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“Make the business case” is a key aphorism in sustainability, and many of you dear GreenFin Weekly readers have long been fighting the good fight as case-makers.
Underpinning this case is a canon of credible research, much of which has been delivered by George Serafeim at Harvard Business School, who has been doing ESG before it was cool (or even called “ESG”).
Importantly, Serafeim has been pondering the critical questions and penning equally critical research papers to support a core tenet of sustainability for issuers and alike investors. Purpose and profit are not mutually exclusive, he says, but are deeply intertwined and interdependent.
I may not have read all that was assigned in graduate school, but Serafeim’s work was key to equipping us students of sustainable enterprise to go forth and be effective. Serafeim has teased out measurable and meaningful answers to questions at the center of ESG: Are purpose and profits substitutes or complementary? What are the technological, social and market forces reshaping this relationship? What can we all do to better link purpose and profit as entrepreneurs, managers, consumers, employees and investors?
We should not assume that by having more disclosure we will be able to reach consensus on what ‘good’ ESG performance looks like.
I recently checked in with him on some of these themes, which are also covered in depth in his forthcoming book, “Purpose + Profit: How Business Can Lift Up the World.”
I recommend perusing Serafeim’s treasure trove of findings on sustainable management, and I hope you enjoy his thoughts shared here, which have been edited for clarity and length.
Grant Harrison: Your research has informed much of the foundation for the business case for sustainability. What mistranslations, misunderstandings or other notable mismatches do you see crop up between academic research and the private sector’s implementation of sustainability practices?
George Serafeim: The biggest one is that it is easy for companies to drive profitable sustainable outcomes. A core message of my new book is that scaling up profitable sustainability outcomes for an organization is a hard management and governance process that involves transformation of culture, processes and incentives.
And, in many cases for the business leader, it involves an assuming personal career risk, as not all transformations succeed. So, the idea that you can hire two or three people in a sustainability department and publish a sustainability report and that somehow you have created value is just not true. The same is true for investors: Picking up an ESG rating that you just lay over your investment process of portfolio formation is unlikely to provide much value.
Harrison: Your new book interrogates whether purpose and profit are in conflict, or whether both can be achieved simultaneously with the right mindset and tools. Two questions therein: First, can you define purpose in this context? And second, if purpose and profit are not in conflict, what are the right mindsets and tools needed to realize a transition to a clean and just economy?
Serafeim: The way that my colleague Claudine Gartenberg and I have operationalized and measured purpose in large-scale empirical analysis is through employee beliefs on the meaning and significance of their work. So, purpose is not words on the walls of the headquarters or in the speech of the CEO but actually how it is felt and diffused among employees inside an organization.
Why employees? Because they are arguably the closest to having information about what the organization actually represents and how it behaves. So then, to your question, what is the connection between purpose and the sustainability transformation?
In a paper with my colleague Rebecca Henderson, we argue that purpose-driven organizations can be helpful in multiple ways. First, they are more likely to be the ones to assume the types of market and operational risks that could accelerate the adoption and diffusion of sustainable practices and products. Second, they are more likely to measure the sustainability outcomes they pursue and as a result spread transparency in the market, which makes detection of companies that engage in unsustainable practices more likely. And third, they are more likely to ask for the kinds of regulations and policies that can promote better sustainability outcomes.
Harrison: In your 2015 article titled “Corporate Sustainability: First Evidence on Materiality,” you, Mozaffar Khan and Aaron Yoon found that “firms with good performance on material sustainability issues significantly outperforming firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing.” What are your thoughts — constructive, positive or otherwise — on the current state of the ESG ratings industry?
Serafeim: The first thing to understand is that most measurements are imperfect. Credit scores are imperfect scores of an individual’s credit profile. Credit ratings are imperfect assessments of a company’s creditworthiness. Many of the metrics that physicians take for us all, such as BMI, are also imperfect proxies of our health condition. Measurement is just intrinsically hard. If it was not then accounting standards would not change every few years.
In the case of ESG ratings, this is even harder because this is a relatively newer field of study. When I started working in this space there were almost no data. So now people get upset about ESG ratings but at least there are some data. This is good because we now have a base upon which we can build off and improve. As I have said many times, in my view we need to focus on measuring and valuing outcomes. This is what we have been doing at the Impact-Weighted Accounts Project at Harvard Business School.
Also, we should not assume that by having more disclosure we will be able to reach consensus on what “good” ESG performance looks like. In a paper of mine with my colleagues Dane Christensen and Siko Sikochi we found that in fact ESG rating disagreement is positively associated with ESG disclosure. The conclusion we draw from that is that as a society we still have not developed the rules and norms of how to assess what “good looks like.” Education will be a crucial part of this process.
Harrison: An Axios poll last year found that 54 percent of Gen Z adults in the US have a “negative view” of capitalism, and the number of 18- to 34-year-olds with a “positive view” of capitalism fell from 58 to 46 percent since 2019. The number of young Republicans with a favorable view of capitalism even dropped, from 81 percent in 2019 to 66 percent in 2021. Imagine you have the stage and rapt attention of the above groups. What do you tell them?
Serafeim: I love business. I love the idea that you can come together with a few other people and create an amazing product that solves somebody’s problem, small or large. Or, that you can create jobs and provide meaningful change in the ability of people to provide for their families. And the more successful your products are the more profit you make so you end up scaling up the operations and products allowing more customers to access the product.
So, for me, business is one of the most amazing institutions in society. But the question is why we do what we do. The more I have drilled into understanding some amazing successes that people have had in business it comes back to purpose. Waking up in the morning because of that purpose and profit being the outcome. I would encourage everyone to find that purpose, that meaning that makes them wake up in the morning and go to work, and try to think about solving real problems that people have through the agility and innovative capacity that characterizes business.
Harrison: Tapping into your imagination again, you are hired for the fictitious role of chief sustainability officer of the S&P 500, overseeing every firm in the index. The job is on a six-month contract. What would be your priorities, and how would you go about executing them?
Serafeim: I would go and speak to people in all business units and functions. I would identify what their most significant problems are and what they think could be the most significant solutions. I would then create a matrix between solutions and problems and focus on the ones that I could be part of the solution from a sustainability perspective. I would prioritize the ones that I could see myself, creating some quick wins to build credibility inside the organization as someone that creates value and then try to scale up solutions from there. I am a big believer of the idea that positive momentum builds on positive outcomes, and from there you create bigger and bigger solutions.