Applying Economics—Not Gut Feel—to ESG

Abstract

Interest in ESG is at an all-time high. However, academic research on ESG is still relatively nascent, which often leads us to apply gut feel on the grounds that ESG is so urgent that we cannot 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 that create long-term financial and social value. A large literature on corporate finance studies how to value investments; asset pricing explores how the stock market prices risks; welfare economics investigates externalities; private benefits analyze manager and investor preferences beyond shareholder value; optimal contracting considers how to achieve multiple objectives; and agency theory examines how to 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.

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