- ESG is the idea that companies should use nonfinancial factors to influence and challenge their environmental impacts (E), social impacts (S), and governance attributes (G).
- ESG factors have become a significant consideration in the way businesses are led and managed.
- ESG investing has several key business benefits, including giving companies the ability to better manage risk.
The requirements of business were once much simpler: Make money. Whatever good or ill befell the people in and around the business was secondary for those who were eager to see returns on investments and growth.
But investors are changing, and with them, business changes, too. Today’s corporate landscape is a mixture of shareholder earnings, responsibility to employees’ well-being, and accountability to the greater good. In short, businesses have to do good, and they have to be good.
That’s never been clearer than in this challenging and unprecedented era of COVID-19, which is impacting businesses and people—from small manufacturers to giant construction companies—all over the world. Environmental, social, and governance (ESG) investing was important before, but it will be even more meaningful as humanity recovers from this pandemic and strives for resilience in the future.
What Does ESG Mean?
This brief acronym, ESG, captures a big idea: that companies should also use nonfinancial factors to influence and challenge their environmental impacts (E), such as use of energy and materials; social impacts (S), including workforce health, safety, and diversity; and governance attributes (G), such as business ethics, shareholder rights, and executive compensation policies.
While business leaders should look at ESG fund valuations and predictions with a critical eye, there are currently an estimated $12 trillion in assets managed with sustainability goals in the United States, and Bank of America Merrill Lynch analysts estimate that ESG funds will see $20 trillion of asset growth in the next 20 years. Meanwhile, a 2017 survey (p. 9) by KPMG states that 75% of the largest 100 companies across the globe are implementing sustainable approaches—up from 12% in 1993. There is no question that ESG factors have become a significant consideration in the way businesses are led and managed.
As a CFO, I look at the need for ESG investing as an imperative for companies and the planet. After all, there’s only one Earth. Everyone has to share it and care for it—and for each other. Fortunately, people can use their positions in the business world to help shape better practices for the future.
But if the idea of embracing change that will cost money, at least in the short term, causes you anxiety, I have good news: ESG investing is good business. Informed by my experience as CFO and as a member of the US chapter of the CFO Leadership Network (founded by Prince Charles), here are five reasons why business leaders should care about ESG and invest in it for their companies’ future and growth potential.
1. ESG Investing Is Good for the Planet
Each month brings new and alarming details of the accelerating decline of the environment. While governments certainly have an important role to play in mitigating the problem and creating solutions for a better future, businesses have to lead, too. They can partner with governments and agencies to embrace and even push for systemic changes that will reap rewards around the world, but businesses cannot wait for policies and governance to be implemented.
For example, a company might embrace a plan to become carbon neutral, like Autodesk has. This admirable goal requires you to account for the impacts your business processes have on the climate and zero them out. You can achieve this by doing things like investing in efficiency and buying renewable energy and carbon offsets. Will it cost money in the short term? Yes. But it will pay dividends down the road.
2. ESG Helps Businesses Manage Risk
You’ll find few, if any, board rooms that don’t know what ESG is and speak about it frequently. Indeed, the need for ESG strategy and planning increases with each passing day—as does the cost of not doing anything.
BlackRock CEO Larry Fink wrote a 2020 letter to CEOs that outlines why ESG is a standard benchmark for investors today. Essentially, Fink said in his letter, “Look, there are climate risks, but you can’t separate climate risks from business risks anymore.”
But Fink added that without real ESG standards and disclosure of ESG metrics, it’s hard to price these investments into equities. So with leadership from corporations like BlackRock (which now has $7 trillion in assets under management), companies are trying to figure out how to price both the cost of ESG investing and the cost of not investing in ESG into investment decisions.
Perhaps that’s what cuts about as cleanly as possible to the CFO community: What will the cost to you ultimately be if you choose not to make these investments?
3. ESG Is Good for Business
It’s my responsibility as CFO to pay attention to trends that affect the future of business. It’s becoming clear that good ESG behavior is an investment that can pay off in multiple ways: Managing ESG risks such as carbon emissions from data centers and customer privacy and security issues—as well as fostering employee diversity to enable innovation—can maximize revenues. But it can also create extra incentive for investors to consider you.
Why does good ESG investment bring superior returns? It shows that you’re paying attention to the right things. You’ve got the right management hygiene. You’re focused on the long term, not just the short term. That type of smart management focus is what leads to greater investor interest and, ultimately, higher returns.
But investing in ESG has to be more than a check mark in a box. You can’t just write a couple of paragraphs in your annual report and market yourself in a feel-good way. A lot of companies place the elements of ESG as tertiary to income and investment. As long as you’re not dumping pollution into a river, you may believe you qualify for an ESG tag. But in a real side-by-side comparison of a true ESG focus and processes, companies can clearly set themselves above the level—and investors can tell the difference.
4. The Next Generations Are Driving ESG Investing
In the coming decades, America will undergo a major shift in wealth, as baby boomer numbers and wealth are eclipsed by Gen Xers, millennials, and Gen Zers. It’s no secret these younger generations think that baby boomers—a generation I’m at the tail end of—are whistling past the graveyard on this burning issue.
These upcoming generations care deeply about ESG, and a company’s ESG reporting standards and performance will greatly impact how and where these younger investors participate. They routinely look to sustainable corporations to lead the way and help them know where and how to invest.
If you’re not already incorporating ESG planning and behavior into your business’s objectives and goals, know that this shift is taking place now. Companies that don’t get ahead of it are going to be left behind as generational wealth transfer occurs over the next couple of decades.
5. ESG Standards Are Coming
As widespread and warmly accepted as ESG investing is, there are no real standards for ESG scores. You can look at corporate debt, which has a well-established set of standards, and know what that means relative to another company. That doesn’t exist for ESG right now.
But that’s changing. Firms such as Sustainalytics and MSCI have created scoring mechanisms that help investors understand businesses’ efforts and returns. A universal measurement will be welcome as companies look to base expenditures and business decisions on ESG returns and impact. Disclosure standards will help reveal the internal processes inside a company that drives good ESG behavior.
When that comes, will you be positioned ahead of your competition? And if you’re behind, what does that mean for your investment potential?
Companies are embracing ESG investing because they’ve decided that what is good for people and the planet is worth any short-term pains for the long-term growth in goals and revenue.
Yes, profits are still paramount. But fair, socially responsible, and environmentally sound practices matter—to employees; to business partners; and, increasingly, to investors. And the companies who adopt these progressive practices now will win in the long run.
This article has been updated. It was originally published in June 2020.