March 14, 2023

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Why greenwashing and competence greenwashing are risks to ESG integration and corporate sustainability

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Credit: CC0 Public Domain

The following is an interview with ESG expert professor Kim Schumacher of Kyushu University.

What is ESG and why is it important?

ESG is an acronym that stands for "environment, society and governance". ESG was originally introduced in the financial and management sectors to break down factors that companies and financial institutions should consider when they make investment and business decisions.

Basically, "E" includes metrics in climate change, biodiversity, nature, ecosystems, water, to name a few; "S" covers human rights, , education, health (which was very important during the COVID pandemic), and "G" includes primarily corporate governance metrics such as corruption, board diversity, or executive pay. These non-financial metrics are used to track or measure how a company's ESG performance, which also serves as an indicator to evaluate their sustainability footprint.

ESG is supposed to be a standard element of what matters to a company. It is important to note it is not the same as sustainability. The concept of sustainability, most commonly associated with the SGDs (Sustainable Development Goals), has a much broader scope than ESG. The latter is not a scientific concept but a management, finance, and . It includes science-based metrics to measure factors such as carbon or water footprints.

ESG is generally rooted in science, however, it is not an established scientific concept as sustainability or sustainability science. So ESG remains more limited in scope and looks at the degree of sustainability integration among companies by taking into account their ESG risk exposure and measuring the impact that they have on various non-financial ESG performance indicators. I apologize for the long explanation but often, ESG and sustainability are conflated and seen as identical, but they are not.

How does ESG differ from CSR?

ESG, CSR, and the SGDs are often conflated. CSR is the acronym for "corporate social responsibility." It was introduced as a form of self-regulatory corporate governance that tries to partially incorporate societal and ethical factors into business management that previously were not taken into account like healthcare and employee well-being.

CSR gradually came into focus through issues like "how do we impact society as a whole? How do we impact society through our business practices? How do we create shared value among societal stakeholders?" "How do we impact the community via our products?" It was the first attempt to take account of the impacts, both positive and negative, that company's products or services might have on society.

ESG goes beyond CSR, which over time transformed mostly into a mere communications and marketing tool, interested more in making the company look good than a serious attempt at assessing the societal impacts of its products or services. This was exemplified by many businesses creating CSR-related positions, often located within the HR or PR remits, and tasked with creating colorful reports with nice pictures.

ESG on the other hand, is meant to be a risk management tool to identify various material risks and opportunities concerning factors such as climate change or societal disruptions, highlighted by movements such Extinction Rebellion in the UK or Black Lives Matter in the United States. ESG is utilized to look at these likely risks, impacts, and disruptions and to what extent they could affect both the financial returns of the companies, but also how companies might exacerbate these issues even further through their own activities.

ESG focuses primarily on financial risks, whereas sustainability is a much broader scientific term that also includes the impacts of companies and how the planet's resources should be managed in ways to compromise the needs of future generations. Therefore, nowadays, sustainability as a concept is largely aligned with the SDGs and the Planetary Boundaries.

For example, sustainability would also look at how a company's business activities impact climate change via its carbon emissions, whereas ESG looks at how climate change impacts the company's business activities. This concept is called "Double Materiality", which looks at the entire life cycle of a company's products and services, so "how are we being impacted but also how do we impact?"

CSR ended up focusing mainly on the social aspects of corporate governance, which sometimes included the societal impacts of climate change. However, it was used mostly by companies as a way of improving their reputation and corporate image by aiming to positively influence society's perception of their corporate activities. ESG can be considered an evolution of the original CSR concept with a much stronger risk management angle.

Sustainability considerations did underpin both concepts but corporate and shareholder value creation always remained their key focus. Whereas sustainability considers "how companies create value for all stakeholders, including civil society, while preserving planetary resources for future generations."

You have a very global education, with degrees from France, the United States, and Japan. How has it prepared you for your career?

My diverse education has shaped my career. I originally studied law when I graduated from high school in Luxembourg. To be honest, I chose law because I didn't yet really know what I wanted to study. I thought it was a subject that had many applications, so I decided to study law in France. I had the privilege of studying all over Europe with the Erasmus program. I was able to go to Germany and England. That broadened my horizon, and then I had the immense fortune to get a Fulbright scholarship to go to UC Berkeley to do an LL.M. (Master of Laws) in Environmental Law.

