In deciding whether to buy, sell or hold, prudent investors generally want to know the following about a company’s financial performance: What are the material risks? What are the long-term rewards?
As public companies prepare annual reports, corporate communicators and investor relations also need to consider how their business narratives will change in response to the growing demand from institutional investors for disclosure about environmental, social and governance (ESG) factors.
Screening issues for ESG exposure is a new imperative for the professional investment community. A Chartered Financial Analyst Institute survey of members (2015) found 73% of portfolio managers and research analysts “take ESG…into account in their investment analysis and decisions.” The Institute altered its curriculum for 2017 based on this finding, a Dec. 30, 2016, article in ValueWalk says. CFAs are “telling us loud and clear that investors are demanding ESG, and there’s increasing academic evidence that sustainable companies are better-managed companies and have higher risk-adjusted returns,” Steve Horan, managing director of credentialing for the Institute, says in the article.
Communicators will be asked to add much-needed context, creating usable insights for investors.
Fluency
Communicators who engage shareholders must work closely with their financial teams to meet Securities Exchange Commission (SEC) requirements. As these worlds intersect, so do language and concepts that serve as guiding principles within each domain.
For example, marketers and PR pros use terms interchangeably such as sustainability, corporate social responsibility (CSR) and ESG. Of the three, sustainability and CSR are used more frequently to explain business actions toward aspirational goals. In contrast, ESG is a term rooted in responsible investing, which has propelled it into widespread use for reporting among investors and in capital markets. The SEC noted this overlap last April: “Sustainability disclosure encompasses a range of topics, including climate change, resource scarcity, CSR and good corporate citizenship. These topics often are characterized broadly as environmental, social or governance (ESG) concerns.”
Materiality
Amid a low-growth environment and market uncertainty from political upheaval, ESG practices and policies can help businesses shelter in place. Results from the 2016 MIT Sloan Management Review Sustainability & Innovation Global Executive Study indicate more than 60% of investors agree that adoption of sound ESG practices lowers business risk.
To better engage these stakeholders, IR communicators need to develop compelling ESG narratives. They must rely on their version of a storytelling plot device: materiality.
The concept of materiality forms the bedrock of financial disclosure in the U.S., and prioritizes certain business information over others.
Risky Business
Keep in mind that explanations of ESG materiality for investors are useful when they can be served up in measurable units. The goal for communicators is to provide context for metrics that help investors make more informed decisions.
Consider some examples of possible material ESG risks with associated metrics that investors may be reviewing closely:
- Environmental:Rising cost of health care premiums for businesses as a result of treatment for climate change-related health threats to employees, such as asthma and other chronic respiratory disorders; increased costs from property insurance and recovery operations for businesses located along coasts or expanded flood zones, where rising water temperatures are causing unprecedented storm surges
- Social:Lack of supplier policies that safeguard companies against human rights violations, such as child and slave labor; employee remuneration that falls short of benchmarks for fairness, transparency or adaptability
- Governance:Board structure with director tenures of 10 years or more, and composition lacking independent representation; CEO and executive compensation policies that encourage the sort of risk taking likely to have a material adverse effect
While a discussion of material risk within an SEC filing follows strict rules for structure and format under Regulation S-K, IR communicators have more flexibility within an annual report to provide details on ESG targets. Many annual reports are integrated with updates on corporate responsibility/sustainability programs, and guidance on quantifiable and non-financial data.
Shareholder calls and analyst meetings are other opportunities for CEOs and IR officers to describe specific ESG measures that are material to the company’s financial future. Such steps may include the launch of a global ethics and compliance initiative, the response plan to a supply chain crisis or the long-term cost savings associated with adoption of renewable energy technologies.
Opportunities
Embracing ESG also has its rewards, and IR communicators certainly can play a strategic role in illustrating how ESG can be an engine for value creation.
Academic and professional research has established a direct link between global companies that embrace ESG practices and positive financial performance. Companies with rigorous sustainability programs “significantly outperform their counterparts over the long term, both in terms of stock market as well as accounting performance,” a Harvard Business Schoolstudy of 180 U.S. companies found. Positive outcomes include key measures such as higher average sales increases, return on assets, profit before taxation and lower cost of capital.
In addition, ESG has caught the attention of institutional investors looking for opportunities to create long-term value. The theme of impact investing, which targets assets that deliver financial returns and positive societal and environmental impact, is no longer a niche approach. Early in 2016, a Wall Street Journal article declared, “sustainable investing has gone mainstream,” as BlackRock and Goldman Sachs became part of a movement among big financial firms to introduce ESG-focused investment products. Investment managers at the California Public Employees’ Retirement System (CalPERS) now are required to consider ESG in their investment processes.
ESG and Reputational Value
The final consideration in ESG value creation takes communicators back to a fundamental expertise: Reputation management. More than two-thirds of Americans say businesses can contribute to their positive reputations with sustainable practices such as conserving natural resources (72%) or supporting environmental or social causes (66%), according to the 2015 G&S Sense & Sustainability Study.
Reputation management falls into a particular asset category, intangibles, which marketers and PR pros deal with regularly. Reputation, brand equity and customer and employee relationships are non-physical properties that qualify as intangible assets.
In the high stakes game of investing, ESG now positions IR to play dealer’s choice in developing corporate narratives around materiality, risk and reward. It will be a position of strength from which communicators can help guide CEOs and CFOs through the 2017 earnings season and beyond.
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Note to Subscribers: Making ESG matters a bit more complex is that SEC updates about ESG disclosure have been scarce recently. A concept release to modernize disclosure requirements under Regulation 8-K as well as a speech from SEC chair Mary Jo White discussing sustainability disclosure can be found at the PR News Pro Essentials page: prenewsonline.com/pr-news-pr-essentials/