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Private Equity: Greenwashing Galore

We are awash with ESG slogans – companies often include a glorified caption of how they care about their employees, environment and our children’s future. This has reached a point where we are flooded with advertisements for sustainable groceries, home appliances, holidays, and pro-ESG workplaces. Even massive polluters like Rio Tinto now claim they are decarbonizing the high seas, and Exxon has committed to net-zero targets in some far-away future. The to-go coffee we had today morning had in big font: “Made With Love, 100% Sustainable.” But what is exactly sustainable? The coffee? The water? The transport of coffee grains all the way from Bolivia? The energy used in production or fair wages for farmers? Of course, the coffee chain is owned by a private equity (PE) firm, and given the unregulated nature of these entities, it is hard to give them the benefit of doubt. The pressing question remains: how many of these proclamations are substantiated by genuine actions and transparent data?

Our working-paper, available on SSRN, examines the ESG practices of the top 100 PE firms in the United States. These firms, which collectively represent over $1.5 trillion of committed capital, are significant players in the corporate landscape, employing directly around 12 million individuals. For each firm, we read and examine every ESG-related document that they disclose on their website. While many firms are quick to adopt catchy slogans such as “together for a green future,” our findings unveil that these stark claims are often not backed by concrete explanation what they mean for the practices of the firm. A staggering 58% of these firms offer no substantive information about their ESG practices, resorting instead to generic, boilerplate language.

Delving deeper into the specifics, we found that 71% of these firms are signatories to environmental frameworks. But these frameworks are often relatively lenient and lack rigorous implementation requirements. In stark contrast, the adoption rates for more stringent frameworks, such as the TCFD and SASB, are quite low, standing at 8% and 6%, respectively. This may explain why only 11% of the firms provide detailed information on their environmental practices. Or why only  22% have established an official diversity, equity, and inclusion (“DEI”) practice. Just 21% have a clearly defined ESG policy, and only 6% have set aside a dedicated ESG fund. Interestingly, while 39% of the firms engage in extensive discussions about the social aspects of their ESG programs, only 19% have at least 10% female representation in their top management..

The proliferation of over 600+ ESG frameworks presents companies with a list of veritable options, leading to a natural assumption that firms will gravitate towards those that best align with their interests. Practically, this often means prioritizing those that demand the least effort and offer minimal verifiability. This vast array of choices, while seemingly offering flexibility, can inadvertently incentivize companies to cherry-pick frameworks that allow them to project an image of sustainability with the least amount of substantive change. The potential for such strategic selection underscores the pressing need for a more standardized and rigorous regulatory approach to ESG disclosures, ensuring that companies don’t just opt for the path of least resistance but genuinely commit to sustainable and verifiable practices.

This leads us to a pivotal challenge: distinguishing genuine green initiatives from superficial greenwashing. With an overwhelming presence of over 700 ESG rating agencies in the USA and Europe, the methodologies employed often remain shrouded in ambiguity. Alarmingly, the current system allows for “rating shopping” by asset managers. Research from Chatterji et al. (2016) and Berg et al. (2022) highlight inconsistencies in the ESG landscape, revealing that correlations between ESG ratings from the six major providers fluctuate between a mere 0.38 and 0.71, while credit ratings are generally almost perfectly correlated. Therefore, the asset manager, if displeased with a company’s ESG rating, can simply approach another agency, hoping for a more favorable assessment. This practice eerily echoes the 2008 financial crisis debacle, where rating agencies liberally awarded AAA ratings to “junk” fixed-income instruments. Such parallels underscore the urgent need for a more transparent, consistent, and accountable ESG rating system.

So, what is truly green and what is greenwashing? And how can consumers separate it out? The average retail investor, driven by a genuine desire to support sustainable and ethical practices, is increasingly gravitating towards ESG products. However, they often find themselves at a disadvantage, lacking the years of expertise and analytical background required to navigate the intricate landscape of ESG claims and ratings. This knowledge gap underscores the importance of transparent and standardized ESG disclosures, ensuring that consumers can make informed decisions without being overwhelmed by the complexities of the industry.

Sunlight is the best disinfectant“, as aptly remarked by Louis Brandeis. This essence of transparency is pivotal in the realm of ESG practices.  The primary objective of ESG is to instill transparency and foster a long-term vision in financial markets. However, to the eye of the average consumer, the credibility of sustainability claims is under scrutiny, as evidenced by a recent McKinsey survey which revealed that a whopping 88% of Gen-Z respondents are skeptical of ESG claims made by fashion brands.Just as the SEC has been instrumental in upholding the integrity of stock exchanges, a regulated ESG framework and/or an audited ESG report is imperative to ensure that sustainability claims are not merely fashionable slogans but are rooted in verifiable actions and transparent data. Such regulation would not only bolster the credibility of ESG claims but also empower society to effectively monitor the activities and commitments of corporations and private entities, ensuring accountability and fostering trust.

In our comprehensive examination of Private Equity (PE) firms, we discerned a pattern reminiscent of their publicly traded counterparts: a modest engagement with ESG principles. The adoption metrics are not particularly encouraging, with practices that are varied and often devoid of the desired consistency and comparability. We firmly believe that for ESG to be genuinely transformative, two fundamental shifts are imperative:

First, there must be an unwavering commitment to transparency, ensuring that both consumers and investors are adequately informed. Second, there is a pressing need for a standardized framework for labeling these activities, ensuring uniformity across entities. For those PE firms that opt for transparency in their ESG practices, it is essential to have a robust mechanism that ensures clarity, reliability, and comparability. Given the complexities involved, perhaps a simple system, such as a carbon counting mechanism accompanied with an audit and certification system, is the way forward. Only with such rigorous measures can we be assured of the authenticity of sustainability claims. We are still far away from such an ideal system.

  • Garen Markarian

    Garen Markarian is a full professor at HEC Lausanne, teaches “Sustainability Accounting” in E4S (IMD, EPF, UNIL - Master Program in Sustainable Management and Technology) and former Economic Officer for the United Nations. As an international scholar specializing in Corporate Finance and ESG Reporting, he has taught at WHU-Otto Beisheim (Dusseldorf), University of Iowa (CIMBA-Italy), IE Business School (Madrid), HEC (Paris), Institut Mines-Télécom Business School (Paris), Bocconi, (Milan), Concordia (Montreal), Rice (Houston), and Case Western Reserve (Cleveland).

  • Alexander Semionov

    Alexander Semionov is a Graduate Student at HEC Lausanne (Master of Science in Finance) and alumni of Ecole Hôtelière de Lausanne (EHL), with previous work experiences in Business Development in Singapore and in South-East Asia frontier markets.

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