Investors’ Search for ESG Risk & Value

Investors’ Search for ESG Risk & Value

The 2019 proxy disclosure season will showcase how 10-K filings, annual reports, proxy statements and corporate sustainability reports are rapidly evolving to meet the growing demand from investors for decision-useful environmental, social and governance (ESG) data.

Addressing Risk 

Investors’ steadily increasing focus on corporate ESG-related risk and value creation is a mainstream concern for C-suites and boards.  A survey of institutional investors, coordinated by Donnelley Financial Solutions (DFIN) and SimpleLogic revealed a disconnect, between the ESG information public companies are disclosing in their corporate social responsibility reports, 10-K, proxy and other public disclosure documents and what investors are seeking as "decision-useful" in assessing risk, as well as the value of the company's sustainability strategy.  

Over 90 percent of investor respondents indicated their desire for a clear link between ESG issues and corporate strategy, risk management and operational context, as well as detail and transparency. 

Yet, 70 percent of investors surveyed said the ESG information companies provide does not provide them with what they need to make an informed assessment of the materiality of these factors in their business. 

Lack of quality corporate ESG data is driving asset owners and investors to third-party service providers. DFIN’s investor study found, 55 percent of investors feel their third-party ESG data is sufficient to make an informed assessment of the materiality of ESG factors in the company’s business. While, only 30 percent of investors feel the company-provided ESG information is useful to make those decisions.

Corporations disclosing ESG data — and even those who don’t — are being scored by third-party ESG rating and ranking services, including: MCSI ESG research, Bloomberg, Thomson Reuters, Sustainalytics and ISS E&S Scores and others. These ratings services use different methods of collecting and scoring ESG data, often resulting in ratings that vary widely, even for the same company. 

The C-suite needs a plan to assess their ESG scores for accuracy and completeness. Just as with proxy advisors, not all the data the firms use is complete, consistent and accurate. Issuers need to look at what information the ratings agencies are using for grading and determine if the company is providing comprehensive and accurate information.

Not having an ESG strategy has a cost: negative ESG ratings that can impact your company's credit ratings. It’s important to understand the data used to score your company’s ESG rating and have continued awareness around your company’s rating. Without this knowledge, you risk losing value through investors’ perception of your company, which in turn signals low management quality, low board engagement on ESG ownership and an inarticulate long-term corporate strategy. 

Conversely, by getting started on your ESG journey you can own your ESG message and shape the story being told by the third-party ratings agencies. C-suite executives who take proactive steps with their boards, such as following good governance guidance set in the COSO ERM-ESG Risk Framework, and initiating an ESG materiality assessment, may begin defining metrics and KPIs that convey environmental and social (E&S) priorities to shareholders and establish management accountabilities around them. Credible standard-setting organizations like GRI and SASB, and disclosure frameworks such as CDP IIRC, TCFD, and RobecoSAM help inform and provide clear, objective, relevant and comparable measures. 

Value Creation

Investors are linking ESG to value creation. They are identifying value from human capital, innovation capital and company KPIs that tell the story of your corporate sense of purpose, using quantified metrics that are comparable year-over-year. ESG reporting has been shown to be a beneficial way to demonstrate valuation, making it an area of increased importance for institutional investors and companies.

A recent report by G&A Institute highlights that 85 percent of the S&P 500 companies provided sustainability data in their 2017 disclosures. This includes companies posting ESG information on their website, in corporate social responsibility reports and in 10-K and proxy statements. Companies’ disclosures vary widely from using clear ESG metrics aligned with reporting standards that provide measurable E&S performance data, comparable year-over-year, to providing boilerplate data that is useless to investors.

Decision-useful data is also on the rise. In a recent report from IIRC, Fortune 500 companies’ ESG reporting is evolving. They are using industry materiality assessments, as well as emerging ESG standards and frameworks such as GRI, CDP, SASB and TCFD.

Additional key findings include:

• 95 percent of sustainability reports include environmental performance metrics (quantified measures that are comparable year-over-year); 67 percent of companies set quantified and time-bound environmental goals.
• Nearly all (97 percent) companies customized sustainability reporting models in style, format and content, rather than closely following any one framework. Just 10 percent sustainability reports closely followed only one reporting framework — GRI or another industry-specific model.
• About 40 percent of the S&P 500 include the concept of sustainability in their annual reports on Form 10-K.
• 38 percent of companies include discussions of corporate responsibility or sustainability in their proxy statements, beyond typical board governance and executive compensation disclosures. Many of those describe company sustainability efforts and goals — typically in a proxy statement summary prominently placed at the beginning of the filing (see, e.g. Bristol-Myers Squibb's Global Corporate Citizenship & Sustainability disclosure).

DFIN’s latest white paper, The Future of ESG and Sustainability Reporting: What Issuers Need to Know Right Now expands on ESG trends discussed here, following a few key themes, namely, the drivers of ESG’s evolution from niche to mainstream investing; ESG as an increasingly important talking point for boards and the C-suite; a new laser focus on decision-usefulness; growing impact of ratings and rankings and emerging ESG frameworks, including a checklist for crafting a decision-useful ESG strategy. Click here to access the full report.