Sustainable Finance Newsletter-Oxford prof Eccles says AI can help end the ESG wars: Ross Kerber

Pollution, public health risks and greenhouse gas emissions are examples of things that economists call "negative externalities," the hidden costs that businesses impose on the rest of us, which do not show up in corporate financial statements. Some executives have tried to bridge the gap with sustainability reports showing data like pollution rates or power consumption. Notably, many companies keep issuing these reports despite the anti-ESG pressure from Republicans in statehouses and in Washington, D.C. But the sustainability reports still largely leave it up to investors to decide how to price environmental impacts. Putting the data to use has been a goal of Robert Eccles, whom I spoke with for this week's column via video from his home near Boston. Eccles is a visiting professor of management at the University of Oxford’s Said Business School who previously taught at Harvard Business School and elsewhere. He's also the co-author, with Columbia's Shivaram Rajgopal, of a new book on how to map financial sustainability details to specific line items in corporate documents like income and cash flow statements and balance sheets. The title, "Making Sustainability Financially Relevant: A Man/Machine Collaboration" nods at how the two used artificial intelligence to zero in on key report details and slash from 100 to 30 the number of hours an expert would need to estimate the financial consequences of the material risks facing a company. (AI advances have probably slashed that number down to around three hours since the book was finished in the spring, Rajgopal told me.) THE FUTURE OF ESG Q: We're in a moment where social and environmental reporting is in retreat. Where are we headed? How well do you think companies have balanced the competing political pressures on them? A: Companies kind of created the opening to be attacked. They confounded value creation with making the world a better place. They would talk in their sustainability reports about the sustainable development goals. That's about making the world a better place. I'm not opposed to that. I don't want to live in a bad world. But you need to distinguish between "these are the material issues that matter to value creation" and "here's how we're managing them, and these other things we really can't deal with because that requires regulation and legislation." So they were sloppy and you had these completely separate, as we talked about earlier, the sustainability function and the financial function. Do I think that the Republican red-state attorneys general and governors are coming from an intellectually sound place? No, I don't. I think they're idiotic in what they're doing. It's been good political theater. Companies left themselves exposed to it. They were playing defense with the left, now they're playing defense with the right. I'm actually quite encouraged because I think this is a good wake-up call for companies. And again, just to pitch my book with Shiva a little bit, the solution is pretty simple. And it's boring. The boring is good. It's like, okay, these are the material issues we think matter for value creation. Here's how we think they affect financial performance, income statement, balance sheet. I think companies need to quit playing defense. They should go on offense. It's not like they need to be, you know, screaming at Trump or Republicans, just like, here's our narrative. These are the sustainability issues we think matter to value creation. THE NEBRASKA-DELOITTE FRENEMYSHIP Q: Let's talk about Nebraska (and) the letter that attorneys for a number of Republican-run states wrote to the Big Four accounting firms. One of the leaders of the letter was the Nebraska Attorney General, Mike Hilgers. You found that Nebraska had actually become a major recipient of environmentally focused funding, using the accounting firm Deloitte. Now, technically, this was under the Republican governor of Nebraska. So it's two different officials. A: Let me start out with a shout-out to Nebraska, you know, because the title of my piece is Nebraska is a Climate Champion. Under the (former President Joe) Biden Administration, the EPA selected Nebraska, Nebraska got (an award) for $307 million. On a per capita basis, this is the highest by far. A lot of it went to the Agricultural Data Bank and Grants Program. They've got Deloitte helping them with their climate stuff. They've got Deloitte helping them on the financial side with their internal controls. Q: I think you regard this letter as posturing? Or something else? A: The letter was sent to the Big Four firms, including Deloitte, and it basically accuses them of supporting external standards for climate reporting so that they can make money on it. They ask all these questions, and it's interesting because they express these concerns that they have no data whatsoever that any of these problems that they're concerned about exist, but it's interesting, there's no deadline to respond. So it's kind of like getting this in the public eye, get some attention. It's theater. A representative for Hilgers declined to comment. Deloitte representatives did not respond to requests for comment Q: Bob, you and I have talked a lot about sustainability reporting. Why don't you talk a little about the impetus for this (book) and what you found? A: For a long time, nobody really knew what ESG was. And then they kind of thought it was philanthropy and then sort of didn't like it. And then it's about the material issues, you know, sector specific that matter to value creation. It's funny because the haters of ESG didn't start out with Republicans and we'll get to them in a second. It was people on the left. They were like, “companies should be making the world a better place.” And they didn't like capitalism. Then the right comes along, you know, with Mike Pence and his famous article in the Wall Street Journal. So (with) Shiva, who's a brilliant guy, an accounting professor at Columbia Business School, we had an idea: you take a company's 10-K, you look at risk factors, you look in the footnotes, you identify things that the company has disclosed itself. You compare those to the SASB material issues. Don't take SASB as gospel, but you know, it's a good place to start. Q: One of the things you wrote in the book is that it's really for directors, for example, (to ask themselves): "Who in the organization owns the relationship between sustainability risk and financial exposure? In most companies, the answer is no one." A: Organizational choices vary, but the obvious solution is to have the CSO (chief sustainability officer) report to the CFO (the chief financial officer). The CSO has to be able to understand financial stuff and the CFO needs to understand sustainability stuff. Q: Tell me about Exxon. Exxon is interesting because they're so big and also because some of their stances are unpredictable until you think about their place in the market. They were backers of the U.S. staying in the Paris Climate Agreement, for example. ON USING AI A: Shiva analyzed ExxonMobil's 10K, and it took him like 100 hours. But he couldn't get to the precision and estimates in terms of what the relative impacts were. He did the analysis, which is a set of prompts. He was using ChatGPT. Then, I developed sort of a so-called black box model. Where it was just like a gigantic prompt, to oversimplify it. With ExxonMobil, we basically took the data in their 10K and we can show that pretty much all of the SASB (Sustainability Accounting Standards Board) issues are addressed. An Exxon representative declined to comment for this column.

Sustainable Finance Newsletter-Oxford prof Eccles says AI can help end the ESG wars: Ross Kerber

Eccles on ESG, materiality and AI

Where ESG reporting goes from here

Nebraska, Deloitte and the politics of ESG

ExxonMobil and the use of AI in sustainability analysis

Related News

Rapport Therapeutics, Inc. <RAPP.O>: BTIG Raises Target Price to $75 From $65

Lanvin Group repays €48.1 million secured loan early

PulteGroup, Inc. <PHM.N>: Truist Securities cuts target price to $136 from $145

Majority of US Gen Z healthcare workers eye new jobs within the year, survey shows

Ryan Specialty Holdings, Inc. <RYAN.N>: Mizuho Cuts Target Price to $43 From $48