The Theory of Sustainable Finance

The Theory of Sustainable Finance

April 25, 2023

Profit Versus Societal Impact

A study led by the United Nations Environment Programme published in 2015 proposed that the financial system needed to be rethought from the ground up. Its sole purpose was to identify a new direction for finance that was both desirable and achievable in the context of accepted economic theory.

While some of the causes of the Great Recession could be traced to relatively “natural” macroeconomic events, such as the housing bubble in the U.S., the inherent conflict between the maximization of profits on the part of financial agents and what is best for society at large also played a major role in this financial crisis.1 It was this division of labor and the rational behavior by selfinterested agents to maximize profits that is so accepted by neoclassical economic theory that seemed to be at odds with the financial system.2

In other words, sellers of subprime loans must have been aware of the great risks that they imposed on lowincome borrowers, but it was “worth it” to them in terms of the profits and individual bonuses they received.3 This view, unfortunately, only measures societal welfare in terms of economic efficiency and market production. It does not consider that our society could be both economically efficient and both socially and environmentally sustainable.4

Time For More Regulations?

In response to these issues, as quoted in Sandberg (2015), some have argued that the financial markets need to have more and better regulation, such as the following:

  • regulations to better contain financial risks, such as mandatory “stress tests” and increased capital reserve requirements;
  • regulations of management incentives, such as limits on stock options and bonus programs; and
  • increased taxation of financial agents, such as financial stability contributions (a “bank tax”) or a financial transaction tax.5

The idea behind many of these regulations is to move some of the risks or costs that financial agents have imposed on society back onto these same financial agents. In a response to regulate sustainability and social responsibility more heavily, the following regulations have also been proposed:

  • reformed definitions of the fiduciary standards and duties financial institutions have towards their beneficiaries and society;
  • more stringent requirements that financial agents disclose and report on their work with ESG issues; and
  • requirements that specific policies or governance structures are put in place to facilitate the consideration of ESG concerns.6

The point of these regulations is to make financial markets pay closer attention to sustainability issues and to look beyond just the bottom line. While this can improve the situation, there are some inherent problems associated with increased regulation of any kind; namely, financial agents will do their best to evade these regulations or will actively lobby against them. And, since much of society’s resources are controlled by these financial institutions, it is not hard to envision major push back and opposition to these rules, not to mention the wasted resources and bureaucracy associated with financial agents and regulators focusing on the same activities.7

For this reason, it seems that regulatory solutions are likely to be ineffective and unsustainable over the long term.

Should Agents Be Held Responsible?

If regulation is not the answer, then what about the premise that financial agents themselves accept greater social responsibility? As quoted by Sandberg (2015), some economists argue that financial agents should base their investment decisions not only on financial concerns but also on social and environmental goals. This is otherwise known as the stakeholder theory. Under this theory, instead of just striving to maximize shareholder wealth, financial agents have similar responsibilities to all of their stakeholders (i.e., all the people that either affect or are affected by the agents’ decisions). This includes, employees, customers, creditors, and the local communities they work in and serve, as well as to shareholders.8 But for this theory to work, it assumes that financial agents will accept social responsibility far beyond their main goal of generating profits.

In other words, they could become surrogate regulators burdened with balancing both financial and social obligations in almost every decision.9 With this said, it appears that the dominant view goes too far in one direction (agents have no social responsibilities), and the stakeholder theory goes too far in the other direction (agents have too far-reaching social responsibilities).10

The study proposes that there may be a middle ground between these two competing economic theories called the twolevel model of sustainable finance. Under this model, there is still a division of labor between the financial markets and the state as long as there is a common consensus about and a commitment to a general societal good.

Financial agents can still focus on profits and efficiency in their daytoday operations but must monitor the potential conflicts between their individual and societal aims. This can be accomplished by codifying this social consensus into the fiduciary duties and responsibilities of financial agents and the sway of public policy and sentiment. This does not suggest that financial regulation does not continue to have a role in society to provide a safety net or act as a backstop to keep financial agents in tow. This will always be necessary to secure the greater good.11

While this theory, on the surface, seems to be able to answer several questions concerning the role of increased regulation, division of labor, increased individual awareness, and fiduciary responsibility to stakeholders and society as a whole, there is much that still needs to be considered if it were to be put into widespread practice. 12

With that said, the underlying premise for this theory to work is that there needs to be consensus on the shared values that are important to society from an environmental, social, and governance perspectiveall aspects of ESG investing.


I hope you enjoyed the second post in our series on Environmental, Social, and Governance (ESG) investing. Check out other posts in the series here:

An Introduction To ESG Investing

What Is The Triple Bottom Line?

What Is ESG Investing?

The Popularity of ESG Investing

Who Are The Millennials?

Is ESG A Marketing Ploy?

Drawing Conclusions


1-12 Sandberg, J. (2015, October). "Towards a Theory of Sustainable Finance". Retrieved from United Nations Environment Programme: wed=.

The views expressed within this newsletter are subject to change at any time without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security or strategy. This material has been distributed for informational purposes only. All investments carry certain risk and there is no assurance that an investment will provide positive performance over any period of time. Because ESG criteria excludes some investments, ESG strategies may not be able to take advantage of the same opportunities or market trends as those that do not use such criteria.