New research provides evidence that legally nonbinding commitments from corporate managers to Environmental, Social, and Governance (ESG) principles may help predict subsequent corporate behavior. [1]  This study provides cautiously optimistic evidence that CEOs who claim to consider the ethical implications and the effects of corporate actions on non-shareholder constituencies do run their firms differently from CEOs who make no such claims—at least on the margin.  This is likely to come as a surprise to many corporate law scholars and practitioners who have derided pledges, such as the 2019 Business Roundtable Statement on the Purpose of the Corporation, as mere window dressing.

But the skeptics are likely right that actual differences in corporate behavior do not suggest diminished concern for shareholders’ pecuniary interests – only that some firms prioritize higher returns at the cost of taking on greater risks, while those that embrace ESG expend more resources on risk mitigation.  In other words, the sorts of differences in corporate behavior we can observe that are empirically linked to ESG pledges reflect a reasonable exercise of business judgment and not a substitution of progressive ideology for that business judgment.

Some firms may try harder to avoid negative press coverage, may prepare well in advance for regulations or disruptions that may only later come into play, and may seek to do more to protect the corporation’s reputation to avoid a costly backlash. This pragmatic approach may enable such CEOs to chart a more ethical course without undermining long-term shareholder value.  Indeed, it is unlikely that the U.S.’s baseline one-share, one-vote corporate governance regime, coupled with beneficial share ownership and defacto voting power that are highly concentrated in the hands of the wealthiest 1 to 10 percent of households, would tolerate sacrifices of long-term corporate profits except under very limited conditions.[2]

The view that the 2019 Business Roundtable Statement on the Purposes of the Corporation does not call for sacrificing profits is supported by Dammann and Lawrence’s study. They find evidence that abnormal returns around CEOs signing the Business Roundtable Statement were close to zero or were slightly positive.[3]

The Dammann and Lawrence study shows correlations between the Refinitiv ESG ratings of publicly traded U.S. firms, whether those firms’ CEOs signed the Business Roundtable Statement, and whether they terminated their dealings in Russia after Russia’s 2022 invasion of Ukraine.[4]  Early signatories were more likely to withdraw from Russia.[5]

Firms that signed the Business Roundtable Statement were, on average, different from firms that did not.  Compared with the latter, the former were larger (measured by both assets and employees), more profitable (measured by return on assets), and less highly leveraged.[6] Such firms likely have more to gain by managing reputational risks and more resources to make long-term investments in risk mitigation.[7] Lower leverage levels at signatory firms arguably also suggest greater managerial power relative to investors (including creditors).[8]^,[9]

Industry differences make sense intuitively. For example, firms in mining (including oil and gas extraction) and manufacturing (which consume large quantities of energy and produce pollution) were unsurprisingly less likely than firms in many other industries to sign a pledge that promised, inter alia, to protect the environment.[10] By contrast, utilities were far more likely than most firms to sign the pledge. Utilities have been dramatically raising consumer electricity prices to help defray the costs of transitioning to environmentally friendly approaches to power generation and transmission. [11] By explaining that higher consumer prices – which lead to higher utility profits – are necessary as part of an overall program of promoting environmental protection, utilities can limit consumer and regulatory backlash.

Signatories had higher average ESG scores than otherwise similar non-signatories in the year they signed, especially on environmental, employment, and human rights measures.[12] They also had higher than average ESG scores in the years before they signed the Roundtable statement, as well as the years after. Thus, high ESG scores and signing the statement both describe something similar about firms that is relatively stable over time

Dammann and Lawrence find evidence that signing the statement predicts roughly a 2-percentage point increase in the probability of a firm withdrawing from Russia after Russia’s 2022 invasion of Ukraine.[13] They view this withdrawal as a credible demonstration of the firms’ commitment to human rights.

