The dilemma between ‘comply or explain’ and SRI, ESG methodology; transitional terminology

Speaker: Prof. Kazuyuki Shimizu, School of Business Administration, Meiji University

Abstract:This paper tries to find out what the difference is between ESG and SRI. ESG developed from the SRI concept with “comply and explain” which was introduced in 1992, and it creates difficulties between their concepts and also can make difficulties for their methodological development. ESG and SRI had different concepts from each other before, but they mix their methodologies after this introduction. Both concepts need to be rechecked against the pure (principle) model. ESG and SRI have different investment strategy which tries to capture both financial returns and societal good. The fundamental question of this dilemma between SRI and ESG is analysed with three steps.

At first, the difference between the SRI investment approaches was investigated. The logical implication of SRI refers to a segmentation (Euler diagram). It contains three segments. The economic segment forms the smallest circle in the core and the social segment embedded within the environmental component. The Euler diagram is showing a clear stance for the limitation of environmental resources, compared to Venn’s idea. The Venn diagram reveals an interactional relationship between the economy, society and the environment but is not interdependent, that is why stocks were selected on the basis of investment assessment in favour of unlimited inclusion rather than limited exclusion.

Secondly, as far as the SRI and ESG investment approach is concerned, the stocks should serve as a screen in the evaluation process. The screen can be applied with either exclusionary (negative) or inclusionary (positive) methodology. According to GSIA, The largest sustainable investment strategy globally is exclusionary screening ($15.02 trillion). However, the “exclusionary strategy” that several index firms are using still includes the stocks dealing with Alcohol such as Diageo plc, and others exclude industries such as Gambling, Tobacco, Military Weapons, Civilian Firearms, Nuclear Power, Adult Entertainment and Genetically Modified Organisms. Therefore, this paper gave a trial difference between SRI and ESG from the historical and methodological point of view. SRI needs to be in place before the introduction of the “comply or explain” idea in 1992. After that, the index used might be ESG, which assesses more through the “included exclusion” criteria.

Finally, the performance of ESG and SRI are investigated, compared with a known-ESG index such as the MSCI world index. The DJSI World index is applied as an SRI category and the FTSE4GOOD index as the ESG group. There is skepticism between social responsibility and financial performance. Then, we found stability in SRI in the long-term capital performance, especially during the crisis. However, ESG methodology reveals almost the same movement, like the MSCI world index. Values are changing due to crises such as Lehman and the Covid19 shock. Therefore, I would like to consider ethics and stock performance by comparing the performance of SRI and ESG with stocks excluded by the Norwegian Pension Fund’s own ethical standards. Ethics and stock performance are levelled by countervailing power of the values of various AIs and DAOs with human values.