No Stakeholder Left Behind: The Dangers of ESG Metrics
The No Child Left Behind Act of 2001 promised a radical reform of U.S. education — a field historically plagued by a lack of accountability. Teachers were tenured and had no incentives to improve their instruction. There were no standardized measures for school performance, so school districts couldn’t tell which ones were underperforming and needed remedial action.
NCLB would solve all that. Public schools had to give students a nationwide standardized test each year. Those that failed to make Adequate Yearly Progress in their test scores for two straight years were publicly labelled as “In Need of Improvement”; continued underperformance could lead to their funding being cut or even their closure.
And NCLB aimed to tackle the lack of rigor in not only assessing school performance, but also the teaching methods themselves. Teachers shot from the hip, doing what felt right rather than what was tried and tested. To clean up this chaos, the Act required schools to use scientifically based research — such as scripted curriculum, which told teachers exactly what words they should say for each topic.
The idea of using measurement to bring accountability seemed sensible. But it failed miserably as schools “hit the target, but missed the point” — they focused on the dimensions being measured rather those that mattered. 71% of school districts cut at least one subject to concentrate on the tested areas of reading and math, with humanities, arts, music, and even technology often on the chopping block. Even among the prioritized subjects, teachers started “teaching to the test” — practicing rote memorization of disconnected facts to be regurgitated in an exam, rather than explaining how to use this information and think for oneself. Scripted curriculum assumed there was “one best way” to run a class, preventing teachers from using the style best suited to their abilities and their kids’ needs.
NCLB is now confined to the history books. But a mutant variation is rapidly spreading in the very different field of responsible business. It goes by the name of environmental, social and governance (ESG) metrics. They gauge a company’s impact on wider society, such as carbon emissions, CEO-to-worker pay ratios, or boardroom diversity statistics. Almost every card-carrying member of the responsible business brigade is advocating them. There’s a plethora of ESG reporting frameworks, each with their own list of metrics for companies to report, to ensure no stakeholder is left behind. And this list isn’t going to shorten anytime soon. In 2020, the World Economic Forum, in conjunction with the Big 4 accounting firms, came up with its own set of measures.
The rationale is eerily similar to NCLB. Responsible capitalism has also been plagued with a lack of accountability, with companies making seductive promises but failing to deliver. Metrics will separate out those who are walking the talk from those who are greenwashing. In turn, this will allow investors to decide which companies to sell or engage in — similar to a district closing a school or taking remedial action. Shareholders can set targets for companies to hit, and if they call these targets “science-based”, surely they’re a good thing?
But the problems are similar to NCLB. Just as the breadth of a child’s education can’t be whittled down into a test score, no set of ESG metrics can capture the totality — or even majority — of a company’s social impact. Many dimensions of sustainability can’t be measured, so executives will “test to the test” by focusing on only the ones that can. To improve the CEO-to-worker pay ratio, they may raise salaries by cutting training and working conditions. The diversity box can be ticked by focusing on demographic but not cognitive diversity, and without developing a culture that actively encourages dissent. Highlighting emissions may punish products like semiconductors, whose manufacturing process releases carbon yet they may be used in solar panels.
Moreover, one-size-fits-all targets ESG targets assume there’s “one best way” to become a sustainable company. Policymakers or investors setting them effectively micromanage a company by telling it who they can hire, how much they should pay them, and how much carbon they can emit. All of these decisions are important, but involve tricky trade-offs. Shutting down a polluting plant cuts carbon but jeopardizes jobs, just like a more laissez-faire teaching style might foster creativity but also indiscipline. As with teachers, managers might be best placed to evaluate such trade-offs.
So where does this leave metrics? The solution is not to throw the baby out of the bathwater and scrap them. They provide useful information about a company’s sustainability — but only partial information. Any user should be aware of what they measure and what they don’t, rather than automatically investing or divesting based on them. They need to be supplemented with narratives to understand why a particular metric is high or low, context to discern whether it’s even relevant to begin with, and qualitative information that captures what it misses. This requires investors to have boots on the ground and get deeply into the weeds of the company, rather than analyzing datasets from a desktop.
In ESG, just as in education, not everything that counts can be counted — and not everything that can be counted counts.