- Turo is the world's largest car-sharing marketplace offering a wide selection of vehicles for various budgets.
- The Economics of Everyday Things is a new weekly show in the Freakonomics Radio Network.
- Kelly Shue, a finance professor at Yale, was inspired to work on a paper after hearing arguments from her MBA students about ESG investing.
- ESG investing aims to make money while also improving the world, but Shue believes it violates basic corporate finance concepts.
- The Norwegian Sovereign Wealth Fund, one of the largest in the world, considered divesting from oil and gas stocks due to climate change concerns but ultimately kept investments in larger energy firms.
- The fund also avoids investing in coal, tobacco, cannabis for recreational use, certain weapons, and companies involved in deforestation or reliant on child labor.
- ESG investors often prioritize the environmental aspect over social and governance factors.
- Shue's research focuses on the environmental impact of firms categorized as "green" (low greenhouse gas emissions) or "brown" (high greenhouse gas emissions).
- There is a large middle group of firms not considered in the analysis.

- Approximately 20% of firms are responsible for almost all of the environmental impact.
- Brown firms, active in energy, agriculture, and transportation, are the main contributors to environmental impact.
- Green firms, mainly services firms, have minimal environmental impact and do not significantly change with increased capital.
- Investing in green energy firms could be a promising strategy, but most ESG money goes to firms that already have low pollution.
- When ESG investors pull their money, brown firms either continue business as usual or cut corners on compliance and pollution abatement efforts.
- Divesting from brown firms is a mistake as they are more likely to develop new green technology and cutting their emissions even slightly would have a significant impact.
- ESG investing is often driven by a desire to avoid associating with brown firms rather than a carefully thought-out strategy.
- ESG investing has increased the cost of capital for brown firms, but the size of the movement is growing and could have a greater impact in the future.
- Pushing brown firms to bankruptcy may lead to negative consequences as they are crucial in sectors like agriculture, transportation, and natural resource extraction.

- The video discusses the importance of making sectors like agriculture, transportation, building materials, and natural resource extraction more environmentally friendly rather than eliminating them entirely.
- The Yale finance professor argues that selling off shares in "brown firms" incentivizes them to keep polluting, and instead suggests engaging with these firms to help make them greener.
- Chris James, the founder of Engine No. 1, supports engaging with brown firms and shares the success of their engagement with ExxonMobil to change its environmental impact.
- The ESG movement is driving corporate transparency, but ESG ratings by firms like MSCI, Sustainalytics, and Bloomberg are not considered useful by James.
- James believes that sustainable investing flows and engagement should target brown firms rather than green firms to be more effective in driving change.
- The engagement with ExxonMobil focused on the governance issue and the lack of energy experience on the board.
- James believes that ExxonMobil's management has been responsive to shareholder demands and is pivoting towards creating value in the energy transition.

- ExxonMobil has been responsive to shareholder demands by pivoting towards creating value in energy transition and improving core business execution.
- They plan to spend $17 billion on decarbonizing their operations.
- The activist campaign focused on governance issues rather than solely decarbonization.
- The goal was to shift the perception of energy transition from an existential risk to a business opportunity.
- Despite owning less than 1% of ExxonMobil shares, the activist firm Engine No. 1 was able to influence change.
- The biggest change has been the establishment of a low carbon solutions business.
- ESG investing may not effectively promote environmental goals, as it often focuses on investing in already green firms and divesting from brown firms.
- Engaging with brown firms rather than shunning them may be a more effective approach.
- Government funding, such as the Biden administration's Inflation Reduction Act, can incentivize brown firms to become greener.
- CF Industries, the world's largest ammonia producer, plays a crucial role in global food production and reducing their production would increase food prices and greenhouse gas emissions.

- CF Industries, a natural gas company, is looking to stop venting carbon dioxide (CO2) into the atmosphere.
- They have signed a deal with ExxonMobil to start sequestering 2 million tons of CO2 per year.
- The Inflation Reduction Act provides a subsidy of $85 per metric ton of CO2 for sequestration.
- CF Industries believes that sectoral evaluation is necessary to accurately assess the environmental impact of companies.
- The paper argues that ESG investing strategies provide weak incentives for brown firms to become greener.
- CF Industries believes that without access to affordable capital, brown firms may struggle to become greener.
- The company hopes that investment dollars will go to firms with tangible decarbonization plans.
- Investing in brown firms that are making efforts to reduce emissions can be more beneficial than punishing them.
- The ramifications of the erroneous belief in ESG investing include investors paying high fees without getting desired environmental impact.
- While some investors may want to hurt brown firms, it is not considered a scam as they are responding to investor demand.

