Why is it Difficult to Develop Better ESG Case Studies?

Photo courtesy of Pexels, for illustration purposes only

Introduction

Does Environmental, Social and Governance (ESG) management bring financial returns to companies? That is the common question that from companies when they are encouraged to go beyond reporting compliances.

Whenever companies are being asked on the limitations to uplift their sustainability management, one of the common responses is budget restrictions. To them, investing in environmental protection or in the workforce wellbeing or other social issues would bring no or little financial profits to shareholders.

Failure to present convincing insights on the financial outcomes, will make getting companies on board to focus on sustainability issues to always remain a challenge. But since the Covid-19 pandemic has impacted business around the world, only now companies have started to realise the severe effect in putting sustainability risks on the side-line.

It is in fact not a new discovery that integrating ESG considerations into business strategies is not only important to mitigate external risks, but also profitable as well as important to customer allegiance and protecting against the rising number of major threats to social stability, vibrancy, and inclusivity.

 

But why is it difficult to build sound and comprehensive ESG business case?

Variations of ESG reporting – Companies around the world, in different sectors as well as different regulations, are self-reporting using different ESG metrics. Particularly for early reporters, the majority of ESG reporters disclose data and information that are not audited hence the accuracy and credibility of the disclosure are not determined. Hence, it is a challenge to validate and compare ESG performance clearly.

Limited standardisation of ESG ratings by third parties – Third-party ESG data providers are organisations outside of reporting companies. These third parties would normally use different data and rating systems, resulting in a substantial deviation of assessments.

Unclear linkages of the reporting ESG metrics to the effectiveness of ESG strategies – Many companies tend to report on whatever they have, including based on the operational initiatives in place pertaining some material matters but not directly derived from the companies’ overall ESG strategy. This restricts companies to gauge the effectiveness of the ESG strategies as the data they are monitoring is not exactly the data that they need to focus on to deliver value creation, rather than the data that they have for annual reporting purposes only.

Clear segregation of ESG metrics with financial metrics – As mentioned earlier in the article, qualifying the financial outcome of ESG initiatives could be difficult. To date, only few companies are able to track the return of ESG initiatives to their overall business revenue, and even lesser companies can provide comprehensive and consistent data.

Intangible ESG values are not easily measured – Companies often find that accounting is not the best tool to measure ESG performance as there are a lot of variables to monetise ESG values that are intangible that to date is over 80% of companies value.

To work on building a good business case, we also first need to understand the relationship between ESG and the overall business financial performance.

Companies by now should understand that integrating ESG into business operations is not just mere through corporate social responsibilities programmes. ESG integration should be aligned and centred together with business corporate strategy. A few research has found that companies that have integrated ESG into their core business outperform companies that have not in financial performance as well as stock market performance. This is because these companies strategically focus on managing the material matters that truly have impact on the business and stakeholders. This kind of research is widely available, but it is not good enough to be considered as sound business case for ESG. This is mainly due to the fact that there are still inadequate presentations on the details of how the management strategies or efforts actually work in making performance enhanced or profitable. This is why top leaders are not able to be relate and be convinced the ESG management levers that push towards financial performance.

Case studies on financial performance from sustainable investment on the other hand, have been rather complex due to various investment strategies having different performance profiles. For instance, in reference to negative screening (avoiding investment in industries, such as tobacco or weapons, that work against certain values or social goals) may limit performance as it reduces portfolio range and diversity. But currently, negative screenings that omits coal portfolios are doing well.

Regardless of these research complexity, the trend of ESG performance is showing that there is positive correlations between good ESG performance, stock price, cost of capital, and operational achievements.

 

Conclusion

A clearer business case on ESG’s financial impact are still needed to provide companies to relate and get inspired to make the move towards sustainability excellence. The business case will pave way for companies to scale up their investments in ESG in the face of pandemics like COVID-19, as well as other pressing issues such as climate change, inequality, and many other perceived or real challenges to their bottom lines. The companies’ commitment to meet its fiduciary duties as well as overseeing ESG performance should go hand in hand.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation