There is a movement afoot to make corporate America more woke. Known as ESG (environmental, social and governance), the idea is to pressure companies, through negative publicity, boycotts and investment choices, into being better citizens. Last year, the normally staid Business Roundtable issued a letter signed by 181 CEOs declaring that the purpose of a corporation is to serve all stakeholders—not just shareholders. One of the world's biggest money managers, Blackrock, issued a similar letter. Although serving communities, employees and the environment sounds great in theory, there is a tension at the heart of the ESG movement that should scare everyone about companies choosing to go down this road.
The problem stems from the attempt to broaden the appeal of ESG by including within its ambit the goals of promoting three things—the environment, society and good governance. If we add earning profits, corporate managers are supposed to maximize along four dimensions. This is an impossible task, since these things may often be in conflict with one another. Looking out for the environment might mean shuttering factories, which could devastate a local community. Putting workers' interests first might mean worse products for consumers. Instituting the best governance might mean no more corporate donations to local charities. Almost every action to please stakeholders reduces profits. No one can serve four masters simultaneously.
Vesting in corporate management how to trade off these conflicting goals creates another problem. Corporations operate under delegated authority, from shareholders to the board to the CEO. This is the genius of American corporate law, because it allows massive investments (from diffuse shareholders) to be put to work creating products and services unimaginable to our ancestors. But giving one person the authority to direct billions of dollars and thousands of workers is risky because, unless watched closely, corporate managers can serve their own interests instead of those of others. The ashes of corporate empires built on hubris and the contrails of corporate jets are evidence of what economists call "agency costs."
The solution to unfaithful agents is the discipline of markets—most importantly, the stock market. In a company's stock price, one finds a distillation of how well corporate managers are doing in satisfying the profit-making dimension. The stock price is a simple and powerful signal that gives shareholders, managers and everyone else an easy way to judge corporate managers.
A focus on stock prices and creating shareholder value transformed American business. During the 1980s, corporate empires (known as conglomerates) built to satisfy the egos of CEOs were dismantled, unlocking huge new efficiencies and benefiting society at large. American corporations went from being laggards to the Japanese and Germans to the most dominant in the world. Not surprisingly, Nicholas Bloom and John Van Reenan, two British-born academics, show that U.S. firms today are the best-run in the world, on average.
Telling corporate managers to consider the environment and countless social considerations dilutes the signal of performance. This is especially true since there are no good measures of performance in satisfying environmental or social goals. Whereas the stock price tells us exactly how much a company expects to earn in the future, how can we measure a company's satisfaction of the net interests of all other stakeholders, from workers to plant and animal life to politics? There are some rankings by various NGOs, but none that have the power of the stock price—and none that balance across all the ESG dimensions.
To make matters worse, without informative signals about stakeholder performance, a wedge can open up between the "E" and the "S," on one hand, and the "G" on the other hand. Governance has improved over the years by reducing agency costs and holding corporate managers' feet to the market's fire. If instead managers are able to use their discretion to balance the innumerable interests of countless stakeholders, there is the danger that managers will instead serve their own interests under the guise of serving diffuse and fuzzily defined stakeholders. These selfish interests could be about satisfying their own political preferences, or merely shielding bad operational performance from view by talking good about serving the needs of others. In short, the ESG movement is likely to increase agency costs, thereby leading to worse management and lackluster corporate performance.
Corporations generate not just jobs and the things we consume, but also wealth for society to put to solving our social problems. Insofar as the ESG movement wants to enlist corporations in this work instead, it poses a serious risk of serving the narrow interests of CEOs and leaving fewer resources for society to use to solve our social problems.
M. Todd Henderson is professor of law at the University of Chicago Law School.
The views expressed in this article are the writer's own.
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