INTRODUCTION:
The term ESG stands for Environmental, Social and Governance. Initially coined in 2005, the term was introduced to check how businesses handle issues like climate change, water management, the effectiveness of their health and safety regulations in preventing accidents, supply chain management, how they treat their employees, and whether they have an innovative corporate culture.[1] As of now investing in ESG by corporations stand at a whopping $20 trillion. While this has caught wind only now, it worth noting that such a concept is not new. Since time immemorial investment decisions have been influenced by religious an ethical belief. Muslims created investments that abided by Sharia law, which forbade the use of weapons.[2] Quakers and Methodists created the first ethical unit trusts in the UK and the US. Investor awareness of ethical market participation has grown as corporate social responsibility (CSR) and social sustainability have gained in popularity today. Following the publication of the Principles for Responsible Investments (PRI)[3] in 2006—a collection of United Nations principles for the implementation of ESG elements into business policy and strategy[4]—ESG investing may have formally entered the mainstream of investment debate. The PRI, which has more than 2,000 signatories, is widely regarded as the official reference point for everything related to ESG investment.
While ESG investing saw a stable and steady growth throughout the 2010’s, it is now in full acceleration as now the market has transformed for the better. Nowadays, the bigger challenge is not how to implement a business plan or how to market their products out to the world, rather it is about keeping aside the dogmas of the industrial period, when pollution was free, labor was just a cost consideration, and scale and scope was the predominate approach, and learn to adapt to a new environment that supports smarter, cleaner, and healthier products and services.[5]
While environmental and ethical principles are important to follow, it is worth noting that a businessman would only follow those principles wherein he can maximize his own profit, after all a person will only enter a business to cater to his own self-interests and certainly not about the society. However, since ESG investing has now been linked to profit maximization and value creation, it is in the corporation’s best interest to set up a strong ESG proposition. Better performance in ESG will not only have financial perks, about which we shall elaborate further in the paper, but also gain from improved reputations and public perception, which may make it simpler to recruit and keep personnel as well as increase customer loyalty. These external variables serve as sources of a competitive edge over other businesses, resulting in higher sales growth and reducing costs associated with employee turnover. all these factors end up contributing to the long-term value of the company.[6]
IMPACT ON SHAREHOLDERS VALUE:
While ESG investing has numerous financial and non- financial benefits, we shall stick to the former and elaborate on how a strong ESG proposition benefits the shareholders of a particular company.
1. Reduction in costs:
As mentioned briefly, a strong ESG proposition can lead to a decrease in costs. A reduction in costs would leave a surplus in the operating expenditure of the company thus increase profits, ultimately benefiting the shareholder. Research conducted by McKinsey[7] demonstrates that higher equity returns are correlated with an effective ESG strategy. Value with ESG practices can take many different shapes. For instance, lower water and energy use can result in cost savings, and productivity can increase when top talent moves to businesses with a feeling of higher purpose. Let us understand this with the help of certain examples. Take 3M, which has long recognized that proactively addressing environmental risk may result in a competitive advantage. Since launching its “pollution prevention pays” (3Ps) initiative in 1975, the corporation has saved $2.2 billion by preventing pollution up front through product reformulation, enhanced manufacturing techniques, redesigned equipment, and recycling and reuse of industrial waste. Similarly, to date, 20% of FedEx’s fleet of 35,000 vehicles have been changed to electric or hybrid engines, which has already decreased fuel use by more than 50 million gallons thereby reducing their operating costs.[8]
2. Reduction in Government Intervention:
At the outset, it is quite evident that if corporations start dealing with their matters in a sustainable and environment friendly manner while adhering to all the rules and regulations, they are less likely to face inspections from the governmental authorities and in the off chance that they do, they won’t be surprised as every step will have been followed by the book. Now one might wonder, that how lack of government intervention or regulation is likely to benefit the shareholders or rather increase their value. Well, according to report published by McKinsey[9], “typically one-third of corporate profits are at risk from state intervention”. In an industry analysis conducted by the same it was observed that the profits at risk for pharmaceuticals and healthcare are in the range of 25 to 30 percent. The value at risk in banking is often between 50% and 60% due to the importance placed on rules relating to capital requirements, “too big to fail,” and consumer protection. The value at risk can also exceed 60% in the government-subsidized automobile, aerospace and defense, and technology industries, where other types of intervention are also common.[10] If firms tend to follow the regulations and make an effort to be transparent with their operations, it may help them to deal with the stringent government regulations in place throughout the world. In a report published in the Harvard Business Review, it was observed that the stock market responded positively to companies with good ESG disclosure and adversely to those with inadequate disclosure when the European Union announced stricter disclosure standards.[11]
3. Employee Satisfaction:
According to report published by Alex Edmans it was claimed that content and satisfied employees share a positive correlation with shareholder returns.[12] A key finding in the research published at MarshMclennan was that, top companies have much higher ESG scores than their peers in terms of employee satisfaction and talent attraction. This pattern is somewhat explained by the comparatively good environmental performance of these businesses, but it is also consistent with unique social and governance difficulties. This result implies that ESG performance might assist businesses in increasing employee satisfaction and luring in new hires.[13] Implementing ESG provisions would give the employees a purpose to work for apart from the financial aspect. This would keep them motivated and thus be a driving force in raising their productivity. Higher productivity would increase the shareholder’s value and thus maximize stock returns.[14]
SUGGESTIONS:
While it is noticeable that ESG investing is likely to benefit a company financially as well as in a non-financial manner, it is important to keep certain key points in mind while drafting an ESG proposition meant to impress and keep the shareholder’s content.
