Lessons For Sustainability Investing From The 2024 Election

The future may lie with a carbon tax, private sector innovation, economic inclusion of communities left behind and muscular corporate governance. Businesses will continue to treat ESG problems as business problems.

The scale of the defeat of the Democratic party in the 2024 election is staggering. They have lost the House, the Senate, the Presidency and one might argue the Supreme Court. The question now is what, if anything, can the sustainability movement learn from this defeat? What can one do over the next four years?

To answer this question, consider arguments under E/S and G categories, for expositional ease.

1.0 Environment:

1.1 Reporting as the theory of change to address climate might have peaked:

Did we burn too much political capital on the theory of change caused by extensive reporting of emissions and climate risk exposure? The theory, loosely speaking, was to force firms to disclose their emissions. Market participants could then channel capital away from firms that disclose more emissions and hence increase their cost of capital. Capital would flow to firms that report smaller or even negative emissions (as they remove carbon) and hence encourage innovation in producing scalable cheap green energy. The theory proved to be somewhat simplistic as my co-authors and I have shown in several papers. Green innovation took off thanks to subsidies not reporting. It is not obvious that divestment in equity of the so-called sin stocks hurts the cost of capital of firms that sell sin.

The SEC climate risk rule will probably be shelved although more and more firms are voluntarily disclosing scope 1 and 2 emissions anyway. Abandoning the SEC’s climate risk rule makes the ISSB the de-facto ESG/sustainability standard setter for the world. The ISSB is shareholder focused and is hence more likely to strike a balance between decision usefulness of new data points for valuation and risk assessment relative to compliance costs imposed on firms, unlike CSRD, CSDDD and the like asked for by the EU. The extra-territorial requirements imposed by the EU disclosure rules and California’s emission disclosure requirements will force most US multi-national and inter-state companies to report on climate risk and emissions (scope 1, 2 and 3 for California) anyway. But pushing reporting as the theory of change to address climate risk may have peaked with the 2024 election.

1.2 Push for a sensible carbon tax:

Instead of worrying about net zero commitments that very few firms were on track to fulfil anyway, should we instead advocate for a price on carbon? Neither side of the political spectrum is happy with how the current system works. We have defaulted to a world where we hold fossil fuel manufacturers, asset managers and financial institutions to account for high carbon products and services. As a result, we have implicitly absolved politicians and consumers from their responsibility to reduce society’s carbon footprint. Creating a set of rules for red states separately from that for blue states is not sustainable in the long run. By asking banks and other companies to deprive fossil fuel firms of investment, we expose ourselves to the risk of energy insecurity as supply demand imbalances will spike gas prices as we saw after the Ukraine invasion. Making public companies report carbon emissions will create incentives for high carbon emission units to go dark or go private. Such arbitrage, in turn, only enables a small number of individuals or funds to make outsized financial returns at the cost of societal pain.

A carbon tax would automatically increase the prices of carbon intensive goods, lead to lower demand for such goods and hence coax consumers to switch to low carbon alternatives, wherever available. If low carbon alternatives are not available, innovation dollars will more readily flow to try and discover such alternatives. Indigent citizens, dependent on high carbon products such as commuting and heating oil, will naturally have to be shielded from the economic pain of a carbon tax for a while via subsidies that are financed from the revenue that flows in from carbon taxes. Banks and financial companies will have to then account for the impact of the carbon tax explicitly on the cash flows and credit worthiness of the companies they finance. The cost of capital to finance carbon friendly solutions will automatically fall. On top of that, a gradually increasing carbon tax will provide much needed certainty to businesses about the US’s regulatory response to climate change.

In sum, we need a cohesive agenda where every citizen has skin in the game to address the climate crisis. A carbon tax is perhaps the only viable tool at our disposal. Without a carbon tax, climate losses will keep escalating and will eventually be borne by the taxpayer, one way or the other. A targeted well designed carbon tax now will stop worse outcomes in the future such as energy insecurity and social unrest. I hope both the red and blue stripes of our country can come together around a carbon tax. The alternative is a much bigger bill for taxpayers and the planet in the future. Thankfully, a small bipartisan caucus supporting a carbon tax does exist. Is it time to get to know and empower that caucus?

