Today's investors react more strongly to information on a company’s ESG performance compared with past decades.
By Dinah Koehler and Chris Park
Part of the Business Trends series
Earlier this year, Deloitte published its inaugural Business Trends 2013 report, a collection of articles that summarize eight emerging trends that influence top-line strategy. One of the trends, The Responsible Enterprise, explored the accelerating interest in environmental, social and governance (ESG) issues and provided insights on how companies can reap the benefits of the trend and use ESG to drive shareholder value.
In a series of blog posts over the next several weeks Deloitte will provide an overview of the trend, explore the drivers behind the trend, provide lessons learned and share insights on what can be expected in the future.
Our last post explored the significant shift underway, with companies increasingly expected to address ESG issues head-on, and ESG becoming a C-Suite priority. Today, we will explore the drivers behind the trend.
What’s Driving This Trend?
Five factors account for much of the accelerating growth of corporate interest in ESG issues and none of these factors show any sign of letup. A new era of the responsible enterprise appears to be here to stay.
1. Loss of Trust
According to the 2012 Edelman Trust Barometer, public trust in business continues to decline, dropping to 45 percent in the United States, compared to 51 percent in 2010. Trust in government is even lower. These findings indicate a growing perception that large institutions are not serving the public interest well.
Trust goes hand in hand with reputation. After regulatory pressure and commodity price volatility, respondents to our Deloitte ESG survey ranked potential damage to corporate reputation and brand as a primary risk arising from environmental and social issues. Protecting the brand and reputation has historically been a top reason companies focus more on managing ESG issues. [Eric Hespenheide, Kate Pavlovsky, Steve Wagner, “The Responsible and Sustainable Board”, Deloitte Review, issue 4, 2009]
An outside-in focus helps companies better anticipate and manage these reputational risks, and ultimately protect their valuation. Without a foundation of trust, it is harder for managers to establish a solid track record with their stakeholders that builds reputation. [A Risk Intelligent view of reputation: An outside-in perspective, Deloitte and RIIR, 2011]
2. Stakeholder Pressures
Pressure from consumers and investors is an important motivator for businesses to take action on ESG issues. Stakeholders have always mattered to a company. However, in an age of transparency, any stakeholder – including many that may not have been considered stakeholders a few years ago – can act, and many do.
How stakeholders view a company, what they expect of a company, and how they understand the company’s impact on society and the environment matters to business value. Quite often, stakeholder perception of the risks differs from that of corporate managers and experts. Rather than argue on a scientific basis, many companies find it best to acknowledge stakeholder concerns and reduce or remove the risk altogether. [Dinah Koehler and Eric Hespenheide, “Drivers of Long-term Business Value, Stakeholders, stats and strategy”, DU Press, 2012]
Globally, stakeholder pressure is increasing, especially as the ranks of the middle class expand in emerging markets such as China and India. A wealthier and more educated middle class tends to have higher expectations for corporate ESG performance, as illustrated by growing public outcry over air and water quality in China. In fact, academic research finds evidence that today’s investors react more strongly to information on a company’s ESG performance compared with past decades, as shown by steeper stock price drops after the information is known.
And companies that disclose more ESG information tend to be rewarded by investors. The number of S&P 500 companies that issued sustainability reports jumped from 19 percent in 2010 to 53 percent in 2011—and is expected to continue rising. [See: New University of California Study Uses CSRwire to Prove 'Voluntary Disclosure Theory] Without a deeper understanding of stakeholder judgment, a company risks being adrift in a vast sea of information, facing difficulty in crafting a strategic response and mapping a course to long-term business value creation.
3. Natural Resources Pressures
Growing global demand and supply constraints are generally pushing up prices for energy, agricultural products, and raw materials—an upward trajectory punctuated by periods of extreme volatility, according to the IMF Commodity Price System database.
For example, precious metal prices have increased fourfold since 2005. Also, last year’s drought, which affected nearly two-thirds of the U.S. contiguous states, was the worst in 60 years and drove up cereal prices by 17 percent. In fact, the cost to the U.S. economy has been estimated at 1 percent of GDP.
Such resource trends are increasingly top of mind for business leaders and managers with more than 70 percent of Deloitte’s ESG survey respondents saying their organizations were making a significant commitment to improve resource efficiency. Add to this, sprawling global supply chains, and efficiency is fast becoming a competitive advantage on a global scale.
4. Supply Chain Pressures
Executives surveyed by Deloitte also see a multitude of supply chain risks that directly affect their businesses, including climate adaptation, regulatory pressures, and the unethical practices of certain business partners.
Companies rely on global supplier networks that are largely beyond their immediate control, but those same companies are being held publicly accountable for the actions of those suppliers. Also, the strong emphasis that many companies have placed on supply chain efficiency often reduces the margin for error and makes supply chains more vulnerable to all forms of risk, including ESG risks.
In recent years alone, companies have been hit by a number of major disruptions, including floods in Thailand, the tsunami in Japan, and labor unrest in China and South Africa. The increasing frequency and financial impact of these types of supply chain risks are not going unnoticed.
5. Social and Mobile Enablement
A Deloitte risk management survey of 192 U.S. executives found that social media ranks among the top five most important sources of risk.
With social and mobile technologies becoming globally pervasive, questionable business practices have no place to hide. Problems that in the past might have remained behind closed doors can now be exposed to the world in a few minutes without a lot of advanced technology—and then scrutinized in detail, long after traditional media sources would have lost interest.
In essence, these drivers work together and jointly increase risks to a company’s operations and its entire value chain. This makes managing them a daunting task, but one that many companies are starting to approach proactively.
More on the implementation is next, so stay tuned!