Firstly, one must evaluate and analyze the multiple outcomes in which the environmental, social and governance can add value to the long-term wealth of the shareholders. This must be done while keeping the firm’s goal in mind and to see what exactly shall benefit the firm. It is a common practice among big corporations that they take up multiple socio-economic issues and are unable to cater to these to their full capacity. If, in order to help out the community a firm should take up specific issues and deal with them one by one. While each industry will have different end goals it is necessary to avoid risk and maintain ties with the community.
Secondly, keeping the aforementioned point in mind, a firm should clearly set out its end term goal, which in respect to this paper is value creation. A firm must set its outreach work while keeping this in mind. It should be a part of their mindset that whatever that they do, its end result should add benefit to the long-term value of the shareholders. Pre-establish the point that your company’s ESG initiatives do link to value and demonstrate to the executives in such a way, ideally with real indicators that feed into the business model. This shall help to gain maximum support from everyone from shareholders to customers.
Lastly, the upper management should always be transparent and honest about its ESG endeavor’s. Even though it can be painful and cause some short-term pain, being mindful and upfront about ESG risk increases long-term value. An open admission that getting it wrong could lead to significant value destruction is part of an honest evaluation of ESG. Even if a company is at the hand of poor environmental, social, and governance performances, transparency shall only reduce the risk of materially adverse occurrences for companies.
CONCLUSION:
The main aim of this paper was to identify as to how ESG investing and performances helps in adding value to the shareholders. To achieve this, we set out to find out the different methods by the virtue of which the value of shareholders is maximized. While the academic literature currently available offers only a few insights, the paper has still been well-set out. According to the findings[15], increased financial performance is the single most important factor connecting higher sustainability corporations with greater shareholder value. Other advantages of higher ESG organizations that contribute to better long-term shareholder value include better capital policy and management, more qualitative and dedicated management, and less uncertainty and risk. Further research conducted indicated that a number of nonfinancial intermediary elements also have a significant impact on businesses. Companies boost shareholders’ worth through creating intangible asset value by upholding a positive reputation and cultivating more favorable connections with key stakeholders including employees, customers, and communities.
[1] Georg Kell, The remarkable rise of ESG Forbes (2021), https://www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/?sh=fe3810016951 (last visited Oct 6, 2022).
[2] Sherwood M & Pollard J 2018, ‘A historical survey of ESG investing’ in Responsible Investing, Routledge, London, 4-28; “The History of Sustainable Investing”, Morningstar, 2020, https://www.morningstar.in/posts/57694/history-sustainable-investing.aspx.
[3] Principles for Responsible Investment, What are the Principles for Responsible Investment?, viewed 23 February 2020, https://www.unpri.org/pri/what-are-the-principles-for-responsible-investment
[4] Gifford J 2010, ‘Financial markets and the United Nations Global Compact: the Principles for Responsible Investment’ in The United Nations Global Compact: Achievements, Trends and Challenges, Cambridge University Press, 195-214.
[5] Ibid 1
[6] Zumente, I.; Bistrova, J.ESG Importance for Long-Term Shareholder Value Creation: Literature vs. Practice. J. Open Innov. Technol. Mark. Complex. 2021, 7, 127. https://doi.org/10.3390/joitmc7020127
[7] Witold Henisz, Tim Koller & Robin Nuttall, Five ways that ESG creates value McKinsey & Company (2021), https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/five-ways-that-esg-creates-value (last visited Oct 6, 2022).
[8] Witold J. Henisz, “The costs and benefits of calculating the net present value of corporate diplomacy,” Field Actions Science Reports, 2016, Special Issue 14.
[9] Ibid 7
[10] Ibid 9
[11] George Serafeim, Social-impact efforts that create real value Harvard Business Review (2021), https://hbr.org/2020/09/social-impact-efforts-that-create-real-value (last visited Oct 6, 2022).
[12] Alex Edmans, “Does the stock market fully value intangibles? Employee satisfaction and equity prices,” Journal of Financial Economics, September 2011, Volume 101, Number 3, pp. 621–40, sciencedirect.com.
[13] Robert Bailey & Angela Ferguson, ESG as a workforce strategy Marsh McLennan (2020), https://www.marshmclennan.com/insights/publications/2020/may/esg-as-a-workforce-strategy.html (last visited Oct 6, 2022).
[14] Alex Edmans, “The link between job satisfaction and firm value, with implications for corporate social responsibility,” Academy of Management Perspectives, November 2012, Volume 26, Number 4, pp. 1–9, journals.aom.org.
[15] Ibid 6
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