However, their analysis does not control for the potential financial cost to firms of withdrawing, which is likely to vary substantially across U.S. firms, instead treating withdrawal as a binary outcome variable. Exposure to Russia, unfortunately, is not easily determined from many firms’ public disclosures. Nevertheless, there is good reason to believe that ESG-oriented firms would be less exposed to Russia than substantially similar firms even before Russia invaded Ukraine in February 2022.

Firms’ decision to withdraw from Russia could be viewed not so much as a sign of a universal commitment to human rights or pacifism, neutrally applied regardless of national allegiances, but rather as an exercise in prudent risk management based on a greater ability to predict future government actions in key markets such as the United States and Europe.[14] Once Russia started a war with Ukraine – a European country that was becoming a viable candidate for EU membership and possibly even NATO expansion – it became extremely likely that the U.S. and E.U. would at a minimum impose increasingly strict economic sanctions against Russia and that businessmen with ties to Russia would come under close scrutiny from Western intelligence and law enforcement agencies.[15] It also became plausible that Russia would take a harsh approach toward companies perceived as beholden to U.S. or European foreign policy, possibly including seizure of assets, theft of intellectual property, and arrests of executives on espionage or other charges.[16]

Russia under its current leadership has a long history of engaging in such actions. Russia arrested businessmen with Western ties on questionable charges as early as 2003 and seized control of their firms.[17] Publicly traded Russian companies have long traded at much lower price-to-earnings ratios than their American and European counterparts, reflecting investor fears of misconduct and government interference.[18] Russia’s longstanding reputation for severe corruption would make many foreign corporations reluctant to become dependent on the Russian market.[19]Russia’s 1998 default on its sovereign debt did not inspire investor confidence.  Although Russia has low labor[20] and energy costs[21], locating productive capacity within Russia has long been seen as risky and was not particularly popular with U.S. firms.[22]

Russia’s governance problems are compounded by longstanding geopolitical tensions with the U.S. and NATO. Even after the dissolution of the Soviet Union in the early 1990s and before the 2022 invasion of Ukraine, Russia had tense relations with the United States and EU member states and acted aggressively toward former Soviet Republics drifting from Russia’s sphere of influence toward Western alignment, including both Georgia and Ukraine.

In 2015, Russia fought a brutal war in Syria, using aerial bombardment and artillery and working with Iranian special forces to support the Syrian government against rebel groups backed by Turkey and the United States.[23] The Syrian civil war resulted in the deaths of over 500,000 Syrians and the displacement of millions of refugees as entire cities were leveled.[24] Russia succeeded in its goals of keeping a pro-Russian Syrian regime in power.[25]

Thus, Russia had a long track record of a hostile business climate, geopolitical tension with the United States and its allies, and disregard for human rights before the 2022 invasion.

What this means is that firms with an ESG orientation, or simply a prudent approach to geopolitical risk management, would have had concerns about Russia long before the invasion. These firms had time to prepare by insulating their supply chains from dependence on Russia. Such preparations would have made officially “withdrawing” from Russia in 2022 or 2023 easier because these firms would have started effectively withdrawing sooner. Such firms would have found it financially less expensive to withdraw than firms with a less holistic approach to risk management. Firms stood to benefit in terms of public relations by announcing a withdrawal after the Ukraine invasion even if they effectively withdrew earlier (or never entered).

The amount of attention Russia’s invasion of Ukraine generated was partly a function of its geopolitical and economic context and not simply a function of the severity of human rights abuses. So far, the U.S. and European sources estimate that roughly 100,000 Ukrainians have died in the conflict,[26] compared with more than 500,000 Syrians who died in their civil war.[27] The fact that recent conflicts that were more deadly than Russia’s invasion of Ukraine did not generate comparable corporate pledges to cease doing business with belligerents suggests that the corporate withdrawal dynamic is more complex than a simple concern for human rights. Thus, ESG can perhaps be understood best through the lens of corporate risk management.

ENDNOTES

[1] See generally Jens Dammann & Daniel Lawrence, CEO’s Endorsements of Stakeholder Values: Cheap Talk or Meaningful Signal? An Empirical Analysis, 49 J. Corp. L. 577 (2024) (analyzing the correlation between signing the 2019 Business Roundtable Statement with ESG performance, likelihood to withdraw from the Russian market, and stock performance).

