Why is there no “profit-washing”? The importance of incentives

In his book “White Man’s Burden”, William Easterly argues that there are two approaches to international aid:

  • Planning: a top down approach. “A Planner thinks he already knows the answers […] A Planner [is willing to] impose solutions.”
  • Searching: a bottom up approach. “In foreign aid, Planners announce good intentions but don’t motivate anyone to carry them out; Searchers find things that work and get some reward. […] Planners at the Top lack knowledge […]; Searchers find out what the reality is.”(source)

While it’s clear that Easterly thinks one of these is good and the other is bad, I’m a bit more neutral when applying this to ESG finance.

But here’s my main claim: If the ESG project is going to succeed in the long term, I believe we will need the right incentives; in other words, I believe we will need searchers, not just planners.

If ESG is to achieve impact in the short term, it needs planners

It is only recently that ESG considerations have started becoming part of mainstream finance. If we want the ESG concept to achieve positive change in the world, in the short term, it needs to take a planner approach. It needs people to identify specific goals and bring members of the finance community together to achieve them. For example, initiatives such as the Net Zero Asset Managers initiative were planned by some people.

If ESG is to achieve impact in the long term, it needs searchers

The financial system (pre-ESG) currently optimises for profit. It doesn’t really need planning, it occurs naturally, courtesy of the “invisible hand” of the markets.

For example, imagine a company’s senior directors make promises to the markets (e.g. “we will cut costs by 20% without losing revenue”). An army of analysts will crawl over every word and give the directors a grilling.

We don’t need the term “profit-washing”, because no company makes fake, facile claims of profitability and gets away with it. Not like the green-washing or impact-washing we see with ESG.

Why is “profit-washing” not an issue? 

If you think it’s because of audited accounts and better transparency and better availability of profitability data and Sarbanes-Oxley and regulations and Reuters and Bloomberg, I’m going to ask you to look deeper and find a more fundamental reason.

It’s because of incentives.

When a CEO promises its shareholders that the company will deliver shareholder value, the shareholders have something to lose if the CEO is wrong.

It’s because the financial markets are filled with searchers, not planners.

The question is whether we can create a world where ESG thinking helps the financial system to make the world a better place in a “searcher” way — without requiring a top-down planner.

The answer is yes, we can. But I’ll explain that in another post.

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