Environmental, Social and Governance (ESG) – Why Investors Should Care
Article

Environmental, Social and Governance (ESG) – Why Investors Should Care

April 30, 2021

For many companies, fiduciary responsibility to shareholders and lenders has always been at the forefront of decision-making. While interest in the return to investors of corporate social responsibility (CSR) has been the subject of academic discussion for many decades, social good was a fringe movement.

A few mutual funds with an investment thesis of “doing well by doing good” touted solid returns posted by companies with a focus on being good corporate citizens. However, Silicon Valley had not yet caught up to returns on social responsibility and the impact it could have on companies, thereby passing along the benefit to investors. Hedge funds took flight with nary a thought to anything but financial returns.

A few companies like Ben and Jerry’s stood out as examples of the “doing well by doing good” thesis – but it wasn’t relevant or important to investors focused on ROI. Then, in the last several years, the focus on corporate citizenship began to snowball, helped along by environmental impact discussions and growing attention to the rights of minority groups, all tagged under the moniker of CSR.

Fast forward to today, and the disparate impact of the COVID crisis on communities of color and the Black Lives Matter movement have captured headlines around the world. The snowball became an avalanche. Environmental, Social and Governance (ESG), which refers to three main factors in measuring the sustainability of an investment, has rapidly became a corporate buzzword and a standard item on investor diligence checklists.

Titles like Chief People Officer and Chief Inclusion Officer are now almost mandatory among many larger corporations, with small and mid-sized companies following suit.

Impact on Portfolio Companies

It’s important for investors to realize the impact social responsibility can have on portfolio companies. Although there are myriad factors to consider, the following four stand out:

Recruiting

The competition for talent has never been greater. Younger recruits increasingly rate a sense of purpose as a key factor in choice of employers. Visibility regarding employee satisfaction is critical (and unavoidable).

Retention

Gone are the days of grinding early career employees through the mill with a promise of economic rewards to come. Today’s employees expect active diversity and inclusion efforts, and quickly become disenchanted with companies that conduct “greenwashing” as a practice.

Clients

Clients are seeking partners with shared values. Evidence of your company conduct through action, such as achieving B Corp status, lends credibility and relevance when advising clients on decision-making. You can be seen as a forward thinker, helping clients move from a focus on the bottom line to considering the impact of choices on all stakeholders, from employees to the planet.

New Markets

Green technology, wellness, minority-owned businesses…these are but a few of the verticals experiencing explosive growth. Business founders and consumers alike seek vendors that enhance their reputations and reduce the risk of embarrassing exposés around business practices.

Stronger Corporate Valuation Through ESG

A 2018 study by university researchers and authors Ali Fatemi, Martin Glaum and Stefanie Kaiser found that ESG strengths increase firm value and weaknesses decrease it. They found that ESG disclosure, per se, decreases valuation, but more importantly, that “disclosure plays a crucial moderating role by mitigating the negative effect of weaknesses and attenuating the positive effect of strengths.”

Larry Fink, chairman and CEO of BlackRock, an American multinational investment management corporation, in his 2021 Letter to CEOs, wrote, “We have long believed that our clients, as shareholders in your company, will benefit if you can create enduring, sustainable value for all of your stakeholders…In January of last year, I wrote that climate risk is investment risk…then the pandemic took hold… and the reallocation of capital accelerated even faster than I anticipated… January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets, a 96% increase over the whole of 2019.”

It is also true that serious scholarly research and large databases of information support the conclusion that attention to social good increases shareholder value.

An excellent study of a vast array of business literature and available data, written by Mahfuja Malik and published in the Journal of Business Ethics, summarizes information from Michael Porter to the Dow Jones Sustainability database, with a particular focus on reputable quantitative accounting studies of market value. “Both the theoretical as well as the empirical findings…suggest that CSR plays a significant role in enhancing firm value by promoting employee productivity, ensuring better operating performance, expanding the product market, improving capital market benefits, building a corporate reputation, and strengthening a firm’s relationship with the society, regulators and other stakeholders.”

Proving It Through B Corp Status

Achieving B Corp status is rapidly gaining awareness as the preeminent objective measure of meaningful adherence to CSR. A recipient’s scores in areas of governance, labor, community, customers and the environment must be made publicly available. It isn’t a marketing campaign; it is a process requiring meaningful devotion of resources and an invitation to intense scrutiny of how well you walk the talk. It doesn’t preclude consideration of profits, nor impose a host of prescribed activities. Instead, it frees management to no longer be solely focused on the returns to investors.

Armanino can relate. We have always understood the need for social responsibility. We have been early adopters with a long-standing mission: To be the most innovative and entrepreneurial firm that makes a positive impact on the lives of our clients, our communities and our people. But we wanted to prove we weren’t just putting words on paper.

A year ago, Armanino set out to obtain the ultimate proof of its dedication to these goals by pursuing B corporation status, and we recently achieved it. We truly understand the intricacies and what it takes to become a B Corp. (You can learn more in our recent blog post, “Balancing Business With Purpose: Armanino’s Road to Becoming a Certified B Corporation.”)

What’s Next?

The world is changing, and there is no turning back. Cultural shifts require purpose, planning and resources. Dedicated staff with incentives aligned with measurable results in ESG are necessary for companies to avoid being rendered obsolete by failing to meet client demands for demonstrable commitment.

This doesn’t happen overnight, and it doesn’t happen by adding marketing dollars. The shift can only happen under the guidance of General Partners and CEOs making global citizenship a priority. We’re welcoming all companies to make that commitment.

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