- The speaker discusses the belief that individuals have in their ability to affect change in the market
- They mention that people tend to believe they matter more and are more optimistic than they actually are
- The speaker acknowledges their own irrational optimism, but believes they are less optimistic than the person they are speaking to
- The episode also mentions upcoming content featuring Satya Nadella, CEO of Microsoft, discussing artificial intelligence
- The episode concludes with a preview of a new show called "The Economics of Everyday Things" about sports mascots

- Turo is a car-sharing marketplace with a wide selection of vehicles for different budgets.
- The Economics of Everyday Things is a new show on the Freakonomics Radio Network.
- Kelly Shue, a finance professor at Yale, disagrees with ESG investing, believing it violates corporate finance concepts.
- The Norwegian Sovereign Wealth Fund considered divesting from oil and gas stocks but kept investments in larger energy firms.
- ESG investors prioritize the environment over social and governance factors.
- Shue's research focuses on the environmental impact of "green" and "brown" firms.
- Brown firms in energy, agriculture, and transportation have the highest environmental impact.
- Most ESG money goes to firms with low pollution, limiting the impact of investing in green energy firms.
- Divesting from brown firms is seen as a mistake as they are more likely to develop green technology.
- ESG investing has increased the cost of capital for brown firms, but the movement is growing.
- Engaging with brown firms may be more effective than divesting from them.
- Chris James of Engine No. 1 supports engaging with brown firms and shares success with ExxonMobil.
- ESG ratings by firms like MSCI are not considered useful by James.
- ExxonMobil has responded to shareholder demands and is investing in decarbonization.
- ESG investing may not effectively promote environmental goals.
- Government funding can incentivize brown firms to become greener.
- CF Industries is working with ExxonMobil to sequester CO2 and believes sectoral evaluation is necessary.
- ESG investing strategies provide weak incentives for brown firms to become greener.
- CF Industries hopes investment dollars will go to firms with decarbonization plans.
- Investing in brown firms making efforts to reduce emissions can be more beneficial than punishing them.
- The belief in ESG investing can lead to high fees without desired environmental impact.
- The speaker discusses people's belief in their ability to affect change in the market.
- The episode mentions upcoming content featuring Satya Nadella and discusses sports mascots.

Probably not. The economist Kelly Shue argues that E.S.G. investing just gives more money to firms that are already green while depriving polluting firms of the financing they need to get greener. But she has a solution.

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Before we start today's episode, an announcement, a birth announcement.

There is a new weekly show in the Freakonomics Radio Network, a show I think you will love.

In fact, we know a lot of you already love it because we put out a few pilot episodes earlier this year, and the response was strong.

The show is called The Economics of Everyday Things, and it's hosted by Zachary Crockett.

You can get it right now in your podcast app.

Just look up The Economics of Everyday Things and follow or subscribe for free.

To hear a sample, just stick around to the end of this episode.

And now, here's this week's episode of Freakonomics Radio.

I'm a professor of finance at the Yale School of Management.

Some professors want to spend all their time on research.

Shu does plenty of research, but she also does a lot of classroom teaching, and she likes her students.

I get a lot of research ideas from talking to them, and a lot of insights about how the real world differs from what I'm teaching in class.

So I like it when they push back and they say, what you're teaching me is unrealistic because that's not how we do it in a firm.

But sometimes it's the students who Xu thinks are unrealistic.

That's where she got the idea for a new paper.

I was inspired to work on this paper because I was actually just quite annoyed by an argument that I had heard frequently by some of my MBA students about how ESG investing is supposed to make the world more green.

ESG stands for environmental, social and governance.

And ESG investing is about allocating resources in a way that makes money while also improving the world.

When Xu heard people explaining how it was supposed to work, She couldn't make the math add up.

I'm just hearing this argument over and over again.

