“For over a decade now, you have seen research from a range of really mainstream groups showing that companies with strong ESG performance in fact outperform peers in a range of financial metrics,” says Veena Ramani, senior program director of capital markets systems at sustainability nonprofit Ceres. “No one should be making the argument that working on ESG is a choice between doing good and doing well — it means the company is set up for strong financial performance in the long term. There is a global blurring of the lines between ESG and finance.”
According to FactSet, 24 S&P 500 companies cited ESG in earnings calls during the second quarter last year, up from only six in the second quarter of 2018. In a report issued last year, S&P Global Ratings noted that in 2017, around 15% of the S&P 500 mentioned in earnings releases that extreme weather events impacted the business, and this is likely to increase as climate change concerns grow, Ramani says.
“I think this kind of high-level research needs to be linked to information that is happening in the world right now,” Ramani says. “And, investors are looking at this research and these events too — which impacts your job as a director.”
One area companies are grappling with is the metrics to use when measuring ESG performance and their link to financials. Indeed, many companies are still in the early stages of producing standardized ESG metrics due to the difficulty in quantifying the impact of certain factors, says Cathy Allen, chairman and CEO of the Santa Fe Group, who has served on several public company boards.
“The metrics aren’t quite there yet. It has been difficult to figure out how to measure it, and it depends on how companies define ESG,” Allen says. Last month, asset management giant BlackRock announced that it wanted companies to use the Sustainability Accounting Standard Board’s frameworks for disclosure by the end of 2020. For disclosures on climate-related risks, BlackRock cited the Task Force on Climate-Related Financial Disclosures, as Agenda has reported.
Meanwhile, some companies have taken a creative approach in measuring ESG linked to financial elements and disclosing outcomes to shareholders.
For example, French luxury group Kering discloses an environmental profit and loss statement that measures the company’s environmental footprint and then calculates the monetary value of it. The company decides what to measure, such as carbon emissions; maps the supply chain; identifies priority data; collects primary and secondary data; determines the monetary value of the data; and then calculates and analyzes the results.
Strategy First
Ramani says in order to tie financial performance to ESG, it starts with fundamentally shifting strategy to include ESG issues.
“When you craft a sustainable business strategy, the metrics become obvious,” Ramani says.
For example, Ramani points to British retailer Mark and Spencer’s Plan A sustainability plan, which breaks down how different channels, including finances, align with its sustainability strategy. The company also aligns incentives in executive compensation with Plan A–related key performance indicators.
Mylle Mangum, chairman at Express and a board member at Barnes Group, Haverty Furniture Companies and PRGX Global, says ESG should lie in the risk management area of a company.
“Good companies have been doing this all along,” Mangum says.
“Nobody does well in the business world without being a good community member, and nobody does well without being environmentally sound,” Mangum says. “It is really a matter of intensity and degree.”
For example, Mangum says it is important for companies to strike the right balance between sacrificing short-term financials for long-term gain. Some companies “go way beyond” what is necessary to tackle the ESG issues that are making an impact and incur higher costs, which may end up harming financials as opposed to boosting them.
“You don’t want to lie on your swords and go too extreme so that it negatively impacts your bottom line,” Mangum says.
Other Board Considerations
Despite the growing focus on ESG generally, many boards are still lost in the weeds, sources say. Indeed, according to PwC’s annual corporate director’s survey from last fall, only 34% of respondents said ESG issues are a regular part of the board’s agenda and 29% said the board needs more reporting on ESG-related measures. About half (49%) said ESG issues have an impact on a company’s financial performance.
Several sources tell Agenda that boards should consider assigning ESG oversight responsibility to a committee. Additionally, boards need to ensure ESG risks are properly accounted for in enterprise risk management programs.
For example, FMC Corp. has a sustainability committee, PepsiCo. has a public policy and sustainability committee, McDonald’s has a sustainability and corporate responsibility committee, MDU Resources has an environmental and sustainability committee, and Whitestone REIT has an ESG committee.
Allen says boards need to ask management, “What is considered an ESG issue and how are others accounting for it? How are investor groups defining ESG? What is the risk appetite for these issues?”
“Once boards can understand and visualize what is included in ESG and how investor groups and regulators are looking at it, they can come to management to get ahold of the positive and negative financial impacts from those areas,” Allen says.
This way, the board is holding management accountable for looking at the fiscal impacts, Allen says. And boards need to stay educated. Many board-focused conferences, for example, now include sessions on ESG issues.
