As Firms Pursue ESG Goals, Business Leaders Need to Keep Pace

There is a moment when a movement evolves from a trend to a permanent part of the public discourse. At UCLA Anderson, that moment has arrived for the concept known as ESG. The acronym stands for “environmental, social and governance,” and in practice it refers to how executives and investors are considering non-financial factors as part of their analysis of business opportunities. Recently, Anderson’s Professor Magali Delmas and her co-authors released a groundbreaking study that looked at how corporations are disclosing information about sustainability.

Concurrently, Associate Professor of Accounting Henry Friedman and Associate Professor of Finance Valentin Haddad introduced a new ESG course to the school’s curriculum. Friedman’s research relates broadly to how information is produced and used in firms and capital markets. Haddad has studied how financial institutions trade and manage risk, and how their practices affect market prices and the economy — and he’s found that “a lot of what we thought was obvious is not.”

Q: If you were to describe the course to someone you just met in an airport during a flight delay with some time to kill, what would you tell them?

Henry Friedman: In the last few years, there has been an intensification in how firms’ stakeholders — customers, employees, investors, managers —push for firms to do better on the types of things that fall under the ESG umbrella. You see this in customers’ maybe not wanting to buy products that are filling landfills; or, witness the backlash against plastic straws because of their effects on marine life. With this class, we want to empower students to make decisions balancing these considerations with more traditional business objectives. It’s important for our business students because it’s something that everyone in the business community is talking about and has to confront. Businesses use ESG when reporting their performance. It’s what investors look at, and it’s increasingly what consumers and employees hold businesses accountable for.

Part of effectively doing this is understanding the current frameworks people are using. The term ESG helps organize the broad set of social impacts firms can have across various dimensions. So we devote quite a bit of time to understanding the ESG umbrella and related frameworks.

Valentin Haddad: That’s the easier part of the class, though. A lot of our time is spent on the tough questions that come with making decisions around ESG issues. Sure, we all want to limit global warming, but how much profit are we willing to sacrifice for doing so? How much should an individual business be held accountable for changes caused by global or historical trends? As an investor, what does it mean to focus on sustainable goals, what are you trying to accomplish?

We take on many of those questions and give students the tools to address them. Of course, there are no simple answers and some of the exchanges are particularly difficult — our first class in late March of 2022 started with a discussion of whether American businesses such as Papa John’s should pull out of Russia after the attack on Ukraine. But by spending time with those issues, it becomes easier to see the big picture and be ready to face similar questions in any position.

Q: You’re both scholars, and the nature of that work involves years of research, writing and publishing. This topic feels a little different, with issues evolving in real time, often in the headlines. How do you design and teach a course for which the subject matter is changing practically while you’re teaching?

HF: I think that makes it exciting.

As professors, we try to tie things back to what is constant. In general, we’ve got firms providing products and services to their customers to generate returns to their financial stakeholders. At least historically, shareholder value maximization was managers’ guiding light. But there’s also a long legacy of concerns about the societal impact of firms that we can learn from. What’s really new today is the breadth of where these concerns show up. So, what we as research academics can bring to the class is a strong foundation of economics and, in some cases, psychology. And then we can incorporate the quickly changing world. Our research background gives us a good framework for thinking about how firms respond to these changes — what are the opportunities and what are the risks?

VH: We don’t know all the answers, we even don’t know all the questions. What we’re trying to do is help students get ready to respond to those questions. The class is not a traditional class, we don’t come and just lecture. We spend a lot of time discussing these challenges, and we invite many speakers, people who have been doing this for a long time, to share their experiences. Some are part of this new generation of ESG, and we’re trying to get inspiration from many dimensions to bring in ideas and add to the framework for facing those issues. We see the long-term academic framework that Henry is talking about and the more recent experiences as two sides of the same coin.

Q: What are the assignments like and what form does the students’ workload take?

VH: The workload is very team-based. What we do almost every week is spend some time as a class discussing a case regarding a company or an investment firm, and how they address and face a challenge. Every couple of weeks, the students have to prepare reports on these cases as a group.

We also have a final project, with teams of students taking a more in-depth look at an issue. Students can take an existing company and assess its performance in terms of ESG issues and determine how it can do better. Or they make a proposal for an investment on the financial side to support ESG progress. Some of the students also create proposals for companies that are trying to make a positive impact on the world. The goal is for everybody to take a deep dive into making ESG business decisions.

Q: How do you approach co-teaching?

VH: This is a brand-new topic and extremely challenging. We thought it would be valuable for our students to provide a variety of perspectives, instead of one of us coming up with “the answer,” in part because things are always changing. We learn from the news and — I think this also goes for Henry — we learn from each other.

We teach about half of the lectures each but it’s not a formal division. When topics are closer to finance, it’s me. When we are closer to accounting, that’s more Henry, but there’s a lot of broader discussion where either of us can step in. The goal was to leverage our different expertise.

HF: I think it leverages both our backgrounds, and I think it results in a class that’s in some sense a core class on ESG. We’re trying to create something that’s useful across a wide range of potential students. It’s not just 10 weeks on ESG reporting issues. There are a couple of days on reporting issues, and those are definitely important, and a couple of days on financial strategies. But there are also lectures specific to each of the letters in ESG, so that we can really take a deep dive into aspects of a few different areas. What we were going for was breadth of coverage to help students understand some of the top issues when it comes to ESG.

Q: Looking ahead, how do you intend to keep bringing in fresh research and also fresh headlines?

HF: There are portions of nearly every class that are ripped from the headlines. Some of that’s driven by us, some of that’s driven by students. For example, the SEC disclosure rule that got released mid-March [2022]. We were discussing it in class a couple weeks later. I think the way that we talk about stuff like that will change, certainly if the big players on the finance side shift their preferences a bit. If there are big outflows for ESG funds or if investors shift toward prioritizing biodiversity rather than climate, that’s something that will definitely come into the class.

It’s a very easy class to keep topical. Nonetheless, we still look at issues that will stay timely for several years.

Q: Not everyone holds the same viewpoint on issues related to ESG. There are those who are skeptical of the implications of climate change, for example. How do you handle those differing opinions?

VH: Of course, everybody has to be respectful, but we very much welcome skeptical points of view, and any point of view. The reality is, any business deal — no matter what someone’s opinion is, whether someone wants to do it, whether they don’t — is going to be held accountable for some of these issues. The class provides tools to make decisions.

HF: We want our students to be challenged by what you might call the traditional viewpoint. We think that it’s appropriate to find a balance between impact and profits. We also know people come to this with different views. So, that balance is going to be different depending on who the stakeholders are.

It goes in both directions: If you can’t justify why you’re pursuing ESG goals, then you’re going to be a worse manager, a worse investor. What we want the students to be thinking about is how they would show that they are performing on these goals, and how the pursuit of ESG goals contributes to their bottom line. We want our graduates to succeed as managers and investors, to be leaders; this is all about striking an appropriate balance and justifying it.