In a Global Compact Study,

More than 90 percent of CEOs are doing more than they did five years ago to incorporate environmental, social and governance issues into strategy and operations, according to a survey of chief executives participating in the Global Compact.

Seventy-two percent of CEOs said that corporate responsibility should be embedded fully into strategy and operations, but only 50 percent think their firms actually do so. Almost 60 percent of CEOs said corporate responsibility should be embedded into global supply chains, but only 27 percent think they are doing so.

Goldman Sachs suggests that there is a connection between environmental, social and governance (ESG) policies and sustained competitive advantage.

A report released by Goldman Sachs, one of the world’s leading investment banks, showed that among six sectors covered – energy, mining, steel, food, beverages, and media – companies that are considered leaders in implementing environmental, social and governance (ESG) policies to create sustained competitive advantage have outperformed the general stock market by 25 per cent since August 2005. In addition, 72 per cent of these companies have outperformed their peers over the same period.

Statistically this could be right; in the sense that there could be a correlation between the companies which were considered leaders in ESG and their general stock performance. However, it is important to be cautious with these results. Can correlation lead to causation?

From the Everyday Economist:

correlation |ˌkôrəˈlā sh ən| noun – a mutual relationship or connection between two or more things

causality |kôˈzalətē| noun – the relationship between cause and effect

Perhaps the most important thing that an economist, and any individual for that matter, can learn is the difference between correlation and causality. The famous saying is that the rooster does not make the sun rise, but unfortunately that is not always the perception.

As the Executive Director of the UN Global Compact, Georg Kell, says: “The evidence is building that embedding universal principles and related environmental, social and governance policies into management practices and operations delivers long-term business value and is rewarded by markets”.

This might be true to a certain extent. However, in the Goldman Sachs survey we need to understand whether the 25% greater stock market performance is all due to the ESG factors or whether leaders in ESG are also generally leaders in general management and hence, that being a causality to the stock market performance.

In a fantasic Google Answers response to this issue, tox-ga explains the issue and provides multiple silly examples of correlation without causation.

The fact that correlation never implies causation, which may be lost on many people, is extremely important. Causation is just one of three possible relationships between two correlated variables:

a) Causation – a change in X causes a change in Y
b) Common Response – both X and Y change in common to some third, unseen variable
c) Confounding – the effect of X and Y is mixed up with the effects of
other explanatory variables on Y.

To establish causation, a carefully controlled designed experiment must be run.

In this case a better explanation may be “common response” or “confounding” where both ESG and stock performance is responding to the effects of good management.

I do think ESG is about “managing risks and opportunities presented by globalization” however, we need to be more cautious in attributing all the benefits to ESG policies.