Harvard's Gandhi Cautions India Inc. About Greenwashing
But how many chief executives, promoters and business leaders are going to be around to see it through, asks Vikram Gandhi, senior lecturer of business administration at Harvard Business School.
"I advise a lot of boards here in the U.S. that net carbon zero by 2050 is great but you're not going to be there, your CEO is not going to be there, nobody's going to be there."
You've really got to create five-year plans, Gandhi says.
"As a board member I would push the management team really hard saying, yeah, you made these big aspirational goals which is fantastic. Let's have five-year goals and let's have five-year goals that we can achieve and benchmark ourselves against that. I hope that happens."
That's if the company is serious about minimising its carbon footprint and not just "greenwashing" or faking it.
The lack of common international reporting and rating standards on ESG has allowed companies to play pretend-ESG. While efforts are on to curb that, both country-wise and internationally, it's going to take a while, Gandhi points out.
"It took over 100 years for people to get to a financial disclosure mechanism that's consistent across countries so that investors could actually compare companies' financial performance.
I think getting to a similar thing around sustainability issues is going to be the next Holy Grail."
Till then, companies could identify the four or five material issues to disclose from an ESG standpoint with help from agencies such as SASB, he says. Company boards will have to engage with ESG-led investors in a meaningful way, says the professor who teaches a course on impact investing.
"...ultimately, it's going to be that the board's going to have the right intent. If the board's intent is I'm just going to kind of massage my data so that I can get into some index it's going to backfire on you."
Close to $40 trillion in assets have some overlay of sustainability and impact on them, he estimates. With that much at stake, investors have moved beyond tick-box approaches by companies.
That is an area that is going to be what I would call ESG 2.0 or 3.0. It's not about ticking the box, it's not about risk management, it's about generating alpha.Vikram Gandhi, Senior Lecturer, Harvard Business School
Earlier this year, a tiny activist investor, Engine No. 1 put one of the world's largest companies in the dock when it, backed by other institutional investors, was able to grab three seats on the fossil fuel giant's board.
"People don't realise it but this is a huge event—that a small investor could replace three board members out of 12 at a large Dow Industrial company called Exxon. It's never happened before."
But it may happen more frequently here on, Gandhi says. Not just against fossil fuel companies but also big tech, gaming companies, junk food makers.
As investors pick engagement over divestment, Gandhi says boards will have to go beyond their fiduciary duty to just shareholders.
The question for boards is what is the purpose of a corporation, poses the former Wall Street banker.
Watch the interview with Harvard's Vikram Gandhi.
Here are edited excerpts from the interview.
Large pools of global capital are now tied to ESG goals. What do investors look for as they identify businesses they believe will deliver on this promise?
Vikram Gandhi: Over $35 to $40 trillion, which is more than 30% of the world's assets or investable public market assets have some overlay of sustainability and impact on them. This is a trend that's, like they say, the horse has left the stable and is not coming back and most boards understand and realise that.
The $35 - $40 trillion that I'm talking about have a fiduciary obligation. They're looking to maximise returns. What they care about is the fact that hey, if in the long term we don't care about climate, environmental issues, societal issues, equality issues—be gender, income or other kinds of inequality—and governance issues, if we don't factor those into our long term decision making process, we're going to be making bad long-term decisions. That's what's driving this.
These are not three equal attributes — environment/sustainability, social and governance goals. These are three distinct goals and some are more measurable than others.
Vikram Gandhi: ESG has all been bucketed into one thing, but I find G is very different than E and S. Good governance is the fundamentals of any company and that's what the role of the board is. It is to provide good governance, which is making sure that the management is doing what they are meant to do etc. I'll keep that aside.
On the environmental and the social front yes, they're very different. If I'm not factoring those things in, I'm actually not going to be making good long-term decisions.
I'm not questioning the 'why'. We spent the last few decades answering the why. I'm mostly interested in 'how'.
For instance we have no standardised disclosure format right now for ESG or ES across the world. I know that agencies across the world are trying to arrive at one, but that makes it really very challenging to be able to apply the same benchmarks, let's say, in the U.S. as in India.
How do investors and companies navigate that?
Vikram Gandhi: The whole issue of disclosure, financial disclosure, ESG disclosure is big -- there's tons of effort being put in that area and my hope is that over the next couple of years that will actually get resolved fast.
That literally took 100 years and you still have debates - what should be the reserve levels, how do you do this, how do you do that, it is still going on.
I think getting to a similar thing around sustainability issues is going to be the next Holy Grail. I think it's happening in the sense that you need to have regulators come together, companies come together and investors come together to make that happen. It's a work in progress.
The other thing which I would say is that the material issues that a company has—what I would call the materiality factor—is very different from a tech company or a energy company to a service provider or to a consulting firm.