It was around that time that the tragic Fukushima accident happened, which sparked my interest in the scientific aspects of energy and environmental issues. It represented a natural continuation of my prior Master's in International Law from the University of Lille, where I had written my thesis on the carbon taxation policies in Europe. During my graduate studies in California, one of the lecturers who was most instrumental to my eventual career path was the current Secretary of Energy of the United States, Jennifer Granholm.

She was the lecturer of one of my courses at UC Berkeley, and the interdisciplinary teaching methods of her class really left a lasting impression on me on how to approach environmental, energy, and sustainability issues. Furthermore, she always displayed a level of humility, because even with her status as former two-time Governor of Michigan, and despite her incredibly busy schedule, she was kind enough to continuously support my career over the years, always responding to my multiple requests for letters of recommendation.

After having taken Prof. Granholm's class at UC Berkeley, I started realizing that law might not be the best fit for me, but I powered on and I completed my degree. I even tentatively accepted a job as a lawyer back home in Luxembourg, but immediately I felt it was not right me, so I eventually didn't continue down this career path. Given the ongoing media coverage of the Fukushima nuclear power plant crisis, I looked at programs in Japan, because I wanted to know more about how Japan would deal with this sudden and almost complete nuclear power shutdown, which previously represented about one-third of its electricity generation. I wondered if Japan would be able to transition to a low-carbon sustainable society by energetically scaling renewable energy.

Hence, I started looking for suitable doctoral supervisors, and came across a University of Tokyo professor, who used to work for the Tokyo Electric Power Company (TEPCO). His profile was very interesting as I could benefit from his academic expertise just as much as his strong network of energy sector-related connections. Throughout my Ph.D. studies, I more and more came to the realization that renewable energy, sustainability, and the environment are topics that I feel very comfortable with and ultimately my passion started overlapping with my work.

My personal and educational backgrounds made me appreciate diverse perspectives and how important proper understanding of context is to understand other people's points of view. That is equally important to develop solid sustainability-related skills. These big issues often seem so overwhelming because we seemingly are constantly bombarded with so many bad news. However, it depends on perspective; what seems evident for you might appear very different for someone else.

Has your multinational education helped you prepare for sustainability issues that need international collaboration?

Absolutely, I will not deny that. Learning from a mix of approaches can lead to the best outcomes because climate change and sustainability issues are truly global in nature. If you do not have an understanding of how people live and work in other parts of the world, it gets very difficult to solve these big issues.

For example, in Japan, I can appreciate people following the rules and sticking to established frameworks. Depending on your perspective, you might perceive rules as to strict and or loose, which again can be positive or negative depending on the situation. Without international collaboration, it is often difficult to see, understand, or appreciate these differences.

How can students prepare themselves for a career in sustainability?

Take my course! (Laugh) In all seriousness, there is still a lack of sustainability-related business courses in Japan. Especially that go beyond the worn-out phrases that sustainability is important and show in concrete ways what genuine sustainability means in a business context or in the financial sector.

In Japan, there are often significant gaps between how companies try to portray themselves in a positive way, extensively highlighting the positives while often omitting the negatives, for example, how climate change will affect them and how their activities might worsen the problem.

Without properly acknowledging the problem, there is no responsibility, and without responsibility, there can be no solution. Therefore, it is very important to raise awareness among the next generation of students, who will constitute the next generation of leaders, to avoid merely preserving the unsustainable status quo of companies continuing business as usual.

Professional training related to sustainability is important because it will gradually improve practitioner-level skills, however, the degree of relevance of each training program has to be determined. This is where we need to discuss materiality, which signifies contextual relevance. To illustrate the concept of materiality, I often provide the example of someone collapsing on a plane, and the flight attendants ask if there is a doctor on the plane, and someone raises their hand and says, "I have a Ph.D. in history," which technically speaking is true but is said genuinely relevant in that context? Not really.

Whether a skill is material always depends on the situation and the context. The question that those who do work or want to work in the areas of sustainability and ESG need to ask themselves: "Is the skill that I have adequate to solve the issue or problem at hand?" This matters since all knowledge have value, but not all knowledge is material. Any experience, degree, or training is valuable, but again, its relevance will depend on the context.

You coined the term 'competence greenwashing,' could you please explain what it means?

In case I am inflating or misrepresenting what my skills can do regarding a certain sustainability or ESG issue, then I am competence greenwashing, which is the greenwashing of skills or expertise. Unfortunately, awareness and passion do not equal subject matter expertise. It's not because someone is passionate about climate change that they can be considered a climate expert.

