A tragedy of perception

Read this article to understand:

• Why sustainability has been left out of business, finance and economic models
• How our perception and sense of reality gives rise to ESG blind spots
• Why we need to take a systems approach to fix market failures

I recently read a quote that left me reeling. Within the space of a few words, physicist Geoffrey West managed to convey what I had known in my heart for years but had had no clear way of expressing.

“I once did a little exercise: I took about half a dozen economics books, the big fat ones like Samuelson’s, and so on, and I looked up in the index: do the words ‘energy’, ‘entropy’, or ‘thermodynamics’ ever occur? Not once in any of them.”

I knew instantly he was right, save for a few pioneers who have (so far) failed to turn the tide of mainstream thinking. I began to wonder whether the same was true for finance and corporate strategy. Though I heavily suspected the answer, I needed to validate my impulse.

Sustainable firms?

Let’s look at corporate strategy first.

Academic theorists have always played catch up with innovative practitioners like Henry Ford and Alfred Sloan who, among many other achievements, invented the production assembly line and organisational chart respectively. Business leaders had to take leaps of faith, plunging their economic ventures into the unknown as there was no sure-fire academic model capable of predicting whether their bets would pay off.

Many would argue not much has changed and the theory of the firm still lags the practice. However, where theory tends to meet practice most acutely today is on the campuses of business schools and within the meeting rooms of management consultancy firms. Questions of how a firm should be organised, the role of management, and other strategic considerations have all been hotly debated and codified by thought leaders from these professional vantage points for decades.

Management gurus like Michael Porter, Tom Peters and Peter Drucker all cut their teeth in these institutions and found riches in blending the newfound science of management with the art of business. Save for an enlightened few – such as John Elkington of Triple Bottom Line fame (although he has since ‘recalled’ that concept¹), George Serafeim at Harvard Business School and Bob Eccles at Oxford’s Saïd Business School – the legacy of leaving out sustainability in management thinking lives on through the everyday business decisions inspired by Messrs Porter, Peters and Drucker.

As for the enlightened few, while their work has not been given the prominence it deserves within their institutions, they would all also likely decline the ‘management guru’ moniker.

A recent article by Sarah Murray in the Financial Times emphasised the gaping flaw in the most influential management frameworks. She wrote: “Between 1998 and 2012, the Aspen Institute’s Beyond Grey ­Pinstripes ranking, which every two years assesses the sustainability content in schools’ curricula, routinely found that environmental topics were covered as separate modules or elective courses but were missing from core MBA programmes.”²

In fairness, both Porter and Drucker have made attempts to weave sustainability into their grand theories. Their original ideas still carry the day, though.

Sustainable finance?

Finance is slightly different in that mathematical theories portrayed an illusion of precision, resulting in an almost immediate transfer of knowledge from theory to practice.

Harry Markowitz, Bill Sharpe, Eugene Fama, Kenneth French, Myron Scholes, Fischer Black and Robert Merton have been key personalities in ‘professionalising’ finance. Their respective works on modern portfolio theory, efficient-market hypothesis, capital asset pricing model and derivatives pricing have come to shape and define risk and portfolio management in finance and investing. Add in discounted cashflow analysis, and you have all the major theories and thinkers covered.

One of my colleagues has studied their work extensively and found references to sustainability distinctly lacking in their models.

Their beautifully neat equations missed a crucial point about market integrity – that alpha means nothing if beta implodes. After all, over the long term, chasing alpha is pointless if you completely ignore systematic risks. Existential threats like climate change jeopardise the very foundations of society. If society starts breaking down, markets will too.

The same FT article referenced earlier pointed out the myopia is not limited to MBAs and corporate strategy. “Failure to integrate climate change into courses such as finance, accounting, marketing and operations has long been a cause for complaint among those pushing for management education to focus on climate change,” wrote Murray.

Even now, the Chartered Financial Analyst course mainly bolts ESG onto the curriculum rather than integrating it throughout.

Elephant in the room

These mainstream failings across finance, companies and economics represent staggering oversights. It is logical to wonder how and why this has occurred. An ancient Indian parable can help us understand why.

Figure 1: The blind men and the elephant parable

Source: Aviva Investors, August 2022

As the story goes, a group of blind men stumble across an elephant. Unaware of what they have found, they try to piece together the full picture by touching it. They each feel a different part of the elephant’s body and describe it based on their narrow experience. Unsurprisingly, their descriptions vary wildly, and they even come to suspect dishonesty in the group members.

The moral of the story, I hope, is clear. We tend to claim absolute truth based on our limited and subjective life experience. In search of peace of mind and clarity, we conveniently ignore the perspectives of others, as well as the simple fact we can never see the ‘whole’ picture.

In true siloed form, while all the influential papers and thinkers in finance, corporate strategy and economics lack the perspective of sustainability, the opposite is also true: all major texts on sustainability lack any real depth of reference or understanding of business, finance and economics. It is a tragic case of intellectual and spiritual tribalism.

Bridging the gap

With this in mind, I recently re-read Limits to Growth, a ground-breaking piece of systems thinking.

Commissioned by the Club of Rome, this 1972 work – updated in 1992 and 2012 – has inspired many within the sustainability movement, despite having no discernible effect on the global economic system. Yet on re-reading it, I was struck by how little finance and investment features. Even the best systems thinkers have biases and blind spots.

We don’t necessarily do any of this intentionally; we just don’t understand the system we have built or our impact. Fritjof Capra – a physicist, systems theorist and deep ecologist – believes we need a new way of looking at the world:

“The more we study the major problems of our time, the more we come to realise that they cannot be understood in isolation. They are systemic problems, which means that they are interconnected and interdependent. … Ultimately these problems must be seen as just different facets of one single crisis, which is largely a crisis of perception.”

Building on Garrett Hardin and Mark Carney’s respective tragedies (of the commons and horizon), I have come to agree with Capra’s bigger, more pervasive and pernicious tragedy: of perception.

Macro stewardship and changing the system

Systems thinking is the only proper starting place for attempting to solve the planet’s climate, nature and social crises. The interlinkages are profound and highlight why I have become particularly obsessed with what we now call macro stewardship.

I see macro stewardship as the only way finance can become sustainable, or even deserve to call itself responsible.

Mark Versey, our CEO, sets out in detail in Redefining stewardship³ what we mean by this. In essence, it means taking a more holistic view of our stewardship responsibilities and actively engaging with policymakers, industry bodies and peers, regulators, standard setters and other influential parties to advocate and push for changes that will help create a more sustainable economic system.

Combined with micro stewardship (active corporate engagement) and capital allocation, macro stewardship can make a real difference. We must all start to lean in and empathise with others and place sustainability at the heart of all our efforts.

We have to work together to build a more sustainable future. The alternative is a reversal of the enormous progress that economics and finance has delivered since the industrial revolution. In other words, systems collapse that brings an end to civilisation as we know it.