Is ESG Just Common Sense?

Image featuring the words 'Common Sense' from OWL ESG

According to a new global survey of C-suite executives, Environmental, Social and Governance (ESG) efforts have slipped lower on corporate priority lists. The business media site (all lower-case), which serves sustainability, energy, and environmental professionals, reports that The Harris Poll surveyed more than 1,476 top-level executives in 16 countries for the second year and found that ESG efforts “fell from the number one priority for businesses to third in 2023.” The top two priorities were “driving revenue and growth” and “optimizing client relations.”

Should ESG be a company’s top priority?

We were not disappointed by the results of this poll. That may seem strange, given that we are dedicated to bringing accurate, timely, robust ESG data to all types of businesses (in other words, we live and breathe ESG). Frankly, we were surprised that “ESG efforts” ranked as the number one priority in the prior year’s survey.

Except…and this is not back-pedaling…except that the survey respondents in the previous year may have chosen ESG as their top priority because evaluating a company’s ESG practices offers a disciplined way of focusing on factors that are too often overlooked but that actually help to drive sustainability. And, if C-suite executives are not prioritizing ways to make the business sustainable they are not going to create shareholder value; in fact, they risk destroying it. 

Oh sure, a company could probably save money in the short-term by ignoring the factors that an ESG perspective highlights. For example, it could make no effort to reduce greenhouse gas emissions, refuse to invest in improving employee retention, use the cheapest suppliers from countries with poor track records on human rights (thus creating huge reputational risk when it inevitably comes to light), not enforce policies against discrimination, and so on.

Those would almost certainly keep costs low in the short-term. But that modus operandi is like not changing your car’s oil or air filter and continuing to ignore the Check Engine light on the dashboard because you don’t want to pay for maintenance. With that short-sighted mentality, the car is virtually guaranteed to have a major breakdown that may not be fixable. The same goes for a business. Top executives have to think about keep the company on a sustainable path, for the long-term, or there will be no business to run. 

ESG’s far-reaching economic connections 

Let’s look at the fallout of ignoring just one element of ESG. If we (all of us, collectively, meaning every government, business, and household) fail to reduce global GHG emissions to the target level established by the Paris Accord, the implications for just about every type of business are ominous. The cost of food will increase, so households will have less disposable income. That’s not good for any retailer or business that manufactures consumer goods. Supply chains will be disrupted and tourism in many places will decline, hurting those economies and the travel and tourism industry. And we haven’t yet said anything about health problems, the cost of insuring property, and so on. 

An article in Time reports that, while the lion’s share of carbon emissions can be tracked to a fairly small number of the world’s largest companies, roughly 90 percent of businesses worldwide are small to mid-sized companies that form part of the supply chains that drive big businesses. In other words, everything is connected. If a large corporation wants to reduce its carbon footprint by 10 percent, it is likely to pressure its suppliers to pitch in to help reach that goal.

The article goes on to note that small businesses have less ability to absorb hardships caused by climate change. These hardships can pose severe economic threats to a small business – such as a florist shop that can’t get flowers due to a persistent drought – and small businesses account for roughly 50 percent of all jobs worldwide. If every small business had to lay off 20 percent of its employees because of an inability to source the products it sells, that would be an economic catastrophe.

The implications of many aspects of ESG are extensive and financially material – in other words, they should be top priorities.

Common Sense?

Is all of this just common sense? If that’s your view, you’re in good company. As Fidelity International put it, “to think that a company can thrive in the long run while continually ignoring ESG metrics – which present real and material risks – is entirely unrealistic.” Pensions & Investments recently wrote that, according to the state treasurer of Massachusetts, who chairs the Massachusetts Pension Reserves Investment Management board, taking ESG considerations into account is, “what practical common sense business people and investors and, by the way, the ratings agencies have been doing for years.” 

Wait – hold on – rating agencies? To be clear, the MA state treasurer was not talking about ESG ratings; she was referring to ratings that measure a company’s credit quality (default risk). Those ratings have been around in one form or another for over 100 years. Indeed, sustainability is intimately tied to credit quality — simply put, businesses that pay attention to sustainability issues have a higher probability of being able to repay their bondholders in the future than companies that ignore how ESG factors affect them. 

Unfortunately, ESG has become politicized in the U.S. (not elsewhere, we remind ourselves). But common sense, specifically common business sense, tells us that examining ESG-related risks is not a political issue. It helps companies to recognize potentially serious threats to their business model, remain competitive, attract customers and employees, stay out of legal trouble, etc. But this isn’t the same as the kind of common sense that keeps us from jumping into swimming pools when we don’t know how to swim. Common sense may tell company management that ESG factors can create or destroy shareholder value, but they need data to take meaningful action. 

Measure to manage

It comes down to the old adage, “if you don’t measure it, you can’t manage it.” Without quantifiable, objective ESG data, companies cannot:

  • decide where they need to make improvements, whether that is reducing their carbon footprint or reducing employee turnover, 
  • know whether or not they are making progress on a given issue,
  • provide investors and other stakeholders with meaningful reports so they can evaluate progress on the company’s ESG initiatives,
  • identify whether an investment opportunity involves unacceptable ESG-related risks (imagine making a bid to acquire a company without knowing whether it could continue to source key raw materials at an economically viable cost).

Investors also want to be able to measure all of these things, because it helps them to make better decisions. If a company in Industry X reports that its greenhouse gas intensity (GHG emissions per million dollars in revenue) is Y, investors need to be able to compare that against the average for the industry to know if that is good, bad, or ugly. The same applies to water consumption, employee turnover, UNGC violations, and any number of ESG-related issues that can be measured. Greenwashing is a serious issue that makes investors wary, and that companies can address by publishing quantifiable, verifiable data about their ESG practices. 

Way back in 2015 (a different era with respect to the state of corporate social responsibility reporting) a study published in the Journal of Business Studies Quarterly showed a significant positive relationship between corporate social responsibility, market-to-book value, and return on capital employed. Is it common sense to suggest that companies that are well-managed in terms of key ESG metrics tend to have their act together overall? It sure seems feasible.

OWL collects data on hundreds of ESG-related metrics from a wide range of sources that our clients use to make informed management decisions, compare companies to industry peers across a wide range of issues. Contact us to learn how we can help your business to go beyond the common sense aspects of ESG to make informed, data-driven, value-creating decisions.