Bet on innovation, not ESG metrics, to lead the net zero transition

• Published date: 01 March 2023
• Author: Bartley J. Madden
• Date: 01 March 2023
• DOI: http://doi.org/10.1111/jacf.12554

DOI: 10.1111/jacf.12554

ORIGINAL ARTICLE

Bet on innovation, not ESG metrics, to lead the net zero transition

Bartley J. Madden

Florida Atlantic University, Boca Rotan,Florida, USA

Correspondence

Bartley J. Madden, Florida Atlantic University,Boca Rotan, FL, USA.

Email: Bartjm43@gmail.com

An earlier version of this article was published in Systems Research and Behavioral Science 23 October 2022 open access. The author thanks Don Chew for especially insightful editing.

In 1987, the United Nations defined sustainable development as

meeting the needs of present generations without compromis-

ing the needs of future generations. Today, the top priority for

sustainability is the transition to Net Zero—that is, net zero green-

house gas (GHG) emissions. Carbon dioxide, a GHG, is a major

contributor to global warming.

In the pages that follow,I provide three different perspectives on

how companies are most likely to help get us to Net Zero. The first

is the widespread, conventional perspective that Environmental,

Social, and Governance (ESG) metrics will lead the way to a suc-

cessful transition to Net Zero. The second uses systems thinking

to better describe the complexity of navigating a path to Net Zero

and highlights the critical role of innovation. The third promotes

systems thinking for corporate boards with the aim of improving

decision-making and accelerating innovation and adaptation in a

fast-changing Net Zero world.

PERSPECTIVE #1—ESG METRICS

Facing pressure from institutional asset managers, companies

today must begin navigating a path to Net Zero.1As metrics

keyed to the “E” of ESG and specifically related to GHG emis-

sions proliferate, investors are increasingly using ESG scorecards

as part of their decision-making. At the beginning of 2022, the

capital devoted to exchange-traded, ESG-focused funds exceeded

$2.7 trillion. Moreover, regulatory bodies continue to make this

kind of data mandatory in corporate reports. As a consequence,

managements and boards of directors are motivated to take actions

that can make their companies look good at least in terms of ESG

metrics.

But the objective of such companies ought, of course, to be

to reduce their GHG emissions. The current default report-

1Forespecially comprehensive analyses, see the annual reports prepared bythe United Nations

IntergovernmentalPanel on Climate Change (IPCC). For a succinct summary of the issues, see

Bill Gates. 2021. Howto Avoid a Climate Disaster: The Solutions We Have and the Breakthroughs

WeNeed.NewYork:AlfredA.Knopf.

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is

properly cited.

© 2023 The Authors. Journal of Applied CorporateFinance published by Wiley Periodicals LLC on behalf of Cantillon & Mann.

ing methodology is the GHG Protocol, in accord with which

Scope 1 emissions are those directly produced by a firm’s

operations—for example, from driving owned and leased vehicles.

Scope 2 missions are those produced by facilities that gener-

ate electricity bought and consumed by the company. Scope 3

emissions originate from upstream operations in a company’s

supply chain and from downstream use by both its “whole-

sale” and end-use consumers. The GHG Protocol methodology

has been criticized as lacking accuracy and verifiability (pri-

marily in terms of Scope 3), in significant part for requiring

that the same emissions reported multiple times by different

companies.

To address this and other limitations of the Protocol, Robert

Kaplan and Karthik Ramanna have proposed an innovative solu-

tion that recognizes the integrated nature of pollution activities

across the economy. A company’s existing accounting system and

cost-accounting infrastructure would record the GHG units emit-

ted during operations as an E-liability.2All along the supply

chain, companies would transfer the E-liability associated with

goods delivered and record their end-of-period E-liability. This

method eliminates multiple counting of emissions in the concep-

tually flawed Stage 3 method while also limiting opportunities for

greenwashing gamesmanship.

The conventional perspective with its emphasis on ESG met-

rics represents linear cause-and-effect thinking. That is, a logically

tight path is assumed to exist from implementing ESG metrics

to “incentivizing” companies to take actions to improve their

ESG scores, eventually leading to a successful Net Zero transi-

tion. Interestingly, those who embrace this perspective invariably

do appreciate the complexity and messiness of the climate change

problem reflected in the interrelatedness that brings together polit-

ical, economic, ecological, and social issues with multiple causes

generating multiple effects often separated in time and space.3

2Robert S. Kaplan and Karthik Ramanna. 2021. “Accountingfor Climate Change.” Harvard

Business Review November-December120–131

3C. S. Holling. 2001. “Understanding the Complexity of Economic, Ecological, and Social

Systems.” Ecosystems 2001 (4): 390–405.

J. Appl. Corp. Finance. 2023;35:35–44. wileyonlinelibrary.com/journal/jacf 35