One of the open questions that has emerged during this global pandemic is whether the issue about the environmental, social and governance (ESG) data – information about companies carbon footprints, labor policies, board makeup and so forth – will remain as relevant to investors, even with the recent economic downturn.
The answer seems to be positive, because companies are likely to be more resilient when they face unexpected shocks, if they are managed for the long term. As a result, the crisis should increase the awareness that companies should not only consider short-term profits, but also the long-run performance.
Why do ESG issues matter?
Firstly, not only the ESG performance is directly related to the improvement of prosocial behavior, but also its pay-offs can bring benefits to companies, such as the increase of productivity due to higher employee engagement, or the rise of sales due to more loyal and satisfied customers.
Secondly, an ESG focus can help the reduction of capital costs and can enhance the firm’s valuation, because more and more investors are looking to put money into companies with stronger ESG performance. Moreover, this phenomenon is happening not only in equity markets, but also in loans markets, where some banks are linking interest rates on loans to ESG performance.
In addition, considering the transparency issue, after the European Union announcement about broader disclosure requirements, the stock market reacted positively to firms with strong ESG disclosure and negatively to those with a weak one.
Finally, efforts to ensure sustainable practices will help maintain shareholder satisfaction with board leadership.
Therefore, because ESG practices are part of long-term strategies, it can be said that every company needs investors who support plans for the future.
Where are the difficulties?
The majority of corporate leaders are not yet sure about how to improve their performance on ESG dimensions, due to the fact that there is a lack of appropriate evaluations and decisions concerning the actions to be carried out.
In fact, many executives incorrectly believe that simple or standardized actions will suffice, but they are not enough. In order to gain a competitive advantage and achieve real results, companies should look beyond the traditional paradigm followed by the crowd and embed ESG considerations in both strategy and operations.
For example, some companies implement environmental, water or waste management systems to operate more efficiently, but although those elements can be included in ESG ratings, few firms would expect to establish a competitive advantage simply by adopting them.
Consequently, corporate leaders need to replace the common mentality with an ambitious and differentiated ESG strategy if they want to see real financial dividends.
One solution in order to outperform the competitors is finding approaches that are more difficult to imitate, for example Airbnb’s creation of a peer-to-peer network and a “circular economy” business model. Those distinctive practices have contributed to reaching a competitive position that cannot be easily replicated.
Another important aspect, which must be outlined, is that not all ESG issues are equal in terms of relevance, because it depends on the industry which is taken into account. In the energy and transportation sectors, for instance, investing to make the transition to a low-carbon economy is becoming increasingly important, while, in the technology sector, carbon-footprint reduction is not as relevant as building a diverse organization, which can strengthen a brand’s reputation and lead to increased revenue.
In conclusion, on one hand, the strategic challenge for corporate leaders is to be farsighted about the ESG themes that are emerging as important industry drivers, identifying them before the competitors and, on the other hand, the boost of the long-term financial performance can be achieved only with a distinctive differentiation.