Cultivating and reporting ESG success can be profitable

Stakeholders are keeping track of how companies navigate environmental, social and governance (ESG) issues, and a new report says understanding their perceptions can help organisations develop strategies that may create financial benefits.

Determining the value of ESG issues to multiple stakeholders can lead to reduced risk and lower cost of capital, according to a Deloitte report, Drivers of Long-Term Business Value: Stakeholders, Stats, and Strategy.

The report advises businesses to maximise value for a wide range of stakeholders—such as employees, business partners and community groups—in addition to shareholders and regularly disclose sustainability successes.

Companies have found that ESG disclosure can lead to reduced cost of capital while attracting institutional investors with a long investment horizon, according to the report. Organisations with a poor ESG record are less likely to remain profitable because of pressure from regulators, customers and investors, the report says.

When deciding how to disclose, here are some factors to keep in mind, according to the report and its authors Eric Hespenheide and Dinah Koehler of Deloitte:

• ESG disclosure without underlying action is risky.

• It takes a steady stream of positive and credible news to increase valuation.

• Shareholders appear increasingly critical of companies with poor environmental records, and less impressed with the high environmental performers.

• Companies are compared to peers in their industry, so it is best to keep up.

The authors said the actual valuation increase due to disclosure is difficult to assess, but research shows that investors tend to react to negative ESG news with an immediate, short-term, downward correction.

Over time, however, “disclosure can reduce the cost of capital for more transparent firms regarding financial data, and empirical research indicates that the same is true for non-financial data,” the authors said in a joint statement. “Thus, we point out that ESG disclosure can have a longer-term positive benefit by improving the company’s risk profile, thus reducing the cost of capital.”

How value is created

Before disclosing, though, a company must act. Companies can address needs of various stakeholders by creating value for employees through HR policies, for the community through investment, for suppliers through resource efficiency improvements, and for the environment, according to the report. Interests of shareholders and other stakeholders need not be at odds because focusing on long-term value maximisation can increase market value, the report says.

The authors explain that many ESG investments will have a slow return on investment and will generate value by minimising business interruption risk, especially in supply-chain hot spots. The authors said ESG investments also can increase brand equity and reputation, improve employee satisfaction and open up new dimensions of competitive advantage through innovation.

“This type of information on future long-term growth is crucial for companies to discuss with their shareholders,” the authors said. “It is plausible that shareholders would react differently if they called these ‘investments in future cost savings’ rather than ‘sustainability initiatives.’ ”

Investing in positive community relations, for example, has improved the financial valuations of mining companies and emerged as an important factor in production, according to the report. An International Finance Corporation report delivered in October at the First International Seminar on Social Responsibility in Mining described how including more stakeholders in land negotiations helped Newmont Mining build community trust in Ghana, saving time and money while gaining access to land for gold mining earlier than expected.

Hespenheide and Koehler said such consultations with stakeholders do not occur enough at businesses. When they do occur, the conversations could be structured better.

“Doing this well and less often is probably a more optimal outcome and ultimately more resource efficient,” they said.

Although various conversations can take place throughout the year that lead to relevant ESG issues, a determination of which ones affect the company’s valuation should take place at least once a year with the goal of incorporating them into the company’s strategy and annual budgeting while informing public disclosures, according to the authors.

Related CGMA content:

“Enhancing Value Through Sustainability: Tips for the Finance Team”: Finance professionals can expect to play a bigger role in sustainability reporting, says Stephen T. Starbuck, CPA, the Americas leader for climate change and sustainability services at Ernst & Young.
 
“Sustainable Business: Shared Value in Practice”: Some companies have adopted strategies that aim to benefit society. This report, illustrated with case studies, explores the concept of shared-value creation and will be useful to CGMAs working in organisations adopting more sustainable business practices.

“IFAC Report Outlines Five Ways Accountants Can Meet Demand for Certain Non-Financial Data”: Investors increasingly are using ESG information to determine how organisations will perform over long periods. To meet that demand, accountants need to apply their standards to the process of collecting, analysing and reporting ESG data while supporting the addition of ESG factors to management systems, according to an IFAC report.

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine senior editor.