The Ukraine War Exposes the Failures of ‘Ethical’ Business, Says Professor of Finance

Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, is well known to many of those who have worked in finance. His valuation datasets are widely used by bankers and consultants. But Damodaran does not just collect and publish useful data. In a recent article he asks important questions about the usefulness of so-called ESG-measures, metrics that focus on the environmental, social and governance related performance of businesses, and what the war in Ukraine tells us about their usefulness.

The ESG metrics are based on the idea that companies should look to all stakeholders instead of focusing only on profitability. This idea, often described as Corporate Social Responsibility (CSR), has been around for a long time. Originally an ethical concept, it stipulates that companies, or in fact shareholders and management, should aim at having a positive impact on society, that it is their duty to do so.

Many have criticised this idea, most notably Nobel laureate Milton Friedman in a 1970 New York Times Magazine article, where he argues that the only social responsibility of companies is to maximise their profits by constantly finding new ways to lower costs and increase revenues, always within the frame of the law of course.

If CSR was only about being ‘virtuous’ for no profit it would not have lasted long. But the promise of CSR is that by behaving in a socially responsible manner companies will in the long run benefit. It is on this basis that the environmental, social and governance metrics have been developed and are being implemented by businesses, investors and banks all over the world. If this development continues, it may mean, for instance, that otherwise successful and profitable businesses or investment funds which refuse to let an essentially political agenda dictate their business or investment decisions will face restricted access to loan financing. We are already seeing restricted access to equity financing as more and more pension funds use the ESG metrics to evaluate investments.

According to ESG advocates, companies that score high on those measures are better at dealing with unexpected adverse events, such as pandemics and wars. Professor Damodaran asks if this is really the case, using the war in Ukraine as an example.

Since war is one of the adverse effects ESG should protect companies against, companies with a high ESG score should be less affected by the Ukraine war than others. But as Prof. Damodaran shows, this is not the case at all. Funds that adhere to the ESG principles should perform better than those which don‘t, but as Prof. Damodaran explains coal, oil and gas, shunned by the ESG-conscious investors, have been the best performing sector since the war started. Furthermore, Prof. Damodaran quotes a recent article in Harvard Law School Forum on Corporate Governance that shows the ESG-scores of companies with substantial operations in Russia, with its disregard for all that ESG stands for, are in fact higher than those of companies without Russian operations. The article is titled “The False Promise of ESG“, which is only fitting.

Prof. Damodaran also criticises the view that the management of companies pulling out of Russia now are morally superior to others. The real reasons they pull out, he argues, are rather that Russian operations are a minimal part of their business, the business is not worth the increased risk the war brings, or fear of expropriation or nationalisation.

In his article, Prof. Damodaran groups the proponents of ESG into Revisionists, Expansionists and Utopians based on their reaction to the indications of its failure. He predicts the ESG is a fad just about to fade, and finishes by outlining in a somewhat cynical manner the basic requirements for the “next big thing”.

Thorsteinn Siglaugsson is an economist who lives in Iceland. Find him on his blog.