1.3 Coalesce around innovation and bipartisan agreement:

There are several small wins that both sides can agree on. Republicans are unlikely to be averse to setting up a carbon market with adequate guardrails. Both Republicans and Democrats can come together on permitting reform. The Republicans will potentially push for permits for oil and gas firms and the Democrats for renewables. Presumably both agree on the focus on nuclear energy. It is interesting to observe that Microsoft, Amazon and Google have invested in nuclear power to deal with the ravenous power needs of the AI revolution. The political left would also do well to stop calling for the end of fossil fuel companies as the pace of the energy transition is likely to slower than previously thought possible and because we have not given consumers an alternative to fossil fuel in most cases. Perhaps one could focus on opportunities to innovate out of the climate hole in the form of new technology to make green technology affordable at scale. Out-innovating China and Europe is surely the best version of an “America First” policy.

1.4 Live with segmented markets in the US and overseas:

Turning to green bonds, net zero commitments and green financing in general, markets are geographically segmented as Europe has pursued these initiatives more vigorously than we have. Blue states are also likely to pursue decarbonization and transition at the local level (city, municipality) via building codes, traffic tolls and the like. Impact and ESG investors are likely to cluster in the blue states and in Europe. For instance, BlackRock sells sustainable investing strategies more successfully in Europe than in the United States.

The rhetoric fueling the anti-ESG movement in the red states will hopefully die down. The blue states might double down on ESG almost as a means of resistance. Fragmentation in rules will lead a Balkanized regulatory framework that will increase a firms’ cost of compliance and risk management.

Of course, the business reality on the ground is much more complex and displays shades of red and blue. Texas, for instance, is already a leader in clean energy. My co-authors, Dhruv Aggarwal and Lubo Litov, and I have just discovered that the state pension fund that votes the most aggressively against “Say on Pay” proposals related to CEO compensation was not New York, or California but Florida!

2.0 Social factors:

It is quite clear from the data that voters in rural areas and small towns did not vote for the Democratic party. The educational, healthcare and social support infrastructure in these areas leaves much to be desired. Recognizing fully that it is not necessarily the remit of companies to address social problems, could we consider a world where:

· we provide subsidies to companies to open distribution centers or factories in these regions. Perhaps the state picks up the health care costs of private sector workers located in these areas. Healthcare is a significant driver of outsourcing and the temping of America.

· we in-source our call centers from overseas to these regions.

· we find opportunities for folks in rural areas to work remotely for larger firms.

· we provide a quota for rural and small-town poor students in our elite universities, with family incomes below a certain threshold, and add service back home as a criterion for such assistance.

· we provide subsidies for universities or community colleges or coaching academies to train the workforce in these areas for service jobs, given that manufacturing is not coming back to the US.

A quick glance at the 50 poorest counties in the US suggests that most of them host prisons or correctional facilities. The US census finds that roughly 20 million people lived in a persistent poverty county in the 30-year period spanning 1989-2019. The 341 counties identified in persistent poverty were not evenly distributed throughout the US. Over 80% were in the South and nearly 20% of all counties in the South were in persistent poverty. Many were clustered in informal subregions such as the Southwest border, the Mississippi Delta, the Southeast, Appalachia, and in some counties with higher amounts of American Indian and Alaska Native tribal lands. Although, this is not just a red state problem. It turns out that 21% of the counties in New York state are persistently poor. Can companies that aim to do well by doing good play a part in addressing persistent poverty, with appropriate attention and help from the Government?

3.0 Push on G: Make the lives of activists and short sellers easier:

The implicit idea that sustainability investing is about long-term corporate thinking or long-term EPS, as opposed to next year’s EPS. It is hard for me to believe that long term thinking is somehow out of fashion after the election or less needed than before. Indexers will continue to hold stocks for decades. The question is whether we want them to be disengaged owners. If yes, will the new administration consider empowering short sellers and activists such as Elliott Management or Trian to release capital trapped in overvalued firms and invest more capital in undervalued firms? As I have written many times before, there are hundreds of firms in the S&P 1500 that have not earned a return that covers the opportunity cost of investing in US treasuries.

Finally, it is worth repeating that businesses, even without ESG investing, will do what it takes to address changing social norms of the customers, workers and communities they interact with. This is because most ESG problems are business problems, as articulated next.

4.0 Most sustainability/ESG problems are business problems

I have stated several times that, to me, sustainability/ESG problems are mostly business problems. I am not sure much is going to change on this dimension. To illustrate this argument, consider the risk factors disclosed by Waste Management, a company headquartered in Houston Texas (a red state), in its 2023 10-K. I have classified these risk factors as E and S. One does not expect to see G flagged as risk factors as no CEO wants to suggest that his governance ecosystem is not effective. I have left brief comments under a few risk factors to indicate whether the new administration will mitigate relevant risks for Waste Management (WM).

E risk factors

1. We utilize an energy surcharge and other mandated fees.

2. Supply chain, regulatory or permitting disruptions or delays could detrimentally impact the execution timeline for our planned expansion of our Recycling Processing and Sales and WM Renewable Energy businesses.

