Dr. Kaushik Sridhar

Elon Musk vs ESG

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First published in Pro Bono News.

In late May, Tesla was removed from the S&P 500 ESG index. In a blog post, Standard & Poors (S&P) explained that Tesla’s “lack of a low-carbon strategy” and “codes of business conduct”, along with racism and poor working conditions reported at Tesla’s factory in Fremont, California, affected its overall ESG score.

In response, Tesla CEO Elon Musk took to Twitter to announce that “ESG is a scam. It has been weaponized by phony social justice warriors.”

He pointed to the fact that Exxon is rated in the top 10 best in the world for environment, social and governance (ESG) by S&P 500, while Tesla didn’t make the list.

So how do we explain this?

To go back to a positive note, Tesla’s influence in the electric vehicle (EV) industry and how the company was able to create enough momentum for EVs is undoubtedly its legacy. From the beginning, Tesla challenged the traditional automakers, and was able to fast-track the development of EVs at a global level.

Despite not being the best-in-class in ESG ratings, Tesla is producing high-energy efficient vehicles, and is investing heavily to mitigate its environmental risks. It does this by improving the management and transparency in its supply chain, and developing better recycling processes and technology for its batteries.

But while Tesla may be playing its part in taking fuel-powered cars off the road, it has fallen behind its peers when examined through a wider ESG lens. ESG focuses on understanding whether an organisation is efficiently and/or effectively responding to a diverse range of stakeholder needs, demands and requirements within specific internal/external contexts (i.e. environment, social, governance).

In this case, it is important to remember that ESG is about more than just the “E” (environmental part).

If you judge a company on one metric, you might come to a different conclusion. ESG doesn’t do that. It’s a holistic framework to assess what makes a company great. If Musk wants to be a leader for the 21st century, he needs to do more than just one or two good things.

How does Tesla rate on ESG?

Several ESG rating agencies have rated Tesla on ESG. While these agencies use different criteria, there are some similarities in their assessments.

Sustainalytics ranks Tesla at 42nd out of 83 companies in the automobile industry group, giving the company an ESG risk rating of 28.5 points. This is classified as medium risk (the lower risk, the better the rating). Traditional automakers usually do not perform well in ESG, due to their high emission products. For example, Volkswagen has an ESG risk rating of 29.7, with Toyota Motor Group at 28.9.

In comparison, MSCI has been downgrading Tesla’s ESG rating since commencing measurement. In 2017, MSCI gave Tesla an ESG rating of “AAA”, but reduced it to “AA” in 2018 and now, in 2022, it rates Tesla as “A”. When comparing to its peers in the automobile industry, MSCI indicates that Tesla is a laggard in both labour management and – here it differs to other agencies – as a corporate governance leader.

S&P Global, at the ESG Industry Report Card: Autos and Auto Parts, rates Tesla as B-/negative. It expects Tesla’s ESG risks to be high for governance and social risk factors, and low for environmental risks, due to the company’s focus on electric vehicles. For S&P Global the main governance risks are Musk’s dominant role in the company and the potential impact that has on corporate governance. The main social risks are related to “product liability, government scrutiny, and further regulation”.

It’s true that ESG data is “noisy”: this can create divergence between independent agencies that evaluate and assign ESG ratings to firms. However, the above-mentioned ratings agencies’ ESG scores for Tesla highlight a number of common challenges facing the organisation.

In addition to supply chain issues, Tesla hasn’t performed well on certain “S” and “G” criteria. These include the environmental impact of its batteries, paying a fair and living wage, poor working conditions, diversity, equity and inclusion (DEI)-related discrimination controversies, and the sometimes eccentric and unusual governance of Musk himself.

One can’t live in a vacuum of just environmental or just social issues – they are all intertwined.

ESG vs sustainability vs impact

This brings us back to Musk’s criticism that Exxon Mobil still makes the cut.

Some – like Musk – believe the ratings should reward companies that support the planet and society best. Others, including firms like S&P (who produce the scores) say the ratings are intended to show how much risk a company’s stock faces from ESG factors. This is why major contributors to climate change (such as oil and gas multinational Exxon Mobil) are allowed to stay in an ESG index – if they can demonstrate action to reduce that risk.

ESG and sustainability are different, but intertwined, concepts. The former is a performance assessment framework aimed at measuring/quantifying an organisation’s legitimacy and competitiveness. The latter stands as a management paradigm aimed at safeguarding an organisation’s “operability” – aka “the business of staying in business”.

ESG is primarily focused on assessing risks and opportunities to companies created by evolving social, environmental and governance factors. As practised in the US, it is principally about the impact of the world on the company, and not the impact of the company on the planet.

Effectively Musk is confusing ESG with sustainability and impact.

The problem with Musk’s claims is that ESG is not about impact: but operations. It’s a lens through which to better understand how world events might risk a company’s enterprise value, not how a company might pose risks to the world. If, hypothetically, there was an S&P 500 Impact Index, then Tesla would probably still be in it, and Exxon Mobil would not. But, that doesn’t mean Tesla can claim ESG.

So, Musk is both right and wrong. Yes, Tesla has done a lot for climate. No, ESG is not a scam. ESG simply doesn’t necessarily measure the things Musk and others think it does.

When it comes to investors, rather than defaulting to generic ESG ratings, they should first identify the specific ESG considerations most important to them ­– and then choose an investment strategy accordingly.

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