Meeting ESG expectations is about more than reputational risk.
Companies are increasingly under pressure to improve their environmental, social, and governance performance. According to two new research, investors penalize companies that either violate their corporate duties or overpromise on their greenness. Companies that haven’t yet assigned a senior leader to oversee ESG accountability should do so.
The Swiss Finance Institute used data from RepRisk, a company that tracks companies’ environmental, social, and governance (ESG) violations. More than 76,000 ESG incidents were investigated at 8,000 organizations in 45 countries or regions.
To draw comparisons, the analysts linked companies with ESG alerts with peers in the same country and industry but without notifications.
Analysts penalised firms with negative ESG news events, according to the researchers, who cut their profits per share projections for transgressors in the following quarter and over one- to three-year horizons. The higher the decrease to earnings projections, the more incidents a company experienced. Downgrades were driven more by social and governance difficulties than by environmental malpractice.
Analysts predicted decreased future revenue for companies with poor ESG records, rather than an increase in their cost of capital or more spending to resolve the issues, according to the report.
Companies struggled to recover from the negative effects of bad ESG news. A credit-rating drop had nearly half the influence on longer-term expectations compared to a one-year horizon; by contrast, a downgrade to profits estimates in the following three years was 1.36 times bigger than in the following 12 months.
Both expected and actual share prices were affected in the same way. Analysts cut their price target guidance for ESG offenders, and they were correct: when compared to non-offenders, miscreants’ returns to investors were on average 2 percentage points lower a year later.
In Europe, where investors are more receptive to ESG issues than in the U.S., the study found that “analysts who exhibit more sensitivity to ESG news provided significantly more precise forecasts than their peers.”
The second study, by the EDHEC Business School’s Risk Institute, echoes the impact on market valuations, however it is focused on greenwashing rather than true ESG infractions. EDHEC compared Newsweek Sustainability Rankings with ESG scores issued by London Stock Exchange Group Plc’s Refinitiv unit to examine the performance of the 500 largest U.S. firms between 2012 and 2017. 1 According to the researchers, the former ratings are “more reliable and accurate” than the latter, and any widening of the margin in favor of the ESG valuation over the NWS count is proof of greenwashing.
The study discovered that companies that overstated their environmental credentials had a long-term decline in value, as measured by excess market capitalization over book values.
The survey indicated that larger companies, as well as those with larger executive boards, are less likely to engage in greenwashing.
In ESG, there’s more at stake than just reputation. With investors demanding that the capital they invest doesn’t go to enterprises that hurt society or the environment, offenders are likely to face greater financial consequences as a result of their perceived misbehavior.
