One of the world’s leading governance academics has called for a truce between Republicans and Democrats over the use of ESG principles in corporate America, arguing this could be achieved through a change to “fiduciary laws”.

In an article co-written for the Harvard governance blog, Robert Eccles, professor at Oxford University’s Saïd Business School, along with Eli Lehrer, president of the R Street Institute think tank, write that both Republican and Democrat states have chosen ESG tactics that make no “economic sense”.

“Recognising this creates a real opportunity for a truce, based on fiduciary duty and the separation of political issues from investment decisions,” they write.

ESG—or “woke” corporate governance as it is labelled in some quarters—has become a major point of conflict in US politics. But the battleground has become the application of ESG to state pension funds. Some Republican (“red”) states, such as Texas and Florida, have banned the use of ESG principles by fund managers investing state funds. Elsewhere, “blue” states, including Maine and California, have considered ordering investment funds to divest holdings in fossil fuel companies.

The pair write that banning the use of ESG in fund management could cost red states huge sums of money. One study they cite says this could be as much as $6bn over ten years. Though it is still too early to tell, Eccles and Lehrer write that “efforts to ‘protect’ state funds from ESG are likely to have very high costs for states…”. States that fail to embrace diversity as an issue are also likely to struggle recruiting Millennial and Gen Z staff.

Divestment difficulties

But divestments are problematic too, they write, as they will have huge costs and could prove “counterproductive”. When divestments were ordered of tobacco companies, share prices fell at first, then recovered and are now high performing stocks.

Eccles and Lehrer argue there is an answer on which both left and right can agree: “Clear fiduciary duty laws that define who is responsible for state investment, allow them to consider ESG factors ONLY when they contribute to economic value creation, and assure state employees in defined contribution plans they can select non-ESG options.”

Debate over ESG gas been intensifying for some time. Presidential candidate and Florida governor Ron DeSantis has locked horns with Disney, the media and amusement park giant, over LGBTQ issues. He has also passed laws instructing the state’s pension scheme to prioritise investment returns without considering “the ideological agenda of the environmental, social and corporate governance movement”.

Elsewhere, the attorneys general of 18 Republican states, among them Texas, Arizona and Kentucky, famously wrote a joint letter claiming BlackRock, the world’s largest fund manager, was in breach of its “fiduciary and legal obligations” by failing to be “neutral” on the question of fossil fuels and ESG.

ValueEdge, a shareholder advisory company based in New York, dubbed the letter “political theatre, shrill, slanted and completely unsubstantiated”.

Eccles and Lehrer argue it is now urgent to calm the debate because so much ESG-focused legislation is emerging and is bound to create more conflict. A change in fiduciary laws could quell the conflict. “This truce on state level ESG laws involves some give and take from both sides.

“It points a way towards a fiscally sound future that holds investment managers accountable, while allowing them to make the best possible judgements.”

Fund managers caught in the middle may be relieved that there are compromise options being discussed. Whether they will gain traction in a highly polarised and heated political environment, especially in the run up to next year’s presidential election, is another question entirely.