Why Sustainability Needs a New Lens

A Strategic Planner's Review of The End of ESG by Dr. Alex Edmans

You take ESG issues seriously. There is much more that organizations of all kinds can and should do to support sustainability, but they don’t seem to be doing enough. In fact, some are Greenwashing to escape the worst blame.

However, in interwoven short/long-term strategic planning retreats, I have seen a reversal of this trend. Instead of lapsing into short-termism, they do the things Dr. Alex Edmans talks about in this draft paper, The End of ESG, dated January 4, 2023 and available here or here.

You can use his advice to help create the case for long-term planning in your organization, or as a way to connect it to ESG efforts.

Here are the highlights of the paper which relate directly to the topics we cover here at the JumpLeap newsletter on interwoven short/long-term strategic planning.

Abstract

ESG is both extremely important and nothing special. It’s extremely important because it’s critical to long-term value, and so any academic or practitioner should take it seriously, not just those with “ESG” in their research interests or job title. Thus, ESG doesn’t need a specialized term, as that implies it’s niche – considering long-term factors isn’t ESG investing; it’s investing. It’s nothing special since it’s no better or worse than other intangible assets that create long-term financial and social returns, such as management quality, corporate culture, and innovative capability. Companies shouldn’t be praised more for improving their ESG performance than these other intangibles; investor engagement on ESG factors shouldn’t be put on a pedestal compared to engagement on other value drivers. We want great companies, not just companies that are great at ESG. Alex Edmans.

The article abstract quoted above is a decent TL;DR summary of Alex’s ideas if you are only skimming!

Dr. Alex Edmans

In it, Edmans states the purpose of the paper: to find ways to “create long-term financial and social returns.”

Against this backdrop, he observes that many companies are taking extraordinary steps to hire Sustainability Officers, justifying strategic decisions based on ESG logic and tying pay to ESG metrics.

He argues that all this activity is well-intended, heading in a positive direction, but still lacking. There is something more important than having a company which plays the game of ESG superbly.

Unfortunately, the popularity of (or fixation on) ESG is getting in the way.

Why There’s Something More Important than ESG

…considering long-term factors isn’t ESG investing; it’s investing. It’s nothing special since it’s no better or worse than other intangible assets that create long-term financial and social returns. Alex Edmans.

Throughout the article, Edmans implies that ESG is a useful way to think about long-term value, but not the only one. It may be the one which is in the headlines, and top-of-mind, but so what?

There is something more important; much grander to accomplish. And ESG is just one factor among many which executives need to manage.

The ultimate goal? The creation of long-term financial and social returns. Organizations of all kinds play a crucial role in reaching these aspirations, whether they are for-profits, non-profits, government organizations, clubs, churches, alumni groups, etc.

In this context, ESG is a value creation tool. In the paper, he lists many other drivers which leaders must manage at the same time: corporate culture, companies which encourage dissenting view points, management quality, innovative capability, productivity, capital allocation, strategy, patents, diversity, inclusion, net promoter score, customer attrition.

He observes that ESG has taken a leading role. But it’s just one of the long-term factors in the above list.

As such, his aim is to knock ESG off its peculiar, recently created pedestal. Let’s implement a “long-term value lens” instead of using a specific “ESG lens”! All the factors listed before would then be seen in their proper context as “value creation tools.”

It won’t be long, he predicts, before ESG takes its proper, ordinary place in that list. It will be seen as a mainstream concern: neither more nor less important than the others. For him, great companies use all the levers they can define to create long-term value. Not just one.

This point is manifestly commonsensical. But there are powerful reasons why this lopsided attention is being paid to ESG, which he only hints at.

The Problem Executives Are Having

The fact is, executives don’t practice long-term thinking in their strategizing around value creation. While Edmans doesn’t say this directly, let’s take a look ourselves at some underlying facts, starting with a quote from Flammer and Bansal:

Perhaps the most striking evidence is provided in a survey by Graham, Harvey, and Rajgopal (2005), who find that 78 percent of the surveyed executives would sacrifice projects with positive net present value (NPV) if adopting them resulted in the firm missing quarterly earnings expectations. Flammer and Bansal.

The authors studied the increasing tendency of companies to think short-term, to the detriment of all their stakeholders. This tendency, honed in reactions to global disasters like 9/11, the 2008 recession, the COVID pandemic and the Russian-Ukranian War, is now a habit. Now, most companies refuse to make long-term strategic plans. Others redefine their 5-year-plans as “long-term.” Why?

“Things are changing too quickly.” “Long-term plans need too many revisions”. “The process of planning for the long-term is too hard”.

Whatever the excuse might be, the result is the same: short-termism.

However, climate change won’t be ignored, and it’s the product of rampant short-termism at a global scale. This much is obvious to most leaders who have reacted to societal pressure by becoming “great at ESG”.

While this state of affairs is better than no attention whatsoever to long-term value creation, Edmans argues that it’s not enough. Not if we’re serious about creating long-term value.

When executives adopt the new lens and undertake this transformation, it’s easier for them to see all the drivers, and therefore use them. But where should they be applied?

The measures that track value creation will be specific to a company’s strategy. Alex Edmans.

In other words, as companies change the way they do their strategic planning, they will engage in more long-term value creation and the specific metrics that pertain. He goes a long way in the article to argue that there are no universal long-term metrics which apply to all companies. Instead, they must be uncovered by the enterprise via its long-term value lens.

However, Edmans doesn’t mention the word “planning” in his article. Not once. As strategic planners, we need to make the connection and pick up the ball.

The Link Between Planning and Measurements

If you interweave short/long-term strategic plans, you know that value creation is an intentional activity. It doesn’t happen on its own.

Edmans also complains that most of the metrics being collected to categorize sustainable stocks are backward-looking. They don’t predict future potential.

Similarly, classifications into ESG and non-ESG buckets are typically based on current status rather than future potential. This highlights another problem with the metric-driven approach: metrics only capture what’s happened in the past. Any analysis of long-term value would focus on a company’s future potential; certainly, historic data is useful, but only to the extent it helps you forecast future cash flows. If ESG were viewed through the long-term value lens, assessments might not be so backward-looking. Alex Edmans.

I think you may agree: a company which uses “long-term value lens” is one which is likely to conduct an interwoven short/long-term strategic planning effort. The typical retreat generates a slew of lead and lag metrics to be tracked. They are to discuss ESG and other drivers of value.

This switch from analysis to planning is the bridge we, as strategic planners, should want every organization to take.

I believe Edmans would agree that strategic plans arising from long-term thinking capture and document decisions around what’s important, and what gets measured. By contrast, a company which has no interwoven short/long-term plan may not find use for a long-term value lens.

Their short-termism in the form of outside pressure may even lead them to become great at ESG reporting. But if you have read this far, this is probably not the ultimate outcome you are interested in.

We can do far better as a species, and as strategic planners, but we need to make the practical connections Edmans suggests.

It’s time for us to reverse the new conventional wisdom that short-term planning is all that matters.