In brief
How EY-Parthenon can Help
EY sustainability and ESG strategy consulting teams can help you with strategy, M&A, capital allocation, ESG due diligence and portfolio optimization.
Read moreThe climate crisis and pandemic have heightened interest in environmental, social and governance (ESG) issues. Yet, many companies have been struggling to understand the link between their level of commitment to ESG factors and long-term value.
ESG encompasses a broad range of issues. Environmental factors include biodiversity, climate change, pollution and resources, and water security. Social factors can cover customer responsibility, health and safety, human rights and community, and labor standards. Governance includes anti-corruption initiatives, corporate governance, risk management and tax transparency.
Since the 1980s, boards have been heavily influenced by American economist Milton Friedman’s view that businesses serve society best when they maximize shareholder value. ESG matters were traditionally considered outside the scope of fiduciary duty, with the board and management often, at best, considering it an ancillary topic under the ambit of corporate social responsibility, or at worst, taking an out-of-sight, out-of-mind approach.
However, with increased consumer, regulatory and capital markets scrutiny, this approach has exposed companies to reputational and brand equity risks. It also increasingly exposes them to shareholder pressures, resulting in an erosion of shareholder value in very real ways.
As ESG becomes a key boardroom topic with a direct link to value, it is now more important than ever for companies to assess the role of ESG in their corporate strategy — and view it as the seed that can help crystallize transformation.
Importantly, companies need to truly embrace ESG principles, rather than just greenwash their current strategies with token actions. How they embrace ESG and bring that into their corporate practices can make a difference to their valuations.
ESG factors have been found to be positively correlated with financial performance and attractiveness to investors. There is a mismatch between the growing amount of investment dollars looking for genuine ESG leaders and the limited supply of these companies. This can result in a lower cost of capital for companies that embrace ESG and demonstrate tangible success.
How EY-Parthenon can Help
EY teams can help address ESG and sustainability issues, investor concerns and improve ESG performance. Find out how.
Read moreAt the same time, companies may see shifts in their performance as they adopt ESG principles in their strategy. Strategies that may appear lucrative without considering the impact of ESG on the cost of capital can be destructive to value. Based on an EY-Parthenon analysis of various studies, many value-creation-linked metrics such as operating margins or return on invested capital may move favorably along the journey to ESG leadership. On average, net margins could see a drop. However, the aggregate result of all the movements in metrics — including the cost of capital — is often an increase in the valuation.
Given the link between ESG strategy and the cost of capital, investors are increasingly focusing on understanding a company’s ability to manage long-term risks through ESG disclosures. The credibility of ESG disclosures has therefore become critical in the process of attracting the right investors, across the capital structure.
As investors increasingly seek genuine ESG leaders from a limited
supply of such companies, businesses that embrace ESG and
demonstrate tangible success can realize a lower cost of capital.
A coherent ESG strategy does not just impact the cost of capital. According to EY-Parthenon analysis, which measured the profitability of the top sustainable corporations globally based on Corporate Knights’ 2020 Global 100 ranking, sustainable companies outperformed their industry peers on gross profit, EBITDA, EBIT and net profit metrics.
Other studies agree with this finding. The Oxford University metastudy, From the Stockholder to the Stakeholder, highlighted that for 88% of companies studied, solid ESG practices resulted in better operational performance. In addition, 80% saw stock price performance positively influenced by good sustainability practices.
There are many reasons that can explain this performance. For instance, the increasing influence of ESG factors on consumers’ purchasing decisions has allowed sustainable companies to charge higher price premiums on their products and services. The EY Future Consumer Index found that consumers are displaying increased loyalty and affiliation to brands that demonstrate a clear commitment to their purpose and ESG principles. A majority of the consumers covered in the study stated that they consider ESG factors when making a purchasing decision.
At the same time, a focus on sustainability has often pushed firms to pursue operational and process efficiencies, therefore supporting profitability. These include eliminating waste, simplifying supply chains and cultivating an innovative culture that proactively advocates reinventing existing processes to achieve true circularity.
Despite the overwhelming evidence in favor of incorporating ESG into corporate strategy, the push to prioritize sustainability has proven challenging for corporate strategists as ESG considerations are wide-ranging and require trade-offs that may be hard to quantify. The topic can often be complex, contradictory and even confusing.
Multiple studies show that investors look for focus. Companies that direct their efforts in a concerted manner on the most material ESG aspects for their sector have historically demonstrated a higher alpha than peers that do not. This is illustrated below.
How EY-Parthenon can Help
EY Long-term value teams can help you shape your strategy, drive transformation and measure progress in providing sustainable value through use of the WEF-IBC’s common metrics. EY leading role in developing the metrics means we’re uniquely placed to advise on their adoption and impact.
Read moreCompanies also need to be very clear to all stakeholders on their level of ESG commitment. While managing ESG trade-offs is not easy, “going big” on the ESG focus can be worth it, depending on a company’s individual parameters. Achieving these results is not just a matter of investment but also of thoughtful communication of the company’s ESG commitment to all stakeholders, including capital markets.
By leveraging the long-term value creation metrics identified by the World Economic Forum’s International Business Council, businesses can better demonstrate their contributions toward sustainable, long-term value creation across the full ESG strategy development process from vision definition to implementation.
Long-term value requires companies to have a strategic lens for defining how a business creates, delivers and measures value across the planet, people, governance and prosperity. Having a good understanding of the drivers of future long-term value will prove invaluable in a corporate ESG journey.
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Companies are under increasing pressure from consumers, regulators and investors to consider ESG factors in their business. To succeed, companies need to embark on an ESG journey and embed ESG considerations into their corporate strategy. They also need to leverage the appropriate long-term value creation metrics to better communicate their ESG commitment to stakeholders.
