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Summary.The paper “Corporate Sustainability: First Evidence on Materiality,” published in 2016, marked a significant shift in perceptions of corporate sustainability. It demonstrated that focusing on financially material ESG (environmental, social, and governance) factors positively impacts portfolio returns and shareholder value. Despite its influence in popularizing ESG investing, the topic remains controversial with mixed academic consensus and political debate in the U.S. Recent research by the author has further explored this field, highlighting two critical aspects: the role of high-ability managers in selecting profitable ESG projects and the long-term value of ESG practices in supply chains. The study found that companies with high-ability CEOs and strong ESG investments outperform others, and firms with fewer supplier ESG incidents yield higher returns. These findings underscore the importance of ESG efforts in resource allocation and their potential to attract investment by demonstrating a tangible impact on shareholder value. The ongoing challenge lies in enhancing disclosure, transparency, and effective use of ESG information by investors and regulators.
A main criticism of corporate sustainability has long been that it results in firms not putting shareholders first, thus contradicting managers’ fiduciary duty. In 2016, however, I published a paper, “Corporate Sustainability: First Evidence on Materiality,” with George Serafeim and Mo Khan, that began to overturn that narrative. We documented that considering financially material ESG factors (i.e., those sustainability activities that are related to the core sector practices of the firm) improve portfolio returns, which is consistent with financially material sustainability activities creating shareholder value.
FAQs
Two critical factors—managerial ability and supply chain ESG activities—have emerged as key drivers in linking ESG efforts to enhanced shareholder returns. This evolution underscores the importance of skilled management and responsible supply chains in achieving both sustainability and financial objectives.
How does ESG increase shareholder value? ›
Tying ESG to value levers
Waste reduction and energy efficiency can save operating costs. Addressing climate risk in supply chains and physical infrastructure can also help prevent losses, reduce insurance costs, and avoid negative hits to shareholder value due to write-offs.
What are the key factors of ESG? ›
ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities.
What are the ESG factors in equity valuation? ›
Abstract. ESG stands for Environmental, Social, and Governance. Investors increasingly consider these nonfinancial ESG factors to identify material risks and growth opportunities.
Why ESG factors may be important factors for investors to consider in their investment decisions? ›
By incorporating ESG criteria, investors can identify companies that are better positioned to navigate the challenges of climate change, social unrest, and governance scandals, which can adversely affect profitability and sustainability.
What increases shareholder value? ›
An increase in shareholder value is created when a company earns a return on invested capital (ROIC) that is greater than its weighted average cost of capital (WACC). Put more simply, value is created for shareholders when the business increases profits.
Why is ESG important for shareholders? ›
Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
What are the three factors of ESG? ›
It measures how your business integrates environmental, social, and governance practices into operations, as well as your business model, its impact, and its sustainability. The three components that make up ESG are environmental, social and governance.
Which ESG factor is most important? ›
While all three factors are important, the 'E' in ESG - Environmental - is perhaps the most critical, especially in light of the growing concerns around climate change and environmental issues. Common ways to address this issue is to lower greenhouse gas emissions and reduce carbon footprint.
How could ESG factors be taken into consideration in valuation? ›
If ESG factors are not included yet, the planned cash flows should be adjusted accordingly. For example, a reduction in sales revenue due to poor reputation, an increase in taxes due to legal requirements or increased CAPEX to reduce ESG risks could be taken into account.
A better ESG performance company is inclined to have a higher P/B ratio, which can be attributed to the positive prospect and long-term sustainable growth with lower volatility in earnings, hence supporting the firm's valuation.
Do shareholders care about ESG? ›
Investors recognize that ESG can be an important factor in choosing whether to invest in specific companies. It may be time for executives to step up and fully integrate ESG into their equity story, making sure to connect ESG to value creation, and differentiate themselves from their peers based on ESG value impact.
What is the most important factor to keep in mind when considering ESG issues? ›
The most important factors to consider when choosing ESG practices are risk, information, and strategy, as well as macro, meso, and micro factors. The study found that competitiveness is the most important factor in determining the financial performance of companies and countries when considering ESG practices.
What do investors look for in ESG reports? ›
Since ESG reports summarize the qualitative and quantitative benefits of a company's ESG activities, investors can screen investments, align investments to their values, and avoid companies with the risk of environmental damage, social missteps or corruption.
How does ESG impact valuation? ›
ESG factors can have a significant impact on company valuation. Environmental factors, for example, can affect a company's reputation and long-term viability. A company that has a poor environmental track record may face regulatory action or public backlash, which can result in lost revenue and a lower valuation.
How does ESG rating affect stock price? ›
Understanding the Effect ESG Rating Changes on Stock Returns
This positive sentiment can generate increased demand for the company's stock, potentially driving up its price and resulting in positive stock returns. Negative Rating Change: Conversely, a downgrade in ESG rating can raise concerns among investors.
How does ESG correlate with stock price? ›
ESG performance improves stock price synchronicity by reducing information asymmetry. The “noise reduction” effect of ESG performance is significantly lower in non-state-owned enterprises and enterprises with low investor trust.
How does ESG affect stakeholders? ›
The ESG framework serves as a valuable tool for communication with stakeholders. It provides a structured approach for companies to share information about their environmental, social, and governance efforts.