And in my head, I'm thinking, you know, that violates the basic corporate finance concepts that I teach in class.

I too want to make the world more green, but I don't think this is going to work.

Today on Freakonomics Radio, why wouldn't it work?

We've looked at what seems to have been a blind spot in the ESG investing movement.

It's a huge movement and getting bigger by the minute.

Political progressives think it will help save the planet.

Republican lawmakers ridicule it as woke investing and they're trying to ban it.

Kelly Shue says that both sides are missing the point.

What we're showing is actually not difficult to prove.

It's just something that for some reason hasn't been looked at before.

This is Freakonomics Radio, the podcast that explores the hidden side of everything, with your host, Stephen Dubner.

Okay, so Kelly Shue argues that investors who focus on the ESG rating of a company or an investment fund are making a fundamental mistake.

Before we get into the mistake, let's hear from 1 such investor.

In this case, the investor is an entire country.

So my name is Carine Smith Ihena Cho, and I'm the chief governance and compliance officer for NBIM, which is Norge's Bank Investment Management.

I work for the Norwegian Sovereign Wealth Fund.

We are a fund for around 1.4 trillion US dollars.

It's a fund that's owned by the government, but in many ways it's owned by the 5000000 Norwegians.

Norway has 1 of the biggest sovereign wealth funds in the world.

The source of this money is the same as that of many other big sovereign wealth funds.

It's come from the oil and gas resources that was found in the late 1960s on the Norwegian continental shelves.

And what the government then decided was, let's take all the revenues from the oil and gas resources and put it in a fund.

Before oil, Norway was a relatively poor country.

In many places, this sudden infusion of wealth has led to trouble.

It's what economists call the resource curse.

The money might be spent recklessly or siphoned off by autocrats.

But Norway did the sensible thing, essentially putting the money into a gigantic piggy bank.

Ihena Chu says the investment returns from the fund cover 20 to 25 percent of Norway's annual budget.

Ihenichu The fund pays for every fifth teacher, nurse, road that's being built.

I often say it's easy to be a politician in Norway because they have a free 20 to 25 percent of the budget that they don't need to find anywhere.

The fund's investment approach is fairly conservative.

Part of that strategy is diversification.

The fund owns stock in nearly every major public company.

That includes oil and gas companies like ExxonMobil and Shell and BP.

Norway's own wealth came from oil and gas.

On the other hand, it's not very diversified to invest in energy firms when all your wealth comes from energy, especially since energy prices can be so volatile.

But also, Norway considers itself an enlightened place, a place where the threat of climate change is taken seriously.

So In 2017, the fund's managers proposed selling off the oil and gas stocks in their portfolio.

This led to a good bit of friction and debate.

end, it was decided to sell out on just pure upstream oil and gas producers.

Being a company that just focuses on exploring for where oil can be and drilling it up.

But they kept their investments in the larger, more integrated energy firms.

So the Exxon, Chevron, BP, Shell type of companies continue to stay because they do much more than just upstream production.

If the Norwegian fund had fully divested from oil and gas companies, that would have meant selling off around

billion in stocks, selling off just the shares of upstream drillers.

And there are some other industries they decided they don't want to own at all.

So coal is a product we are not supposed to be invested in.

Coal being, of course, a particularly dirty fuel, but also.

Tobacco, cannabis for recreational use and certain type of weapons.

They've also sold off companies with business models they consider unsustainable for 1 reason or another.

A lot of companies involved in deforestation.

Some companies, if they're reliant on child labor to survive, we don't think that's a sustainable business model.

Every quarter, the fund combs through its portfolio to see if there are other companies they want to sell off.

We have sold out around 400 plus companies.

This is exactly what ESG advocates would like to see.

If a company has a low rating on environmental, social or governance dimensions, investors should pull their money and put it elsewhere, like into a company with a high ESG rating.

It's always been strange that E, S and G are bundled together.

That again is the Yale economist Kelly Xu.

Various publications have tried to survey ESG investors to estimate how much they care about the E and the S and the G.

And it seems like these funds on average care 50 percent about E, a little bit about S and far less about G.

So there is a ranking of how much they care about these 3 letters.

So Xu decided to focus on the E as well, the environmental impact of a given firm.

