Contradicting Skeptics, New Research Links ESG Performance to the Bottom Line

The importance of environmental, social and governance performance in business has become the subject of growing skepticism and pushback. But recent research has come out squarely in favor of ESG as a decisive factor for both sustainability and profitability. 

More than 90 percent of S&P 500 companies currently publish ESG reports in some form, according to McKinsey. So do approximately 70 percent of Russell 1,000 companies. For these firms, ESG is considered part of the societal license to operate.

Yet there is concern about over-regulation inside the executive ranks of some corporations, according to a recent CNBC survey. Some chief financial officers (CFOs) said they do not see enough of a correlation between climate data and financial statements. Such skepticism may be what’s behind some of the recent corporate pushback against the upcoming Securities and Exchange Commission (SEC) climate risk disclosure requirements. Reportedly, the SEC is considering revising a component of its climate disclosure rules.

The link between profitability and ESG performance is elusive but present

The Center for Sustainability and Excellence (CSE) conducts annual research which measures how ESG best practices and standards are affecting profitability and transparency. Its latest deep dive analyzed the practices and commitments of more than 310 Fortune 500 companies in North America and Europe — including 31 industry sectors — for the sixth consecutive year. The findings are worth considering, especially for those who remain skeptical of ESG.

While the research found no direct correlation between ESG practices and financial performance or absolute profit among the highest-ranked companies, there is evidence that applying ESG goals along with specific reporting frameworks and ratings results in better financial performance, according to CSE.

“Direct correlation is very hard to prove since there are so many different factors that affect profitability, including inflation,” Nikos Avlonas, president of CSE, explained in an interview with TriplePundit.

“For example, business models and leaders’ decisions on strategic issues are among several other factors that can affect profitability," he said. "However, it's known that intangible assets, including non-financial data, represents about 80 percent of the value of the business, and ESG criteria and data represents a very big portion of the 80 percent. So there is some kind of indirect correlation between financial performance and ESG practices, because these factors represent a very big portion of the value of the business.”

The leading companies and industries 

When it comes to ESG performance, the top 25 companies in CSE’s research are also among the most profitable in their sectors. These include General Mills, Prologis and Prudential Financial, which led the pack in the 10 sectors that came out on top: beverage and food consumer products, health and life insurance, and real estate.

A number of industries trailed behind, including diversified financials, food production, property and casual insurance, metals, and petroleum refining/energy. The leaders in these sectors were American Express, Alcoa, Marathon Petroleum, Newmont, Tyson Foods, AIG and Dominion Energy.

The other sector leaders were: Colgate-Palmolive, Lockheed Martin, S&P Global, Microsoft, Nike, Nvidia, Hilton Worldwide Holdings, Stanley Black & Decker, Starbucks, Truist Financial, Ford Motor, UPS, Edwards Lifesciences, 3M, Target, Cisco Systems, Jacobs Engineering Group, Walt Disney, eBay, Cigna and Regeneron Pharmaceuticals.

The standout ESG practices among leaders

All of the top performers had these three aspects in common, according to CSE. They averaged high consolidated ESG ratings, as demonstrated by MSCI, CDP, Sustainalytics and S&P Global. They used ESG-related standards — of which GRI, SASB and TCFD are good examples — and they incorporated stakeholder concerns and preferences into their strategies and reports. Finally, their ESG reporting was comprehensive, and they committed to ambitious medium- and long-term quantitative goals. Some 86 percent of top performers have published an accessible, independent sustainability or ESG report.

While adherents of ESG are finding that their businesses benefit in multiple ways, these firms are also looking at the growing investor trend that prioritizes companies with high ESG rankings. Global ESG assets are expected to hit $50 trillion by 2025.

A big push for decarbonization goals, less for transparency

CSE found that 29 percent of the surveyed companies had committed to decarbonization and 50 percent had set net-zero goals. But a lack of transparency in how companies planned to achieve those goals threatens to erode credibility in such ambitious targets.

Avlonas offered a clear recommendation for companies that want to lead in the ESG space: Report progress on climate action annually via the Science-Based Targets initiative, which encourages companies to set long-term targets in line with the latest climate science.

“Right now the Science-Based Targets are the best tool through which companies can demonstrate that they are truly committed to reducing their greenhouse gas emissions and becoming net zero,” he told 3p.

Third-party assurance makes a difference

CSE’s research also found that only 30 percent of companies used third-party assurance for their ESG reporting. So while there might be transparency of data, there is no external verification.

“We get two main reasons from sustainability professionals about why this number is low,” Avlonas explained. "The first is a lack of understanding of the importance of external assurance from C-suite executives. The second is the unjustified high fee from the Big Four accounting firms.”

However, “investing in third-party assurance does provide more points in ESG rankings and enhances credibility,” he added.

While there may always be some skepticism around ESG, the initiative’s momentum seems unlikely to abate. What’s clear, Avlonas concluded, is that doing business in a more sustainable way is increasingly synonymous with doing good business overall.

“Companies we have seen that have not taken ESG seriously face some kind of risk in terms of branding, investors’ preference or in transforming at a time when business models need to be sustainable, he said. "Overall, we believe that doing 'business as usual' is no longer a valid option.”

Image credit: Simone Hutsch via Unsplash