Hills Sustainability
12 September 2023 Financial Analysts Journal Volume 79, Issue 4

Applying Economics—Not Gut Feel—to ESG

  1. Alex Edmans
Mainstream economics can be applied to ESG once we realize that it is no different from other investments that create financial and social value. This paper overturns conventional thinking on 10 key ESG issues by applying sound economic principles.
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Interest in environmental, social, and governance (ESG) issues 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 nonfinancial preferences. I identify how conventional thinking on ten common ESG myths is overturned when applying the insights of mainstream economics.

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