[2] See Michael Simkovic, Natural Person Shareholder Voting, 109 Cornell L. Rev. (forthcoming 2024) (manuscript at 4) (electronic copy at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4180982#) (presenting a model that suggests that if shareholders broadly care about their own welfare, including both externality exposures and profit shares, and corporations are governed according to the preferences of the shareholder voting majority, concentration of equity ownership leads to more corporate negative externalties, especially externalties that do not adversely affect the value of other assets).

[3] Dammann & Lawrence, supra note 1, at 577.

[4] Dammann & Lawrence, supra note 1, at 577.

[5] Id. at 620 tbl.12. This is supported by additional data provided by Professor Dammann to the author.

[6] Id. at 604 tbl.7.

[7] Dammann & Lawrence, supra note 1 at 603, tbl.6.

[8] A moderate amount of debt may also reduce agency costs by reducing financial slack and preventing imprudent expenditures of internally generated funds.

[9] Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate Governance, 154 U. Pa. L. Rev. 1209, 1211 (2006).

[10] Firms in natural resource extraction industries may also be compelled to operate in parts of the world where respect for human rights and workers’ rights are not high priorities because those countries are where deposits of the required resources are located.

[11]  Dammann & Lawrence, supra note 1, at 600 tbl.4; Garrett Hering, Skyrocketing Electricity Prices Test California’s Energy Transition, S&P Global (Feb. 26, 2024), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/skyrocketing-electricity-prices-test-california-s-energy-transition-80305308 [https://perma.cc/V5XK-2GN3].

[12] Dammann & Lawrence, supra note 1, at 615 tbl.9.

[13]  Dammann & Lawrence, supra note 1, at 620 tbl.12.

[14] See, e.g., Guido Giese et al., Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance, 45 J. Portfolio Mgmt. 69, 70 (2019) (finding that higher ESG scores predict lower idiosyncratic and systemic risk); Benjamin Hübel & Hendrik Scholz, Integrating Sustainability Risks in Asset Management: The Role of ESG Exposures and ESG Ratings, 12 J. Asset Mgmt. 52, 52 (2020) (finding similar results).

[15] Nate Raymond, Russian Businessman Convicted of U.S. Hack-and-Trade Charges, Reuters (Feb. 14, 2023), https://www.reuters.com/world/us/russian-businessman-convicted-us-hack-and-trade-charges-2023-02-14/ [https://perma.cc/W2AD-YLY5].

[16] See, e.g., Madeleine Speed & Courtney Weaver, Ex-Carlsberg Executives Detained in Russia over Fraud Claims, Fin. Times (Nov. 16, 2023), https://www.ft.com/content/145f2310-7222-4df9-9976-f268ed1f1eb2 (on file with the Journal of Corporation Law); Saabira Chaudhuri, Russia Arrests Two Executives at Seized Carlsberg Unit on Fraud Charges, Wall St. J. (Nov. 16, 2023), https://www.wsj.com/world/russia/russia-arrests-two-executives-at-seized-carlsberg-unit-on-fraud-charges-45cde873 (on file with the Journal of Corporation Law) (framing charges as linked to geopolitical tension and not any wrongdoing of executives); Armani Syed, Russia Arrests Dual U.S. Citizen on Accusations of Treason, Time (Feb. 20, 2024), https://time.com/6696617/russia-arrests-dual-citizen-treason/ [https://perma.cc/CYG3-VYN6] (connecting treason charges to geopolitical tension between the US and Russia).

[17] See, e.g., Greg Schneider, Arrested Russian Businessman Is Carlyle Group Adviser, Wash. Post (Nov. 9, 2003), https://www.washingtonpost.com/archive/business/2003/11/10/arrested-russian-businessman-is-carlyle-group-adviser/7e20a4a3-b67b-493e-bc4e-f05f63ec7ac5/ [https://perma.cc/E5U4-Z535] (“Because the billionaire is seen as a possible political rival to President Vladimir Putin, his arrest has unsettled the country’s business community and worried foreign investors”).

