Private Equity’s ESG Generation

Originally published at Project-Syndicate | July 12th, 2022

The private-equity industry is about to undergo an epochal shift, as the founders of many leading firms retire and a younger generation with a different view of capitalism takes over. Capital flowing through private markets can thus play the role it should in taking environmental, social, and governance criteria mainstream.

NEW YORK – When faced with a major threat, people have usually turned to religion or government for help. Today, the climate crisis is accelerating, part of Europe is at war, the United States is deeply polarized and beset by rising gun violence, COVID-19 is still with us, and developed economies are facing the prospect of a stagflationary recession. But while millions of people around the world are suffering economically and emotionally, religion has largely lost its moral authority and practical influence, and many governments are either hamstrung or controlled by autocrats.

The private sector cannot solve all these problems by itself, of course. But might the world at least be a better place if firms and investors consistently adhered to environmental, social, and governance criteria?

Not so fast, say some. The idea that business has an obligation to report on and discuss ESG metrics with the same rigor that it currently applies to its financial results is controversial. Some politicians have sought to make ESG considerations a partisan issue. Big investors claim that a surfeit of prescriptive ESG proposals in this year’s proxy season of annual shareholder meetings shows that the sustainable-investment movement has gone too far. Tesla CEO Elon Musk recently tweeted his opposition to the concept after the electric car manufacturer was removed from the S&P 500 ESG Index.

Nonetheless, capital can still be a critical lever for positive global change – but perhaps not in the way one might think. It is the capital flowing through the world’s private markets – not public stock exchanges – that can play the key role in taking ESG mainstream. After all, globally, nine out of ten people employed in the corporate sector work for a private firm. And for every publicly traded company, there are 200 private firms. Private businesses form the heart of capitalism. And the main artery through which the most important firms obtain resources to grow is private markets – and particularly private equity.

To be sure, private equity has traditionally not been the first thing people think of when discussing how to improve the world. But though this industry has been around in its current form only since the 1980s, today it manages more than $9 trillion of assets and owns many of the companies we depend on for daily life. Moreover, it is about to undergo an epochal shift, as the founders of many leading private-equity firms retire and a younger generation takes the reins.

This cohort, now in their thirties and forties, is well aware of the failures of Gordon Gekko-inspired, baby-boomer investors and of the limitations of Milton Friedman’s view that business leaders’ only social responsibility is to maximize shareholder value. The new wave of private-equity leaders fundamentally believe that capitalism can produce shared and durable prosperity. They think that generating good financial returns requires recognizing that sustainability, the environment, and the dignity of workers are core to building enduring enterprises. Underscoring this view is the ideal of purpose: the belief that successful organizations create a mutually positive dynamic between their owners, employees, customers, and suppliers, and the communities in which they operate.

In this environment of multidimensional returns, it is essential to develop key non-financial yet material metrics and establish benchmarks and standards of performance. The management guru Peter Drucker probably never said, “If you can’t measure it, you can’t manage it.” But that doesn’t make it any less true.

The choice of which ESG metrics to measure may vary, depending on the region, industry, company size, and owners’ goals. But this is no reason to give up on establishing standards. There are many important indicators that every business can regularly measure in order to make good on talk about doing the right thing.

For example, all companies should track their freshwater usewaste generation, and direct and indirect emissions, and monitor whether any of their activities are causing soil sealing. Other key metrics include the diversity of the management team and the board of directors, employee attrition, work-related injuries, and data breaches.

There is no one-size-fits-all approach to capturing ESG data, but there is a minimum that does fit all. We applaud the work of the ESG Data Convergence Initiative to develop baseline reporting metrics, as well as efforts by the International Sustainability Standards Board to update and globalize industry-based standards.

This information needs to be tracked now. Globally, there are over 8,000 private market investment firms, and the vast majority have not yet embraced ESG criteria. That needs to change. Regulators will soon demand it, as rules and standards such as the Sustainable Finance Disclosure Regulation and those recommended by the Task Force on Climate-Related Financial Disclosures come into effect. Investors will demand it, too – and already are, as the significant rise in the number of climate-related proposals in this year’s proxy season shows. And society needs investors to pay greater attention to ESG factors in the face of heightened social tensions and unprecedented environmental instability. Put simply, we must move from “trust me” to “show me.”

Almost 90 years ago in the US, Congress created the Securities and Exchange Commission, and the accounting industry established Generally Accepted Accounting Principles. Businesses whose financial disclosures had been uneven and spotty began reporting regularly and transparently. In turn, capital markets were bolstered by broader investor participation and the advent of shareholder democracy.

We now need to do the same for ESG reporting and stakeholder democracy. And a new generation of private-market players can lead the way.


Alex Friedman: Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in…

Sébastien Mazella di Bosco: Co-Founder and Managing Partner of Px3 Partners.

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