Evan Harvey, Nasdaq: Medium Is the Message – ESG Delivery and Market Distrust

Despite cultural assumptions surrounding content and interpretation, we tend to believe that the way we communicate is meaningful.

“In operational and practical fact, the medium is the message” — this sturdy pronouncement from Canadian philosopher and social theorist Marshall McLuhan appears in the first line of his 1964 book Understanding Media: The Extensions of Man — and tends to be the only thing that people remember about his work.

Which is unfortunate, because that phrase sits atop a deep and disturbing critique of machine culture worth revisiting in an age of automation and trust in artifice.

But if we focus on the medium of sustainability disclosure, the various channels through which companies champion their environmental, social, and governance bona fides, the underlying spirit of McLuhan’s catchphrase lives on. Stakeholders tend to measure disclosures in a few ways. Some may attend to the rigour, transparency, and frequency of performance data. Others may pore over lengthy narratives, searching for alignment on keywords or common ambitions.

“How are investors and others to properly evaluate the responsibility (and sustainability) of a company if that is the predominant delivery channel for performance data?”

There is another, more prevalent way to rank and rate the value of a particular ESG disclosure, and it has everything to do with the medium. Where are companies disclosing this information? Is it a mandated practice, in a mandated form, or is it voluntary and freeform? Are there real consequences (legal, financial, reputational) for inaccurate or misleading disclosures? The answers to these questions tend to influence transactional decisions and macroeconomic trends.

Changing Channels

Most companies around the world disclose ESG data in sustainability reports. These reports are haphazardly published, varied in content and length, self-edited and self-audited, and more often organised around a company’s key messaging points rather than established disclosure protocols. Given that characterisation, one can see how the medium may be undermining the message.

How are investors and others to properly evaluate the responsibility (and sustainability) of a company if that is the predominant delivery channel for performance data?

Most experts recognise the problem. “The potential for losses from inaccurate or fraudulent ESG disclosures will rise,” says Leonard Wang (ESG Disclosures—Prospects for the Future, Bloomberg Tax, August 2019). “Fraud and deception gravitate toward unguarded venues. Investor losses from ESG disclosure failures could increase pressure for broad mandatory disclosure requirements. Companies should anticipate a high probability for eventual broad ESG disclosure rules”.

Sustainability reporting in Europe has undergone a transformation in trust and acceptance because regulators stepped in. The Paris Climate Agreement (COP 21), EU Sustainable Finance Action Plan, Non-financial Reporting Directive, Taxonomy Regulation, and various individual country Governance Codes have all driven ESG reporting to maturity. Mandates to green government insurers and pension funds have increased investment; ESG-minded asset managers are offered more business than they can handle (The Remarkable Rise of ESG, Forbes, 2018).
US adoption rates have lagged. According to an RBC Global Asset Management survey, European investors are still ahead of their US counterparts. While 97 percent of UK investors said they use ESG principles, only 65 percent of Americans do the same (Responsible Investing Survey, RBC GAM, 2019). Interestingly, there was no change in US investor attitudes on this topic between 2018 and 2019 — a which saw tremendous upticks in ESG investment, particularly open-end and exchanged-traded fund flows.

Trust Is a Fragile Commodity

If measurable performance alone could drive trust in an idea, ESG would only have fervent supporters. A 2015 study in the Journal of Sustainable Finance & Investment, which itself aggregated data from 2,200 other studies, found not only a non-negative correlation between ESG performance and corporate financial performance, but also a positive relationship in a large majority. Another large study found that stock price performance is positively correlated with good sustainability practices in 80 percent of companies (The Comprehensive Business Case for Sustainability, Harvard Business Review, 2016). A report by investment bank Nordea concluded that “the relative [return price] performance between the top and the bottom ESG-rated companies differed by as much as 40 percent” (Cracking the Code, 2017).

This doesn’t even cover compelling ESG connections to product innovation, risk-resilience, resource-cost modelling, stakeholder engagement, or even an evolving understanding of fiduciary duty. Yet market acceptance of ESG as a legitimate force still seems to hang in the balance. This may sound strange to readers in countries or economies where certain issues (climate change, gender equality) are simply native to the social scene and business culture. But a fair amount of evidence suggests that the attitudes of a few key constituencies are still unformed, and that has much to do with the format of ESG data.

“The biggest obstacle to investment,” said Robert Eccles and Svetlana Klimenko in a recent HBR article, “is that most sustainability reporting by companies is aimed not at investors but at other stakeholders, such as NGOs, and is thus of little use to investors.” (The Investor Revolution, Harvard Business Review, 2019). They also point out that regulators rarely stipulate standards of disclosure and most companies avoid the scrutiny of third-party data auditing or assurance.

Most investors say that ESG performance increases their trust in a company (2019 Edelman Trust Barometer Special Report: Institutional Investors), even if they may harbour doubts about ESG as an enduring market trend. Progressive firm Generation Investment Management said in a white paper last year that current ESG metrics are “imperfect proxies” and in dire need of third-party verification.

ESG could tip over into common practice — standards will emerge, stakeholders will engage, and meaningful capital will flow — or it could become contaminated with misinformation, misuse, and mistrust. Given the crises we face, it isn’t certain that we have the time to correct this scenario.

“No society has ever known enough about its actions to have developed immunity to its new extensions or technologies,” wrote McLuhan in the same book.

Do we now know enough to create a cure…?

About the Author

Evan Harvey is the Global Head of Sustainability for Nasdaq. He also serves on the Board of Directors for the UNGC Network USA and the Global Sustainability Standards Board for the GRI.