The first question you need to answer is, to what extent does good ESG translate into good financial performance? On that, there have been more than 2,000 academic studies and around 70 percent of them find a positive relationship between ESG scores on the one hand and financial returns on the other, whether measured by equity returns or profitability or valuation multiples. Increasingly, another element is the cost of capital. Evidence is emerging that a better ESG score translates to about a 10 percent lower cost of capital as the risks that affect your business, in terms of its license to operate, are reduced if you have a strong ESG proposition.
There’s a reason why companies aren’t fighting this.
We looked at the reasons behind the relationship between ESG performance and financial outcomes and identified five sources of fundamental business value that explain these findings. The first is top-line growth. If you are a consumer goods company with a stronger sustainability proposition, you are more likely to attract customer loyalty and new customer segments. There is evidence that brands with more sustainable impact grow faster than brands that have a less sustainable proposition. On the business-to-business side, there also is a link. Large companies are seeking to channel ESG through their value chain. If you want to be a supplier to one of the world’s largest retailers, for example, you had better have a strong sustainability proposition on plastics, packaging, water use, and so on.
The second aspect is cost. If you are more resource-efficient, more water-efficient, have less packaging, you will generally have a lower unit-cost structure. The third area are your regulatory relationships. If you are more responsible about your assets’ environmental footprint, then the chances of an adverse, punitive regulatory outcome are lower, so there is potentially regulatory value here.
The fourth is talent. These days, newer recruits and millennials demand purposeful work and if you are an employer that can meet that need, you will attract and retain that talent, and likely higher productivity in the workplace. The evidence suggests that this is worth roughly 2 percent of your stock price each year. Then the fifth factor we found is investment optimization. There are downside risks of holding assets that become stranded. Coal assets and oil tankers, for example, have seen significant write-downs in recent years. Conversely, there are enormous opportunities in ESG-related investments. For example, there is a huge demand for technology that could improve air quality. When you add up all five factors, they explain this roughly 10 percent advantage in your cost of capital.
Above is the perspective of McKinsey’s partner in charge of sustainability investing (always an odd number of proof points from consultants, btw - it’s never 4 or 6).