Is the lack of ESG a risk for big firms?

With all the work, all the talk, all the strategy, and all the investment being pumped into environmental, social, and corporate governance (ESG), many people sitting on boards will no doubt wonder about the actual value of their efforts.

Managers and board members might ask questions similar questions of ESG across many companies:

• “What does ESG achieve?”
• “What are the benefits of ESG?”
• “Is ESG too costly? What will happen to our short-term returns?” 

Inevitably, the flip side of that argument may surface as well:

• “What will honestly happen if we do nothing?”

ESG has grown dramatically in importance over the past twenty years. It now commands over $41 trillion worth of assets globally, and the figure is only expected to climb. This fact alone strongly argues that a lack of ESG is a risk for companies. But let’s dig deeper.

Criticism continues that ESG efforts are, at their core, merely a trend for companies to follow so they can tick the “look good” box.

The ‘gravy train’ and similar problems

The question of ESG is a topical one in mid-2022. Elon Musk, one of the most influential business people in the world, called the concept a “scam” after Tesla was removed from the S&P 500’s ESG Index. ESG has also come under severe scrutiny in the aftermath of Russia’s invasion of Ukraine as fossil fuels like oil and gas surge in value.

Meanwhile, the criticism continues that ESG efforts are, at their core, merely a trend for companies to follow so they can tick the “look good” box. 

ESG is ‘too many conflicting meanings, metrics, and milestones, all grouped under a vague umbrella of companies trying to focus on something other than profit.’

Too broad for its good

In an interview with Market Watch earlier this year, NYU professor of corporate finance and valuation Aswath Damodaran criticised the ESG effort as being too broad, with too many conflicting meanings, metrics, and milestones, all grouped under a vague umbrella of companies trying to focus on something other than profit.

“The problem with goodness is how the heck do you come up with a consensus on the measure of goodness,” he told the publication. “It [ESG] seems to be a gravy train; many people are making money on this idea.”

Damodaran said local laws might well mandate measures to address the “environmental” component of ESG. 

The enormous EU and US financial markets were given as examples, as both jurisdictions are now introducing stricter, greener legislation that companies need to follow.

“With climate change, you don’t need ESG,” he said. “It’s going to show up in your cashflows; it’s going to show up in your value.”

Companies that don’t actively pursue an ESG strategy risk losing the attention of investors, despite the investors knowing that, short-term, ESG is almost purely about costs.

Should companies be worried? Is the lack of ESG a risk? 

This criticism may suggest that a lack of ESG strategy does not immediately lead to a heightened risk for your business. “It’s just a fad; it’s not impactful; there are other ways to achieve the same results” – in other words: don’t worry about it.

But is that way of thinking honestly the case? There is a strong level of support for ‘no’ also.

Much of this argument starts with investors: the people want absolute certainty that their money will create value.

According to Deloitte, Forbes, and PwC, companies that don’t actively pursue an ESG strategy risk losing the attention of investors, despite the investors themselves knowing that, short-term, ESG is almost purely about costs.

Investors aren’t thinking short-term, these organisations say. They aren’t as worried about costs now because they know that there are higher rewards at the end of the tunnel. These include:

• More revenue
• Better employee performances
• Higher motivation
• An improved reputation for attracting more customers. 

The corporate world is quite clearly moving towards a greater focus on ESG values.

Will ESG continue to matter in future?

Investors’ enthusiasm for ESG may change if the endgame looks different, but right now, the chances of the endgame looking different are slim at most. A different endgame means that governments and societies would suddenly care less about green legislation, diversity in the workspace, tackling social issues, improving the welfare of employees, and the penalties for not contributing to these causes. In many of the world’s leading markets, this just isn’t going to happen.

The world is quite clearly moving in the opposite direction, towards a greater focus on ESG values. This is evidenced by the increasing importance of COP summits, employment law, and continuing efforts to promote inclusion and move away from the hierarchical patterns of past decades.

In summary

If ESG issues remain, then investors will remain attached to them, and this alone might convince many that operating without an ESG strategy is an inherent risk that could lead to trouble down the line.

Ultimately, that risk will always be there. Sometimes it’s big enough to need urgent attention; other times, it might be small enough to be negligible. But in some of the biggest markets in the world, where the values of ESG are only gaining in importance, companies should certainly think twice about choosing not to consider them.

Further reading:

1. Is ESG a gravy train?
2. Here’s what big investors feel about ESG
3. ESG will help your risk management 

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