Environmental, social and governance (ESG) evaluations are now commonly used among corporates, investors, businesses, and universities. Metrics can be wide-ranging and the amount of ESG data available is increasing. ESG has transformed from a niche concept to a common household reference in a decade, leading to confusion and misconceptions about its effects. ESG is a term now frequently used by investment committees, at board meetings, and by corporate management. Many companies are integrating ESG strategies, developing ESG products, and regulators are designing ESG policies.

Given the rapid rise in ESG, unrealistic expectations have been created surrounding the effects of ESG. The author calls out hyperboles created around ESG, and highlights how ESG can be a force of accountability and progress, while recognising that it will not solve all of society’s problems. The paper discusses the criticisms of ESG mechanisms used to influence corporate behaviour, such as divestment, shareholder engagement, reporting, sustainability payoffs, and regulation.

Some hyperboles in ESG come from estimates on how many investors consider ESG information when decision making. Increasing numbers of investors have ESG policies and intentions, yet this does not mean they respond to ESG news by changing capital allocations.

Various papers have measured market reactions to ESG principles and integration, which have addressed the implicit assumption that all investors consider ESG issues in their due diligence processes. Yet, the reality is, the lack of significant market reaction to ESG news indicates investors do not seem to regard such news as relevant for assessing the value of companies.

One of the most hotly debated issues the disagreement among ESG rating providers. Disagreement is primarily driven by scope and measurement rather than what factors are prioritised. While disagreement may create confusion and contribute to a lack of accountability with companies, multiple viewpoints can be helpful in preventing inferior evaluations and facilitate new ideas.

Transparency and increased disclosure are often cited as helping to mitigate disagreement, but research has shown the opposite. In the presence of more information, analysts have more data to disagree about, and will tend to disagree more on ESG outcomes rather than ESG activities. This highlights the importance of developing a shared understanding of what constitutes good or bad ESG performance, and metrics to assess ESG outcomes.

The debate over whether ESG portfolios will outperform or not is complex, given the difficulty of measuring ESG regarding investment funds. Providing robust assessments on ESG requires in depth analysis and weighting of ESG issues based on performance. Yet conversely, not understanding the value and price of ESG investment can lead to underperformance.

It is not realistic to expect the adoption of ESG practices will universally raise corporate performance, and nor will every organisation experience positive results. Most organisations have commitments to take ESG seriously, but many have not yet developed robust management tools and frameworks to drive ESG outcomes forward.

Whether the full potential of ESG will be achieved remains to be seen, and its potential will be shaped by both market forces and public policy.

1. Divestment as an ESG approach is limited, given the potential unintended consequences leading to worse societal outcomes. If companies are forced to shift from public markets to private markets, this may hurt transparency, and reporting becomes opaque.
2. Engagement as an ESG strategy is criticised for being a greenwashing mechanism. Investors can engage at length without tangible progress. Yet, it is a productive way forward for standard setting, transparently communicating to investees, and exiting if standards are not met. A combination of engagement and divestment is likely to be a better alternative.
3. ESG reporting is used as a mechanism to influence behaviour, and research indicates that reporting and transparency is effective at changing behaviour and outcomes in general. ESG outcomes are said to change behaviour if strong incentives are tied to metrics.
   
   
4. While studies suggest positive social impact and financial returns could be complementary, it is not clear that over time firms will act in a way that will provide solutions to many of society's problems. As such, we cannot expect ESG to lead all the way, but it could be a force for accountability and progress.
5. Regulation is a necessary condition but unlikely to be a sufficient condition. Firms that are motivated to improve ESG outcomes are more likely to make more aggressive investment in innovating, experimenting, and pursuing ESG-driven purpose. Therefore, the ESG movement could go from incremental to transformational and regulation has a foundational role to play.
6. ESG can represent a preference or taste among companies or investors. The paper argues to think about ESG not as a preference but as a set of common versus differentiated practices. Some ESG practices are becoming a common standard of doing business, while others can be thought of as a strategy if it allows the organisation to differentiate itself.
7. We should be careful when assuming ESG information is a strong force in moving markets, and the extent that investors use ESG information. Investors react to news more likely to be financially material for an organisation. The strongest market reaction generated by news is from the social category of ESG, but capital markets do not seem to regard the news as significantly relevant in assessing the value of companies.
8. Providing robust assessment on ESG requires in-depth analysis and weighting of ESG issues based on performance. Not understanding the value and price of ESG investment can lead to underperformance.
9. Disagreements among rating providers in their evaluations of the ESG profile of a company creates confusion among market participants and market expectations. It can also contribute to a lack of accountability when companies can find a rating provider with a more desirable score. In the absence of developing a consensus on evaluation metrics, there is a wide variety of outcomes for assessments.
10. Some have dismissed ESG assessments as useless, partly due to disagreement among rating providers, and because some highly rated companies have proven not to align with their assessment. While assessments can be improved, and their connection to future realisations can also be better, this does not mean they do not already perform an important function.