It's not that my passion for nature automatically translates into becoming a biodiversity expert. It doesn't work that way. If we go with the "10,000 hours concept" of Malcolm Gladwell to acquire world-class expertise in any area, even though that number can be disputed, completing a 100-hour online course does not equal subject matter expertise.

One has to look at what kind of skills were acquired, not just what kind of online degrees a person has. In practice, most HR people and recruiters currently have no other ways of properly evaluating sustainability or ESG skills. Therefore, HR personnel should ideally complete robust introductory sustainability courses themselves to know how to evaluate those skills contextually. That is why we need a government accreditation system that verifies basic sustainability skills.

In the past, society decided that some jobs require an extreme level of trust in someone's skills and integrity, justifying government-mandated professional certification. These mandatory government certifications are required for lawyers, doctors, accountants, and engineers, among others. These are professions that require extremely high skill levels, but also equally high levels of trust in said skills are required.

That is where we need to look at what kind of degree or certification someone obtained and if we have trust in that person's skills to do the job diligently and professionally. Or we need to look at whether some company CEOs are just trying to protect their own backs by pointing to all of their presumed ESG experts they recently recruited with little attention to whether their skills are really material to what they are actually trying to do and what is relevant to their respective companies or businesses.

Can artificial intelligence be used to regulate ESG?

It is already being used, albeit artificial intelligence (AI) in and of itself is not necessarily the solution to all ESG data-related issues. For the time being, AI initially requires human-procured input data. It requires a foundational set of data in order to be trained. If the original input data is not good, then you will also get inadequate, inaccurate, or immaterial outcomes from AI-driven processes. AI cannot operate in a contextual vacuum.

Therefore, it requires experts to monitor the data that is being input. That is extremely important in the ESG space because if the underlying data is not properly vetted through quality measurement, reporting, and verification (MRV) processes, there are risks of obtaining distorted or overly optimistic views of ESG issues, especially climate change or biodiversity. With more and more companies being found out to be greenwashing and competence greenwashing their ESG data, unadjusted AI-based results will reflect these trends.

Without proper challenges, it might make society complacent because we think we are on a good track in terms of sustainability when in reality many corporate ESG data and sustainability reporting have been greenwashed.

AI can be a very useful tool in terms of streamlining and accelerating the gathering and structuring of data, but also the monitoring and highlighting of potentially greenwashed data. AI could also become an instrument to identify instances of greenwashing by looking at what language is used in corporate reporting, if there are data outliers.

If the reported data differs from the scientific consensus, then there might be something wrong with it. It can and has a very purposeful role. Once the data becomes more reliable, AI could be used to determine what data is relevant or marginal in terms of importance, so that we can focus on the areas where the data is material.

It has been more than a decade since Fukushima. What have we learned?

One of the most important lessons is that Japan continues to be off track in meeting its goals under both the SDGs and the Paris Climate Agreement, underpinned by only modest carbon reductions, slow scaling of domestic renewable energy capacities and low rates of domestic sustainability-related investments.

Too much focus has been on what I would say are "red herring" technologies, including carbon capture and storage (CCS), which has been shown to be technologically economically viable only in a few places in the world due to favorable local geological contexts. These limited examples include several Norwegian oil and gas rigs. However, the situation in Norway is very different from Japan, so we can't just capture all the carbon and store it somewhere random in nature or in deep undersea sites and hope that the problem will be solved.

It would be much more efficient and quicker if Japan were to properly decarbonize through genuinely renewable, and readily available technologies, such as solar, wind, and geothermal power in combination with ongoing improvements in energy storage technologies, including electric batteries and green hydrogen.

Regarding nuclear power, although I am not categorically against the time-limited use of existing, recently built, and safe nuclear power plants, Fukushima was a wake-up call for Japanese society and the world to start focusing more seriously on renewables, and not to extend the lifetime of fossils through risky, often unproven, and capital-intensive technologies such as CCS, blue hydrogen, or ammonia, which ultimately are all just different ways to artificially extend fossil fuel usage and try to make it less polluting.

However, less unsustainable or less polluting doesn't mean sustainable. Our energy systems need to become genuinely sustainable very quickly, because they continue to be highly unsustainable. Incremental steps by replacing older coal power plants with newer ones that are a little bit less polluting will not work. Every time a new coal powerplant is being built it will be used for at least a few decades, which means its carbon emissions are locked in for the next 20 or 30 years. This means we will move even farther away from any realistic anthropogenic climate change mitigation trajectories.

