Copyright © 2023 Telesto Strategy LLC, All rights reserved.
ESG's role in corporate transparency, accountability, and reputation-building is well established, but less is known about its financial ROI. Here are 13 ways that companies can achieve higher ROI through ESG.
In a few short years, ESG has emerged as one of the hottest and fast-moving topics in the business world. While much has been said about ESG’s role in corporate transparency, accountability, and reputation-building, not enough has been shared about the concrete financial returns it can generate for businesses which embrace it. Across many dimensions, solid ESG and sustainability practices drive measurable value for shareholders. Moreover, with the momentum driven by investors and regulations, companies would be remiss to not craft a bespoke strategy to maximize the inherent financial potential of ESG.
As a testament to the momentum of ESG, the Business Roundtable updated its Statement on the Purpose of a Corporation in August 2019. 181 CEOs endorsed and signed the commitment to lead their companies for the benefit of all stakeholders, customers, employees, suppliers, communities, and shareholders.
It’s not just investors and CEOs who are recognizing the importance of ESG, it’s also policymakers. With the latest wave of climate legislation from California, companies will be legally required to disclose their emissions and climate risks. Given that they now must start an ESG journey, strategically minded companies are making moves to capitalize on their ESG efforts for short- and long-term financial gain. The much-anticipated SEC ruling is expected to reinforce the emissions (inclusive of Scope 3) and risks disclosure requirements that California has now put in place.
With so much to win or lose, we have cataloged the many opportunities for leaders to explore to get more financial return from their ESG and climate efforts.
Revenue Uplift
- Attract and retain B2B customers by meeting ESG reporting and data criteria. For large companies like Coca-Cola, Meta, and AWS, submitting ESG data (be it emissions or otherwise) is now a matter of doing business. Procurement requirements are stiffening alongside intensifying global and domestic regulation. Moreover, as Scope 3 emissions include partner (value chain) emissions, the integrated dependency of vendors and partners in emissions reporting is now well entrenched. As such, leading companies realize they can attract and retain customers and clients by elevating their ESG reporting. Experts predict this trend will only intensify, with IDC predicting that by 2026, 50% of RFPs will include metrics regarding carbon emissions, material use, and labor conditions.
- Win over B2C consumers who are increasingly demanding green products and services. Demand for green products isn’t coming from a niche segment of young, affluent climate activists; it’s coming from the mainstream audience. According to a recent report by First Insight and the Baker Retailing Center at the Wharton School of the University of Pennsylvania, it’s not just the younger generations that are willing to pay a premium for green products and services. In fact, consumers across all generations — from Baby Boomers to Gen Z — are now willing to spend more on sustainable products. Just two years ago, only 58% of consumers across all generations were willing to spend more on sustainable options. Today, nearly 90% of Gen X consumers said that they would be willing to spend an extra 10% or more for sustainable products, compared to just over 34% two years ago.
- Invest in ESG positive funds, which have outperformed globally. Match your investment portfolio to ESG priorities and see better financial performance. Stock funds outperformed across global markets over the last five years if they were weighted toward companies with positive environmental, social, and governance (ESG) scores, research from sustainability data firm ESG Book shows. Global ESG and sustainable investment now tops $30 trillion – up 68% since 2014 and tenfold since 2004.
- Reduce capital costs and improve valuation. Having a clear ESG focus can help management reduce capital costs and improve the firm’s valuation. That’s because as more investors look to invest in companies with stronger ESG performance, larger pools of capital become available to those companies. MSCI has found that companies with high ESG scores experienced lower costs of capital, on average, compared to companies with poor ESG scores in both developed and emerging markets during a four-year study period. The cost of equity and debt followed the same relationship.
- Protect valuations proactivity and manage investor expectations. Positive action and transparency on ESG matters can help companies protect their valuations as more global regulators and governments mandate ESG disclosures. Currently, 87% of investors think that corporate reporting, voluntary or not, contains at least some greenwashing, as was recently reported by PwC. These concerns erode trust in what companies say about how they are addressing sustainability risks and opportunities and make it difficult for the investment profession to allocate capital where it needs to go.
Cost Management
- Unlock operational efficiencies. Companies can save on energy and raw materials costs as well as reduced waste and water consumption by embracing sustainability. Strong ESG credentials drive down costs on average by 5 to 10%, as these companies focus on operational efficiency and waste reduction.
