Sustainable Investing — the Path Forward

Sustainable investing expert Caroline Flammer joined the Columbia faculty in January 2022 as a professor of international and public affairs and of climate with joint appointments at SIPA and the Climate School. Among her many roles, Flammer also serves as director of SIPA’s Sustainable Investing Research Initiative (SIRI), which aims to foster scholarship, education, and dialogue on system-level investing.

Flammer’s work examines whether and how sustainable finance and impact investing can help capitalize a more sustainable world. Moreover, her research explores how firms can incorporate environmental, social, and governance (ESG) considerations into their activities to enhance their competitiveness and help address climate change, biodiversity loss, inequality, and other grand world challenges.

Web of Science ranked her among the top 100 Highly Cited Researchers in economics and business, and she has received many prestigious awards, including the 2023 University of Oxford Greening Finance Prize.

This conversation with SIPA Magazine has been condensed and edited for clarity.

For someone unfamiliar with ESG, can you explain how it can improve their competitiveness?

In so many ways! Companies’ social and environmental responsibility practices can foster innovation, enhance employees’ motivation, help companies differentiate them- selves from their competitors on the product market, and improve their resilience during times of crisis.

Why then are companies’ social and environmental responsibility practices often not considered at the core of their corporate governance and strategy?

A potential reason is a lack of good corporate governance practices, such as a long-term orientation and private incentives for managers to care about societal and environmental issues. We know that individuals, in general, are myopic. As a result, they prefer short-term over long-term re- wards, even if the long-term rewards are substantially higher. For managers, this myopic behavior might be further reinforced by career concerns, short-term incentives, and analysts’ quarterly performance expectations. Because of this, managers may put more weight on business practices and in- vestment strategies that pay off in the short term and less on the potential benefits of long-term investments, even if they would improve firm value in the long term. This tragedy of time horizons, as it’s known, has negative implications for companies’ social and environmental business practices.

My research suggests that corporate short-termism is really hampering business success. Unless we incentivize managers to adopt a longer time horizon and pay attention to these broader societal and environmental issues, whether through ESG-linked executive compensation or long-term financial-performance incentives, they tend to underinvest in long-term projects, which hurts companies and investors as well as society and the environment.

Switching to the financial sector, how are investors responding to this governance issue and the increasing risks and costs associated with climate change, inequality, and other societal issues?

Investors increasingly pressure their portfolio companies to adopt a longer time horizon and to improve their sustainable practices, as well as to disclose their exposure to climate-change risks and to what extent they adapt to these risks. Besides investing in equity and actively engaging with their portfolio companies via shareholder engagement and proxy voting, investors can also try to influence their practices by investing in debt instruments such as certified green bonds and other ESG fixed-income instruments.

You’ve recently launched SIRI, which aims to foster research, education, and dialogue on system-level investing. What is system-level investing, and how is this different from current ESG investing?

In the absence of effective government actions to mitigate climate change, social inequality, and other system-level challenges, the spotlight is on the private sector. The question is: What can the private sector do to help mitigate these various crises? If you look at the current way we approach ESG both in academia and practice, our thinking, frameworks, theories, and practices are really confined to the firm and portfolio level, ignoring the broader system. For example, investors might consider divesting from emission-intensive industries to clean up their own portfolio. Yet the effectiveness of such an approach is likely limited as the investors lose their seat at the table and can no longer influence the sustainable business practices of those portfolio companies they just divested from. A likely more effective way would be to actively engage with the portfolio companies to help them transition to more sustainable and inclusive practices.

A second example is that our current ESG metrics mostly focus on firms’ core ESG practices, such as their DEI practices with respect to their own employees, without considering their engagement with policy-makers — for example, their lobbying practices over abortion rights. Critical factors are needed to ensure the long-term health and resilience of individuals, communities, the natural environment, and economies.

Like what, for example?

For one, adopting a systems-focused approach that considers how business and investment practices impact the broader environmental, social, and economic systems and how these systems impact business and investment practices and opportunities. Another is developing better measures to track progress toward the mitigation of system-level challenges. And lastly, creating public-private partnerships to fill financing gaps.

Is that how SIRI fits in?

Correct. As you mentioned, SIRI fosters scholarship, education, and dialogue on system-level investing. We focus on five pillars: the development of better measures; the fostering of rigorous academic scholarship on system-level investing; improving dialogue across sectors; curriculum development and education to train the current and next generation of leaders; and executive education to inform and train investment and management professionals. SIRI is well aligned with the efforts of three of SIPA’s five global policy challenges as it supports climate and sustainable development, inclusive prosperity and macroeconomic performance and technology and innovation.