Environmental, Social, and Governance (ESG) has evolved into a central framework for evaluating corporate responsibility and sustainable investment. What began as ethical investing has transformed into a comprehensive strategy for addressing environmental sustainability, social equity, and governance integrity. This article will delve into the history of ESG, exploring its origins, key milestones, and the factors that propelled it into the financial mainstream.

The Apartheid and Early Ethical Investing

In the 1970s, global condemnation of South Africa’s apartheid regime led to one of the most famous cases of selective disinvestment based on ethical principles. Reverend Leon Sullivan, a General Motors board member, developed the Sullivan Principles in 1977. This code of conduct outlined how U.S. companies would ethically engage in business with South Africa. The widespread adoption of these principles by U.S. firms led to significant disinvestment from South Africa, exerting economic pressure that contributed to the dismantling of apartheid. This example demonstrated the power of collective investor action in influencing social outcomes – a foundational concept for ESG investing.

During the same era, conflicting ideologies emerged regarding corporate responsibility. Milton Friedman, a renowned economist, argued in his 1970 essay that a corporation’s sole responsibility was to maximize profits for shareholders. His Friedman Doctrine posited that social responsibility was a distraction from the primary goal of financial performance. This view dominated much of 20th-century economic thought, emphasizing short-term gains over broader societal concerns.

However, Stakeholder Theory, advanced by scholars such as R. Edward Freeman later came to challenge this narrative. It argued that corporations should balance the interests of all stakeholders – employees, customers, communities, and shareholders alike. By the late 20th century, the concept of social capital emerged, particularly through James S. Coleman’s 1988 article “Social Capital in the Creation of Human Capital,” which emphasized the value of social networks and trust in creating economic value. This shift in thinking laid the groundwork for ESG’s emphasis on long-term value creation through sustainable and responsible practices.

The Triple Bottom Line and Social Auditing

In the 1980s and 1990s, new frameworks for measuring corporate success beyond financial performance gained traction. Freer Spreckley, in his 1981 work Social Audit: A Management Tool for Co-operative Working, introduced the concept of evaluating organizations on financial viability, social wealth creation, governance, and environmental responsibility. This approach became known as social auditing.

In 1998, John Elkington coined the term Triple Bottom Line in his book Cannibals with Forks: The Triple Bottom Line of 21st Century Business. Elkington argued that businesses should measure success not only by financial profit but also by their impact on people (social) and the planet (environment). These ideas further solidified the integration of ESG factors into mainstream business practices.

Establishing Compliance                              

In 2005, the United Nations Environment Programme Finance Initiative (UNEP FI) commissioned a report by the international law firm Freshfields Bruckhaus Deringer to examine how the law applies to investors regarding ESG issues. The report concluded that not only is it permissible for investment firms to incorporate ESG factors into their analysis, but doing so could also be considered a fundamental aspect of their fiduciary duty.

A turning point for ESG came with the launch of the UN Principles for Responsible Investment (UN PRI) in 2006. This initiative, backed by the United Nations, established six principles encouraging institutional investors to incorporate ESG considerations into their decision-making processes.

In time, major financial institutions began to recognize the importance of ESG. In 2011, Alex Edmans published a study showing that companies listed in the “100 Best Companies to Work For” outperformed their peers in stock returns, proving the financial value of strong ESG performance.

ESG Today

During the COVID-19 pandemic, major asset managers like BlackRock and Fidelity pressured pharmaceutical companies to collaborate in vaccine development, underscoring the growing influence of ESG principles in global crises. In 2021, The Task Force on Climate-related Financial Disclosures (TCFD) and regulations such as the EU Sustainable Finance Disclosure Regulation (SFDR) further institutionalized ESG compliance.

Despite its rapid adoption, ESG has faced backlash. In 2023, conservative networks launched campaigns to dismantle ESG, particularly targeting climate-friendly investments. However, the momentum for ESG remains strong, with many in the investment industry viewing its integration as inevitable.

The evolution of Environmental Social and Governance (ESG) investing reflects a profound shift in how businesses and investors approach value creation. From the ethical disinvestment of the 1970s to the formalization of the UN PRI, ESG has become a critical framework for managing risks and seizing opportunities in the modern economy.

Acknowledging the growing significance of ESG compliance, Axial Consulting has designed a robust ESG Rating Framework to evaluate corporate ESG performance and pinpoint key risk areas. This framework aims to help create value for investors and stakeholders, fostering informed decision-making and long-term sustainability.