- Achieve better value for money for carbon offsets. Companies that begin the decarbonization journey now will be better prepared to avoid carbon taxes and costly offsets (and offset verification). BloombergNEF has evaluated potential market outcomes based on different regulatory scenarios for carbon offsets (defined as verified reductions in climate-warming gases used to compensate for emissions that occur elsewhere). Research results suggest that an oversupplied voluntary market could produce prolonged growth in prices. On the opposite end of the spectrum, a carbon-removals-only scenario could cause a pricing surge of as much as 3,000% by 2029.
- Decrease exposure to carbon border tax. A carbon border adjustment tax is a duty on imports based on the amount of carbon emissions resulting from the production of the product in question. As a price on carbon, it discourages emissions. As a trade-related measure, it affects production and exports. The EU’s Carbon Border Adjustment Mechanism (CBAM) is a landmark tool to put a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries. It entered its transitional phase on October 1, 2023, with the first reporting period for importers ending January 31, 2024. Therefore, companies that want to import goods produced outside the EU will have to purchase certificates corresponding to the amount of emissions generated in the production of those goods. Decreased carbon intensity across your portfolio will reduce the cost of purchasing CBAM certificates and the overall expense burden of doing business with the EU.
- Mitigate risk of devaluation of carbon-intensive assets by early divestment. The Economist Intelligence Unit predicts that the cost of climate change may reach $43 trillion and that 6˚C of warming represents a present value losses worth $43 trillion, or 30% of the world’s entire stock of manageable assets. Companies most at risk are those with the greatest concentration of carbon-intensive assets (physical or financial assets with direct or indirect exposure to high levels of greenhouse gas emissions). Examples of these assets include assets in the fossil fuel industry or those which are most reliant on fossil fuels.
- Avoid climate litigation risk and legal penalties, as well as adverse government action. In a working paper by the London School of Economics and Political Science, over 100 climate-related lawsuits between 2005 and 2021 found that the filing of a climate-based litigation claim or corresponding unfavorable court decision reduced the market capitalization of the defendant company by about 0.41%, on average. Broken out by incident, the study found that the mere filing of a climate-related lawsuit could decrease a company’s market valuation by 0.35%, while an actual court decision finding liability against the company reduced the defendant company’s market capitalization by 0.99%.
Attracting & Retaining Talent
- Enhance shareholder satisfaction with stronger board leadership. Sustainable practices can help maintain shareholder satisfaction with board leadership. As more investors with more assets under management commit to ESG investing, they will have more voting power to oversee and steward changes. In PwC’s 2021 Annual Corporate Directors Survey, 64% of directors surveyed said ESG is linked to their company’s long-term strategy, but only 25% think their board understands ESG risks very well. Moreover, Morrow Sodali’s findings in its 2021 Institutional Investor Survey point to climate risk as investors’ number one engagement priority, with human capital management as a close second. All companies, regardless of their sector, are experiencing increased investor scrutiny on how they approach the issue.
- Improve employee attraction and retention. Companies with meaningful ESG commitments have more motivated employees, which means more engagement and productivity, retention and improved recruitment outcomes. An IBM survey reported that 71% of employees believe environmentally sustainable companies are more attractive employers.
Enterprise Risk Mitigation
- Bolster enterprise risk mitigation to fortify business continuity and long-term value creation. Layering an ESG lens to Enterprise Risk Management improves detection and mitigation of corporate risks. Corporate boards who have integrated ESG into existing ERM process have cited numerous benefits:
- Minimize costs by reducing the financial and reputational consequences of non-compliance with sustainability regulations;
- Improve regulatory compliance;
- Greater access to investors and funds;
- Anticipate and address customer demand;
- Reduction in regulatory and legal intervention;
- Greater access to capital alongside revenue growth;
- Protect reputation and brand value
To realize these benefits, a company must have the political will, coherent ESG strategy, and discipline to see a roadmap through to completion. Moreover, with global and domestic regulation moving quickly, companies must continuously monitor the changing landscape for new opportunities and threats.
Start your ESG journey now and realize financial ROI
To guide executives in designing a bespoke ESG strategy and program, we encourage leaders to familiarize themselves with our ESG Maturity Model. In setting an ambition and then effectively directing focused resources to their stated goals, leading companies will achieve benefits for shareholders and stakeholders alike.
We’re here to help. Reach out to our team of ESG experts for support on how to activate and accelerate your ESG financial return, info@telestostrategy.com.