· It is hard for me to believe that WM will quit the recycling business because of the new administration.

3. Our operations must comply with extensive existing regulations, and changes in regulations (environmental protection, health, safety, land use, zoning, limitations on siting and constructing new waste disposal, limitations, bans, taxes or charges on disposal or transportation of out-of-state waste, significant financial obligations relating to final capping, closure, post-closure and environmental remediation, environmental regulatory changes; new information about waste types previously collected, such as per- and polyfluoroalkyl substances (“PFAS”) or other emerging contaminates and other reasons, governmental entities have increased their interest in implementing EPR regulations to reduce municipal spending on recycling programs).

· Some of these regulations will ease. But class action lawyers might end up becoming more aggressive if enforcement agencies back off.

4. We may be unable to obtain or maintain required permits or expand existing permitted capacity at our landfills, due to land scarcity, public opposition or otherwise, which can require us to identify disposal alternatives, resulting in decreased revenue and increased costs.

5. We have made significant investments in an extensive natural gas truck fleet, which makes us partially dependent on the availability of natural gas and fueling infrastructure and vulnerable to natural gas prices, and requirements to transition to other vehicle types could impair these investments.

· Businesses make long term investments that are harder to simply unwind because of a new administration.

6. The seasonal nature of our business, severe weather events resulting from climate change and event driven special projects cause our results to fluctuate, and prior performance may not be indicative of our future results.

· Good businesses, regardless of whether they are in a blue state or a red state, worry about the cash flow implications of climate change.

7. Our operations are subject to environmental, health and safety laws and regulations.

· It is again hard to believe that the entire apparatus of environmental, health and safety laws will be abandoned by the new administration.

8. Our sustainability growth strategy includes significant planned and ongoing investments in our WM Renewable Energy segment; changes to federal and state renewable fuel policies could affect our financial performance, and such investments may not yield the results anticipated.

9. The impact of climate change, and the adoption of climate change legislation or regulations restricting emissions of GHGs, could increase our costs to operate.

· The costs of having to comply with climate change legislation may fall but WM operates in California and is hence subject to that state’s Clean Fuels Program and Corporate Data Accountability Act and the Climate-Related Financial Risk Act.

S risk factors

10. Our employees, customers or investors may not embrace and support our strategy.

· This is the textbook argument for why companies have incentives to worry about stakeholders in the long run, even if there are no regulations mandating such a focus.

11. We may not be able to hire or retain the personnel.

12. Our business is subject to operational and safety risks, including the risk of personal injury to employees and others.

13. If we are unable to attract, hire or retain key team members and a high-quality workforce, or if our succession planning does not develop an adequate pipeline of future leaders, it could disrupt our business, jeopardize our strategic priorities and result in increased costs, negatively impacting our results of operations.

14. Our business depends on our reputation and the value of our brand.

15. Increases in our labor costs as a result of labor unions organizing, changes in regulations related to labor unions or increases in employee minimum wages, could adversely affect our future results.

16. We may not be able to achieve our sustainability related goals, including reduction of our greenhouse gas (“GHG”) emissions, or execute on our sustainability-related growth strategy and initiatives, within planned timelines or anticipated budget, which could damage our reputation and negatively impact the benefits anticipated from our investments.

· These risks will dramatically fall under a Trump administration.

17. Focus on, and regulation of, environmental, social and governance (“ESG”) performance and disclosure can result in increased costs, risk of noncompliance, damage to our reputation and related adverse effects.

· These risks will dramatically fall under a Trump administration.

18. Increasing customer preference for alternatives to landfill disposal and bans on certain types of waste could reduce our landfill volumes and cause our revenues and operating results to decline.

· One could argue that customer preferences will encourage innovation in private structures to effectively signal participation in green initiatives.

19. Increasing regulatory focus on privacy and data protection issues and expanding laws could negatively impact our business, subject us to criticism and expose us to increased liability.

20. We could face significant liabilities for withdrawal from multi-employer pension plans.

The long and short of this review is that it is difficult to imagine a radical rehaul of firms’ strategies, which intentionally or otherwise are designed to care for stakeholder interests, just because of the 2024 election.

In sum, the sustainability movement would do well to pivot to innovation around affordable green energy at scale, a carbon tax supplemented by a well-functioning carbon market and corporate social responsibility at home to address the plight of those left behind in the last three decades. Neither party wants managers to waste capital that can be released by doubling down on G. Businesses will do what it takes to address changing social norms of the customers, workers and communities they interact with.