Rethinking Incentives: How Sustainable Investing Reorients Market Behavior

Having no prior experience in sustainable investing, I took SIRI Practicum as a way to gain both exposure and experience in how capital flows to companies and projects that make the world a better place. I came in with a baseline understanding of ESG and impact scores. My understanding was that these metrics are put in place as a way to place value on the impact, or lack thereof, that these companies have on the world around them. However, through my research and work in this class, I have come to realize that usually the opposite is true. These scores are often designed to gauge a company’s vulnerability to the societal and ecological changes taking place in the world rather than to measure the company’s impacts on these systems. What interests me the most about sustainable investing, which I have learned through this class, is that it provides a way to flip this system on its head and, in doing so, make the world a better place for everyone.

Investors do not hold shares of the planet; they hold shares of the company. Therefore it makes sense that their view is nearly always company centric. Convincing people to support a strategy that is not in their own best financial interest is nearly always a losing strategy. As a result, a key component of the business models for many companies since the Industrial Revolution has been the absence of negative externalities being priced into the costs of their operations. This has historically resulted in a kind of 'societal subsidy' where companies can extract and pollute, and society pays the price for their unsustainable practices. However, as McKinsey reported in 2022, society as a whole is increasingly dissatisfied with this arrangement. This poses an existential threat to all companies because every company requires 'societal license' to operate. As the total global supply chain grows and becomes more resource intensive, the potential for negative externalities is only increasing. This has created an urgent need for companies to begin reimagining their relationship with society and the world as a whole in order to maintain their societal license.

This semester I have learned that this is where sustainable investing enters the picture. Capital is always risk averse, especially when risk is accurately priced into the cost of capital. Sustainable investing shifts traditional capital flows towards good actors because, everything else held equal, there is inherently less risk in organizations that try to avoid these externalities. By identifying and quantifying these risks, then allocating capital accordingly, sustainable investing incentivizes firms to avoid these externalities. The firms are not doing so out of moral necessity, but rather out of necessity for survival. Morals and ideals can vary between times and places, but the instinct for survival is omnipresent. This makes sustainable investing an extremely powerful tool in incentivizing a better world. When operations that harm the planet are accurately penalized and ones that help are rewarded, we are left with a system that aligns investor incentives with societal good.

In SIRI Practicum I have learned that not only is this way of thinking not unique, it is becoming increasingly commonplace. Through the work with my own project and seeing the work of my colleagues on their projects, it is clear that a wide array of stakeholders view sustainable investing not as moralistic or idealistic investing but rather as a smarter way of investing. Through this lens, sustainable investing becomes not just an ideal to strive for but an inevitability of the market.

Sources

1. Pucker, K. P., and King, A. (2022, August 1). ESG investing isn’t designed to save the planet. Harvard Business Review. https://hbr.org/2022/08/esg-investing-isnt-designed-to-save-the-planet

2. Pérez, L., Hunt, V., Samandari, H., Nuttall, R., and Biniek, K. (2022, August 10). Does ESG really matter and why? McKinsey and Company. https://www.mckinsey.com/capabilities/sustainability/our-insights/does-esg-really-matter-and-why