How to enhance long-term business value through sustainability

As stakeholders’ expectations focus more on sustainable development, companies must fully embrace this paradigm shift to create value.

In brief

• Companies are under increasing pressure to focus on sustainable development and long-term value creation beyond generating profits for shareholders.
• The correlation between corporate sustainability initiatives and long-term value creation is clearer today than in the past.
• By embracing sustainability on the strategic and operational levels, companies can realize greater long-term business value.

When the COVID-19 pandemic struck the world, images of clear waters along Venice’s waterways and clean air in many major cities surfaced during the lockdowns. This once again underscored the human impact on the environment and heightened the interest in sustainability and environmental, social and governance (ESG) risks. Such an interest is not new but has been escalating. Investors are paying more attention to how businesses are managing their ESG risks.

The 2020 EY Climate Change and Sustainability Services (CCaSS) fifth global institutional investor survey found that an overwhelming 98% of investors surveyed evaluate nonfinancial performance based on corporate disclosures. Among them, 72% said they conduct a structured, methodical evaluation.

Yet, it appears that ESG considerations have not been adequately addressed. Investor dissatisfaction with ESG risk disclosures has risen since 2018 and 86% of investors dissatisfied with environmental risk information received said it is critical for disclosures in this area to improve.

This emphasis on corporate sustainability extends beyond the investor community, increasingly underpinning interactions between companies and their customers, supplier networks, partners and employees.

With the growing importance of sustainability in business, corporate executives are hard-pressed to embrace a paradigm shift away from the sole purpose of generating profits for shareholders toward advocating sustainable development and long-term value creation in their organizations.

In recent years, numerous studies have linked the implementation of corporate sustainability initiatives to improved business and financial performance. Similarly, from a valuation perspective, it is believed that sound corporate ESG practices would increase a company’s value. This can be attributed to the impact of ESG practices on three areas: cash flow accretion, lower cost and better access to capital, and market-specific factors.

This is corroborated by an EY analysis, which measured the profitability of the top sustainable corporations in the world based on Corporate Knights’ 2020 Global 100 ranking2 against that of their respective industry medians. Sustainable companies in the ranking outperformed their industry peers on gross profit, EBITDA, EBIT and net profit metrics (see chart below). These companies recorded higher EBITDA and net profits than their peers for 73% and 61% of the industries analyzed respectively, with the extent of outperformance ranging from 3.1 to 6.3 percentage points.

Higher ESG-rated companies have also been associated with lower idiosyncratic risks. According to The Journal of Portfolio Management, sustainable companies experienced a lower frequency of large, adverse idiosyncratic stock price moves between 2009 and 2019, compared with those that had a lower ESG rating.3 This could be attributed to better risk management and compliance standards across their operations and supply chain practices, resulting in organizations that are more resilient and less susceptible to the risks of black swan events, including compliance breaches and supply disruptions.