For far too long, mainstream finance education has focused on teaching financial principles and tools based on the assumption that most of humankind will be lifted by free and perfectly competitive markets in which individuals work in their own self-interest. Unfortunately, negative externalities and market failures, long ignored in finance, are today our most critical problems. The COVID-19 pandemic has killed millions around the globe, climate change threatens the planet, economies are leaving far too many people behind, longstanding injustices have fueled major protests, and authoritarianism is attacking democracies.
Now more than ever, scholars must connect finance to its fundamental purpose, which Robert Schiller defines in the book Finance and the Good Society as “the structuring of the economic arrangements necessary to achieve a set of goals and of the stewardship of the assets needed for that achievement.” Sustainable finance provides the arrangements and the stewardship necessary to achieve global environmental and social goals, and the world outside academia is already rapidly adopting the practice. Driven by increasing risks, institutional investors are allocating more than one out of every four dollars into sustainable finance, an amount that continues to grow. Consumers and employees are demanding that companies build diverse workforces, create healthy products, and care for communities, all while reducing their environmental footprint.
Impact Investing Today and Tomorrow
At the same time that global businesses are transforming, critics are raising concerns about data transparency and the authenticity of celebrated environmental and social impacts. This presents an opportunity for scholars and educational institutions. We must step up to define, promote, and grow sustainable finance through our teaching and research. Here are five ways we can move the field forward:
1. Clarify the Terminology
Through research and teaching, academics need to draw the boundaries of approaches that fall under the term “sustainable finance,” which describes the field as a whole and encompasses investments that consider the societal or environmental impacts of the investee. Under its definitional umbrella, it is particularly important to understand the nuances of the terms “impact investing” and “environmental, social, and governance (ESG) investing.” Without an appreciation of the subtle differences between the two, teachers in the field run the risk of overstating the potential of sustainable finance to tackle pressing global challenges.
Following recent convention, we define impact investments as those that have the “the intention to generate positive, measurable social and environmental impact, alongside financial returns.” Impact investors often operate in private markets, seeking concessionary or non-concessionary returns in nonprofits, early-stage ventures, small and medium-size businesses, and public-private partnerships. Though it makes up a smaller share of sustainable finance than ESG investing, it creates more impact per transaction. It is one of sustainable finance’s best tools for building the financial architecture that stewards assets toward doing good for society.
ESG investing, unlike impact investing, includes entities that are not explicitly set up for an impact mission but use ESG considerations to guide their activities. Such investments reflect a financial strategy that incorporates concerns about how an investee approaches pollution management, the conservation of natural resources, employee well-being, or many other facets of doing business that may impact societal health or the environment. This strategy could involve: negative screening, which entails the avoidance of investments like tobacco or firearms that are perceived as contrary to certain values; integration, which includes investments in companies demonstrating positive ESG performance such as the use of renewable energy or fair labor standards across supply chains; and activism, which aims to exercise shareholder voting rights to influence corporate strategy toward sustainability.
2. Make Sustainable Finance Part of the Required Curriculum
Many top business schools have started offering impact investing and ESG investing courses over the past few years. However, very few of them require sustainable finance topics in the curriculum, instead treating them as electives for students to take toward the end of completing a degree. This catches too few students, too late in their education. As a result, a large number of business students, especially finance majors, are left to begin their careers with the impression that sustainable finance is a nice add-on, not something that could add value to a firm and society.
Any introductory course can easily incorporate sustainable finance topics, such as how to calculate the social and environmental benefits and costs in traditional net present value (NPV) analysis, how to value green bonds, and how to assess systemic risk like climate change in investment portfolios. In addition, introductory finance courses need to go beyond their narrow focus on sophisticated public markets and corporate financial management. Students should be made aware of how market imperfections may be worsening or sustaining some social problems, and understand that innovations can and do occur outside the private sector. Students should know, for example, that capital does not flow to all people equally, which is made apparent in classes that feature case studies such as Village Capital 3.0: Democratizing Entrepreneurship. And they can learn about the cost of decaying infrastructure, the benefits of green infrastructure, and the ingenuity of collaborative efforts by studying DC Water: Turning Sewers From Grey to Green.
Such discussions in required courses would prepare students to become business leaders and investors who would be more likely to direct capital toward solving critical social and environmental problems. That, in turn, would help sustainable finance go mainstream.
3. Build a Bigger Tent
Sustainable finance cannot become sophisticated, widespread, and effective without the involvement of other sectors and scholarly areas. Though the field has been welcoming allies for years, more needs to be done.
