The Flaw in Anti-ESG Logic: Financial Interests of Companies Like Meta Don’t Always Align with Those of Its Shareholders

In the last few months, there has been an organized effort to falsely argue that companies and institutional investors are inappropriately prioritizing social and environmental responsibility over financial returns. The effort includes state treasurers from Texas, West Virginia, and Florida, as well as anti-ESG activist and fund manager Vivek Ramaswamy.

These critics charge that when companies and institutional investors address systemic concerns (by seeking to reduce carbon emissions or increase inclusivity, for example), they are ignoring financial returns, and instead pursuing a climate or racial justice agenda. In order to protect investors, they argue, it should be illegal for investors to account for any systemic concern, even if the concern relates to profit. 

This argument has a number of flaws. The most obvious is the conflation of motives with methods. It is smart, and in no way duplicitous, for individuals motivated by concerns about the climate to persuade executives and investors that companies can increase profits over the long term by taking steps that reduce emissions, even if doing so is expensive in the short-term. Finding common ground upon which to increase investor returns while preserving social and environmental systems is just a good idea, not a scandal.

But a new lawsuit filed against the directors of Meta Platforms (formerly Facebook, Inc.) illustrates an even deeper flaw in the anti-ESG logic: the uncomfortable truth is that sometimes a company’s financial interests are not aligned with those of the economy. It is these situations that most vividly reveal how the anti-ESG forces misunderstand basic investing principles as their insistence on prioritizing profit at individual companies over their systemic impact ignores the diversification essential to careful investing.

Diversification (finance-speak for the investments like the broad index funds that sit in many retirement accounts) allows investors to receive the high returns delivered by common stock without bearing the unacceptable risk that would come with restricting that ownership to just a few companies. This idea is so prevalent that laws now require pension trustees and other fiduciaries to follow the diversification principle.

Today’s investor is thus likely to own positions in hundreds or even thousands of companies. If one such company profits through conduct that threatens social or environmental systems, the consequent economic harm may pose a risk to the investor’s entire portfolio that far outweighs any gain received from a relatively small holding in the company. In such a situation, a diversified shareholder trying to optimize its returns should use its corporate governance rights (such as voting its shares) to steward the company away from the practice, even if doing so reduces the value of that particular company.

This idea is sometimes called “universal ownership theory,” and its casual rejection by anti-ESG politicians ignores the data, which shows that the return of a diversified portfolio depends much more on broad market returns than on the relative performance of individual portfolio companies. In fact, a new paper from Oliver Hart and Luigi Zingales, prominent economists (one of whom has won a Nobel Prize), explains that because “the shareholders of one firm may be concerned about the impact of that firm’s externalities on the profitability of other firms the shareholder owns,” shareholders might object to a company they own focusing solely on maximizing its own financial returns. 

In other words—and despite the fiery rhetoric— properly practiced ESG investing is necessary if investors are to ensure that companies use their capital to optimize investment returns. Prohibiting this kind of stewardship is clearly bad for investors, but it is also bad for capitalism. By rejecting the basic right of shareholders to steward their own capital to its highest value use, Ramaswamy and the nominally conservative state treasurers are renouncing the core concept behind free market economics: that empowering the owners of capital to pursue profit creates market forces that efficiently allocate resources. The anti-ESG campaigners want to restrict the invisible hand of the market and pick the winners themselves.

The Meta litigation confronts this issue head on by alleging multiple breaches of fiduciary duty based on the conduct revealed by Frances Haugen, the “Facebook Whistleblower.” Unlike many shareholder lawsuits that complain about conduct that is bad for the company in question, however, the new filing charges that company decisions harmed the global economy, and that this economic harm threatened the portfolios of the Company’s diversified shareholders. As the lawsuit asserts:

The economic benefits from—indeed the viability of—a system of corporate law rooted in maximizing financial value for stockholders would vanish if it forced directors to make decisions that increased corporate value but depressed portfolio values for most of its stockholders. 

The truth is that shareholders are getting tired of executives pursuing profit by piling costs onto the rest of their portfolios. The same concerns apply to fund managers, and if advisors like Mr. Ramaswamy are marketing mutual funds to diversified investors while encouraging portfolio companies to externalize costs, they may soon be facing the same challenge as Meta.