So, what we need to identify is that given the industry that your company is in, what are the four or five things that really matter from a materiality standpoint. There's another organisation called the Sustainability Accounting Standards Boards, SASB, by industry they've identified four or five things which really matter to a company's performance. I think that's what we should have. Which is that, if you're in this industry, in this sub industry, here are the five things you need to disclose and they need to be mandated. And if that can happen, I think it'll make a massive difference or progress in terms of moving the ball forward on this front.
Since these are not as objective as some financial parameters do you believe that there will always be a high degree of subjectivity and therefore different investors will look at ESG investing in different ways?
Vikram Gandhi: Absolutely. People look at financial disclosures in different ways and they analyse it. We've done a bunch of studies at the Harvard University and at the Business School which suggest that if companies are focused on the material issues that matter to them, the five or six things that I mentioned in my comment before, if they do actually well on those, the financial performance on those companies has been huge.
Just like in financial and in ESG factors different investors will look at it differently, but let's get some baseline financial disclosure that's out there, that people can then analyse and how they analyse it and how they think about it, that's up to them but at least the data is out there.
Disclosures is one thing. They form the bedrock of ESG ratings. We now have some 30-40 different ESG rating services across the world. Again, how do you navigate something like this? Because you can literally shop around for a better ESG rating, pretty much as you maybe could have at one point in time for credit ratings.
Vikram Gandhi: What I would tell the board members is that don't try and adjust your activities to kind of fit into some index because this is a massive issue right now globally on ESG - greenwashing. Which is that I'll adjust my activities, so I get into some index and people like me and then invest. I think it's a flawed thing and it's going to kind of backfire on people. I think people need to get ahead of the curve on that one.
You see both disclosure and rating standards sorting themselves out in the next two to five years. What happens between now and then. How do investors and companies navigate that period of uncertainty?
Vikram Gandhi: I think it's one of those things which is a transition phase and transition phases always are fraught with danger and fraught with concern. I think that's going to be in this case as well but my point is most long-term investors that are thoughtful and mindful will not get swayed by this indexing and stuff.
My suggestion to boards is -- why is disclosure important? Disclosure is important because the regulators mandate it so you can create a kind of comparison. But companies should want to disclose this. So, if I was a board member - I'd be proactive about it. I think that if you actually proactively disclose data, you will get better investors in your capital structure and you will get better long-term investors who believe in you.
While we will get the regulation, we will get the indices but I think, ultimately, it's going to be that the board's going to have the right intent. If the board's intent is I'm just going to kind of massage my data so that I can get into some index it's going to backfire on you.
How are ESG investors approaching the greenwashing problem?
Vikram Gandhi: Like any investor, you need to do the work, you need to do the bottom up analysis on a company, on an industry, on a business on what its competitive advantages are etc. They need to do a bottoms-up analysis on which companies they want to invest in because of all these factors and ESG is not some peripheral factor that you just have a tick-the-box-kind of approach. It is becoming fundamental to long term investing.
I think if you look at the evolution, five years ago it was okay I'm going to tick the box, I've got my due diligence list. Now it is more about risk management. I can't be investing for example in real estate and coastal areas because 20 years from now, maybe those coastal areas won't exist anymore.
Now what's happening is, people are looking at alpha generation - how do I invest in companies that actually are doing this really well, that can generate superior returns over time? That is an area that is going to be what I would call ESG 2.0 or 3.0. It's not about risk management, it's not about ticking the box, it's about generating Alpha.
Inherently is that more 'engaged' or more 'activist' investing? For instance, Engine No. 1 and what happened at Exxon regarding director appointments.
I'm wondering whether a lot of this change will be pushed forward by more engaged investors than in other ordinary situations?
Vikram Gandhi: I think it's a broader issue — this whole issue of divestment versus engagement. A lot of investors will say I don't want to invest in fossil fuel companies like your Exxon – Engine No. 1 example. I'm just going to divest, I don't want to invest in those.
There are others who say if there's a good financial case to be made in the long-term then maybe I want to invest in those and engage with those companies to make a difference.
There are pros and cons on both arguments, but a lot of a lot of investors will say, okay, I don't want to invest in fossil fuel, I don't want to invest in tobacco companies, I don't want to invest in alcohol companies, I don't want to invest in companies that are against my religious beliefs and I'm just going to get out of those.
Others think that oh if this company may have an interesting long-term financial perspective I'm going to invest, and I am going to engage.
Engine No. 1 - Exxon is a classic example of that which is long term.
On Engine No. 1, we are actually writing a case study right now at Harvard on this. Exxon has got fabulous brand name, huge distribution, seriously good technology etc. but maybe the belief of Engine No. 1 was that they're allocating the capital in a way that's not consistent with long-term. So, moving some of the capital away from traditional oil and gas and investing into renewables that maybe that over time will create more value for the company rather than less. That's the rationale of putting the three members on the board. But the fact is that a lot of pension plans CalSTRS and CalPERS the two big California plans, New York Pension Plan etc., were behind Engine No. 1 because Engine No. 1 was a small investor but they were behind it thinking that they could actually move the needle on this.
