Applying economics – not gut feel – to ESG

Edmans, A (2023) Applying economics – not gut feel – to ESG. Financial Analysts Journal, 79 (4). pp. 16-29. ISSN 0015-198X

Abstract

Interest in ESG is at an all-time high. However, academic research is still relatively nascent, often leading us to apply gut feel on the grounds that ESG is too urgent to wait for peer-reviewed research. This paper highlights how the insights of mainstream economics can be applied to ESG, once we realize that ESG is no different to other investments with long-term financial and social returns. A large literature on corporate finance studies how to value investments; asset pricing explores how the stock market prices risks; welfare economics investigates externalities; optimal contracting considers how to achieve multiple objectives; private benefits analyze manager and investor preferences beyond shareholder value; and agency theory helps ensure that managers pursue shareholder preferences, including non-financial preferences. I identify how conventional thinking on ten key ESG issues is overturned when applying the insights of mainstream economics.