In recent years, there has been a shift in corporate financial considerations around Environmental, Social and Governance issues, or ESG.
While investing in environmentally sustainable initiatives can be costly, it can benefit overall company finances in the long term. The American Multinational conglomerate 3M saved at least $1.4 billion as of 2010 through its Pollution Prevention Pays initiative, which focuses on recycling, reducing waste and improving manufacturing practices.
Sustainable transitions can also reduce costs from stranded assets and equipment made redundant by evolving government regulation. In fact, studies show that the average risk-adjusted return on investment in sustainable companies slightly outperforms their less sustainable counterparts. This is intuitive, as more sustainable companies are better equipped to manage certain long-term risk factors. Sustainable investing involves divesting from certain companies and positive screening, where shareholders invest in certain industries to direct a firm towards sustainable practices. Academic evidence suggests that the latter is more effective.
Divestment from fossil fuels remains a contentious issue as these investments have historically yielded high returns. The issue is that this makes companies complicit in climate change. Such companies could meet minimum sustainability requirements by engaging in carbon offsetting or investing in the development of renewable energies.
Additionally, research suggests that greater corporate responsibility tends to increase employee productivity and retainment. This is accompanied by a willingness to start working for lower wages than in less sustainable companies, as suggested by a 2016 study by Vanessa Burbano.
Increasing consumer awareness regarding the environment, and stories of adverse environmental pollution can ruin a firm’s reputation. This affects consumer choices and reduces sales, particularly in relation to competitors with more positive social and environmental reputations. An example of this is Lyft’s success following the 2017 #DeleteUber movement.
One challenge is the absence of a single reporting standard, making sustainability ratings difficult to compare. Different data providers follow different methodologies, including issues assessed, weightings applied, and indicators used. For example, there are 20 different reporting schemes on employee health and safety, which produce varying results. To combat this, there are efforts by The World Economic Forum and the four largest international accounting firms, to standardise ESG reporting using metrics in line with the most current standard setting bodies.
Another challenge involves integrating ESG data into financial analyses. The existing norms for converting ESG measures into ESG scores are subjective and difficult to assign a dollar value to.
Despite these significant challenges, the shift towards sustainability in the private sector persists, driven by government regulation, more comprehensive reporting and consumer decisions.
“Unlocking the Power of Environmental, Social and Governance Data” by World Economic Forum is licensed under CC BY-NC-SA 2.0.