She launched a research project with Samuel Hartzmark, a finance professor at Boston College, to analyze what ESG investors think of as green firms and brown firms.

So in our research, we categorize brown firms as the firms that are in the top 20 percent in terms of their greenhouse gas emissions per unit of sales.

And green firms are at the other extreme.

Green firms are the firms at the bottom 20 percent in terms of greenhouse gas emissions per unit of sales.

percent in terms of greenhouse gas emissions per unit of sales.

There's a vast swath in the middle, neither green nor brown, and you're just leaving them out of the calculation for now, is that right?

We have actually looked at the 60% of firms in the middle.

We categorize them as neutral, but we find that they are actually much more similar to green firms than to brown firms.

So basically there's about a fifth of firms out there that are responsible for almost all of the environmental impact that firms have on the world.

Name some brown firms that people would recognize.

So they're active in energy, agriculture, transportation.

Names that you might have heard about are Martin Marietta Materials, which is a building materials firm, Duke Energy, which is an energy firm, obviously, Southwest Airlines, a transportation firm.

So think Spotify, Prudential, Goldman Sachs, Allstate, MetLife, American Express, Silicon Valley Bank, which recently collapsed, is 1 of the greenest firms in our sample, which makes sense.

OK, so that's how Shue and Hartsmark categorized the firms.

But What exactly were they trying to learn?

Our research really only looks at 2 simple questions.

The first question is, if you raise the cost of capital for brown firms, how would they react?

Raising the cost of capital is what happens when ESG investors sell off shares of brown firms and redirect their money to green firms, giving brown firms less investment capital to work with.

And the second question is, do brown firms have any other incentives to become green based upon ESG investing so far.

What I've heard from ESG investors, as well as from my own MBA students who are incredibly excited about ESG, they're very well-intentioned people, they talk about how by punishing brown firms that that is somehow going to motivate these brown firms to become more green.

So the idea is if we all collectively choose not to invest in brown firms, then it will be very expensive for them to raise financing and somehow dot dot dot that's going to make them more green.

Shue and Hartsmark recently wrote up their findings in a paper called Counterproductive Sustainable Investing, the impact elasticity of brown and green firms.

How much are they helped by the extra money from ESG investors?

What we found in the data, when we looked at empirically how Brown and green firms have changed their environmental impact in the past with respect to changes in their cost of capital.

What we found is even if it gets easier for these green firms to access capital, their environmental impact barely changes.

And that's just because they don't have much to change.

They're mostly services firms that already don't pollute.

So when they get more money, they continue not polluting.

And they're also not the best candidates for developing green technology because it's not part of their business model.

But what about focusing investment, let's say, on green energy firms, startups or otherwise?

I think that's a very promising strategy if they were to target their efforts at subsidizing and promoting firms that are developing new green technologies.

I just don't think that describes what the movement is doing right now.

There is a part of the ESG movement that I think is quite promising.

They usually refer to themselves as impact investment funds.

They're marketed as niche, risky and specialized products, though.

These target impact funds, they account for less than about 1 percent of the portfolios invested in ESG.

In other words, most ESG money isn't going to companies that are developing new green technology.

It's going to firms that already don't pollute much, like banks, insurance companies, software firms and so on.

And they use that capital to expand their normal, low-polluting activities.

How do they behave when ESG investors pull their money?

When the cost of capital increases for brown firms, they seem to react by becoming more brown.

Well, they continue business as usual, which is brown, or they might cut some corners on compliance efforts or pollution abatement efforts, and that's all going to deliver plenty of cash right now and profits right now.

Alternatively, Brown firms can choose to become a little bit more green, but to become green, they have to invest in new production methods, new pollution abatement efforts.

So this green investment is going to cost money right now.

It's going to cut into profits this year.

So would you consider it a mistake to not invest more in brown firms?

I've seen 1 paper which I'm sure you know of called the ESG innovation disconnect evidence from green patenting and the main finding is that so-called brown firms in the energy sector tend to produce the most highly cited green patents.

So are we making a mistake by looking away from the brown firms?

Yes, so I think we're making 2 types of mistakes by divesting away from brown firms.

The first mistake is exactly as pointed out by the paper you mentioned, which is that if we ignore brown firms, we're ignoring the type of firm that is actually most likely to develop new green technology that could benefit other firms and could benefit the world.

