The Role Of Environmental, Social, And Governance (ESG) Policies In Company Valuations
Environmental, social, and governance (ESG) policies apply standards for a business’s operations that more and more investors are using to assess potential investments, especially investors of younger generations who want to choose investments that align with their values. ESG considerations also increasingly influence company valuations as the issues become more prevalent and essential to business leadership.
According to a report from U.S. SIF Foundation, investors held $17.1 trillion in assets chosen according to ESG investment strategies at the beginning of 2020. That’s up from $12 trillion just two years earlier.
Additionally, studies have revealed that using compelling ESG propositions can increase business value because these considerations play a role in financial performance and risk mitigation.
Environmental principles look at how a company impacts the Earth’s environment. It may include pollution, energy use, waste, conservation, and the treatment of animals. The standards can also be used to measure environmental risks to the business and how it is managing those risks.
Social criteria look at how a business manages its business relationships. This includes employees, suppliers, customers, and its communities. For example, it can assess how well a company sticks to its values, what it contributes to the local community, what it does for its employees’ health, safety, and happiness, and how charitable the business is.
Governance standards assess a company’s leadership, accounting methods, and stockholder involvement. It can involve assurances designed to avoid conflicts of interest regarding board members, political contributions used for favorable treatment, and anything illegal or unethical.
Ways ESG Creates Value
Opportunities for Growth
Vital ESG initiatives can help businesses tap into new markets and expand into existing ones. When a company trusts authorities, it is more likely to gain access, approval, and licenses that can lead to growth. ESG standards can also affect consumer preferences, especially when more customers report that they are willing to pay more for better environmental stewardship and green alternatives. One study revealed that nearly half (44%) of companies surveyed identified business and growth opportunities as their reasons for implementing sustainability programs.
ESG standards can also significantly reduce costs. If executed right, it can offset rising operating expenses such as raw materials costs and improve resource efficiency and financial performance. The farther the ESG strategy goes, the more money a business can save.
Less Regulatory and Legal Action
A stronger ESG strategy can help companies with regard to lessened regulatory pressure and adverse government action while also fostering government support. Corporate profits are always at risk from state intervention, varying by industry. For example, banking, technology, aerospace and defense, healthcare, and pharmaceuticals tend to have more value at stake from regulators. Demonstrating a solid commitment to ESG policies can build trust and turn down the heat on scrutiny.
Boosts in Employee Productivity
ESG initiatives can help attract and retain talent, improve morale, and increase productivity. Employee satisfaction has been directly correlated with shareholder returns and better performance. The more employees feel that their work is meaningful and appreciated, the more motivated they are to care about their work and coworkers. Studies have also shown that positive social action correlates with higher job satisfaction. For example, employees appreciate it when companies “give back.” And while a more heightened sense of purpose can inspire employees to perform better, a lack of ESG strategies can hurt productivity. No one wants to see strikes, worker slowdowns, and other labor issues, especially when significant workforce shortages and retaining staff is more critical than ever.
Better Investment Returns
A solid ESG plan can improve investment returns by distributing capital to more favorable and sustainable opportunities. It can also help avoid investments
that might not pay off due to longer-term environmental factors. For example, relying on energy-hogging factories and equipment can be costly. Waiting to address it can be even more expensive as regulatory actions are growing more and more favorable to ESG standards. Spending a little more now can be more economical than waiting until you have to scramble to catch up.