I think you're going to see more of that. I mean activist investing has been the bread and butter of a lot of investors over the years but activist investing with the ESG kind of overlay will increase over time, and this is just the first example of it.
People don't realise it but this is a huge event—that a small investor could replace three board members out of 12 at a large Dow Industrial company called Exxon. It's never happened before.
So, it'll be interesting to see how that plays out in terms of what these board members will actually be able to do now that they're on the board going forward.
Are there other instances you've noticed in the recent past that have been milestones for you in this journey towards more responsible investing?
Vikram Gandhi: I’ll give you a few examples of case studies that we've done at Harvard.
One was JANA Partners, another active investor, and CalSTRS had written a letter to the Apple Inc. board. Apple at that time was a not at trillion dollars market cap. Also, it was a 2-3-billion-dollar position. So a small position relatively speaking, but their message to the board of Apple and the management team was—you guys have a product that's creating child addiction.
You have a fantastic product, people's lives have changed dramatically because of Apple but you have a product that actually creates child addiction and there've been enough studies which show that child addiction from a mental and a physical standpoint, can have seriously negative implications. So shouldn’t you be doing something about this?Shouldn’t you be doing something to deal with some of these negative externalities, just like energy companies have negative carbon externalities, Apple has a negative externality of creating addiction. That was the basis of the public letter.
Apple didn't respond to it, but within six months it came up with a massive parental control program.
The other one I would say is gun control in America and I think that it is a big issue in India too but less publicised. Gun control is a massive problem in America, so CalSTRS and others came up with the principles of responsible firearms in private firearms industry. How do we, both as a manufacturer of guns and distributor of guns, etc., bring in mechanisms which control the responsible distribution of guns, which we don't let end up in the hands of people that shouldn't have them. So those are some examples of that.
In India and Asia unfortunately things are still behind but I think investors can play a massive role in making a difference on a lot of the societal fronts.
I think this is where the very apparent gray area appears. You can measure emissions, carbon footprint but there is now a growing body of activist investors against big tech, gaming, junk food. It isn't black and white. How do boards navigate those boundaries?
Vikram Gandhi: I think some of the social media is a very interesting example because they've obviously had a lot of attacks on them. The three issues which they have to deal with are antitrust, privacy laws and this whole issue of content management and content control.
I think all those three issues whether it be Facebook or Google or others, they all have a similar issue which is - how do we deal with this? Which is, I'm not trying to be a monopolist.... we have a Facebook class that I teach at HBS. I take a poll and say okay, Facebook owns Instagram, WhatsApp etc., so there are three companies who are seriously right there (gestures high with his hand) in terms of social media.
How many of you are on one of those three? 100%.
How many of you think there's a problem with one of those three? 100%
Okay, why would you not just sign off and not be a part of Facebook and WhatsApp and Instagram? Nobody wants to get off.
So, 100% of them are on it, 100% of them think there's some issue but none of them want to actually get off.
They say "this is my network, I mean if I get off Facebook and Instagram, I'm like cut off from the world".
So, it's really an interesting debate — how do you manage the fact, from a board perspective, that the company is adding serious value but that you and I are the product for these companies, we're not the customer. The customers are the advertisers.
How do you actually navigate that where, yes, you have a fiduciary obligation to create maximum value for shareholders, you've got other aspects that you need to focus on but how do you do what's right in terms of your community?
So, the question for boards is, what is the purpose of a corporation?
Moving back to the broader question of money flowing into ESG. Where do you see India in this?
Vikram Gandhi: I think it's early days right now as far as India goes. In terms of introduction, you talked about my role in terms of advising the Canadian Pension Plan which is a $500 billion fund and has a pretty big position in India, very small as a percentage of their assets but still pretty big and growing. I think they and the discussions we have with companies that we've invested in or are potentially going to invest in -- bringing in ESG into the investment process and the discussion is critical.
If I had to just broadly divide the world I would say Europe is very advanced in this area and that's wonderful. I think U.S. is getting there, given that it has so much to do with regulation and mindset, so with the new administration it's kind of moving in that direction. I think Asia is a little behind.
If I talked to any of the large industrial groups in India, all of them are very focused on the fact that we need to actually think about these things in a much more proactive and a productive manner as opposed to just ticking a box. I think that's a very encouraging thing. For investors or large pools of foreign capital companies that actually are thinking about these things in a more productive, proactive manner will be able to attract more money and longer-term money than others. Again, this is a multi-year process so it's just happening. It will take another three, four years to really kind of gel.
One last thing for board members in terms of net carbon zero. There are a lot of discussions about net carbon zero by 2050 etc., and I'm telling you because I advise a lot of boards here in the U.S., that 2050 is great but you're not going to be there, your CEO is not going to be there, nobody's going to be there.
You really got to create five-year plans. As a board member I would push the management team really hard saying, yeah, you made these big aspirational goals which is fantastic, let's have five-year goals and let's have five-year goals that we can achieve and benchmark ourselves against that. I hope that, that happens.