Alex Edmans is a Professor of Finance at London Business School. He is a Director of the American Finance Association, author of the 2024 book “May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases – And What We Can Do About It,” and winner of 30 teaching awards. He talked with SSRN about the economics of sustainability and how to better understand and develop our concept of truth.
Q: A lot of your research focuses on topics such as corporate finance, responsible business and behavioral finance. Tell me a little bit about the trajectory of your career and what it was that got you interested in these areas specifically.
A: I like social sciences because you do have some theories, so it’s not completely subjective, but those theories are not set in stone. You and I could see the same economic data, and I could say, “I think taxes should be higher,” while you could say “taxes should be lower,” and we can still have an interesting and respectful debate. That’s why I ended up going into finance in general.
After a stint at Morgan Stanley investment banking, I wanted to go into research. As a banker, you serve a small number of clients, but as a researcher, you give knowledge which can be widely disseminated. The topics that I then chose to look at are important for the real world. Some of my first work was on the importance of human capital. Now that is called responsible business, sustainable business, or ESG, but I just thought [of] that as finance, it was nothing particularly “woke.” It was just sensible for companies to think about their most important asset. Back in 2005, when I was a student, nobody was really thinking about that, and it was good to be one of the early people looking into it.
And then second… behavioral finance, which is the importance of psychology. Again, that’s relevant in the real world. People don’t act according to textbooks. I saw even supposedly rational investment bankers and traders being swayed by emotion. So, I wanted to look at how the market is affected by psychology.
Q: How has the subject of your research evolved, with your work in sustainable finance, misinformation, etc.?
A: One thing that I want to do is ensure that my research is not just sitting in academic journals and speaking to other academics, but [that it] has wider impact. So, it’s a huge pleasure for me to discuss these with policymakers, executives and investors. When I do this, I often find that people respond to the research based on whether they like it, not whether it is actually right. That’s not because they’re bad people. They’re just people, and all people have biases, just like I do.
If you see something that supports your viewpoint, you will [shout] it from the rooftops, and if you see something that you don’t like, you will try to shut it out. What I’ve tried to do more generally is not just promote my own research but highlight the importance of the research community in general. I’ve tried to do quite a lot to promote the importance of the impact of the profession, particularly in a world which may have increased misinformation.
Q: Last year, you released a book titled “May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases – And What We Can Do About It,” where you explore biases, problems, and solutions within the realm of truth, lies, and misinformation. Talk about your objectives when writing this book, including why you chose to write it now.
A: You might be pessimistic and say, “Oh, the world is full of misinformation,” but there are sufficient numbers of people who do want to be more nuanced. And that led me to write this book.
It’s something where you see increasing polarization and misinformation. I know it’s really tempting to blame, say, Donald Trump and other politicians – and I’m not here to defend them – but even those on the other side of the spectrum… might be unintentionally spreaders of misinformation themselves. I wanted to say [that] both sides can be improving in terms of being nuanced. That includes me: I give examples in the book of when I fell for misinformation. A lot of these are issues that I, even as a researcher, suffer from my own biases. I think it’s something that we can all get better [at].
Q: What do you think people misunderstand most about the concept of what truth is?
A: You might think people already understand the importance of truth, [so] why did I even need to write this book? But people only understand what I’d call “Level One” truth – whether something is factually true. What I highlight is that truth is not enough. Even if something is 100% true, it can be misleading. Well, how can that be? Let’s use case studies and examples. So the book “Start With Why” says, well, Apple started with a “why,” and Apple is really successful. That is true, but then you massively over extrapolate from that and say, “well, every company which starts with why should be successful,” but there could be lots of other companies that started with the “why” and failed. Even if what is told to you is true, it could be that what’s not told to you is where the real action is. And even if you’re given the full picture, it might be that there’s correlation, but not causation.
If you looked at hundreds or thousands of companies and those with a purpose tend to be more successful, is it purpose that drives success, or is it success that gives a company the headspace to start thinking about purpose? The reader might think [they know] that correlation is not causation… but even though you know it deep down, you don’t put it into practice. In particular, if it’s a causation that we want to be true, we don’t ask if there are alternative explanations. What I’m trying to do here [is] say “take a time-out, look at these things objectively. Ask: is there convincing evidence for this? Or are there alternative explanations?”
This stems way beyond just trying to look at data and evidence and studies, but how we actually make business decisions or life decisions. The idea of taking seriously what we don’t want to believe and being skeptical about what we do want to believe, that’s something which expands way beyond studying individual papers.
Q: What kind of mindset change will help bring a societal shift away from our current misinformation ecosystem?
A: I think one is to recognize our own limitations, and in particular the people who… think [they’ve] gotten to the top and know everything. We often will think about whether to read a study based on if it accords with our experience and that sort of rationale. No matter how sane you are, there may well be blind spots. [It’s important] to try to recognize this and to listen to other opinions that are different from ours.
