As the world faces unprecedented uncertainty during the COVID-19 pandemic, companies are reevaluating their approach to sustainability as a means of preserving and enhancing the value in their organizations. Risk events, like natural disasters and pandemics, have proven their potential to disrupt the global economy and erode investor value. Meanwhile, social issues like insufficient diversity of thought and gender inequality prevail in the daily operations of most firms. Well-prepared organizations that incorporate environmental, social and governance (ESG) practices will be better prepared to mitigate the impact of these threats to their organizations.
Focusing on sustainability through the development of ESG practices offers many potential benefits to organizations and their investors. Here, we will focus on three of the benefits of sustainable business practices and their implications for investors. These include:
Evaluating the sustainability of an organization using ESG factors forces an organization to take a long-term view of their business to assess risk and opportunities. Increasingly, firms are focusing more of their time on enterprise risk management (ERM) as a means of identifying and eliminating risks to an organization. This helps to preserve enterprise value and reduce return volatility. By building a sustainability framework and incorporating it into ERM practices, firms are able to assess environmental, social and governance threats to the organization, which is a key first step towards addressing those threats.
A large part of risk management is the ability to manage change. Mercer’s Talent Trends study revealed that 72% of CEOs with ESG responsibility believe their organization is change-agile. In part, this is because they have reviewed ESG threats to their organization.
In addition, a relationship exists between the incorporation of sustainability and ESG factors in the C-suite agenda and company performance. The Talent Trends survey revealed that CEOs who have ESG metrics on their business performance dashboard tend to lead higher revenue growth companies. In fact, 75% of companies that have ESG metrics embedded into the CEO’s agenda report revenue growth rates of more than 6%, whereas only 35% of companies that have not assigned ESG metrics to their CEO reported the same growth. One possible explanation for these results is that when executives include ESG factors on their agenda, they are taking a more holistic view of the firm and its risks. This helps to reduce the likelihood of unanticipated shocks to revenue and profitability, enhancing investor value.
By adopting and refining an ESG framework, organizations are able to evaluate how ESG factors align with their mission and values. Ensuring consistency between an organization’s values and actions is critical to building a reputation with customers, employees and other stakeholders. Failing to account for ESG factors in the long-term strategy or day-to-day operations of a firm triggers a disconnect for employees and can negatively affect morale, productivity and retention. At the same time, sending an inconsistent message to consumers about a company’s core values can lead to diminishing and less consistent revenue. Both of these factors threaten investor returns and introduce volatility into a firm’s earning potential, making a firm a less attractive investment.
Interestingly, the C-suite sees the need for ESG integration, with 68% of executives attesting to the need to make better progress on ESG, but boards have yet to mandate targets for three-quarters of business leaders. In addition, while ESG-related metrics are rarely adopted in executive incentive plans, companies that have taken a compensation-based approach see about 27% higher ESG scores than those that have not. If ESG-related metrics have been crafted with a company’s mission and values in mind, then ensuring alignment between top management incentives and ESG factors is vital to holding leadership accountable to the company’s mission and values. Absent this alignment, there is less incentive for leadership to prioritize ESG factors, which has the potential to tarnish the reputation of the firm and diminish its prospects of success for investors.
Emphasizing the importance of ESG factors also has significant benefits with regard to attracting and retaining talent. According to Mercer’s Talent Trends survey, one in two employees want to work for an organization that offers “responsible rewards” to its staff. These include environmentally responsible and socially responsible rewards. Employers that are able to build a reward system that incorporates their ESG philosophy will be able to attract and retain better talent, which will in turn strengthen their organizations and potentially lead to better returns for investors.
Diversity of talent is another important factor that can be addressed via an ESG framework. As an example, consider the importance of social factors in the financial services industry. Mercer’s When Women Thrive research reveals that firms in the financial services industry have a stark imbalance between men and women at their upper levels. This means that men are driving most strategy decisions in the financial services sector, which can lead to a situation where the needs of female investors are underserved. Compounding this is a lack of female financial advisors: The Bureau of Labor Statistics estimates that only 31% of US financial advisors are female. Having a wealth advisor of the same gender can help facilitate trust between the investing parties, leading to improved outcomes. A well-designed ESG framework would address the absence of gender diversity and could enhance a financial services company’s ability to meet the needs of female clients, leading to improved financial results.
In addition, sustainability and ESG factors resonate with millennials. For many millennials, these factors are more than just a consideration; they are a way of life and a key component of their belief system. Companies that show a commitment to ESG factors will be better positioned to recruit younger workers. This will help to improve the diversity of thought in the organization, leading to better idea generation and potentially resulting in enhanced returns for investors.
The importance of accounting for and embracing ESG factors as part of a framework for sustainability is critical for all organizations. ESG factors present both risks and opportunities for organizations and their investors. Firms that are adept at addressing and adapting to changes in these factors will not only perform better from a financial risk and return perspective, but also better meet the needs of all their stakeholders.
1 Mercer. Global Talent Trends Study: Win With Empathy, 2020.
3 Mercer. Global Talent Trends Study: Win With Empathy, 2020.
6 Mercer. When Women Thrive – Financial Services Perspective, 2016.
7 CFP Board. “Making More Room for Women in the Financial Planning Profession,” 2014, available at https://www.cfp.net/docs/about-cfp-board/cfp-board_win_web.pdf.