The temperature of the debate surrounding environmental, social and corporate governance (ESG) is already quite high and continues to rise. Last November, Elon Musk commented, “ESG is the devil.” More recently, in March 2023, Utah State Treasurer Marlo Oaks pronounced ESG as opening “the door to authoritarianism” and referred to it as “Satan’s plan.” At the other end of the extreme, ultra-progressive groups like Extinction Rebellion U.S. maintain that action is needed immediately to avert the “extinction of human and all species.” This raises the question: Is there a middle ground?
Most of the heat in the pro-ESG and anti-ESG positions focuses on the “E” and the “S” in ESG. The “G,” standing for “governance,” has to do with principles underpinning how companies are managed. It gets less attention because—in contrast to a broad swath of views on environmental or social objectives to support or contest—there are tried and tested rules specifying governance duties of corporate heads.
Although “E” and “S” generate the most heat and stimulate extreme positions, there is also a spectrum of views on the “G.” At one end, there is the long-dominant “shareholder primacy” view, articulated by Milton Friedman of the University of Chicago in 1970. Friedman held that the sole purpose of a corporation is to maximize its profits and its value. Many Wall Streeters continue to subscribe to the shareholders’ primary catechism: The purpose of a corporation is to maximize book value per share.
The non-Friedman view that has gained currency and fueled an expansive view of ESG is the Business Roundtable Manifesto. The manifesto maintains the role of business is to help not just shareholders, but all society. Whereas the Friedman and Business Roundtable positions were long thought to be incompatible, the hard edge of the shareholder primacy view has softened in recent years. To be sure, as Fortune boldly proclaimed in 2020, “50 years later, Milton Friedman’s shareholder doctrine is dead.”
We can see the drift from Friedman to Business Roundtable Manifesto in an incident involving a middle manager at a publicly traded insurance broker who filmed himself participating in the January 6 U.S. Capitol riot: He was terminated. In conjunction with his termination, his employer, Goosehead Insurance, issued a statement: “While we support our employees’ right to vote and express themselves politically, we do not condone violent or illegal acts. This one former employee’s actions are not reflective of our company culture or values, and we are disappointed with his behavior.”
Had the Goosehead incident taken place closer to the 1970s, when shareholder primary was the dominant view and there was no technology for the participation to be viewed by 1.7 million Twitter followers, the incident may not have resulted in termination. The Business Roundtable Manifesto affirms that a corporation’s duties include [to] “engage with long-term shareholders on issues and concerns that are of widespread interest to them,” which arguably comes down on the side of termination.
Two dimensions of corporate governance are responsible for making “G” the least contentious of the three ESG letters. First is alignment of interests between stakeholders and corporations. Shareholders benefit when the value of their investment increases as directors make prudent decisions. The communities in which corporations operate benefit when companies grow and create employment opportunities.
The second driver of sound governance is the threat of lawsuits when corporate directors fail to act responsibly. Directors have fiduciary duties—legal obligations of the highest degree to act in the best interest of the corporations they serve. Breaches of fiduciary duties may result in federal criminal and civil liability for violations of federal securities or other laws. Corporate law statutes differ from state to state but largely converge with a focus on directors performing their duty of care and duty of loyalty. To the extent directors fail to meet this obligation, both the individual directors and the corporation may be subject to lawsuits and court awards in the range of tens of millions of dollars. In 2022, insurance companies collected $13.6 billion in premium and paid $8.5 billion in losses from directors’ and officers’ liability insurance-related litigation.
Duty of Care
The duty of care requires directors, as fiduciaries, to exercise the proper amount of care as they make business decisions on behalf of their corporation. Taking ESG considerations into account in their decisions does not in any way erode their fiduciary responsibility. They must still act with the amount of care that ordinarily careful and prudent people would use in similar circumstances and should consider all material information reasonably available when making business decisions.
Duty of Loyalty
The duty of loyalty affirms the best interests of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the stockholders generally. This duty takes aim at conflicts of interest.
The “E” and the “S” add another wrinkle to the “G” in that they require directors to consider environmental and social issues that may impact their fiduciary duties. A recent publication from law firm Seyfarth Shaw summed it up well: “[t]he challenges facing directors loom large, in part because of failures of previous generations to deal adequately and consistently with E and S issues. It is hard to overstate the value of selecting directors who are both people of good will and have exceptionally good judgement to face the future issues relating to E and S.” The “E” and the “S” ultimately raise the bar for the “G.” When directors are attuned to the broader panoply of risks emerging from long-term environmental and social exigencies, their job may be harder, but we all benefit.