An unsuccessful net-zero energy transition will also negatively impact the productivity of the economies. So, there are very concrete financial impacts. The sooner we move to renewables, the better overall. Twelve years after Fukushima, the lesson is that Japan is still relying too much on fossil fuels as a replacement for nuclear. We should move more energetically towards renewables.

What can Japan do to become a leader in ESG?

In my opinion, industrialized and developed countries have historical responsibilities in terms of sustainability and climate change. For the past centuries, they were able to develop and accumulate a lot of the world's wealth in unsustainable ways. They often relied on very intense and unsustainable natural resource extraction, and accessing resources through imports, and their respective colonization efforts.

In a historical context, but also a sustainability context, these represent very unsustainable practices, both from societal and natural resource equity points of view. Many of the impacted resources are commons like air and water.

Many countries, especially developed countries that part of the OECD, the G7 or the G20, claim to be climate or sustainability leaders, but that requires transparency, and a genuine, honest will to improve their carbon and sustainability footprints. They need to go beyond their often-empty words or immaterial actions by, for example, simply making everyone wear an SDG pin. Businesses often produce shiny sustainability reports while simultaneously making business decisions that directly contradict their stated sustainability goals.

There should be more honesty around acknowledging what it means to be truly sustainable and what it means to be truly sustainable, from a corporate perspective, but also as an individual consumer. We sometimes forget that businesses are made up of people and thus are not anonymous entities. They're made of people with families and children that will grow up in a world that is warming.

Hence, people, especially in leadership, executive, and management positions should always be aware that their decisions will have very real and long-lasting consequences in terms of sustainability. I think that is companies and the people in charge of them need to realize, that everything they do that will impact sustainability in a negative way happen will already impact them in their lifetimes. With great power comes great responsibility.

To be leaders we need to understand the local government and be connected to the environment that we live in. That can be in a regional or a local context, but also a larger global context because the board chairperson or CEO of a large company will also be affected by increasing global temperature increases, sea-level rises, and natural resource shortages, if they don't start making more short-term decisions fully aligned with sustainability.

Should we be worried about rules and regulations having unintended consequences?

The debates around carbon and green leakage, as well as, green vs. green are always used to question stronger climate or environmental regulation and the expansion of sustainable infrastructure. For example, wind turbines are an efficient technology to reduce carbon emissions, but at the same time, they can kill birds and bats.

Opponents of wind power development often use these incidents as arguments to either prevent the construction of wind turbines in their areas or just out of principle. In numerous instances, I consider many of the arguments around potential bird and bat killings from wind turbines to be smoke screens as they often completely exclude the fact that climate change-related natural habitat destruction will kill many more birds and bats and risks pushing many species to extinction.

Thus, local issues have global implications, yet individual circumstances often have a larger impact than the considerations about what benefits society at large. The same goes for company pay. I do understand that people's feelings change depending on whether it affects them personally in their immediate surroundings.

Executive pay is another case study around balancing short-term corporate competitiveness against more holistic and sustainable business models. Many corporations and industry groups argue that if we limit executive pay, we reduce the amount of performance incentives for CEOs, consequently making businesses less competitive. Many governments feel that if short-term carbon emission reduction policies are too ambitious, companies will just go to other countries where they have less stringent climate policies.

This is in return would negatively impact the economy in the short-term. However, the negative medium-term and long-term implications are usually given less weight. Many governments and businesses have largely moved away from long-term investments as it is quite capital-intensive, and often opt for short-term reactive policies in line with annual corporate reporting cycles or election cycles.

These examples illustrate that human beings are often very short-term oriented. In many instances, we would prefer a dollar today instead of having three dollars tomorrow. If I have the dollar for sure today, it's better to have it because I'm hungry right now, and I'm not sure I will need it tomorrow. If I cannot feed myself today, I might be sick tomorrow. It's very difficult to gauge these unintended consequences. One of the consequences of this thinking applies to how many businesses view environmental laws as many complain that it makes their operations more expensive and thus less competitive.

The same goes for bird and bat-related arguments against wind turbines. We need to understand that environmental policies and sustainable infrastructure will confront businesses and society with new situations, but the short-term local impacts they cause appear to be much more preferable to the scenarios in which uncontrollable global warming and irreversible environmental destruction have become realities.

There will always be short-term negative tradeoffs for certain population groups when the unsustainable economic status and business-as-usual are challenged. But humanity is facing an existential crisis and if the alternative to becoming extinct is adjusting our lifestyles to have less negative environmental and societal impacts, that seems like a fair trade to me. Even if I cannot have avocados or my favorite sweets every day at the convenience store, that might be a small price to pay compared to collective global species extinction.

