Importance of ESG and its true fiscal value to business

As business leaders continue to embrace Environmental Social and Governance (ESG) considerations and understand inherent risks and opportunities, they are having to walk the fine line of showing themselves to be good corporate citizens and at the same time, proving that any investments in sustainability boosts financial performance.

So how can businesses get this balancing act right, and address stakeholder concerns? Globally, there is plenty of discussion in the investor community on the importance of ESG and its true fiscal value to the business.

Decades-long meta studies examining relationship between ESG and financial performance, suggest a positive correlation between ESG performance and operational efficiencies, stock performance and lower cost of capital.

The import of these research findings is that companies that pay attention to ESG, don’t compromise their financial returns, rather, the opposite. However, these studies have also revealed that the measurement and accounting of ESG performance is entirely divorced from the one that assesses profitability and share price.

This means that business leaders are often blinded to the interdependence of ESG and financial performance.

Therefore, even as the case for a strong ESG proposition becomes more compelling, an understanding of how such considerations link to value creation is critical for managers to effectively demonstrate to investors, and shareholders that they care about sustainability without taking their eyes off the ball in matters profit.

It is appreciated that ESG returns may not all be immediate. In some cases, a company’s ESG actions can have obvious and easy-to-measure fiscal benefits. For example, lowering office energy consumption to cut costs is clearly good for the bottom line.

Similarly, companies that can demonstrate sustainable supply chains and good human rights records are less vulnerable to environmental shocks or reputational damage. However the impact on company strategy of ESG actions such as low-carbon initiatives, may take time to materialise but in the long-term, such initiatives can help a firm attract affordable capital, ultimately reducing the cost of doing business.

To effectively identify the connection between ESG initiatives and impact on enterprise value, businesses must marry ESG initiatives with the value chain. Ideally, this means working through the entire value chain to identify, record and link each ESG consideration back to business value creation in a manner that creates a workable balance between all the values.

It is expected that the nexus between ESG and financial performance will become more comprehensive as businesses mature in ESG reporting and as accounting standards evolve beyond traditional financial statement to a holistic assessment of both financial and non-financial attributes of enterprise value.

One key element of this evolution will be measurement of material ESG risk and opportunities that uniquely affect each sector and industry in a manner that allows for comparability of the information carried in the financial and non-financial disclosures.

Wangui is chief officer, regulatory affairs, Nairobi Securities Exchange