Selective Cuttings

Environmental, social and corporate governance: The business of doing good

August 27, 2013

Environmental, social and corporate governance (ESG) are three areas that measure the ethical and sustainability performance of a company or investment. Drivers for firms pursuing ESG strategies can be ethical in nature, but for publically traded companies, are more commonly designed 1) to make their stock or products more attractive to ethically-minding customers, 2) to gain leverage in achieving social license to operate, or 3) because they see direct returns through efficiency gains or human resources/social contract routes. In short, ESG factors impact the ability of firms to generate profit.

Market indices corroborate that ESG is linked to financial success, with companies in the Dow Jones Sustainability Index generally demonstrating superior share performance (Robinson et al., 2011) and companies in GS SUSTAIN (Goldman Sachs’s sustainability index) generally outperforming a global equity benchmark index (MSCI) by more than 40% between 2007 and 2012. If doing good is enough to guarantee higher returns, why aren’t all firms engaging in ESG?

Looking into who these successful ESG-minded companies are may shed some light onto the relationship between ESG and financial success. They are typically large companies with a very strong focus on good governance. Good corporate governance, which stands for structurally well managed companies, includes the management of fiduciary, operational, regulatory, reputational, and innovative upside and downside risks. While small companies are more likely to engage in environmental and social activities for ethical reasons, in large companies, it is the G that typically drives environmental and social activities and results in good financial performance (Meta Study of Deutsche Bank, 2012). A good business model is an essential ESG issue and large investment broker houses are now paying close attention:

UBS Investment Research: “We believe environmental, social and governance (ESG) issues are no different from the many other issues considered in investment research and regarded as ‘financial’.”

Goldman Sachs Global Investment Research: “Future industry leadership and financial returns will become increasingly difficult to achieve without effective engagement and management of ESG issues.”

HSBC Global Research: “… likely that investors will start to focus more on ESG issues in the investment decision-making process. This may mean that companies with strong ESG disclosure and top quality practices will outperform.”

Highly mobile capital in an era when information technology has changed the speed and the reach of business operations is not only bringing about new structures at the market, industry and firm levels, but also changing the role and power of consumers (Porter and Kramer 2011, Goldman and Sachs 2012: investing in a changing world). The rise of environmental and social initiatives is a symptom of a new business model adapted to a new business environment where the influence of the financial sector is stronger. Best-in –class ESG-focused companies are not successful because they are doing good, they are doing good because it is part of their success strategy.

Robinson, M., Kleffner, A. and Bertels, S. (2011) Signaling Sustainability Leadership: Empirical Evidence of the Value of DJSI Membership, Journal of Business Ethics, 101: 493-505.
Porter, M and M. Kramer. 2011. Creating Shared Value. Harvard Business Review. Jan.-Feb. pp 62-79.