A quick guide to ESG and how it works
Environmental, social, and governance will have an impact on your organisation, whether you’re willing to accept it or not.
It may be outside your control, but that doesn’t mean you can’t embrace the value proposition it represents.
So, what exactly is ESG? What does it mean for your organisation? How can you ensure you extract the greatest value?
What does ESG mean?
ESG is becoming an intrinsic part of how you do business. It combines sustainability, social morals, and good governance and respects how much they overlap in modern business.
- The “E” (environmental issues) includes energy and waste. You analyse what resources you use and how that use affects other human beings. The “E” also involves climate change – how your organisation contributes to and helps mitigate it.
- The “S” (social) involves how your company interacts with other organisations and people in your business communities. It also includes diversity, labour relations, and inclusion within a broader, diverse society.
- The “G” (governance) includes all the controls, practices, and procedures. Effective governance makes effective decisions, complies with the law, and meets the needs of external stakeholders. Every company, which is itself a legal creation, requires governance.
ESG is here to stay
Make no mistake: nowadays, no one can cleanly separate leadership from environmental and social criteria. All will overlap.
Rather than formalising a report and letting the results speak for themselves, excelling in governance requires mastering not just the letter of the law but its spirit also. For example, catching violations before they occur, and ensuring transparency and dialogue with regulators.
The scale of ESG investment
Global sustainable investment now exceeds $35 trillion due to ESG-oriented projects. Being proactive about ESG has become even more relevant in recent years. In August 2019, the US Business Roundtable released a statement affirming its commitment to customers, employees, suppliers, communities, and shareholders.
The acceleration has been driven by heightened stakeholder attention to the global impact of corporations. Seeing this, investors and executives realise that a strong ESG proposition can safeguard a company’s long-term success. The magnitude of investment flow suggests that ESG is much more than a fad or a feel-good exercise.
We can say the same about business performance. Environmental, social, and governance concerns do not impede value creation. They have the opposite effect. A strong ESG proposition correlates with higher equity returns from tilt and momentum.
A reduction in downside risk is also associated with ESG performance, such as lower loan spreads and higher credit ratings. ESG propositions are becoming increasingly attractive, but understanding how these criteria contribute to value creation is unclear.
The financial case for ESG
From our experience and research, ESG links to cash flow in five crucial ways:
- top-line growth
- regulatory and legal interventions
- employee productivity
- investment and capital expenditures
When approaching ESG opportunities, leaders should consider these five levers and understand the “softer,” more personal dynamics that enable the levers to succeed.
There is no guarantee that all five links will apply to the same degree in every instance. It depends mainly on the industry or region in which the business operates.
Nevertheless, the five links provide a systematic way to consider ESG, so stakeholders should consider them all. There is too much value creation potential in each of them not to explore.
1. Top-line growth
A strong ESG proposition helps companies tap new markets and expand into existing ones. When governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford growth opportunities.
ESG can also influence consumer preferences. In practice, there can be wide discrepancies, including customers who refuse to pay even 1% more.
More than 70% of consumers would pay a 5% premium for green products that met the same performance standards as nongreen alternatives. Our study found that 44% of companies started sustainability programs because of business and growth opportunities.
In short: it pays off in the long run.
2. Cost reductions
ESG can substantially reduce costs. Among other advantages, executing ESG effectively can help combat rising operating expenses (such as raw-material costs and the actual cost of water or carbon), affecting operating profits by as much as 60%.
Some companies across sectors performed exceptionally well, especially those with the most comprehensive sustainability strategies.
3. Reduced regulatory and legal interventions
A stronger external-value proposition can enable companies to achieve greater strategic freedom, easing the pressure from regulators.
In fact, in case after case across sectors and regions, we’ve seen that strength in ESG helps reduce companies’ risk of adverse government action. It can also encourage government support.
4. Employee productivity uplift
With firm ESG goals, your company can attract and retain quality employees. You will also enhance employee motivation by instilling a sense of purpose and increasing productivity.
Studies show that companies that give back to the community are more likely to have high job satisfaction. Field experiments suggest that employees are more likely to be enthusiastic.
5. Investment and asset optimisation
Capital can be allocated to promising and sustainable opportunities with a strong ESG proposition (such as renewables, waste reduction, and scrubbers).
A do-nothing approach is usually a straight line that erodes over time. Leveraging sustainability tailwinds presents new opportunities for investment returns, and foresight impacts the bottom line.