More and more investors are choosing to invest their money in companies that operate ethically. In doing so, they are looking in particular at ESG ratings. In other words, how a company performs on Environmental (environment and climate), Social (society) and Governance (governance) factors. ESG assets are expected to comprise about one-third of all global assets by 2025, more than three times as many as in 2015.
The popularity of SRI no doubt has to do with a new generation of investors taking responsibility in creating a better world. But idealism is only part of the story. In fact, investing in ESG also delivers more than excellent returns, as companies that score well on ESG tend to perform better financially as well. Why is this and how can you capitalize on this as a company?
Why ESG creates financial value
The market value of companies that in addition to profit maximization also pay attention to their ESG performance generally rises faster and fluctuates less than that of companies that do not (yet) engage in this. This seems contradictory, because isn’t it true that corporate social responsibility (CSR) actually costs money? That is certainly true, but the reverse is even more so. In fact, irresponsible business costs even more, because of the risks it entails.
Consider, for example, Volkswagen, where they opted for tampering software instead of taking responsibility. In September 2015, they ran afoul of the law, after which shares plummeted 42% and the company lost $42.5 billion in two months. Now, six years later, Volkswagen has had to write off tens of billions to pay fines and its market value is still not back to its former level.
Or consider Deliveroo, the courier company that entered the London Stock Exchange on March 31 this year, after years of steady growth, to lose more than 2 billion pounds in value within minutes. The main reason for the loss? Investors had serious doubts about the poor working conditions, the underpayment of wages and to what extent it was actually all legal. Moreover, since margins are small in this market, it is even questionable whether Deliveroo can continue to exist if it is forced to pay couriers better and give better conditions.
Five ways ESG creates value
Specifically, there may be several ways in which investing in ESG leads to financial success. All of these have to do with the fact that doing nothing creates risk, while doing something creates opportunity. For example, Witold Henisz, Tim Koller and Robin Nuttall of McKinsey list five ways in which ESG (and CSR in general) financially benefits companies:
- Revenue growth
- Cost savings
- Government support
- Higher productivity
- Less depreciation on investments
Revenue growth
More and more consumers are choosing green and responsible products, and are willing to pay more for them. Think of electric cars and organic products. The same goes for companies and governments, for whom socially responsible purchasing is becoming increasingly important. So whoever your customers are, they will spend more with you if you have ESG in order.
Cost savings
By using resources and energy more effectively, large costs can be saved over time. A simple example is making business premises more sustainable and installing solar panels. These investments continue to pay for themselves within five to ten years, thanks to substantial savings on gas bills (even if gas prices do not rise astronomically).
Government support
By responding proactively to social developments, you can count on support from the government, for example, in the form of subsidies and obtaining permits sooner. If you don’t do this at all, you run the risk of getting caught (like Volkswagen) or having to change your entire business model (like Deliveroo).
Higher productivity
Companies with good ESG ratings generally have more satisfied employees, especially when Social and Governance is in good shape. Satisfied employees are more motivated, perform better and, in turn, attract talent, thus increasing productivity. Dissatisfied employees, on the other hand, will not only perform less well, but can lead to major problems, such as strikes or even lawsuits.
Less depreciation on investments
The latter is intimately intertwined with the first three ways. Sustainable investments (by definition) hold their value better, because the risk that they will quickly lose their value is many times smaller than for unsustainable investments. Think, for example, of diesel-powered vans. If you continue to invest in them now, you will repel customers (because they want electric vehicles), you will have more costs in terms of maintenance, tax and fuel, and you will no longer be allowed to drive them in the city. As a result, it will not be easy to get a good price for them in a few years.
Implementing ESG in business operations
As may be clear, ESG is actually not that difficult, but mainly a matter of using your common sense. As far as we are concerned, the biggest mistake you can make is to focus purely on achieving ‘tick marks’ in order to get your ESG scores as good as possible. That may attract investors in the short term, but they are soon gone when they realize that the situation was not as rosy as it looked on paper. So do business according to the spirit of ESG, not the letter.
In addition, be realistic and try to align ESG goals with existing business goals, strategy and corporate identity. Where your focus will lie also varies by sector. In the clothing industry, there is much to be gained by taking a good hard look at the supply chain, while in the transport sector the focus could be more on making the vehicle fleet more sustainable or improving working conditions.
Want to know more about implementing ESG in your operations and how Empact can help you make an impact? Then also take a look here, call +31(0)6-45770809 or send your email to info@empact.nu.