By James A. Kaplan
Not that we needed more evidence, but several high-profile reports recently reinforced the relevance of ESG research not only for the financial community, but also for corporate decision-makers.
Late last week, the UN-backed Principles for Responsible Investment (PRI) released the ‘Integrated Analysis’ report which shows that investors are integrating ESG factors into equity research deeply and extensively. Analysts are adjusting earnings forecasts, growth estimates and discount rates to reflect ESG characteristics of stocks and peer groups. The UN PRI report includes case studies from brokers and research providers, including Cheuvreux, Citi, Société Générale and UBS. These are instructive real-world examples of how understanding the impact of ESG factors on sales, costs and long-term return on capital can enhance investment decisions.
A Report in the Deloitte Review (Finding Value in ESG Performance) examines the link between ESG information and investor interest and decisions. The authors find that: “With each decade since 1980, investors respond more to negative environmental news.” They also find that “…positive news on a company’s environmental behavior is rewarded by an average increase in stock returns of 0.84 percent.”
Based on a review of academic literature, the authors of the Deloitte report conclude: “The average investor (not only the ESG-focused investor) is paying attention to ESG when things go wrong and the company is in the limelight and usually under duress. It is likely that the investor reaction to negative ESG events will continue to increase as more investors pay attention and increasingly understand what these events can mean for a company.”
Importantly, the Deloitte report also reviews research that strongly suggests that: “Disclosure of ESG performance can partially protect against drops in shareholder value when things do go wrong.”
A few years ago, a CFO or an investor relations director may have reasonably doubted whether ESG-sensitive investment strategies could really affect corporate valuations. They may have doubted whether they should track their company’s ESG performance as closely as they track accounts receivable. Such doubts will continue to taper.
The typical IR officer or corporate secretary today should no longer wonder if ESG performance matters. It does. The question now is: do investors and insiders define ESG in congruent ways? If they don’t, it is the job of corporate communicators — such IR and PR departments and certainly senior management — to bridge the gap and build a stronger consensus about what matters and what matters less or not at all.
At GMI Ratings, we often hear from corporate representatives displeased with our ESG or AGR ratings on their respective companies. Many firms feel that they deserve higher ratings because of the long list of sustainability initiatives and policies they either have in place or are in the process of implementing. We do not mean to trivialize these positive steps, but our methodology goes deeper, and focuses on identifying the most material misalignments between corporate conduct and the best interests of corporate stakeholders.
Investing in your community is good thing, but it doesn’t negate the deleterious impact of a classified board. Corporate philanthropy is a powerful and generally positive force, but it can’t remedy the warped sense of accountability that results from the fusion of CEO and chairman roles or from perverse compensation practices that reward the outright destruction of value.
In sum, companies can benefit greatly by aligning their approach to sustainability with the financial community’s points of emphasis. This alignment can help companies attract investors, build trust in earnings quality, and mitigate the impact of adverse ESG events. That’s a win-win.