How can investors lead the way for sustainable investing?

By starting to integrate proper sustainability impact assessment and MRV structures inside their organizations. Unfortunately, for many ESG or sustainability-related financial products or services, positive impacts only on paper due to exaggerated ESG/sustainability claims, severe lack in terms of data collection, and lack of genuine sustainability or environmental subject matter expertise across their governance and management structures.

Because of increasing numbers of greenwashing and competence greenwashing, it is hard to know how much of sustainable investing is actually sustainable. So, sustainable investing needs to become more credible instead of just engaging in sustainability-related marketing, and more transparency is one way to do this.

If capitalists and businesses want to demonstrate their belief in capitalism, they should acknowledge that businesses that are not sustainable should logically disappear over time. Society should not reward bad business practices or bad business decisions. In properly functioning markets, businesses would be held accountable by customers/clients and incur losses.

There should be no business that becomes too big to fail. Suppose a business is not performing well in terms of meeting sustainability-related KPIs. We have to think about whether it is worth saving certain unsustainable industries at the cost of collective sustainability degradation. We should focus more on the because on the new jobs that will appear when transitioning to a genuinely sustainable society.,

A pension system has the same responsibility to a beneficiary who is 65 years old as it does to a 30-year-old. Young people also want eventually retire into a world that is still livable. What is the value of a pension, if I am living in a world that I cannot enjoy anymore? I should be able to expect that institutional investors, including pension fund managers and associated asset managers, are looking for companies that are making actual progress, and not just trying to protect their own return-linked bonuses in the short term.

Most capital returns, unfortunately are still generated from companies with unstainable business models. In order to avoid greenwashing and create stakeholder value, capital needs to flow into companies that are credibly sustainable. This includes financing disruptors because when you create a business, there is no guarantee for success. There is a societal obligation to save unsustainable businesses at all costs. Why should there be a guarantee of survival if the managers of a business value their own interests to a disproportionate degree against those of society?

In a world in which reaching sustainability is a global challenge, why should the rights of directors, executives, and shareholders be valued higher than those of other stakeholders, including younger generations that will still live on the planet when those have been able to consume resources at unsustainable rates will already be gone. Even if companies have enjoyed good reputations in the past, and long histories often tied to the economic development of countries, investors and politicians should not shield from having to transition to sustainable business models.

What can we can look forward to in terms of finance, technology and the environment in the future? Is it as bleak as it sounds?

The future sometimes appears quite bleak as someone who is dealing with sustainability challenges, biodiversity issues, and new -related temperature records almost every day. Greenwashing news is particularly disheartening, as they give the illusion that sustainability progress is being made, only then to be revealed to have been misleading communications or reporting. It seems the more companies invest in sustainability promotion, the more they might see their sustainability-related investments might turn out as greenwashing.

Given this apparently bleak outlook, people sometimes ask me why not just give up? From a realistic angle, I think there are two main scenarios right now: Every human is hoping that either they don't live long enough so they don't need to experience the consequences; or that if they live long enough until our climate and sustainability problem will be solved through technological innovation.

These scenarios give me hope as they both require delay tactics to reduce either negative impacts as much as possible. For example, even if we cannot limit global warming to plus 1.5ºC anymore, we still can opt to come as close as possible, ideally below 2ºC. That means there is still the possibility to move towards the scenarios in which we act than eventually living through the ones where we chose to do too little too late.

Humanity still has the capacity to shape its future, but it will ultimately depend most on those in leadership positions, be it politics, finance, or business, to steer capital and resources in a sustainable direction. Because with every year that we delay meaningful action, the consequences will be felt in shorter and short timespans.

The worst feeling humans have is if they feel that all hope is lost, but taking action today and moving decisively towards a sustainable society will prevent us and future generations from experiencing any type of scenario that is infinitely worse than the one where we decided that sensible long-term decision-making is preferable to short-termism. So, trying hard and working hard, and becoming truly sustainable is worth fighting for.

The professor's research is published as a working paper in the SSRN Electronic Journal.

More information: Kim Schumacher, Environmental, Social, and Governance (ESG) Factors and Green Productivity: The Impacts of Greenwashing and Competence Greenwashing on Sustainable Finance and ESG Investing, SSRN Electronic Journal (2023). DOI: 10.2139/ssrn.4303609

Provided by Kyushu University

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