Economy and Society: November 16, 2021
November 16, 2021
Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.
Global ESG reporting authority announced
On November 3, at the COP26 environmental summit in Scotland, the International Finance Reporting Standards (IFRS) Foundation announced the creation of a new partner organization, the International Sustainability Standards Board (ISSB) which is intended to be the global ESG reporting authority. The ISSB was constructed by combining several different organizations – including what was SASB, the Sustainability Accounting Standards Board, which according to its website aimed to set "standards to guide the disclosure of financially material sustainability information by companies to their investors." Nasdaq reported on the announcement:
“Anyone who has dipped a toe in environmental, social, and governance (ESG) investing knows that there is an alphabet soup of reporting standards aiming to measure corporate adherence to sustainability.
Because government regulators have been reluctant to establish mandatory reporting standards, a host of mostly nonprofit groups have worked for decades to build consensus among the private sector, governments, investors, and stakeholders to build out voluntary reporting systems, such as the Global Reporting Initiative (GRI), or the Carbon Disclosure Project (CDP).
Companies were left to pick and choose between reporting frameworks, confounding investors’ ability to compare companies across platforms – and in some cases, enabling greenwashing by companies able to cherry-pick data for a particular reporting system.
Enter the International Sustainability Standards Board (ISSB), a new effort to merge many ESG disclosure standards into one, and to encourage the uptake of these standards globally.
The International Sustainability Standards Board was announced this week at the COP26 global climate conference in Glasgow. Thirty-eight governments expressed support for the standards, including the U.S.
The ISSB will be managed by the International Financial Reporting Standards (IFRS) body, based in Germany. The IFRS released a working draft of climate-related disclosures that will be vetted over the next few months, and released in mid- to late 2022.
Erkki Liikanen, chair of the IFRS Foundation Trustees, says "Sustainability, and particularly climate change, is the defining issue of our time. To properly assess related opportunities and risks, investors require high-quality, transparent and globally comparable sustainability disclosures that are compatible with the financial statements. Establishing the ISSB and building on the innovation and expertise of … others will provide the foundations to achieve this goal."”
Opponents argue against mixing sustainability standards with financial reporting standards
Not everyone is convinced that placing sustainability standards under the same umbrella organization as traditional accounting standards is necessarily a good idea. At least one member of the United States Securities Exchange Commission (SEC), Commissioner Hester Peirce, has insisted that such an arrangement will cause significant confusion and undermine the goals of traditional external accounting practices:
“I urge the IFRS Foundation not to wade into sustainability standard-setting because doing so would (i) improperly equate sustainability standards with financial reporting standards, (ii) undermine the Foundation’s current important, investor-centered work, and (iii) raise serious governance concerns.
Strong financial reporting standards are the bedrock of our capital markets. They enable investors to make informed decisions about how to allocate capital. We must be careful not to compromise accounting standard-setting in an effort to achieve objectives other than high-quality financial reporting, no matter how noble those objectives may be.”
According to Erkki Liikanen, the IRFS Foundation trustee chair, there is a good chance that the ISSB’s first set of global standards will be ready for market use by the second half of 2022.
Annual ESG survey of asset managers produces confusing results
- Where does governance fit in the ESG formulation?
Last week, Russell Investments released the results of its seventh-annual ESG survey of active asset managers. In some ways, the results are unsurprising. According to the results, managers and their clients are concerned about ESG. Clients are especially concerned about perceived climate change and other environmental matters. The UK leads the way on wholesale ESG investment activism, while the United States leads in the percentage of managers who have signed the United Nations-supported Principles of Responsible Investment. In other ways, however, the survey results are somewhat surprising. For example, in an article on the differing ESG priorities of clients and advisors:
“When asked what their most important priority was within ESG, advisors reported governance as the highest consideration. It’s a choice that makes sense because how a company is run is something that applies across industries and sectors, where environmental concerns can vary in aspect as well as how important they are within different industries. For advisors, the focus is on financial returns and value, and how a company is managed plays most directly into driving returns and performance.”
Many ESG observers have argued that governance is the odd-man-out in the ESG triumvirate; that it is a traditional measure of corporate health that has little in common with environmental and social concerns and should, therefore, not be a part of the ESG formulation.
- Is there confusion among advocates over what constitutes ESG?
Survey results highlighted the wide use of screening to determine eligible investments:
“Our 2021 survey results demonstrate that screening is one of the most widely used tools utilized to implement a responsible investment policy in the asset management community. Screening uses a set of criteria to determine which sectors, companies or countries are eligible or ineligible to be included in a specific portfolio as a baseline investment decision. Negative screening with values or ethical-based criteria focuses on product-based considerations and tends to center on certain sectors, such as tobacco, controversial weapons and thermal coal. Norm-based screening focuses on business conduct or operation irrespective of sectors, such as United Nations Global Compact violators. Positive screening focuses on business activities that may identify firms as leaders among peers. In order to gauge the level of screening practices, we asked which screening criteria the asset managers utilize for both labeled and non-labeled sustainable strategy offerings.
