ESG (environmental, social, and governance) stocks and their ratings are a valuable information source for investors today. Whether it is to screen out poor performers, identify superior financial results, target ethical green funds, or support activists as they push companies toward zero emission practices, ESG is solidly established as a guiding force for viable market assessment.
The economic downturn associated with Covid-19 initially opened up questions as to whether ESG issues would continue to remain pressing for investors. An article released in the Harvard Business Review (HBR) by George Serafeim analyzed 3000 firms between late February and late March, 2020. The data indicated that, during this tumultuous period, stocks that the public perceived as ESG responsible outperformed their competitors.
Now comes the tricky part. With the explicit push for companies to consider societal needs instead of a sole focus on profits, how do companies morph into spaces that provide ESG adherence? What’s needed, for example, to develop strong diversity policies and fair employment practices? Are gestures such as reducing waste, strengthening relationships with external stakeholders, and improving risk management and compliance enough?
The HBR article says no. It calls for “a new management paradigm for corporate leaders — one in which ESG considerations are embedded in both strategy and operations.” The author calls for all human beings, “in and out of corporate settings,” to behave in prosocial ways.
To do so can foster results in corporate settings: productivity rises when employees are engaged. Sales blossom due to more loyal and satisfied customers.
The Pragmatism Behind ESG Stocks & Strategies
Using ESG integration to create new forms of competitive advantage involves fundamental strategic and operational choices. Serafeim describes why CEOs and top executives who prioritize ESG strategies create a new central firm culture and can also achieve excellent profitability.
Superior performance emerges through reduction of capital costs that improve a company’s valuation. Many banks are now linking interest rates on loans to ESG performance, so larger pools of capital become available to those companies.
When global regulators and governments mandate ESG disclosures, positive action and transparency can help companies to protect their valuation. When the EU mandated broader disclosure requirements, the stock market reacted positively to firms with strong ESG disclosures and negatively to those with weak ESG disclosures.
Sustainable practices yield shareholder satisfaction with board leadership, and voting power produces more ESG changes than ever. For example, shareholders are increasingly proposing shifts toward gender diversity on boards.
ESG practices are part of long-term strategies, visions, and plans for a firm’s future. When the consumer goods giant Unilever was underperforming, its CEO ended quarterly earnings guidance, was explicit about the company’s commitment to long-term strategies, and attracted more “patient” capital.
5 ESG Management Actions
Serafeim argues that companies can move ahead of trends and realize financial benefits from ESG programs by taking 5 different actions.
- A Strategic ESG Program: Corporate leaders need to be ‘foresighted’ about ESG themes that are emergent and important industry drivers — and to identify them before their competitors do.
- Accountability Mechanisms: The board should be the entity that ensures ESG metrics are incorporated, including executive compensation. Such board involvement “requires innovation, fresh ideas, and creative thinking.”
- The Power of Purpose: A bottom-up culture that rallies around ESG initiatives emerges from a clarity of purpose that serves shareholders but also creates value for stakeholders. This can be achieved by linking strategy to purpose, which can avoid a long-term tradeoff between profits and sustainability when companies redesign how they generate revenue.
- Operational Changes: To reach the innovation and growth stage, companies need to “decentralize ESG activities and empower corporate functions to take responsibility for them.” Such decentralization requires appropriate support mechanisms, and goal-setting is helpful here. For example, managers should be empowered to hit ESG targets.
- Communicate with the (Right) Investors: Companies can influence which investors buy its stock through influence and control by management. Instead of viewing the sell side and the traditional customers, the focus should be on communicating directly with the buy side — “the large institutional asset managers that hold the company’s stock.” Moreover, investors tend to struggle to embed ESG metrics into their business analysis, valuation, and modeling. To offset this confusion, firms can create a system of impact-weighted accounting that measures positive and negative environmental and social impacts, converts them to monetary terms, and then reflects them in financial statements.
Final Thoughts About ESG Stocks
Investors are seeking out firms that are moving from intention to results. When companies make ESG issues central to their strategy and operations, they exceed the performance and culture of their competitors.
Companies that are bold and strategic with their ESG activities can transcend enormous global challenges and be rewarded.
If you’d like to read more about ESG here on CleanTechnica, check out this article about green bonds, how socially responsible investments are a bit different than ESG investments, or about climate action and your portfolio.