The Growing Importance of ESG in Public Companies

Follow the Money

ESG has moved from being a peripheral corporate issue to big business in its own right. According to the Global Sustainable Investment Alliance’s last biennial report, ESG-orientated investment is now worth over $30.7 trillion: up tenfold since 2004. Although nearly half of ethical investments originate in Europe, participation is growing internationally, with US and Asian institutional funds responsible for much of the recent increase. 

Strong environmental, social and governance positioning appeals to an increasing number of investors not only on points of principle but also because it has been demonstrated to improve returns. Nordea Equity Research found that Scandinavian companies between 2012 and 2015 with the highest ESG ratings outperformed those with the lowest by 40%. In part this might be explained at the point of sale. Customers have increasingly been factoring ESG into their buying decisions and will pay a premium for green and ethical products (70% will pay 5% extra according to McKinsey). 

There also appear to be wider, structural factors to explain ESG as a financial benefit. A comprehensive 2015 study published in the Journal of Sustainable Finance & Investment examined over 2,000 investments and found a 63% positive correlation between strong ESG propositions and business performance (compared to 8% negative). Aside from increased sales, solid ESG helped by lowering costs, improving employee productivity and reducing legal and regulatory intervention. For these reasons, a social focus is no longer perceived as a drag on profits or relegated to a page of platitudes in annual reports but rather a core tenet of successful corporate strategy.

‍

‍Hot Topics

The issues that fall within the ESG spectrum are growing. In an attempt at systematisation, the US based Sustainability Accounting Standards Board has in fact come up with 77 ESG metrics across services and industry. Broadly, the environmental aspect is about a company’s contribution to the climate and use of resources; socially, a company’s relationship with people and communities and from a governance perspective, its ethics and employment practices. Within these categories, particular issues tend to wax and wane in the public and shareholder consciousness: carbon emissions; bribery; executive pay; board diversity and child or slave labour having variously headed ESG agenda. 

‍

“63% positive correlation between strong ESG propositions and business performance” 

‍

Adding to the complexity, businesses are not only judged (and valued) on their own ESG actions but are also held to account for the standards of associated enterprises and investments. In the wake of mass shootings in 2015, Walmart stopped selling assault rifles. But in the same year it also faced criticism from pressure groups about low pay, abuses and dangerous working conditions at many Asian suppliers, which was a harder social issue to manage immediately. The retailer now employs 150 people in a responsible sourcing unit and audits the 100,000 companies in its supply chain for adherence to basic standards.

‍

‍Shareholders are Revolting 

Listed companies are of course not only more exposed to public attention on their ethical standards, but also the particular scrutiny of their own shareholders. ESG issues now account for over 50% of shareholder resolutions in the US. Previously passive pension funds and other institutional investors with significant AUM have begun to feel, in the words of Professor Eccles of Saïd Business School, that they are “too big to let the planet fail”. BNP Paribas Asset Management, with the weight of €440bn behind it, has a head of corporate governance, Michael Herskovich, who engages with investees’ climate policies and has stated bluntly that “we cannot afford to wait”. 

Nor are all retail investors content to skim read a few pages of annual reports, take a back seat at Annual General Meetings and let boards get on with it. Rather, shareholders small as well as large have become more aware of their power, more organised and more vocal about ESG. 

In the “Shareholder Spring” of 2017, annual general meetings became battlegrounds over executive pay. Institutional and individual investors called out what they saw as poor governance and unfairness. A fifth of FTSE 100 companies faced significant shareholder opposition on board remuneration, prompting the government to establish a public register to record the dissatisfaction. Since then, shareholder activism has become a regular feature of AGMs, often generating unwelcome headlines. 

Lobby groups also use shareholding as an entry point. The not for profit organisation ShareAction has the stated aim of achieving a “virtuous circle in which people can see what happens to their money and become more engaged with the workings of the investment system… [and] unlocking the power of investors to catalyse positive social and environmental change”. In May this year, 130 ShareAction supporters bought single shares in Barclays and successfully got through a resolution on the bank’s carbon emissions. Public companies in the UK are more in the sights of activist shareholders than most. A report by consultants Alvarez and Marsal highlighted ESG as being of increasing importance in the wider institutional community and growing as a cause of shareholder activism relative to more traditional agitation for mergers and demergers. Their study found that in 2019, the UK had more activist targets than France and Germany combined, with companies in the consumer, industrial and technology sectors most often in the crosshairs.

‍

‍Acting is Reacting

“Publicly listed companies in Europe ignore activist investors at their peril,” states the Alvarez and Marsal report. “Once targeted by an activist, senior management and the board will find themselves expending significant time and money, considering issues that they hadn’t (but should have)… As a result, the companies and their own professional reputations will be put at risk.”

Companies have variously harnessed or resisted the wind of change. BlackRock’s CEO Larry Fink’s famous letter to shareholders declared that “ society is increasingly looking to companies… to address pressing social and economic issues” and that “purpose… is a company’s fundamental reason for being”. At around the same time Amazon’s board garnered unwelcome headlines by recommending against environmental resolutions ranging from food waste to hate speech that had been put to shareholders by its own employees. 

Whatever the strategic or financial justification, clashing with shareholders over ESG is a bad look.

‍

Relationship Advice

In anticipation of being measured and challenged by retail and institutional investors as well as lobbyists, companies about to list have generally formulated an environmental, social and governance policy. But a policy also needs to be explained and disseminated. Mutual understanding and effective communication between boards and shareholders on ESG reduces the risk of activism and rancorous AGMs. This is where the science of investor relations (IR) comes in. 

Richard Davies, Managing Director of RD:IR, EQ’s investor relations business points to the convergence of governance and business management evaluation as the reason that “issuers need to get their ESG strategy messaging out to relevant audiences in the same way they treat their equity story messaging”. This is because “ESG is absolutely and intrinsically part of the IR future, and a significant part of how investors value companies.” 

In his work preparing EQ clients for going public, Richard Davies is always keen to emphasise that the investor base of a public company can change radically. Post-IPO, he helps boards to stay current on who they are reporting to: “Analysing the share register and looking beyond nominees to ultimate beneficial owners helps companies gauge their investors’ ESG expectations and helps them tailor policies and communications more appropriately.”

‍

‍In it Together

Getting the balance between sustaining profits and sustaining the planet will always have tension points and companies readying themselves to go public already have plenty to think about. However, companies with robust ESG policies perform better for their shareholders and for the communities in which they operate. If public companies can combine strong ESG with sound investor relations then their market reputation and value will improve. With corporate interests and sustainability aligned, it is a welcome case of win win.

‍

To find out more, contact our team at equinitiboardroom@equiniti.com

Credit: Equiniti - The IPO Review Q3, 2020

‍