The most popular screening criteria is value-based negative screening for both labeled and non-labeled sustainable strategies. Specifically, 47% of the respondents who use some form of screening criteria apply the value-based negative screening for the labeled sustainable strategies. For non-labeled strategies, the use of the negative screening practices was the highest among European-based asset managers, where the majority of them utilize negative screening criteria (even in non-labeled strategy offerings).”
The prominent rise in the use of screening is further demonstrated by a similar recent ESG survey done by EY (i.e. Ernst & Young):
“A significant percentage of investors around the world are paying more attention to companies' environmental, social and governance (ESG) performance when making investment decisions and may divest from firms with poor environmental track records, says a survey.
According to the 2021 EY Global Institutional Investor Survey, 74 per cent of institutional investors now more likely to "divest" based on poor ESG performance, than before the COVID-19 pandemic.”
Generally considered a tactic associated with traditional social investment rather than with ESG, which is supposed to be more activist, more confrontational, more engaged with corporate management, the increasing prominence of screening and related tactics has, in the view of some ESG observers, made them ask whether there exists confusion about what is or is not ESG investing.
Newsweek column argues against mandating gender diversity on boards
On November 9, Newsweek ran a piece co-authored by the Competitive Enterprise Institute’s Richard Morrison and Siri Terjesen, who is the Phil Smith professor of entrepreneurship and associate dean, research and external relations at Florida Atlantic University's College of Business and visiting professor at the Norwegian School of Economics. The article, which is a brief meta-analysis of the studies and data available on gender diversity mandates, concludes that gender diversity mandates are not helpful and not necessarily beneficial to women:
“Earlier this year, Nasdaq introduced a rule requiring that listed companies have at least one woman on their board. As a self-regulatory organization, Nasdaq required the assent of the Securities and Exchange Commission (SEC) to implement this rule, which the agency gave in August. California's legislature also passed a law in 2018 requiring firms headquartered in the state to have at least one woman on their board and another law in 2020 broadening that mandate to include board members from additional underrepresented communities. By the end of 2021, California will require corporations with six or more directors to have a minimum of three female directors.
When Nasdaq leadership submitted its board diversity proposal to the SEC, it cited multiple studies and reports to support its contention that gender and ethnic diversity of corporate boards was not just socially desirable but good for business. A detailed analysis by the Heritage Foundation's David Burton, however, found that Nasdaq's argument was exaggerated and misleading. "A thorough examination of the literature and of the materials cited in Nasdaq's submission shows that its empirical assertions have virtually no basis in the literature," Burton concluded….
One particularly problematic research issue is the failure to account for endogeneity in the data—for example, that firms with better financial performance might tend to appoint more female directors rather than female directors being responsible for better outcomes. A recent study that fully accounts for endogeneity published in The Leadership Quarterly found that Norway's mandatory 40 percent increase in female directors corresponded with a significant adverse effect on firm performance relative to similar firms in Sweden, Denmark and Finland that did not face a mandatory quota over a seven year period. By contrast, Spain has a "soft" board gender quota of 40 percent, but the only penalty for non-compliance is the potential loss of public contracts. A recent study of Spain's quota found that firms dependent on public contracts were significantly more likely to increase the share of female directors, but even these more quota-compliant firms did not actually receive more public contracts.
A study examining France's mandate for 40 percent female representation on public firms' corporate boards found that 25 percent of newly appointed female directors had close family ties to the company, such as the daughter, granddaughter, sister, niece, or spouse of the founder or CEO. By contrast, about 28 percent had degrees from prestigious academic institutions. Research also identified the possibility that some firms that fall under the quota will shift their organizational form; in Norway, some publicly listed firms simply de-listed to avoid the quota.
One of the few studies of the recent California mandate found that among all 602 public firms headquartered in California, there was a large and negative stock market reaction to this announcement, resulting in a 1.2 percent decline in firm value, with even greater effects for firms that must add more female directors. The authors' robust analyses suggest that for every female director a California-based public firm was required to add by 2021, there was a 0.5 percent loss in shareholder wealth.”
Morrison and Terjesen continue:
“While the case that mandated gender diversity will improve corporate financial performance is weak, the negative social effects on women themselves could prove significant. In a comment letter to the SEC, the nonprofit Independent Women's Forum (IWF) opposed the adoption of the Nasdaq rule, warning that it would "threaten the progress made by millions of women and minorities by giving them special treatment, thus insinuating that they cannot succeed without it." Tokenism and concerns about hiring-by-quota have plagued members of underrepresented groups for decades, at times significantly undermining their professional status and reputation. A recent report by the Diligent Institute also questioned whether female board members are being welcomed to exercise leadership, rather than just membership, in their new roles. This suggests female directors brought on merely to satisfy a diversity quota might not gain positions, such as committee and board chair, consistent with full-fledged board membership.”
The authors also discuss potential legal and constitutional roadblocks to such mandates before concluding that:
“This is an exciting time for women and men to lead companies as executives and as board directors, but the best real-world data we have supports a system based on merit, not mandatory quotas.”
