In recent years, Environmental, Social, and Governance (ESG) factors have garnered substantial attention as businesses endeavor to align their operations with broader societal goals. While acknowledging the undeniable importance of ESG for risk management and long-term sustainability, it is imperative to recognize that ESG serves as a component, not the sole driver, of running a successful business. The paramount goal for any enterprise remains the delivery of advantaged profitability and sustainable return on capital employed. In this article, we delve into the intricate relationship between ESG and business success, reflecting on recent peaks and setbacks in ESG momentum and considering recent studies on the correlations between valuation and ESG scores. Furthermore, we shed light on how Full Scope Insights’ fractional model can assist companies in developing, implementing, and managing effective ESG strategies at a fraction of the cost of fully staffed in-house programs and larger consultancies.
Environmental, Social & Governance (ESG) factors among other key components of successful businesses
Reflecting on Recent History: Peaks and Setbacks in ESG Significance
The surge in ESG practices between 2018 and 2022 wasn’t solely driven by market forces; it was significantly influenced by regulatory pressures and heightened environmental awareness. During this period, governments, investors, and consumer stakeholders intensified their focus on sustainability encouraging businesses to adopt environmentally friendly, socially responsible, and well-governed practices. Investors and consumers, increasingly attuned to global issues, responded favorably to companies aligning with these principles, resulting in a notable increase in the prominence and public discussion of ESG practices. Regulatory pressures acted as a catalyst for change, pushing ESG to the forefront of corporate priorities.
However, we have noticed a recent setback throughout 2023 in the perceived importance of ESG suggesting a more complex and nuanced evolution. As governments grapple with a myriad of challenges and geopolitical risks rise, the prioritization of ESG issues may have momentarily receded in the face of other more pressing concerns, notably hyperinflation, economic recession, and physical security.
Additionally, the concept of greenwashing has cast a shadow over the authenticity of some ESG efforts. Greenwashing occurs when companies, in their pursuit of positive ESG perceptions, overstate or misrepresent their environmental and social initiatives. The fear of being perceived as insincere or opportunistic has led to skepticism regarding the authenticity of some ESG commitments. As a result, investors and consumers increasingly seek transparency in evaluating the actual impact of a company’s ESG practices.
In navigating this evolving landscape, companies must recognize that ESG considerations, while essential, should not overshadow generating sustainable profitability and financial returns for shareholders. To maintain credibility and genuinely contribute to societal and environmental goals, businesses need to ensure that their ESG efforts are substantive, transparent, and aligned with long-term financial viability.
Correlations Between ESG Scores and Valuation: Unveiling Complexity
Several studies, including one conducted by Deloitte (linked here), reveal that companies with high ESG scores tend to have slightly higher valuations (TEV/EBITDA) than their counterparts with lower scores. However, the existence of an “ESG value premium” and the relationship between corporate investment, ESG practices, and higher valuation multiples are complex and context-dependent. Another comprehensive study by NYU Stern (linked here), which aggregates evidence from over 1,000 studies published between 2015 and 2020, confirms that the adoption of strategic ESG practices is positively associated with financial performance, with the impact becoming more pronounced over longer time horizons. Despite these and several other positive correlations that have been identified between ESG score and valuation, challenges are noted due to the lack of standardized ESG data, making it difficult to draw definitive conclusions.
It is our view that ESG disclosure on its own does not drive financial performance. An effective ESG program must integrate material ESG factors into the overall business strategy in a cost-efficient manner to build resilience, mitigate downside risks, and facilitate the creation of both tangible and intangible value over the long term.
Building A Strategic, Cost-Efficient ESG Program with Our Fractional Model
Recognizing the need for a pragmatic and cost-effective approach to ESG strategy development and implementation, Full Scope Insights offers a fractional model that stands out in the landscape of ESG advisory. Our solutions enables companies to access comprehensive ESG services without the exorbitant costs associated with fully staffed in-house programs or larger consultancies. Our model facilitates the development of tailored ESG strategies that align with a company’s unique business model and goals. By breaking down the process into manageable components, Full Scope Insights ensures that companies can implement effective ESG programs that not only meet compliance standards but also contribute to enhanced profitability and returns.
Contact us to learn more about our ESG business solutions.
August Scherer, President