Corporate Social Responsibility And The Rise Of ESG Scores

According to Morningstar Research, socially responsible investing has dramatically increased in 2019.  In the first half of the year alone, ESG funds netted $8.4 billion in funding from investors.  These funds, named for the environmental, social and governance (“ESG”) standards that socially conscious investors use to screen potential investments, have been created in response to investor demand for increased corporate social responsibility (“CSR”).  This demand is in large part inspired by Milton Friedman’s stakeholder theory, under which a firm has a duty to create value for all of its stakeholders, including customers, suppliers, employees, and other impacted communities, not just shareholders.  Stakeholder theory runs in stark contrast to the current theory underlying corporate law—known as shareholder theory—under which a corporation has a singular duty to maximize shareholder profit.  

As ESG funds have grown, so have calls for increased regulation of ESG ranking systems.  In response, the SEC has launched an initiative that is “focused on [investment] advisers’ criteria for determining an investment to be socially responsible and their methodology for applying those criteria and making investments.”  As SEC commissioner Hester Peirce explained, “[t]he collection of issues that gets dropped into the ESG bucket is diverse, but many of them simply cannot be reduced to a single, standardizable score.”  Accordingly, investors should exercise caution when reviewing ESG scores.