ESG Can Lead to Higher Profitability

If you’re a hammer, everything looks like a nail. And if your firm is among the rising tide of companies that embrace “environmental, social, and governance” principles, ESG may look like the only responsible framework for doing business in our enlightened, 21st-century global economy. But not everyone is a hammer. And many who would like to see all companies adopt ESG standards could be more effective at winning over ESG opponents—by persuading them, instead of hammering them with rhetoric that seems to confirm their worst fears.

I realized this at a real estate conference this year where everyone was talking positively about ESG. It dawned on me that the room held entirely different demographics than the boardrooms I had served in that month. Many board-level decision makers broke barriers and set records when building up their own companies—years before ESG’s emphasis on stakeholder (versus shareholder) returns became mainstream. Naturally, such leaders may hesitate before exchanging their proven, profit-focused framework for one that emphasizes other causes. But because ESG is such a politically charged subject, discourse is often (shall we say) dead as a doornail.

Yet ESG proponents and opponents may have more in common than they realize. Understanding this could prove key to persuading more decision makers to adopt ESG standards—not for ideological reasons, but to achieve their own stated desired business outcomes, including profit, risk management, and sustainable growth.

Rational Opposition to ESG

For starters, practically everyone can agree that the most effective organizations are highly focused on achieving clearly defined objectives. Yet, to a highly focused company, the activism and alarmism sometimes associated with ESG can inaccurately paint this stakeholder framework as mission drift and as a drain on resources. This inference is possible even in a company that cares how its actions affect the environment, society, and the general welfare—but that also believes disciplined focus on its “hedgehog concept” (the one thing a company does better than all others) as the surest way to achieving the most good.

Fortunately, ESG need not be distracting; it can prove mission enhancing—although the politicization of ESG often obscures this advantage. Perfecto Sanchez, an entrepreneur and cofounder of Equity Quotient, an AI-powered stakeholder intelligence platform, says ESG’s emphasis on outcomes for all stakeholders makes it a key for unlocking valuable ideas.

“One of the biggest challenges is that ESG has become massively politicized and has been viewed more as a cost center versus a value center,” Sanchez told me in an interview. “Leaders feel that they are being forced to report on something that they do not see value in, when in reality, it is a framework to ask questions on how to make business more valuable.”

The fact is many business leaders are environmentally conscious but will never be climate change activists. Many or even most are committed to treating people with equality and human dignity but will never embrace the critical theory arguments at the center of today’s political stage (i.e., go “woke”). Many desire sound corporate governance but are suspicious of overregulation, including excessive reporting burdens that sap innovation-fueling manpower and profits. (For example, the Securities and Exchange Commission recently unveiled plans to require public companies to disclose to investors information about their greenhouse gas emissions—and other-energy emissions—and the emissions of other companies in their supply chain.)

Depoliticized, however, ESG can complement business growth by multiplying valuable perspectives.

“People have a knee-jerk reaction that this is a burden,” Sanchez said. “In reality, I think it’s a great opportunity for us as business owners to ask ourselves questions for how we can actually create more scalable value in our economy and make more informed decisions to have a greater impact.”

Talking Past Each Other

Few on the political spectrum will disagree that more ideas and clearer thinking is good for business—so why might rational people whose values overlap with ESG resist it as a business framework?

This is largely because the thinking that underpinned most business growth of the past century was Milton Friedman’s theory that a business’s responsibility is to increase shareholder “profits … in open and free competition without deception or fraud.” By contrast, ESG rests on stakeholder theory, which Wheaton College professor and Wisdom-Based Business (2021) author Hannah J. Stolze says “is about how customers, suppliers, employees, financiers, communities, and managers interact to create value.”

Simply put, these two models measure success differently—but not entirely so. In a sense, these camps are talking past each other. Many executives in the traditional shareholder model resent the assumption that their pursuit of profit neglects stakeholder interests. They would argue they maximize shareholder profit by creating value for stakeholders as well—customers, employees, suppliers, and their communities, including the environment. Opponents may also resent the implication that pro-ESG businesses are less intent on reaping huge profits, which they do.

However, the differences between these models are not just semantic; the ESG framework is more regulatory by nature. But appreciating which differences are semantic highlights what businesspeople in both camps value in common. And therein lies the power of persuasion, or at least of productive discussion about ESG.

Productive, Persuasive Discussion

How many persuasive reasons does it take to change someone’s mind? The question implies the answer: just one.

The current ESG debate is swollen with ESG’s most polarizing political hornet nests: what opponents might describe as indignation from climate activists, woke critical theory activism, and anti-business regulation.

Proponents should shift the conversation to the factors most attractive to ESG opponents: Profitability. Risk mitigation. Supply chain health. All companies with any hope of survival manage these things regardless of politics—and Sanchez says the ESG framework can enhance that management: “ESG is another tool for investors to understand a company’s risk profile beyond traditional diligence and to understand where there may be oversight and questions that weren’t traditionally asked before in the past … so that they can derisk some of their positions and also discover potentially unrecognized business opportunities.”

That means ESG’s thought-provoking power could potentially persuade businesspeople in Friedman’s shareholder model—using their own most important criterion: profit. As reported by Equity Quotient, “Companies that proactively embrace their pursuit of stakeholder diversity and other ESG principles tend to be more successful, outperforming peers on every major performance metric.”

• 5.79% higher stock price impact
• 19% higher revenue
• 3.5% increase in EBITDA
• 50 bps lower cost of capital
• 3x stronger retention

People don’t need to persuade each other on the most politicized points of an issue. If something is really good for everyone (i.e., all stakeholders), then it should be fairly easy to identify at least a few pieces most people agree on. Rhetoric, activism, and politics aside, an ESG mindset could genuinely profit a business—and thereby profit everyone else.

Opponents of ESG will come around without coercion as evidence mounts that it promises long-term ROI for shareholders (who are also stakeholders, along with customers, employees, and community members). Those persuaded may very well adopt the ESG framework due to a profit motive—not because of a political-ideological shift. And that’s okay, because when they do (for whatever reason), all stakeholders will benefit, if ESG proponents are right.