The integration of environmental, social and governance (ESG) factors into business agendas is no longer an option, but a necessity. The growing concern for ESG issues permeates the business industry, including books, investment journals and sustainability think-tanks, as well as organizational stakeholders such as consumers, investors and shareholders.
The appreciation for ESG factors stems from the unavoidable interaction of environmental and social issues in the business community. With the effects of climate change looming in the horizon, organizations see the need to make their businesses sustainable and climate-resilient through ESG integration. Moreover, the application of ESG in corporate strategies helps companies adapt to the ever-changing needs of their clients, consumers and investors.
The United Nations officially formalized the link between ESG factors and investment performance when it founded the Principles for Responsible Investment (PRI) in 2006. The PRI is a set of practice standards offered for voluntary adoption by investors, and asks investors to take ESG factors into consideration when analyzing potential risks and opportunities. Investors are requested to incorporate ESG factors into their investment ownership and decision-making practices. As a result, investors are more inclined to recognize ESG as an indicator to help identify companies with superior business models.
A TED Talk by Chris McKnett explains how investors should look beyond financial data and market shares when looking for new business ventures. As these factors only show one side of the equation, there is no guarantee that “numerically strong” companies will remain strong forever. Unprecedented climate conditions combined with the fickle nature of the economy mean that neither companies nor investors can remain complacent. Both need to learn to adapt and embrace ESG in order to survive in a globally competitive market.
ESG as a Growth Driver for Organizations
Organizations rely on their ESG performance to solidify their firm’s sustainability reputation in the business industry. In fact, investors consider ESG information when making investment decisions. A recent EY survey shows that the majority of investors believe that companies use ESG disclosure to help build a better corporate reputation. The survey results also showed that organizations who disclose ESG information in a timely manner had a competitive edge over other organizations.
Thus, it is not surprising that ESG functions as a major factor in the analysis and decision-making process of investors. A report by Global Reporting Initiative (GRI) shows that investors integrate ESG information in investment decisions by adjusting the risk/return calculations for individual company stocks and screening company portfolios against ESG performance criteria. ESG is also incorporated in organizational engagement strategies to improve corporate performance and reduce stock-specific risk.
The investment community understands that ESG analysis is a core component in determining superior investment performance and uncovering opportunities to enhance shareholder value. Studies support this and note the positive relationship between ESG factors and financial performance. A literature survey on ESG performance published by the United Nations Environment Programme (UNEP) Finance Initiative shows an impressive quantity of reports that establish a strong link between ESG issues, profits, business activities and stock prices.
Another survey conducted by PwC shows that ESG factors can enhance investment value. The survey notes that 80% of the responding investors affirmed that they take into account ESG factors and sustainability issues in their investment strategy. Meanwhile, a Harvard Business School working paper affirms that sustainable companies have a tendency to gain higher stock performance and lower volatility, as well as a greater return on assets (ROA) and return on equity (ROE).
These are just a small portion of the growing body of evidence that demonstrates how the transparency and availability of ESG performance data increases a company’s appeal in the investment community. Investors, financial analysts, and investment portfolio managers rely on ESG reports to assess a company’s long-term investment viability. They need comprehensive ESG data in order to carefully analyze and examine the sustainability practices of organizations across a wide range of corporate policies, processes and activities.
The Different Facets of ESG
ESG is the measure of a company’s sustainability because it quantifies an organization’s sustainability factors in three sets of criteria. According to Investopedia, the environmental criterion looks at how a firm accomplishes the stewardship of the natural environment. This includes the proper management of energy consumption, water availability, waste and pollution, and other resources that organizations use in their industry. The social criterion, on the other hand, inspects the relationship that a company has with its human capital. It includes the firm’s business relationship with its organizational stakeholders such as employees, suppliers, customers and the local community. It also deals with the company’s employee engagement programs and innovation capacity, along with the labor rights and human rights of its stakeholders. Meanwhile, governance examines the management of an organization’s leadership, executive pay, audits and internal controls, including shareholder and investor rights.
ESG Disclosure and Corporate Strategy
Integrating ESG factors into an organization’s business management framework will significantly increase a firm’s capability to counteract global challenges such as climate change, population growth and increasing natural resource constraints. Progressive companies are setting themselves apart by upgrading their sustainability process through a more comprehensive ESG disclosure. As a result, these organizations provide high-quality sustainability information in their annual corporate social responsibility (CSR) reports.
GRI listed several characteristics of a good ESG disclosure:
Shows a clear link between an organization’s ESG strategy and business strategy.
One of the pitfalls that investors often see in a firm’s ESG report is that they often fail to correlate their ESG strategy and activities to the company’s overall business strategy and activities. Aligning an organization’s business strategy with their ESG strategy enables investors to see the relevance of their sustainability programs to the company. It also helps investors assess a firm’s performance value better.
Provides supporting documents containing facts and evidence.
Providing organizational stakeholders with contextual facts and evidence that support their ESG report distinguishes an organization from its competitors. Supporting information also helps them gain credibility in the realm of sustainable investment. It serves as the backbone of ESG reports, which makes it easier for investors to appraise how an organization’s ESG strategy relates to the current industry conditions that drive the corporate strategy.
Relates a firm’s ESG strategy to current opportunities and risks.
Some ESG reports hype up positive information more than the negative. In order to have an honest account of a firm’s ESG performance, there should be balance in the ESG report, to reflect the company’s ability to understand and identify risks, and transform them into opportunities.
Strategies to Integrate ESG in the Corporate Agenda
The corporate sustainability landscape is constantly changing. Investors place a stronger emphasis on ESG factors in evaluating their investment portfolio. Companies also view ESG integration as an opportunity to enhance their long-term performance. This is why the process of designing a sustainability policy that incorporates ESG considerations will enable firms to address the specific ESG issues that are relevant for both themselves and their investors.
The UNEP Finance Initiative lists several strategies to help include ESG in corporate agendas:
Link ESG factors, sustainability, financial performance and corporate governance into a unified business model.
A unified strategy that links ESG factors, sustainability, financial performance and corporate governance is important in order to have a clear vision of the company’s long-term sustainability performance. Putting ESG at the core of the business agenda and making it an integral part of the business strategy will help foster sustainable growth and attract long-term investors.
Participate in the standardized disclosure of ESG data to improve a firm’s ESG performance.
Organizations that understand the complex process involved in ESG disclosure are able to supply their stakeholders with relevant information needed to measure the firm’s sustainability performance. ESG disclosure should include comparative data on past performance, as well as advanced forecasts. Providing investors with insufficient forecasts or selective ESG information hinders corporate performance and impedes a firm’s long-term sustainability objective.
Provide a proactive ESG communication strategy in the organization.
Communicating the benefits of a sustainable business strategy to stakeholders is not an easy feat. Organizations often use separate methods to communicate financial data and ESG information. Adopting an integrated communication process that links both financial and ESG performance into one comprehensive CSR report helps companies execute a better ESG communication strategy.
FCS’ Sustainability Strategies for Organizations
FirstCarbon Solutions (FCS), a sustainability solutions provider to a wide range of industries, gives expert advice regarding the various risks and opportunities that improve an organization's ESG performance. FCS assists organizations in increasing their ESG efforts by measuring a firm’s carbon footprint and helping them achieve a sustainable supply chain. With FCS, firms can reach their full sustainability potential and achieve a higher ROI through the execution of in-depth life cycle assessments (LCA) to help reduce resource consumption and waste.
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