ESG’s Staying Power Is Too Big for Businesses to Underestimate

If the going consensus is that ESG investing went mainstream in 2021 and its supporters and opponents expanded their ranks in 2022, we can reasonably expect that 2023 is the year when the doing well by doing good doctrine has been decided.

Yet judging by contrasting indicators across the global regulatory landscape and capital markets, that eventual verdict is anyone’s guess. Even still, uncertainty, suspicion, and objection aren’t suitable pretexts for inaction by any champion of profit-maximizing free enterprise.

It’s clear this erstwhile alternative framework for corporate governance and asset allocation has staying power—regardless of its professed advantages and alleged shortcomings. And should companies fail to adapt their managerial processes, capital spending plans, and corporate disclosure practices to the rigors of “woke capitalism,” they invite nightmarish risks.

Start with the basic premise that in principle and practice, ESG is merely a more holistic methodology for evaluating the slate of ostensibly non-financial but material risks a company faces.

There are due criticisms of this interpretation. Among proponents, there’s the notion that environmental, social, and governance is nothing special. In other words, the tasks of identifying, monitoring, managing, and issuing disclosures describing a company’s inward sustainability risks ought to be seen for what they are: part and parcel of sound corporate governance, precisely what companies’ risk-averse business partners, investors, insurers, and other dealmakers want.

More critically, there’s the equally valid criticism that by omitting companies’ outward risks—negative externalities—from the scope of mainstream ESG performance measurement, management, disclosure, and appraisal processes, a firm’s espousal of ESG performance excellence effectuates little more than a burnished reputation, even when credible. And there’s the well-documented irregularity and, by extension, unreliability of the ESG performance scores conferred to corporates by third-party ratings providers.

ESG naysayers may deserve some credence. But the volume of evidence that suggests ESG-aligned practices effectively create value merits their consideration.

If not a definitively causal relationship, credible research shows a positive correlation between companies’ ESG initiatives and their financial performance outcomes. The intrepid skeptic may argue that ESG’s margin-strengthening effects are attributable more to operational cost savings than to the catalysis of new or existing revenue streams.

But research finds that some three-quarters of executives see their ESG initiatives as revenue enablers, largely due to the entrenchment of sustainability concerns among their consumers and employees alike.

Despite the practice’s shortcomings, there are a number of domains where the supposedly costly tasks of setting, achieving, and exceeding corporate sustainability goals—substantiated by assured disclosures—pay for themselves.

Take equity valuations, and with it, the costs of equity capital and debt, and access to credit. On the heels of tremendous net inflows into US-domiciled and global ESG funds these last few years, institutional investors engaged in public and private equity and debt markets are proving determined to maintain their campaigns. They are rewarding companies for evidence of successive ESG risk management improvements.

What’s more, both active management of ESG funds and active engagement with investee companies, as opposed to passive portfolio screening and index tracking methods, are increasingly commonplace. This trend will continue as evidence mounts that such hands-on approaches compound desirable financial and ESG performance outcomes, such as emissions reductions.

Issuers who thread the ESG performance and disclosure needles can expect leverage as well as protection—essential provisions on any value creation excursion. On leverage, validated ESG credentials strengthen companies’ hands in M&A transactions. This is a domain of business where I’ve witnessed the rapid ascent of two noteworthy trends.

First, considerations for ESG performance outcomes and risk factors in deal identification and prospecting are taking center stage. Both institutional investors, including private equity firms and non-financial corporate acquirers, are especially bullish on the ubiquity and staying power of climate risk concerns—they’re seeking opportunities to burnish their own sustainability records with strategic acquisitions.

Unsurprisingly, there’s evidence that the landscape of supportive long-horizon policymaking, such as the Inflation Reduction Act, is deepening prospective buyers’ appetites for deals in renewable energy and other cleantech sectors.

It stands to reason, then, that competing M&A targets will be judged somewhat by the strength of their ESG performance across the screening, due diligence, valuation, and closing stages of a deal. This underscores the need for companies across sectors to shore up their still-maturing ESG data assembly, performance management, and disclosure practices.

Finally, on protection, business leaders can’t discount the importance of compliance. From the EU’s recently adopted Corporate Sustainability Due Diligence Directive and the Securities and Exchange Commission’s corporate climate risk disclosure rule, to the bespoke ESG procurement criteria of a given corporate ESG champion, renewing the proverbial license to operate entails playing ball.

The opinions and demands of companies’ spectators—including potential business partners, consumers, employees, and civil society—need to be accommodated. This can only happen if we work to mitigate a complete slate of inbound enterprise risks and produce assured disclosures on the outcomes.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mona E. Dajani is partner in the Project Development & Finance practice at global law firm Shearman & Sterling, where she is also the global head of renewables, global head of energy and infrastructure, and global head of the hydrogen and ammonia practice groups.

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