESG. U.S. investors have been pulling their money out of ESG funds, and corporations are mentioning ESG on earnings calls far less frequently than at the trend's peak in 2021.

ESG opponents may be tempted to declare victory. Perhaps ESG was just a byproduct of zero–interest rate policies. But to proclaim the battle over now would be to overlook the critical role of governments in advancing ESG. The effort initially stemmed, after all, from coordinated public and private sector activity. Government policy can prop up bad ideas long after they've exhausted their economic viability.

During a series of House of Representatives hearings this past summer, Politico reported, Democrats "characterized Republican opposition to ESG as anti-capitalist, discouraging market choice and investor freedom." This was supposed to be an ironic, turn-the-tables moment.

But Democrats' invocation of markets was just rhetorical. They are correct that some Republican responses to ESG, such as certain aspects of the anti-ESG law Florida Gov. Ron DeSantis signed in May, have reduced market choice. But many Democrats have pursued an aggressive policy agenda in the opposite direction, as when they support the Securities and Exchange Commission's (SEC) mandatory climate disclosure rule. It is a strange free market phenomenon that requires a regulation that will, in The Wall Street Journal's words, "raise the cost to businesses of complying with its overall disclosure rules to $10.2 billion from $3.9 billion."

Nor is the SEC alone. In November 2022, the Federal Acquisition Regulatory Council proposed a rule requiring all significant government contractors to "disclose their greenhouse gas emissions and climate-related financial risk and set science-based targets to reduce their greenhouse gas emissions." In other words, ESG disclosure and goals would become a condition for contractors making bombs, bullets, and planes for the U.S. government.

As the U.S. Chamber of Commerce has noted, this proposal "would require thousands of employee hours and saddle contractors with billions of dollars in added implementation and compliance costs. The government's acquisition costs would rise as a consequence, and some contractors, and companies in the supply chain, would likely drop out of the market entirely, weakening the competitive forces that keep prices down. The Council substantiates no offsetting benefits to speak of."

Meanwhile, the Department of Labor has moved to advance ESG objectives by amending the regulatory standards for private pension plans. President Joe Biden's first veto was against a Congressional Review Act effort to repeal this rule.

Several Democrats in Congress supported the effort to repeal the Labor Department's rule. Several have criticized the SEC's climate disclosure rule too. Support for ESG has not been uniform within the party.

But the Biden administration has been firmly pro-ESG, adopting a "comprehensive, Government-wide strategy" for climate risk. Climate risk is a component of ESG that includes both physical risks and "transition risks." The latter are attributed to potential future changes in government policy and consumer demand. This is inevitably highly speculative since no one can know much about consumer demand or government policies in the distant future. It's also circular: The government is using the implicit threat of future environmental policies to achieve those policies' expected effects now.

The whole-of-government ESG agenda raises major constitutional and knowledge problems for government agencies. As SEC Commissioner Hester Peirce remarked of the agency's climate disclosure proposal, "the regulators designing the framework have no expertise in capital allocation, political and social insight, or the science used to justify these favored ends." Similar concerns apply to climate risk efforts at the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and so on.

Europe and California are even further along the path of compulsory compliance. The European Union recently released the Corporate Sustainability Reporting Directive, which will force banks to incorporate ESG into their credit decisions. California has passed two ESG reporting bills that go considerably further than the federal SEC is expected to go with its final climate disclosure rule.

While blue states like California have been supporting ESG, a number of red states have advanced anti-ESG regulation. This runs the gamut from protecting public pensions from politicization to banning state contracts with entities that engage in ESG-related activities. Critics of these bills allege they end up costing taxpayers significantly by limiting the pool of financial institutions that are available to the state. Advocates counter that ESG poses an existential threat to the states' largest industries—oil, gas, coal, agriculture, mining, etc.—and that this justifies state action.

Another wrinkle: Public pensions and sovereign wealth funds are among the most significant institutional investors. This further complicates the public-private distinction, since many large companies count government entities among their largest shareholders.

For example, Norway manages the world's largest sovereign wealth fund. The Financial Times reported in May the fund plans "to step up ESG proposals to US companies." This suggests the Norwegian government is using its oil revenue to discourage oil production in other nations. Meanwhile, three New York City pension funds have been sued for violating their fiduciary responsibilities because they divested from oil and gas companies.

That original 2004 United Nations report called for governments, pension fund managers, and corporations worldwide to begin incorporating ESG into their decisions. Such global public-private coordination was necessary, the U.N. argued, because "only if all actors contribute to the integration of environmental, social and governance issues in investment decisions, can significant improvements in this field be achieved." A follow-up report in 2005 suggested that significant progress had already been achieved in directing public- and private-sector activity toward ESG goals, noting actions by a French public pension fund and lauding new ESG regulations in the U.K. and Germany.

Some lament the "politicization" of ESG, but ESG has been political since inception. Though markets have been trending against ESG recently, governments may well step in to counteract that trend, rendering the line between public and private even blurrier than before.