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It's The Psychology, Stupid!

Every day, corporate leadership teams are told – often indiscriminately and with a lack of focus on material factors – that they are not doing enough to disclose and manage their ESG-risk.

Those thinking that the unrelenting assault on the C-suite à la Greta will create an impetus for firms to do more to deal with their environmental and social challenges are making a risky bet.

Burrhus Frederic Skinner, a leading American behaviorist who lived through the 20th century, developed the concept of operant conditioning.’ In his work, he investigated the way individuals mechanically respond to a range of stimuli. Mr. Skinner’s observations indicate that both positive reinforcement (e.g., praising) and positive punishment (e.g., scolding) are essential to trigger desired behaviors – as any parent would instinctively know.

Because they almost exclusively rely on positive punishment, the current psychological dynamics may end up being dramatically counter-productive. Indeed, the constant, disparaging criticism directed to corporate decision-makers could create a negative feedback loop. What does happen to initiatives when they are never deemed to be adequate?

As if it were not enough, new ESG objectives to tackle broadening environmental concerns are being introduced at a time when leadership teams are just starting to grasp the enormity of climate-related challenges. Of course, biodiversity and air pollution are important. But adding these considerations right now is perhaps not as beneficial as intended.

Yet, the European Union is relentlessly proceeding with the formulation of its taxonomy. In Genius or Folly? earlier this year, an attempt was made to explain the framework used by Brussels to define the set of criteria supporting the application of a ‘green tag’ to selected business activities. At the time, the EU’s Platform on Sustainable Finance had only published details related to two environmental objectives, namely climate mitigation and climate adaptation, out of six.

In its latest work published in August, the picture was completed by addressing the remaining four objectives. Meeting minimum Technical Screening Criteriarelated to (waste)water management, pollution, the circular economy, and biodiversity are set to allow an activity to be considered ‘green’ (provided it meets minimum standards across the other objectives.)

Whether admired or loathed, the EU Taxonomy will soon have to be integrated into the world of corporate finance. It will be used to define not only ‘green’ investment funds and debt instruments but also ‘green’ IPOs or ‘green’ M&A transactions – the sole purpose of which is to drive capital to ‘green’ opportunities.

But to maximize the chances of successfully tackling ESG issues, stakeholders, including the EU, must pace themselves. Seeking to seize the current ESG momentum and COP26 is laudable. But at this rhythm, the risk of breaking it is not far from that of leveraging it.

A zest of psychology can go a long way to steer the world in the desired direction. So why not pause for a brief moment and say ‘kudos’ to corporate leadership teams for having implemented so many ESG initiatives under the extreme circumstances of the last two years. They represent a great platform on which to build an appropriate response to the new world challenges.

And on to the next level.

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