Environmental, social, and governance (ESG) issues have become a staple for a growing number of larger companies, but a reasonable question is what impact any ESG initiatives have on the overall profitability goals of any organization or enterprise.
Environmental issues include the energy a company uses and the waste it produces. Carbon emissions and possible global warming impact are “E” issues. “S” issues include labor relations, management or employee diversity, and social inclusion efforts.
The “G” is for governance or the procedures and controls that your company uses to meet legal and ethical standards while benefiting your shareholders. A strong and ethical structure is essential for any company that wants to be socially responsible.
The analysis can be complicated as ESG can cover many different goals, ranging from reducing carbon footprint to promoting gender diversity to other hard-to-measure impacts such as reducing corruption, bribery or diversifying board member representation.
Some of the quantitative progress on many metrics costs almost nothing. Other efforts might involve substantial changes that impose high costs. But most ESG goals have huge elements of discretion in setting targets or goals. As with most other enterprise change efforts, costs are lower when efforts are phased and incremental.
In more than 2,000 studies on ESG impact on equity returns, 63 percent showed ESG had a positive effect while only eight percent showed a negative one, notes Multiview Corp.
Other studies suggest there is almost no correlation between firms using ESG criteria and those which do not do so.
“There is no evidence that ESG funds outperform investment benchmarks (like a passive S&P 500 index fund) over the long-term,” says Wayne Winegarden, Pacific Research Institute senior fellow. The caveat is that determining when a firm is meeting universal ESG goals is a matter of judgment.
One might conclude that firms should early do what can be done at low cost, and implement the tougher changes that affect supply chains, production, distribution or sales costs over longer periods of time, especially since much ESG value is gleaned from hard-to-quantify efforts that cause customers to view a firm more favorably.
Making ESG a line-accountable item can “lift what is already a substantial contribution to our stakeholders further without eroding short term financial or operational performance. Over time, you build greater value and greater returns for shareholders,” said Mike Henry, BHP CEO.
Still, promoters say ESG and positive financial returns can be explained by the following:
Prompts top-line growth – Sustainable products attract more B2B and B2C clients.
Reduces cost – ESG leads to less water intake and lowers energy use.
Minimizes legal and regulatory actions -You’ll see improved government support and earn subsidies.
Increases productivity – ESG principles attract more qualified employees and increase employee enthusiasm.
Optimizes expenditures – You will see better investment returns from sustainable equipment and manufacturing plants.
Some argue that ESG companies must practice all three parts. Others might focus on progress in any of the three areas, and to varying degrees. Still, many would argue the total ESG effort should transform virtually all operations of a firm.
Some might say that grand vision is unlikely to happen systematically and quickly. It is more likely to evolve in a few areas where progress can be quantified quickly and where costs are manageable.
Other efforts might involve changing global supply chains to promote worker rights and wages, and will take much effort and time, also adding costs to the business. By definition, paying workers more will increase costs, and that has to be accounted for in the business model.
The measurement problem will remain difficult, though, partly because some costs are hard to capture, as are the benefits. Some might argue ESG success cannot be measured in terms of its contribution to firm profits. Executives running firms always will counter that financial costs must be taken into account, as ESG cannot be allowed to destroy the firm business model.
A reasonable person might argue that the best way to approach ESG is to look for quick wins in governance or social areas, with longer-term efforts conducted on the environmental areas where basic supply chain, production, distribution and sales processes have to be redesigned.
In other words, do early what can be done with operating cost elements; do more gradually that which requires changing capital investment elements, long-term contracts and supply chains.
It arguably is important to do so in a net-zero way on the cost side, hoping for eventual positive returns on the bottom line or revenue top lines, to the extent such benefits can be measured.
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