[18] For example, RSX, an ETF tracking leading Russian companies, has historically traded at a P.E. ratio of around 5. See VanEck Russia ETF (RSX), Yahoo Fin., https://finance.yahoo.com/quote/RSX/ [https://perma.cc/F4Sq-3G9D] (showing a P.E. ratio of 4.31). By contrast, S&P500 ETFs such as SPY have generally traded at a P.E. ratio above 20 during the last decade, while U.S. energy ETFs such as XLE have generally traded at a P.E. ratio of around 8 to 12. See S&P 500 PE Ratio – 90 Year Historical Chart, Macrotrends, https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart [https://perma.cc/J4LV-E9MS] (showing change in PE ratio over time); The Energy Select Sector SPDR® ETF (XLE), Ycharts, https://ycharts.com/companies/XLE (last visited July 25, 2024) (listing 13.21).

[19] Russia has ranked in the bottom quartile of countries on the “Corruption Perception Index” for more than a decade, meaning it is perceived to be among the 25% of countries with the worst corruption problems in the world. Corruption Perception Index Russia, Transparency Int’l., https://www.transparency.org/en/cpi/2023/index/rus (last visited July 25, 2024).

[20] Statistics on Labor Costs, Int’l. Lab. Org., (Jan 11, 2024), https://ilostat.ilo.org/topics/labour-costs/ [https://perma.cc/3D58-K5YM] (showing Russian labor costs at $0.03 an hour).

[21] Cost of Electricity by Country 2024, World Population Rev., https://worldpopulationreview.com/country-rankings/cost-of-electricity-by-country [https://perma.cc/A9VL-PKUV]

[22] For example, U.S.-originating foreign direct investment in Russia in 2021 was roughly $12 billion, about the same as U.S. FDI in Poland and approximately one-fifteenth of U.S. FDI in Germany. Balance of Payments and Direct Investment Position Data, U.S. Bureau of Econ. Analysis, https://www.bea.gov/international/di1usdbal. Poland had a GDP that was half that of Russia and had much higher labor costs and higher energy costs than Russia. GDP (Current US$) – Poland, Russian Federation, World Bank Grp., https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=PL-RU [https://perma.cc/2BBT-JTJN]; see supra notes 33–34.

[23] Nicole Grajewski, The Evolution of Russian and Iranian Cooperation in Syria, Ctr. For Strategic & Int’l. Stud. (Nov. 17, 2021), https://www.csis.org/analysis/evolution-russian-and-iranian-cooperation-syria [https://perma.cc/MR4E-35YU].

[24] Why has the Syrian War Lasted 12 Years?, BBC News (May 2, 2023), https://www.bbc.com/news/world-middle-east-35806229 [https://perma.cc/5HF2-4KZN]

[25] Assad Welcomes New Russian Bases in Syria After Putin Meeting, Al Jazeera (Mar. 16, 2023), https://www.aljazeera.com/news/2023/3/16/assad-will-welcome-new-russian-military-bases-in-syria [https://perma.cc/TUX6-WW3P].

[26] Max Maldonado, Russia’s Invasion of Ukraine, Two Years Later, PBS (Feb. 23, 2024), https://www.pbs.org/wgbh/frontline/article/ukraine-war-russia-second-anniversary/ [https://perma.cc/GFW4-4EDD].

[27] Agence France Presse, Syria War Death Toll Over 507,000, 13 Years On, Barron’s (Mar. 14, 2024), https://www.barrons.com/news/syria-war-death-toll-over-507-000-13-years-on-32a62fe9 [https://perma.cc/HG8V-B55S].

This post comes to us from Michael Simkovic, a professor at the University of Southern California’s Gould School of Law and Marshall School of Business. It is based on his recent article, “Business Judgment and ESG,” forthcoming in the Journal of Corporate Law and available here.