Even if we think that something is generally true, it’s not going to be true in all cases. So, we sometimes over-extrapolate from single cases. For example, from my first paper on the importance of human capital, some people say that proves that sustainability pays off. They use this to argue for only sustainability, but my study was on human capital. We can’t extrapolate from a human capital study to the other aspects of sustainability.
Q: One of your recent papers on SSRN is “Sustainable Investing in Practice: Objectives, Beliefs, and Limits to Impact,” in which you and your co-authors examine results from a survey of over 500 equity portfolio managers about their firms’ environmental and social (“ES”) performance. One of the results you found is that most fund managers prioritize financial returns over environmental and social performance. What challenges does this create for investors who want to promote stronger ES practices?
A: It’s an unusual study, because normally you’d write equations or just analyze data from your desktop. Here, we wanted to get our hands dirty and actually ask fund managers about how they behave. What was surprising to us was that even managers who run a fund with a sustainability label will only take sustainability into account if it improves financial returns.
How do we interpret this? I’d say, let’s be realistic about the impact that sustainable investing is likely to achieve. It’s unlikely that you’re going to go to an oil and gas company and say, “stop producing oil and gas,” because at the moment, there is enough energy demand that fossil fuels still have a role here. But I wouldn’t be too pessimistic, because there are certain environmental and social actions which are consistent with financial returns. Indeed, my first book, “Grow the Pie,” was about the fact that they do have these win-wins, and the idea of win-wins is not necessarily wishful thinking.
We want to be realistic about the impact that investors and companies can have. They certainly will be able to pursue environmental social outcomes, which are in the long-term interests of financial performance, but it doesn’t mean that we can realistically ask companies to do everything which is good for society. At the end of the day, they’re companies, not charities. This highlights the importance of government action. There might be certain behaviors which are bad for the planet but good for financial performance. You can’t just apply moral suasion to get companies to stop doing those actions; you need to tax them or regulate them.
Q: In your highest downloaded paper on SSRN, “Does the Carbon Premium Reflect Risk or Outperformance?”, from 2023, you and your co-authors study the relationship between carbon emissions and earnings surprises to shed light on whether carbon premiums result from outperformance or risk. For someone unfamiliar with this subject, how would you explain what a carbon premium is and how you can actually determine whether it’s a result of carbon transition risk versus outperformance?
A: This paper is about one of the most important topics today in sustainability: is there a tradeoff between what’s good for the planet and what’s good for financial returns?
There was a highly influential prior study which found that companies that emit more carbon have higher financial returns. Their interpretation was that this is proof that emitting carbon is bad because it’s so risky to hold a company that emits carbon – it might be hit by a carbon tax – that the only way you’ll be willing to invest in that company is if it gives you high returns as compensation. They view those high returns as compensation for the risks of that company. They use this to spin the message that it’s risky to be an emitting company.
But let’s hang on a moment. If you see high returns, that’s a good thing, not a bad thing. Nobody would look at [somewhere with] great returns and say that’s proof it’s risky. It just outperformed. And indeed, if you look at many sustainability studies, they often tell the importance of sustainability by saying that sustainable companies earn higher returns. This is the case of confirmation bias. If there are high returns for green companies, you say it’s a good thing. If there are high returns for bad companies, you suddenly say that’s a bad thing. We can’t have it both ways.
What I wanted to look at was the source of those high returns. It could be theoretically possible that those high returns are compensation for risk, but it could also be possible that it’s resulting from outperformance. What we did was look at the actual earnings that these companies deliver. Every three months in the U.S., the companies need to release earnings. Before they do that, you have professional analysts predicting what the earnings will be. What we find is that these companies do systematically better than what the market was expecting, suggesting that those high returns are indeed outperformance. Companies are able to outperform by cutting their emissions reduction, by not investing in carbon scrubbers, by polluting more, by overextending production. I wish this wasn’t the case. Unfortunately, what we find is that there are companies which are able to get away with polluting the environment.
Q: Your research from this paper suggests that companies don’t fully bear the consequences of their emissions. What types of regulation or incentives do you think would help make the market properly reflect the costs of pollution?
A: The best is a carbon tax. This is fundamental, basic economics. Often, people say economics is all about just maximizing and making money, but that’s not true. Basic economics highlights market failure. One of the most basic principles is an externality – that’s when you have a negative effect on everybody else, but you don’t bear the consequences. This is why we have regulations about overfishing, noise pollution, and things like that. This is what a carbon tax will be doing.
There is pushback to a carbon tax, and this may well be why it’s not being implemented. Some people will say that a carbon tax will then push up energy prices. Those energy prices are particularly salient for low-income households. Yes, wealthy people can afford them, but not people in energy poverty. That needs to be taken seriously, and one way to address that is to take the proceeds of the carbon tax and give this as lump sum subsidies to lower income households.
