Previously, those who wanted to invest ethically used specialist ‘socially responsible investment’ (SRI) products that largely ‘screened out’ particular sectors such as tobacco, alcohol and armaments. For this, investors were charged a premium fee.

However in the last decade or so, mainstream investment funds have begun to commit to new ‘ESG’ (environmental, social, corporate governance) investment approaches. These claim to take account of environmental and social issues through the entire stock valuation process, from company engagement to analysis of ESG performance, across all investment funds.

Such new investment approaches may look like a solution to the critical social and environmental issues we currently face, but our research suggests that their actual impact may be only marginal. If companies and investors only respond to financial signals then changes to tax and regulation, rather than market mechanisms (like ESG integration), are essential for any substantive shift in corporate and investor behaviour.

The rise of the Responsible Investor

The key driver of this change was the launch in 2006 of the UN-supported Principles for Responsible Investment whose proponents argued that ESG issues should be considered by investors not for ethical reasons, but because they were financially material for investment returns. More than 3,500 asset owners and managers with some $US120 trillion of assets have become signatories to the Principles. In doing so they have committed to ‘incorporate ESG issues into investment analysis and decision making’. Our study of a team of 14 equity analysts in a large global asset manager, set out to understand the practical challenges investors face in seeking to implement this new commitment to ‘ESG integration’.

PRI growth

PRI signatories

Assets under management

ESG integration – can it be done?

One set of challenges concerns the quality of ESG data. Whereas the preparation of financial accounting data is subject to international reporting standards and statutory audit -processes designed to ensure its quality and comparability between companies and over time, ESG data can only be gleaned from the mix of quantitative and qualitative voluntary disclosures by companies. Into this space a host of new commercial providers have emerged offering investors their own comparative rankings of different companies. The problem is none of these are consistent with each other - an issue the recently formed International Sustainability Standards Board is seeking to address through standardising corporate environmental and social disclosures.

Our own research, however, suggests that, beyond these issues of ESG data comparability, the challenge of ESG integration lies in the difficulty investors face in actually identifying the potential financial materiality of ESG issues. Financial accounting treats most environmental and social issues as ‘externalites’ whose costs fall outside the boundary of the corporate entity and are therefore ignored. Identifying which of these issues might return to affect the future financial performance of the entity is very difficult to predict. As our study sets out in detail, the different rankings of company ESG performance each use aggregate measures which in practice typically mask the particular environmental or social issues that will prove to be financially material for a company and thereby have an impact on the stock price and investment returns.

The challenge is also one of timing; many investors readily acknowledge that climate change may have severe economic effects in the longer term, but their challenge is to assess its potential impact on a stock price in the more immediate future.

Making ESG issues visible

Whilst getting investors to consider the financial materiality of ESG issues for their investments is a positive development, it would be naïve to imagine that this will be enough to remedy the pressing social and environmental issues that are still being created by the single-minded pursuit of short-term profits by both companies and investors. As the latest IPCC report (2022) makes clear, climate change is no longer just a future ‘risk’ but a present reality with multiple negative effects that are already irreversible.

Radical change to corporate conduct and the allocation of capital by investors is essential. Our research suggests, however, that the myopic and purely economic signals conveyed by financial accounting numbers continue to render this now present reality largely invisible. 

Social and environmental accounting, then, does not become potent through efforts to make it commensurate with traditional financial accounting. Rather, social and environmental accounting is more effective in making visible the systemic vulnerabilities that financial accounting is unable and/or unwilling to see. For responsible investors, ESG integration efforts seem better targeted towards utlising social and environmental accounting as a means to hold investee companies to account (for example, through collaborative engagement), rather than as a narrow economic signalling conveyed through financial accounting numbers and third party ranking.


This is an overview of the authors’ article published online in European Accounting Review: Young-Ferris, A., & Roberts, J. (2021). ‘Looking for Something that Isn’t There’: A Case Study of an Early Attempt at ESG Integration in Investment Decision Making.

Image: Towfiqu Barbhuiya

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