Leaders in financial research are calling ESG a global movement. World renowned companies like Intel and Coca Cola are creating innovative approaches to integrate ESG into their investor relations, and the majority of the leading large public companies are publishing ESG reports. But what are small public companies doing and, more importantly, what should small public companies be doing? As more and more companies adopt sustainable policies and begin disclosing ESG information, this question will only become more imperative.
What is “ESG”?
ESG is the abbreviation for the environmental, social, and governance criteria of a company. These criteria include information about a company’s behavior and non-financials, ranging from topics like sustainability to human rights. Because ESG paints broad strokes over a variety of unrelated factors, it is difficult to have a thorough, meaningful understanding of what ESG is and what it means for a company. It is this lack of specificity and standardization, along with the fact that ESG evaluation is relatively new amongst the investment community, that has independent companies such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) working to systematize ESG regulations and reporting.
For public companies, ESG reporting allows for an increase in the quantity and, more importantly, the quality of their disclosure. Improved ESG disclosure provides companies the opportunity to market their products/services as sustainable, and it improves trust and risk reporting for their potential and current investors. Investors use the information that companies do (or don’t) disclose about ESG to judge the sustainability and ethicality of a company, frequently utilizing published reports or stock market ESG indexes. One of the most relevant uses of ESG reporting is to help gauge the long-term risks associated with a company such as foreseeable changes in legislation that may affect business, environmental issues/ regulations, or resource scarcity.
Those who are skeptical about the reality and importance of ESG may view the movement towards sustainability as a “fad”, or consider it a waste of time and resources. However, research being conducted on ESG criteria indicates the increasing value that it holds in businesses today:
- Ernst & Young (EY) conducted a survey amongst 320 institutional investors and found that 93% of the responding investors either “agreed” or “strongly agreed” that ESG plays a key role and has long-term, real, and quantifiable impacts.
- In 2015, 81% of S&P 500 companies published sustainability reports, up from under 20% in 2011 (National Investor Relations Institute).
- ESG practices can also influence a company's value. As reported by NIRI, 80% of the studies conducted on ESG demonstrated a positive correlation between companies that practiced sustainability and stock performance.
- Renowned organizations such as the London Stock Exchange, NASDAQ, and EY have published reports on the increasing global interest in nonfinancial information on the part of investment professionals and, more specifically, the focus on ESG factors in the decision making process. In fact, Ernst and Young concluded that ESG has reached an inflection point and that it will have an increasingly important role in the marketplace.
What does this mean for small public companies?
Large companies face the most pressure to adopt ESG policies and reporting strategies, but it remains unclear what is expected of small companies. Since small companies may pose less of an environmental threat, and because they may not have the resources necessary to track and report ESG, there has not been the same push towards ESG awareness and reporting with smaller companies.
For those small companies that are involved in industries such as electricity/gas, automotive, and other environmentally challenging sectors, ESG awareness and reporting will become critical in coming years. However, all companies should begin evaluating ESG and what it means in relation to their industry, business model, investors, consumers, and employees. Taking the initial steps toward sustainable practices and initiating conversations about ESG with stakeholders and company employees now will protect a company from being unprepared as ESG gains traction amongst small cap companies.
In order to provide the resources and support that small companies need to become a part of the ESG movement, organizations have created specialized guides for Small to Medium Enterprises (SMEs). For example, the International Network for Environmental Management (INEM) has created a specialized Tool Kit that provides guidelines for sustainability management in small companies. Additionally, the GRI has created a certified training program to teach ESG reporting practices and skills to small-to-medium enterprises. There are many organizations, manuals, and experts available to help smaller companies dive into ESG.
Where do I start?
- Add sustainability discussions to board agenda
- Understand what sustainability means for your company: ESG affects different companies and industries in different ways
- Engage investor relations, legal, operations, and risk management
- Incorporate ESG principles throughout your company; companies with an integrated approach are more successful
- Determine which performance indicators are relevant to you and plan a way to measure achievements
- Be proactive in communicating your progress on ESG by updating your website and engaging stakeholders through a variety of means
- Consider incorporating sustainability disclosures or including ESG criteria on your annual reports
If you are looking for more concrete examples of ESG initiatives, MSCI researched and published a report on the top 10 Small Cap ESG Leaders in the US. You can access the report, and find the top ten list here. Results demonstrate that, despite the potential cost of integrating ESG into their business models, Small Cap ESG Leaders are, on average, performing in line with the rest of the small cap firms.
Mariana Ferreira, Associate - IMS