Now you might think, “well, haven’t we just cancelled each other out by taxing them and then giving the money back?” No, we haven’t, because we’re still affecting the incentives at the margin. Let’s say the average carbon tax will add $1,000 to household bills. If your behavior doesn’t change, well, then tax and give everybody $1,000, but you’re still changing the incentives. What it means is that to take a flight will be more expensive, and so you may choose to take the train instead. Am I going to just be lax and leave my heating or lighting on the whole time? No, I’m now going to have greater incentives to turn the lights off. Overall, you can design this in a way which is both revenue neutral to the average person and revenue neutral to government, but it does change people’s incentives.
Q: You’ve written many papers, given talks, published books, etc. that we’ve only scratched the surface of. Are there any of your papers or work that you want to highlight as particularly interesting or timely?
A: There’s a trilogy of papers that I published, initially on SSRN, which are unusual. One is called “The End of ESG,” the second is called “Applying Economics – Not Gut Feel – To ESG,” and the third is “Rational Sustainability.” I’m really gratified about these papers, as they were all top 10 downloads across all fields, including physical sciences and so on. They’re not traditional academic papers, in that there are no equations or data in them, but they are perspectives on the future of ESG.
The first paper, “The End of ESG,” you might think that’s a bit of a polarizing title, but I’m saying the end of ESG, not because I’m an anti-ESG person, but I’m saying let’s end the idea that this is a niche political issue. I’m saying ESG is good for everybody. Everybody wants to build sustainable companies. So, let’s look at this in a more nuanced way. They are, I think, of general interest to anybody… be you academic or practitioner, finance person or general social scientist.
Q: What inspired you to write these as three separate papers? How do they all connect together?
A: I gave “The End of ESG” as a keynote speech at a conference, and I used this as [an] opportunity to present… some forward-looking perspectives about where the profession should go. People were really complimentary about that, so I wrote it up. And then… to “end ESG,” I don’t want to just be destructive, but I want to be going forward, and that’s why I had “Rational Sustainability.” The one on “Applying Economics – Not Gut Feel – To ESG” was to think about how we can apply basic economic principles to ESG issues. It also highlights that often people like to attack textbook economics and say economics is stuck in the Dark Ages, so let’s rip off all textbooks. To denigrate all people’s past work, that’s unfair. If we think about the decades of science that have been produced over the last 50 or so years, we don’t need to abandon it, but we just need to adapt it for the common trends.
Q: What do you think SSRN contributes to the world of modern research and scholarship?
A: I think it contributes a huge amount to modern research and scholarship. One great thing about SSRN is to disseminate knowledge to a wider audience, not just those who can pay to get behind paywalls. Even before I was doing my PhD, there were certain papers on topics that I was interested in, where I could see the papers on SSRN, which I would not be able to if they were behind a paywall. And then when I was a student, I read huge amounts of papers on SSRN.
I think it makes researchers more accessible to people who might not otherwise know about the research. I subscribe to SSRN digests [and] every day, I see new papers that come out. I’m writing another book right now, and if I want to find the latest research on a particular topic, I’ll go to SSRN. It’s a great way of democratizing research and making sure it’s accessible to everybody, not just academics in that particular field.
Nowadays, I make my work available on SSRN, and I post it on social media, and people can access it. We do have the journal publication process, and I think that’s important, because it’s peer reviewed and so on. But it takes a long time for a paper to get through the peer review process. Some of the issues that we’re dealing with are so urgent that we want to make sure that we are using the most up-to-date research. Yes, that’s something when it says someone is not peer reviewed yet, but perfect should not be the enemy of the good.
More About Alex Edmans
Alex Edmans a is Professor of Finance at London Business School. He graduated from Oxford University and then worked for Morgan Stanley in investment banking and fixed income sales and trading. After a PhD in Finance from MIT Sloan as a Fulbright Scholar, he joined Wharton and was tenured in 2013, before moving to LBS. His research interests include corporate finance, responsible business and behavioral finance. He is a Director of the American Finance Association; President-Elect of the Western Finance Association; Fellow, Director, and Chair of the Ethics Committee of the Financial Management Association; Fellow of the British Academy; and Fellow of the Academy of Social Sciences. Edmans has spoken at the World Economic Forum in Davos, testified in the UK Parliament, presented to the World Bank Board of Directors, and given TED and TEDx talks, which have a combined 3 million views. His book, “Grow the Pie: How Great Companies Deliver Both Purpose and Profit,” was featured in the Financial Times Best Business Books of 2020. He also co-authored “Principles of Corporate Finance” and is the author of the 2024 book “May Contain Lies: How Stories, Statistics, and Studies Exploit Our Biases – And What We Can Do About It.” Edmans has won 30 teaching awards, was featured in Thinkers50 Radar, and was named Professor of the Year by Poets & Quants in 2021.
You can see more work by Alex Edmans on his SSRN Author page here