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Caitlin Styrsky

Pensioner sues Oklahoma over ESG restrictions

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the environmental, social, and corporate governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG developments this week

In the states

Pensioner sues Oklahoma over ESG restrictions

Former Oklahoma state employee Don Keenan is suing the state, alleging that the Oklahoma law prohibiting state contracts with financial firms that boycott oil, gas, and other types of companies violates the U.S. Constitution and federal law:

Don Keenan, a former state employee, is seeking a temporary restraining order against Oklahoma Treasurer Todd Russ and the state over the 2022 law enacted by the Republican legislature. As part of the legislation, Russ released a list of six firms that are restricted from doing business with the state.

The lawsuit, filed on Monday in the district court of Oklahoma County, said the legislation is unconstitutional and violates the First Amendment. “The state’s decision to use its retirees’ retirement funds as political fodder in its quixotic quest to prove a point is patently unconstitutional and violates federal law,” Keenan’s lawyer said in the suit. …

The Oklahoma Public Employees Association, which represents 32,000 state employees, is part of a coalition backing the lawsuit. OPEA wants to use the temporary injunction to prevent Russ from challenging the pension’s vote or taking further action to enforce the law, Executive Director Tony DeSha said in an interview. The ultimate goal would be to get the law declared unconstitutional, he said.

Keenan says he thinks oil and gas are important economically but argues the law, in his view,  imposes unnecessary costs on the pension system:

The cost of having to divest assets from the six blacklisted firms said to boycott the fossil-fuel industry is “monumental,” the lawsuit contends, citing the Oklahoma Public Employees Retirement System, which would pay an estimated $10 million to divest assets from BlackRock and State Street. The other four blacklisted firms are Wells Fargo & Co., J.P. Morgan Chase & Co., Bank of America and Climate First Bank.

“I do not have any objections to oil and gas operations and believe they are important and critical to the world economy,” plaintiff Don Keenan wrote in an affidavit that is part of the lawsuit. “However, as a retiree under the OPERS system, I object to my retirement benefits being depleted because the State of Oklahoma believes that making political statements with retiree dollars is more important than taking care of retirees themselves.”

Opponents of ESG have argued that prohibiting environmental, social, and other non-financial considerations in public investments can reduce politicization and help preserve retirement savings. 

On Wall Street and in the private sector

ESG debates move to courts

At a recent conference in Montreal, Canada, speakers argued that ESG-related class-action lawsuits are likely to play a growing part in the debate over ESG and its value to investors, shareholders, and customers. According to a report on the conference, “class action litigation can emanate from many sources, [but] four areas in particular are of importance in the ESG space,” including shareholder lawsuits and government enforcement litigation:

Shareholders: Lawsuits by shareholders regarding ESG matters are accelerating. Examples include claims that their stock holdings have lost value as a result of false disclosures about issues like sexual harassment allegations involving key executives, cybersecurity incidents, or environmental disasters. Even absent a stock drop, some shareholders have brought successful derivative suits focused on ESG issues. Of recent note, employees of corporations incorporated in Delaware who serve in officer roles may be sued for breach of the duty of oversight in the particular area over which they have responsibility, including oversight over workplace harassment policies …. The decision will likely result in a flurry of litigation activity by the plaintiffs’ bar, as new cases will be filed alleging that officers in corporations who were responsible for overseeing human resource functions can be held liable for failing to properly oversee investigations of workplace misconduct such as sexual harassment. …

Government Enforcement Litigation: Federal, state and local government regulators have taken multiple actions against companies based on their alleged participation in climate change, investments inconsistent with ESG goals, or alleged illegal activities. For instance, in 2019, the U.S. Department of Justice investigated auto companies for possible antitrust violations for agreeing with California to adopt emissions standards more restrictive than those established by federal law. While the investigation did not reveal wrongdoing, it underscores the creativity that proponents and opponents of ESG efforts can employ.

The report suggested that the increased litigation risk was unlikely to reduce corporate ESG programs:

The creation, content, and implementation of ESG programs carries increasing litigation risks for corporations but it is unlikely that ESG programs will diminish is (sic) size or scale in the coming years given increased focus by Fortune 100s and 500s and increased regulation at the federal and state levels.

From the ivory tower

Study argues ESG raters could have conflicts of interest

A new research paper from Columbia Business School argues that a number of companies that earn a significant portion of their revenue from ESG rating services tend to rank businesses with better stock performance more favorably on ESG indexes.

