Environmental, Social and Governance (ESG) is becoming an increasingly popular way for investors to evaluate companies they are interested in investing in. ESG are the three central pillars in the measurement of sustainability and societal impact of an investment and are deemed to be the criteria to determine the future financial performance of companies.
Environmental criteria consider a company’s use of energy, natural resource conservation, waste output, pollution, and animal treatment to determine whether that company performs as a steward of nature. Evaluation can also include environmental risks, such as issues surrounding ownership of contaminated land, disposal of hazardous waste, management of toxic emissions, or compliance with environmental standards.
Social criteria examine a company’s commercial relationship with employees, customers, communities, and other key stakeholders.
Governance criteria encompass company leadership, internal controls and audits, and shareholder rights. Investors want to ensure that a company is using accurate and transparent methods of accounting as well as assurances that the company is avoiding conflicts of interest, and not partaking in illegal practices to govern their business operations.
The rise of ESG investing coincides with how the market and society is changing, and how valuation concepts are adapting to these changes. Specifically for investors, ESG is essential in identifying companies that are well-positioned for the future and to separate them from the companies that are proving to be unlikely to perform or to fail.
Ensuring you have a strong ESG proposition creates higher value for your company. This can be seen through top-line growth, cost reductions, regulatory and legal interventions, optimization of assets, and improved productivity.
A strong ESG proposition can help to improve your company’s top-line growth by tapping into new markets as well as expanding on existing ones. When governing authorities trust corporate bodies, they are more inclined to grant them approval, access and licenses that will present new opportunities for growth. ESG also works to drive consumer preference. Research completed by McKinsey & Company has shown that 70% of the customers surveyed were willing to pay an additional 5% for a green product if it performed the same as a non-green product.
Executing ESG effectively can help to reverse the rising cost of operating expenses. According to McKinsey & Company, a strong ESG proposition can reduce costs by up to 60%. By analyzing processes and finding better ways to improve resource efficiency, financial performance will significantly decrease.
Reduced regulatory and legal interventions are the result of a strong external-value proposition and enables a company to achieve strategic freedom, which eases pressure. A strong ESG proposition can also help to reduce the risk of negative input from the government whilst also working to engage their support.
A strong ESG proposition can enhance investment returns and optimizes assets by allocating capital to opportunities that are more likely to be sustainable, promising, and efficient. Stranded investments that present pay-off risks due to long-term environmental issues can also be avoided under the stewardship of ESG principles.
Employee productivity will improve with a strong ESG proposition as well as enhancing employee motivation and attracting quality employees. An employee’s interest in their work is motivated by their perception of impact on the beneficiaries of their work. As a strong proposition can drive purpose and productivity, a weak ESG proposition can drag this down which can present risks and constraints to operations and employee safety.
When it comes to ESG, companies need to be ready to play a long game. To maximize the value they need to work at satisfying the needs of their customers, employees, and surrounding communities. Investors today are requesting transparency across the board regarding how companies are addressing environmental, social, and governance criteria which means companies are being made accountable for their actions which creates value. Does your company have a strong ESG proposition or is it the reason your business is failing?
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References:
- Atkins, B, 2018. Nasdaq. Strong ESG Practices Can Benefit Companies and Investors.
- Chen, J, 2020. Investopedia. Environmental, Social and Governance (ESG) Criteria.
- Henisz, W., Koller, T., & Nuttal, R, 2019. McKinsey & Company. Five Ways that ESG Creates Value.
- Kell, G, 2018. Forbes. The Remarkable Rise of ESG.
