Investors increasingly recognize that sustainability issues – environmental, social, and governance (ESG) issues that are often overlooked by traditional analysis – can be material to investment performance. Recent examples demonstrate that ESG issues such as toxic waste, workplace safety, or corporate governance can significantly impact companies’ reputations and financial performances. For instance, Apple’s share prices dropped 5% after unsafe working and living conditions of its Chinese manufacturer’s personnel were publicized in 2010. Similarly, the Deepwater Horizon oil spill wiped out more than half of BP’s stock value.
Studies show that strong ESG management can help companies perform better and can mitigate negative publicity in times of crisis. Therefore, it is imperative that companies understand the importance of ESG issues and adopt sustainability strategies focusing on the three main elements – information, innovation, and integration – to moderate sustainability-related risks and take advantage of associated opportunities.
Transparency can help companies control the information flow, improve their reputations, and prepare for increased disclosure standards in the future. In today’s world, information travels fast. Surfacing mistakes can impact companies’ reputations and financial health. Therefore, it is wiser to report proactively on successful sustainability projects, while also mitigating ESG mishaps with voluntary reporting strategies that uphold the company’s reputation. For instance, by disclosing statistics such as injury, fatality rates, and safety management efforts, extractive companies demonstrate their commitment to safe operations. In 2012, by openly reporting that it fell short of its target proportion of alternative-fueled vehicles in its fleet due to the changes in market conditions, Verizon positioned itself as upfront and proactive.
Companies should measure their carbon footprint and participate in reporting initiatives. By making their sustainability data public, they are more likely to receive improved ESG or credit ratings, and benefit from lower cost of capital. As an additional benefit, this will also help to prepare for more stringent disclosure standards. Growing recognition of the significance of ESG has already led to some changes in disclosure requirements worldwide. In the U.S., several prominent pension funds require consideration of ESG factors in their investment policy guidelines. In 2010, the U.S. Securities and Exchange Commission (SEC) issued guidance on climate risk information disclosure. However, broader disclosure requirements are imminent with organizations such as the Sustainability Accounting Standards Board are already developing industry-specific accounting standards that companies can use to report on ESG issues in their required disclosure filings with the SEC.
Innovation can help companies improve their sustainability, financial performance, and competitive edge. Instead of engaging in costly sustainability initiatives irrelevant to their strategy and operations, they need to focus on ESG factors essential for their business, while also benchmarking against competition. A good start is identifying and eliminating the main sources of inefficiency. Reducing manufacturing waste, decreasing emissions, enhancing energy or water management all can improve operational efficiency and help to realize savings. However, getting ahead of competition requires a broad company-wide innovation. New products, processes, and new business models are needed to take companies to the next level of performance. For example, Apple has reduced the amount of materials and energy utilized to produce and maintain its products by making them smaller, lighter and more energy efficient. Facing criticism, Dow Chemicals Company focused its efforts on eliminating waste at the source and innovation of its products and processes. Between 2005 and 2010, Dow reduced production related waste over 17%, despite company’s expansion.
Integration of ESG factors into the main strategic decision-making processes is key to organically improving companies’ sustainability and financial performance. Such comprehensive approach to sustainability would require an organization-wide understanding of ESG factors and their impacts on the company, and uniting all of the elements – transparency, efficiency of operations, and innovation. According to Westpac Banking, an Australian corporation chosen as the most sustainable company of 2014, sustainability includes not only operational efficiency, but also “mechanisms to encourage meritocracy, diversity, innovation and long-term planning beyond the next financial quarter”. Apple has also been addressing sustainability on multiple fronts by not only diligently providing sustainability reporting, but also committing to minimizing its environmental impact and GHG emissions, supplying 100% of power for its facilities from renewable sources, and ending the use of conflict minerals.