Despite growing investor reliance on environmental, social, and governance (ESG) ratings, we know relatively little about how such ratings are constructed especially because widespread disagreement across ESG ratings raises concerns about their credibility. At the same time, several leading ESG raters not only construct ESG ratings but also market index products based on their ESG ratings. We examine whether the incentives associated with deriving revenue from ESG rating-based indices contribute to the variation in ESG ratings. Consistent with this notion, we find that raters with strong index licensing incentives issue higher ESG ratings for firms with better stock return performance and those added to their ESG indexes, compared to raters with weaker licensing incentives. The results hold after accounting for the firm’s fundamental ESG performance and different rating methodologies. Overall, our findings suggest that index construction incentives affect the production of ESG ratings, highlighting the need for greater transparency in the production of ESG ratings.

The researchers’ conclusions suggest that MSCI—a leading ESG rating service—has a strong financial incentive that impacts its ESG ratings:

It is not clear how ESG data providers determine ESG ratings, and there is substantial disagreement in ratings across ESG data providers (Berg et al., 2022; Christensen et al., 2021). This raises concerns about the credibility of ESG ratings and underscores the need to understand the incentives that shape the production of ESG ratings. We examine whether raters with strong index licensing incentives issue higher ESG ratings for firms with better stock return performance and those added to their ESG indexes, compared to raters with weaker licensing incentives. We study MSCI as an example of an ESG rater with high index licensing incentives (HighIndex) and Refinitiv as an example of an ESG rater with low index licensing incentives (LowIndex). While most of Refinitiv’s revenue is from selling data, more than 60 percent of MSCI’s operating revenue is from index licensing fees. Using these raters, we also investigate the degree to which index licensing incentives influence ESG ratings by benchmarking HighIndex ESG ratings to LowIndex ESG ratings.

Our results offer several new insights. First, we report that firms with higher (lower) stock returns receive higher (lower) ratings from a rater with high index incentives relative to ratings from a rater with low index incentives. As our inferences are based on comparisons across ratings issued for the same firm, we effectively hold “fundamental” ESG performance constant in our analyses. Second, we find that ESG ratings from a rater with high index incentives are systematically higher (lower) than those of a rater with low index incentives for firms added (dropped) from the ESG indexes, even after controlling for rating methodology differences. Notably, these ESG ratings upgrades and downgrades, relative to peers, do not appear to be informative about “fundamental” ESG performance. Third, we show that ESG index inclusion decisions are associated with stock returns. Collectively, our findings suggest that ESG data providers’ index licensing incentives influence their ESG ratings.

In the spotlight

Is Disney pulling back from the ESG debate?

The Walt Disney Company (Disney) has been involved in ESG debates for years, especially with the company’s public opposition to Florida Governor Ron DeSantis (R) and his efforts to limit discussions of sexual topics in the state’s public schools. Disney’s political involvement drew pushback from ESG opponents.

Legal analyst Jonathan Turley wrote on November 25 about Disney’s recent SEC filings, arguing that the company may be pulling back from its public political involvement. In its SEC filings, Disney said the company’s public political involvement created “risks to our reputation and brands”:

In its annual SEC report, Disney acknowledges that “we face risks relating to misalignment with public and consumer tastes and preferences for entertainment, travel and consumer products.” In an implied nod to Smith, the company observes that “the success of our businesses depends on our ability to consistently create compelling content,” and that “Generally, our revenues and profitability are adversely impacted when our entertainment offerings and products, as well as our methods to make our offerings and products available to consumers, do not achieve sufficient consumer acceptance. Further, consumers’ perceptions of our position on matters of public interest, including our efforts to achieve certain of our environmental and social goals, often differ widely and present risks to our reputation and brands.” …

Disney has reportedly lost a billion dollars just on four of its recent “woke” movie flops, productions denounced by critics as pushing political agendas or storylines. Yet until now, the company has continued to roll out underperforming movies as revenue has dropped. What’s more, Disney stars persist in bad-mouthing its fabled storylines and undermining its new productions. The company admits that it has suffered a continued slide in “impressions” (that is, viewership) by 14 percent. …

Once an unassailable and uniting brand, Disney brand is now negatively associated with activism by a significant number of consumers. The company is now even reporting a decline in licensing revenue from products associated with Star Wars, Frozen, Toy Story and Mickey and Friends — iconic and once-unassailable corporate images.

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