The impacts of greater ESG performance

Dr Kaushik Sridhar highlights some of the benefits of performing well when it comes to ESG.

Environmental, social and governance (ESG) analysis can be complex. When taking ESG considerations into account, it is not just a case of evaluating the products and services provided by a company, but also its behaviour, conduct, supply chain and other considerations in running the business. ESG analysis must also consider the future, taking into account not only a company’s latest ESG disclosures, but also its strategy, overall impact and evidence that it is keeping to its commitments and standards.

Read more: ESG – What does it mean?

One of the most important questions you need to answer is, to what extent does good ESG translate into good financial performance? There have been more than 2,000 academic studies on this and around 70 per cent of them find a positive relationship between ESG scores on the one hand and financial returns on the other, whether measured by equity returns or profitability or valuation multiples. Increasingly, another element is the cost of capital. Evidence is emerging that a better ESG score translates to about a 10 per cent lower cost of capital as the risks that affect your business, in terms of its license to operate, are reduced if you have a strong ESG proposition.

Here are five other positive impacts to having a better ESG score:

1. Better risk management

ESG issues include many risks – and failing to address ESG issues is not the least among them. ESG risk management includes business continuity planning and supply-chain management, to mitigate the effects of business disruptions large and small. It helps companies act on values such as gender parity in leadership or diversity in board composition; have a ready public response to social justice issues like #BlackLivesMatter; and mitigate and prepare for the effects of climate change and many other risks.

2. Proactive regulatory compliance

If ESG regulations don’t affect you yet, they will soon. State and global regulations, and anticipated federal regulations, require data collection and reporting on ESG issues. Other regulations, such as the European Parliament Agreement, referenced above, require organisations that make ESG claims such as “sustainable business practices” to meet and report on standardised criteria.

3. Attractive to investors

ESG investors want to incorporate values, such as responding to climate change, into their portfolio – in addition to the traditional factors of potential profitability and risk. 

If your company doesn’t yet have ESG initiatives, it’s not hard to make the case: These values are attractive to a segment of investors with a mandate to seek out ESG-specific opportunities. And ESG investors have deep pockets. According to Blackrock’s first Global Client Sustainable Investing Survey, $23 billion was invested in ESG companies in 2020, compared to $450 million in 2019. The Dow Jones publication also noted that investment flowing into ESG funds was up 102 per cent in 2020 compared to 2019. 

It turns out, sustainability is just as good for the bottom line as it is for society and the planet. According to Barron’s, in 2020, ESG stocks outperformed the stock market by 46 per cent in the US, by 20 per cent in Europe, and by 77 per cent in Asia.

4. Employee retention

Employees have an increasing preference to engage with businesses that prioritise purpose alongside profitability. This is true of both consumer buying habits as well as a company’s ability to attract and retain top talent. According to Barron’s third annual ranking of America’s Most Sustainable Companies, employee turnover is 25-50 per cent lower at sustainable operations.

5. Satisfy customer and stakeholder demands

Many regulations and frameworks, such as the SASB Standards, require companies to perform due diligence on their supply chains and resolve risks. If your customers are managing ESG and you are not, you are likely to lose your customers. The same may be true for consumers, who are increasingly savvy about the processes, ingredients, and components in the goods they buy. Many search for labels such as Conflict Free, Fair Trade, USDA Organic, Rainforest Alliance, Certified B Corp, and other standards to help them make buying decisions or justify higher costs.

If you use the sustainability agenda as a performance improvement concept, you are much more likely to drive innovation, cost reduction and risk reduction, as well as elevate your brand. You can use ESG data to provide intelligence and recommendations to the management team, who can then act on it positively.