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How ESG Affects Financial Performance

"What are we getting for our ESG dollars?" is an often-heard question for sustainability professionals.

If you haven't been asked yet, consider yourself lucky. Less than 30% of corporate executives believe their sustainability initiatives to date have been successful, according to a report by ENGIE Impact. Knowing this, it's likely you'll eventually have to answer this difficult question.

Whether the inquiry is expected or a total surprise, it's wise to think ahead about how you will respond. After all, there's nothing worse than stammering your way through an explanation. However, if you prepare properly, there's no reason to dread this question.

In fact, this question is a great opportunity to bolster additional support for your ESG initiatives and stand out to your boss (or your boss's boss).

What executives want to know

As with any question from an exec, the key to crafting a compelling answer is understanding why the question was asked in the first place.

Whenever someone asks, "What are we getting for our ESG dollars?", what they're really asking is, "What is the value of ESG?". Specifically, they want to know how ESG affects the business' financial performance.

Naturally, executives are interested in whether the initiatives they're investing in are having an impact on the business' bottom line. While sustainability professionals might point to things like emissions reductions, CEOs may be more concerned with cash flow, margins, and stock values. 

It’s their job to be skeptical and to question the value of any expenditures. And they want to see real proof, not a hunch or gut feeling. So how do you prove the financial value of ESG? From the research, we've identified five key ways ESG affects financial performance.

5 ways ESG affects financial performance

  1. Operational cost savings
  2. Regulatory compliance costs
  3. Stock prices
  4. Risk & credit ratings
  5. Competitive advantage

1. Operational cost savings

Perhaps the most obvious financial impact of ESG is operational cost savings. Efforts to reduce water or energy consumption will have an immediate impact on your business' bottom line. Take PepsiCo, for example. By treating and recycling water from its Frito-Lay potato chip and snack making process, the food and beverage giant saved over $20 million a year on utilities and other expenses. This is by no means an uncommon situation: McKinsey states that ESG strategies can positively affect operating profits by as much as 60%.  

2. Regulatory compliance costs

Every company has its own regulatory requirements that must be met. Banks must obey policies regarding data privacy and protection. Chemical manufacturers have laws about worker safety and material handling. Oil and gas companies are subject to emissions and transportation regulations. All of these fall under the umbrella of environmental, social, and governance (ESG).

ESG performance (or lack thereof) can have a direct impact on regulatory compliance, and the financial consequences of non-compliance can be severe. Fines and penalties cost, on average, $2 million — and that’s just the tip of the iceberg. Business disruption, lost productivity, revenue loss, and reputation damage all eat away at profits. The true cost of non-compliance is estimated at over $14 million. Most if not all of this can be avoided with strong ESG performance.

Companies may also be required by law to disclose their ESG performance. In the European Union, for example, the Corporate Sustainability Reporting Directive (CSRD) will require all large companies to disclose not only how sustainability issues affect the company but also how the company impacts the environment and society. The U.S. Securities and Exchange Commission (SEC) also plans to make sustainability disclosure mandatory by 2023. While the exact rules and penalty for non-compliance remains to be seen, companies should brace for significant impacts. 

3. Stock prices

CEOs of publicly traded companies place great importance on their stock prices. Stock prices are one indicator of a company’s financial health and long-term sustainability. They are also a key component of how executives get paid. Therefore, the connection between ESG efforts and stock prices will be of great interest to the C-suite.

Researchers from Kellogg and Harvard Business School found that stock value tended to rise after positive ESG news about a company emerged. In particular, news about safety, consumer privacy, improving labor practices, and lowering environmental footprints were linked to a bump in stock prices. 

On the flip side, negative ESG factors can also impact stock valuations. When top Tyco executives were indicted for $600 million in fraud in 2002, the company’s stock prices plummeted nearly 80%. This is a prime example of how a negative ESG factor (poor corporate governance, the ‘G’ in ESG) can hurt stock performance. 

4. Risk & credit ratings

ESG factors can affect a company’s risk ratings when it comes to things like purchasing workers’ compensation or commercial property insurance. From the insurance company’s perspective, the reasons for this are fairly obvious. Companies with a strong track record of safety performance (the ‘S’ in ‘ESG’) have less risk of an accident, and therefore are less likely to make a claim. Because of this, companies with strong ESG performance may benefit from lower insurance premiums

ESG is also rapidly becoming a factor in a company’s credit ratings. Today, both Moody’s and Fitch use ESG as a measure to verify long-term issuer credit rating changes. Therefore, positive ESG performance should help boost companies’ credit ratings, which in turn has a direct impact on the company’s ability to borrow money and on the cost of debt. 

5. Competitive advantage

Of all the financial impacts of ESG, competitive advantage is the most difficult to measure. However, that doesn’t make it any less valuable. 

Today’s consumers have overwhelmingly indicated a preference for more socially and environmentally responsible goods. This is evident from the fact that two-thirds of consumers say they would rather buy from sustainable brands, according to a study by IBM and the National Retail Federation. What’s more, they’re willing to pay a premium for sustainability: Of these environmentally-conscious shoppers, nearly 7 out of 10 said they would shell out up to 35% more for eco-friendly products. 

Take electric vehicles, for example. Ford Motor Company’s gas-powered F-150 pickup has a base price of $28,940, while its new F-150 Lightning electric model starts at $39,974 — or $11,000 more. At that price, it would take more than 17 years for the average driver to make up the price difference in fuel savings by choosing the electric model, yet many shoppers are willing to pay more for an EV  anyway. 

Making the connection

If making the connection between ESG and financial performance seems difficult, that's because it is. Many organizations, including the Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), and International Sustainability Standards Board (ISSB) are all trying to solve this problem.

 The good news is that the volume of data today should make it possible to identify metrics in the five key areas above — operational costs, regulatory costs, stock prices, risk and credit ratings, and competitive advantage —  in order to prove the worth of your ESG program. 

How we can help

Do you have the tools you need to track, measure, and report on your business' ESG performance? Perillon offers an affordable, comprehensive ESG management software that will drive more sustainable consumption and better financial performance. Schedule a demo of Perillon today!

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