What are Environment, Social, and Governance (ESG) concerns?
- Environment
Environment criteria involves the energy resources a company uses and the waste it creates.
- Social
Social criteria is about the relationships a company has with its people, communities, and related parties.
- Governance
Governance is the internal system of controls a company has to govern itself to comply with the law and interact with other stakeholders.
ESG Increases Valuation
Clearly, ESG factors are becoming increasingly important for obvious reasons. But it also creates tangible value for investors and businesses. In 2019, McKinsey surveyed 558 executives and 57% of them said they believe that ESG program creates shareholder value. Some studies have shown that ESG focused businesses are attracting better business opportunities and generating better return. Global ESG investment funds are about $35 trillion now and is set to reach $50T in 2035 according to Bloomberg Intelligence.
ESG is upending the worlds of finance and investing as it moves from the periphery to the mainstream. Assets are poised to reach $41 trillion by the end of this year, Bloomberg Intelligence estimates.
So in what ways can a company participate in ESG and how does it increase value?
Revenue Generation
Companies with high ESG scores are well known in their industry. According to a study by McKinsey, superior ESG execution has paid off even in industry such as mining, where companies are valued based on its current and forecasted commodity inventories. Why? It has shown that customers are willing to pay extra for being good. And they are willing to pay for the same product with a 5% premium.
Employee Productivity
Another area that has dominant effects on a company’s valuation is employee productivity. Companies with strong social proposition have not only strong brand supports but also high employee satisfaction. For SMEs and mid-market companies, the result of lower employee turnover and higher productivity can be astronomical. Simply put, if you take care of your employees, they will take better care of your customers. Many studies have shown that employee motivation has a strong positive correlation with a company’s return and valuation in short and long term.
In a paper in the Academy of Management Perspectives, summarized in a TEDx talk, I studied 28 years of data and found that firms with high employee satisfaction outperform their peers by 2.3% to 3.8% per year in long-run stock returns – 89% to 184% cumulative.
Cost Reductions
ESG shifts capital investments to long-term resources can reduce the use of energy and waste outputs. More efficient allocation of resources reduces future operating costs and increase present value of the company. The bigger the company, the higher the impact of the saving can be. For many sizeable companies, the cost savings come from less legal interventions and additional revenue from government support.
Goodwill
Besides the aforementioned benefits, ESG also create value in ways that are more simple. The company is creating goodwill. Companies are willing to purchase another company if its ESG proposition is evident.
The Edelman survey reported that 96% of respondents agreed that inclusion and diversity have strong impact on their share price. On average business buyers are willing to pay a 10% premium to acquire a company with positive ESG record than a company with negative ESG record found by a McKinsey.