Florida’s New Law Helps Investors Consider Real ESG

I’m a Democrat and was the founding chairman of the Sustainability Accounting Standards Board, a U.S. nongovernmental organization focused on helping companies disclose financially material environmental, social and governance information to investors. Nonetheless, I support Florida’s new law limiting government and corporate activism within the ESG movement.

ESG has become an extremely politicized term, but there are environmental, social and governance factors that have real financial effects on companies and investors. That was what SASB, now part of the International Sustainability Standards Board, worked to identify when it created voluntary standards to help companies who wanted to report performance on ESG issues to investors.

What’s relevant to the bottom line varies by industry. For example, social and governance issues such as product quality and safety and supply chain management are material to apparel, accessories, and footwear companies. Banks, on the other hand, need to focus on different governance issues such as data security and systemic risk management. Meanwhile, environmental practices such as water and wastewater management are germane for agricultural products.

While these factors fall outside traditional accounting standards, they aren’t “woke” issues or masked ideology. They can affect a company’s stock price, which is why thousands of companies worldwide now report on their industry’s SASB-defined material issues in their public reporting.

The Florida bill is wreathed in a lot of partisan language, but all its main two provisions would do is make sure that investors only pay attention to ESG issues that are actually material when investing state money. First, investment decisions can be based on only “pecuniary factors,” defined as a factor that the CFO or another party authorized to invest on his behalf “prudently determines is expected to have a material effect on the risk or returns of an investment based on appropriate investment horizons consistent with applicable investment objectives and funding policy.” Second, it requires that this investing “does not include the consideration of the furtherance of any social, political, or ideological interests.” What’s not to like in this, whatever your political persuasion?

The GOP rhetoric on the bill is over the top:. Gov. Ron DeSantis’s lectern at the signing ceremony read “Government Of Laws, Not Woke Politics.” But it’s true that the ESG movement today engages in some practices that hurt financial value. Ideologically based fossil-fuel stock divestment, for instance, is economically destructive. While our energy mix clearly needs to change, the reality is that we will need fossil fuels for years to come. This should include a large proportion of natural gas and be from American companies with high environmental standards of production. Undermining responsible investment in U.S. fossil fuels only hurts companies, investors and consumers—along with American energy security. We don’t want to be getting our energy from a despotic country like Saudi Arabia.

But we don’t want to stop investors from limiting fossil-fuel investment when it makes financial sense, either. While divestment advocates are being unreasonable, so are red states that punish investors for factoring material ESG issues into their decisions. Legislation excluding fund managers that state governments believe are boycotting fossil-fuel stocks from managing government investments is political theater that is, again, financially self-defeating. In fact, the big three asset managers—Blackrock, State Street, and Vanguard—all have substantial investments in fossil fuels. Limiting the supply of asset managers only raises costs for red-state pension funds and lowers their returns.

These sorts of histrionics permeate the debate about ESG. Take the Biden administration’s amendments to the Labor Department Erisa Rule, which sets standards for employer-sponsored retirement plans. Under President Trump, pecuniary was defined as having a “material effect on the risk and/or return of an investment based on appropriate investment time horizons.” This was exactly right. The Biden administration changed that language, creating an uproar on the right and celebration on the left. But, as I’ve written elsewhere with the Bipartisan Policy Center’s Tim Doyle, the political reaction on each side vastly exceeded the substantive changes in language. Pecuniary is now defined as “relevant risk and return factors,” which may include ESG issues but only if they do “not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated.” That’s about the same as the Trump definition.

Whether you’re on the left or right, it’s time to stop arguing about ESG and start talking about factors that are financially material to value creation. The Florida bill might come with some political theater of its own, but on the substance, it gets us one step closer to doing that.

Mr. Eccles is a retired, tenured professor at Harvard Business School and a visiting professor at Oxford’s Saïd Business School.