Some excellent progress has been made on this front with sustainable finance topics finding their way into classes outside business schools. Courses especially related to impact investing have proliferated in schools of public policy, social work, government, law, and environmental sciences. As knowledge of sustainable finance among students and faculty from different disciplines increases, what were previously considered externalities in financial decision making will be properly understood as the critical global problems of today. With this knowledge in hand, future leaders from various sectors will be better prepared to drive financial solutions in service of society. Without their voices, sustainable finance could easily become a number-crunching, greenwashing exercise.
In particular, foundations and their partners, many of which have pioneered impact investing, could benefit from having more employees with educations more deeply rooted in sustainable finance. Studying cases like the Heron Foundation’s transition to 100 percent mission-related investing might inspire their staffs to look beyond a traditional approach that ties up 95 percent of a foundation’s wealth in non-mission related assets, despite the urgent needs of our time. Similarly, students considering careers in policymaking and development will also find sustainable finance skills to be highly useful in managing the cross-sector collaborations the fields commonly undertake. With a better understanding of the connections between capital and impact, these students will go on to play a vital role in the debate with the private sector about the promise and limitations of finance to solve societal problems.
4. Teach Through a Systems Lens
Systems thinking considers how organizations, individuals, or other entities within a system relate to and influence each other. It is an apt and essential approach to teaching sustainable finance as the world faces “complex, emergent, and interdependent challenges” that “require transformative and collaborative leaders,” as Jeanine Becker and David Smith write in the article “The Need for Cross-Sector Collaboration.”
Systems thinking is well suited to help connect financial performance to social goals, and to spot the unintended consequences of investments before undertaking them. It allows investors to ask better and more open-ended questions, develop a longer-term mindset, and assess impact in a more complete and nuanced way.
A number of impact and ESG investors have begun to practice a systems approach in their strategies as older methods got in the way of achieving ambitious goals like keeping the global temperature rise below 1.5 degrees Celsius, achieving the UN Sustainable Development Goals (SDGs), or building a circular economy.
What might a systems thinking exercise look like in the classroom? Educators could have students undertaking a thematic investing project start with a number of questions. What are the root causes of the problem and how are they linked to each other? What solutions already exist, and how and why are they lacking? What are the levers of change? Will the investments optimize one part of the challenge over the other? What might be the unintended positive or negative consequences of the investments?
Case studies like the one about the MicroBuild Fund are particularly useful because they pay close attention to the legal, business, and policy issues involved with impact investments. The Omidyar Network’s systems practice guide is also helpful.
5. Establish More Evidence
Academic research has heavily influenced corporate and investment finance practices since at least the middle of the 20th century. Sustainable finance lacks similar levels of scholarly attention, but that is slowly changing as interest and investment in the field has grown. Academics have begun to integrate investors’ social and environmental goals into fundamental asset pricing models, but much more remains to be done. It’s important that scholars move beyond the simple question of “Can you do well by doing good?” and onto “How and when can you do well by doing good?”
Progress is stymied by the difficulty of acquiring sufficient data on impact investing, much as it has been for other private markets, such as traditional venture capital and private equity. In public markets, too, we are only now beginning to find reliable, longitudinal data to meet academic research standards. Additionally, academic research is rarely interdisciplinary, but a collaborative approach is essential to understanding the connections between finance and social issues; business academics may understand the nuanced differences of performance as measured by net income or cash flows but they have little to no training in the measurement of well-being, recidivism, greenhouse gases, poverty, gender empowerment, racial inclusion, and other intersecting elements of complex social problems.
There are a few notable examples of advances in research related to sustainable finance. The Review of Financial Studies published a special issue in February 2020 devoted to climate finance, a first for a top peer-reviewed finance journal. While the academic contributions alone were important, the issue also sent a signal to researchers reluctant to pursue the topic that it is worth investigating. The Moskowitz Prize and the Principles for Responsible Investing (PRI) Research Awards also stand out for encouraging the field.
Transforming All Finance
For the future of our planet, all finance needs to become sustainable finance. To get there, we need more than calls for new ways of doing business from the Business Roundtable, World Economic Forum, and other powerful organizations. Educators, researchers, journal editors, theorists, and empiricists all have a role to play. Together we can create and spread the tools and theories that will realize the deep changes discussed at elite business gatherings. Teachers in particular must move away from narrowly focused business education programs that avoid the messy discussions of the imperfections of society. Rank and file of managers around the world need to learn something other than maximizing profits regardless of externalities, structuring compensation around the crude metric of stock price, or accepting short-term earnings as the dominant concern when working with powerful investors. With reframed education and research goals, we will enable the leaders of today and tomorrow to build a more inclusive and democratic financial system that is relevant to the global challenges we face today.