Written by Elle Lambropoulos
Growing ESG Backlash
Investors and operators have rapidly adopted environmental, social, and governance (ESG) analysis as a tool for risk mitigation and value creation. As of 2022, 89% of investors have incorporated a level of ESG analysis into their investment approach. The results show that strong ESG performance is “correlated with higher equity returns” (McKinsey).
The expansion of ESG analysis has been accompanied by growing anti-ESG sentiment. Some critics argue that ESG analysis is an ideology rather than an unbiased investment tool. In the first half of 2023, 37 U.S. state legislatures introduced 150+ anti-ESG bills. This pushback has led many companies and investors to consider dropping ESG terminology and the holistic approach in favor of choosing between environmental, social, and governance analysis.
ESG: State of the Union
The most ascendant dimension of ESG is environmental analysis, as the climate crisis has introduced financial risk. Companies and investors are exposed to potential reputational damage, legal liability, and an increasingly volatile economic landscape. As a result, sustainability reporting and goal-setting are increasingly prioritized as companies and funds are keen to demonstrate their preparedness and commitment to climate action. For example, the Venture Climate Alliance has launched with 75+ signatories pledging to reach net-zero alignment by 2050 or earlier.
As the ‘E’ in ESG gains momentum, governance remains foundational for companies and investors. Copious research has demonstrated the importance of good governance for risk mitigation and strategic planning. Companies financially outperform and operate more efficiently when they align incentives between shareholders and managers, provide transparent financial reporting, and systematically manage risk. Investors are thus attuned to corporate governance—since 2009, 70% of global investor demands have been governance-related.
While environmental concerns grow and governance remains an established priority, the dimension of ESG that receives the brunt of criticism is social analysis. Social KPIs include corporate diversity, inclusion, liveable wages, pay parity, and employee safety. In particular, corporate diversity initiatives are facing increased scrutiny as anti-ESG sentiment grows. DEI roles have been disproportionately affected by recent layoffs, and the ripple effect of the Supreme Court ruling on affirmative action remains unknown. The recent lawsuit brought against Fearless Fund, a VC investing in businesses led by women of color, also raises concerns about efforts to bolster diverse and inclusive teams.
Despite political backlash, the business case remains clear: strong social performance contributes to improved productivity, lower reputational risk, and stronger innovation. Nevertheless, venture-backed companies often lack diversity, starting with the founding teams—women founders raised 1.9% and Black and Latina women founders raised 0.1% of all VC funding in 2022. The lack of diversity can hinder innovation, create insular cultures, and generate high turnover costs.
Investment Tool, Not Ideology
The politicization of ESG risks obscuring its fundamental purpose as a financial tool. ESG is an analytical framework and dataset to help investors and operators understand new dimensions of their business and optimize financial returns. Asset managers have a fiduciary duty to maximize financial returns—which demands comprehensive analysis. The growing body of evidence linking ESG incorporation with improved returns demonstrates that ESG is not ideology but instead a tool that provides necessary insights into an increasingly complex economic landscape.
Metric provides software to streamline data collection and manage ESG performance for venture capital firms and their portfolio companies. Email Elle at elambropoulos@metric-esg.com to get started and learn more about how to use ESG data for sustainable, equitable, and outsized growth.