Ethical or socially responsible investing has gained significant traction in recent years as people grow increasingly concerned about the planet’s future. However, some grey areas need to be addressed—ESG was created to address these grey areas in socially responsible investing.
ESG uses specific criteria to rank investments to see how sustainable they are. According to Bloomberg Intelligence, ESG assets surpassed $35 trillion in 2020, which will continue to climb as time goes on. Today, every business is intertwined with environmental, social and governance (ESG) concerns. But for private equity firms and brands, a strong ESG proposition can create significant value should a potential buyer come along.
How Does ESG Create Value?
While ESG does have some critics, the magnitude of investment seems to suggest that it is more than a feel-good exercise for companies keen to attract investors. Moreover, the vast amount of research conducted on ESG generally reveals that companies that pay attention to ESG matters increase their value through higher returns, reduce risk, encourage growth and expansion and create a highly productive workforce.
A strong ESG proposition can lead to higher returns
Companies with higher ESG scores generally have higher returns than their low-score counterparts. Studies exploring the relationship between ESG and financial performance go back many decades. However, studies conducted within the last five years generally show a positive relationship between ESG and financial performance. For example, a report by NYU Stern Center for Sustainable Business and Rockefeller Asset Management found that 58 per cent of studies conducted between 2015 and 2020 on ESG and financial performance showed a positive relationship. Furthermore, 13 per cent showed a neutral impact, 21 per cent showed mixed results, and only 8 per cent revealed a negative impact.
A strong ESG proposition reduces risk
It goes without saying that a responsible company is less of a risk than an irresponsible one. A responsible, well-run company has ESG concerns at its core: the organisation cares about its people, customers and the wider environment. As a result, the company is likely to be more resilient and outperform competitors that do not pay as much attention to ESG concerns. ESG analysis of a company provides beneficial insights about factors that impact financial performance, meaning potential buyers are more informed about growth opportunities and potential risks.
Companies with strong ESG propositions have a more productive workforce
A strong ESG proposition enables companies to attract and retain hard-working employees who are beneficial to the bottom line. Additionally, a strong ESG proposition enhances employee motivation because it is more likely to instil a sense of purpose in employees. For example, a study conducted in 2012 found that firms with high levels of job satisfaction generate high long-run stock returns compared to firms with lower job satisfaction. However, it has been a decade since that study was released, and, in that time, company culture has shifted significantly. A growing number of firms are taking steps to improve working environments for employees. Because companies with highly motivated, productive workforces are more likely to perform well financially, they are more valuable to potential buyers.
A strong ESG proposition encourages growth and expansion
Companies with strong ESG propositions also find it easier to expand in their current market and tap into new ones. For example, governing authorities will judge corporations based on their treatment of employees, customers and the environment and are more likely to create opportunities for companies deemed as ethical, diverse and sustainable. Additionally, companies with strong ESG propositions are more likely to be perceived as a positive force by the public, meaning attempts to expand will meet less resistance from individuals in the local community.
A strong ESG proposition reduces costs
ESG can help companies reduce costs. For example, companies that implement green initiatives and waste reduction policies generally spend less money on operational expenses, such as water, energy and raw materials.
A strong ESG proposition reduces legal or regulatory interventions
A strong ESG proposition can help ease regulatory pressure or legal interventions, as companies are much less likely to participate in activities that could result in problems for other organisations or communities. As a result, not only does a strong ESG proposition reduce the risk of legal challenges by businesses or governments, but it also increases the likelihood of government support as the company is more likely to be viewed as a credit to the local community.
A strong ESG proposition increases investment
Strength in ESG can enhance investment returns by allocating funds to sustainable activities, such as renewable energy and waste reduction. Additionally, companies committed to socially conscious activities are likely to avoid investing in areas with longer-term environmental problems, which are unlikely to pay off. A good example is investments in non-renewable energy sources, such as fuel. Companies that wait to invest in sustainable activities will pay the price in the long run. Investing in sustainable solutions early does result in substantial start-up costs but will be more cost-effective in the long term.
ESG: An Essential Value Driver
Today, ESG is an essential value driver for firms and a top priority for socially conscious investors. For example, one study found that 93 per cent of limited partners would walk away from an investment opportunity if it posed a substantial ESG concern. In a world where environmental, social, and governance concerns are growing ever more important, firms looking to increase their value should do all they can to ensure they have a strong ESG proposition.
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ESG: Core Elements
E: The E in ESG stands for environmental. Environmental criteria include corporate climate policies, pollution, energy use, waste, deforestation, green energy initiatives and the treatment of animals. The criteria can also assist in evaluating and managing environmental risks, such as compliance with environmental regulations and direct and indirect greenhouse gas emissions.
S: The S in ESG stands for social. Social criteria include employee gender and diversity, working conditions, data security, customer satisfaction, sexual harassment policies and human rights.
G: The G in ESG stands for governance. Governance criteria include the diversity of board members, executive pay, large-scale lawsuits, political contributions, internal corruption and lobbying activities.