The second reason why I think it's a mistake to divest away from Brown firms, and that's what the focus of my research, is if you push a firm toward financial distress or raise its cost of capital, that firm becomes much more short-term oriented, right?

It's more worried about its short-term survival.

It's going to care less about cash flow it could gain in the future because if they're distressed, they become less future-oriented.

And this mistake is actually incredibly costly when you consider that brown firms and green firms have huge scale differences in how much they pollute.

The brown firm typically pollutes 260 times as much as a similar-sized green firm.

So if that brown firm were able to cut its emissions by just a mere 1 percent, that is actually way better for the environment than the green firm cutting its emissions by

This mistake, as Xu calls it, isn't just costly, it's incredibly common, for reasons having less to do with finance than with psychology.

A broader group of investors just don't want to associate with Brown firms.

I'm not sure they've clearly thought through the impact of their actions, but they just don't want to touch them.

They don't want to have those firms in their portfolio.

So you're saying that ESG investing as commonly practiced is less investment strategy and more what some people call mood affiliation perhaps?

I think ESG investing is very much about investors wanting to think that they're not doing evil with their investment and because there's a strong social objective tied to it I'm not sure that they think through as carefully the steps through which they're actually going to achieve that objective.

So what confuses me a bit is if you look at the stock prices of the big energy firms for instance, they seem to be doing incredibly well.

Now oil is obviously a volatile commodity and a variety of things have happened lately to drive up prices, But if there's all this ESG movement away from brown firms and an oil company is the quintessence of a brown firm, why aren't they being punished more in the markets?

So I take your point that energy sector firms had a very good run, but they perhaps did less well than they would otherwise because of ESG investing.

There are a number of estimates showing that already ESG investing has increased the cost of capital quite a bit for brown firms compared to green firms.

The other thing to consider is just the huge amount of money that is right now tied to ESG investing.

So there's a Bloomberg Insights report that shows there's about 35 trillion globally invested in ESG.

And that's expected to grow to about 1 third of all assets under management by 2025.

So even if the ESG movement hasn't quite succeeded yet in punishing Brown firms, they might succeed in the future because the size of this movement is just growing and growing.

And if so, we really have to consider what would actually happen if they succeeded in punishing Brown firms.

Okay, but if I'm an environmentalist or an ESG advocate, I could say, hey, I'm perfectly comfortable pushing Brown firms, not just to the brink of bankruptcy, but into bankruptcy.

So I think there's something to your point, which is that if we were to punish brown firms to an extreme extent, make it infinitely expensive for them to raise capital, they're going to go out of business.

And if they go out of business, they can't pollute.

The problem is that brown firms exist in a lot of sectors that are actually crucial to a well-functioning society.

So it's not just coal mining, which we might all think of as evil and could be easily replaced.

It also includes agriculture, transportation, building materials, natural resource extraction.

So these are sectors that are quite valuable.

And I think it would make more sense to try to make these sectors more green per unit of output, rather than to say we can eliminate them entirely.

But if I'm willing to no longer, let's say, eat food that comes from the agricultural sector, or move around via the transportation sector or be in a building thanks to the building materials sector, then I can with a clean conscience happily drive the brown firms out of business and not worry about it, right?

Yes, if you are willing to purely consume financial and health services and the insurance sector, then we can drive Brown firms out of existence and you would be completely fine.

So do you suggest that investors, whether individual, institutional, or the investment firm side, that they collaborate more with Brown firms rather than demonize and not invest in them?

Yes, my analysis shows that Brown firms are the firms with the greatest scope to change their environmental impact.

So in addition to investing in Brown firms, it might be helpful to engage with their management.

I'm a big fan of the efforts of Engine No.

What these investors did is instead of just divesting away or attempting to punish ExxonMobil, they engaged with its board of directors and exerted shareholder pressure for ExxonMobil to change its environmental impact for the better.

If you're looking to book a car, you need to check out Turo, the world's largest car sharing marketplace.

Whether you're looking to book an SUV for a road trip or even test drive an EV, with Turo you'll find the right car for the right occasion.

See all Freakonomics Radio transcripts on Applepodcasts

546. Are E.S.G. Investors Actually Helping the Environment?