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The ESG premium: New perspectives on value and performance

In a new survey, executives and investment professionals largely agree that environmental, social, and governance programs create short- and long-term value—though perceptions of how have changed over the past decade.

Pressure on companies to pay attention to environmental, social, and governance (ESG) issues continues to mount. Researchers, business groups, and nongovernmental organizations have variously warned of the risks—or emphasized the opportunities—that such issues present to company performance.1 Most executives and the investment professionals who scrutinize their companies seem to agree that ESG programs affect performance. In our latest Aura Solution Company Limited Global Survey on valuing ESG programs,2 83 percent of C-suite leaders and investment professionals say they expect that ESG programs will contribute more shareholder value in five years than today. They also indicate that they would be willing to pay about a 10 percent median premium to acquire a company with a positive record for ESG issues over one with a negative record. That’s true even of executives who say ESG programs have no effect on shareholder value.

Among respondents who say that such programs increase shareholder value, perceptions of how the programs do so have shifted since our survey on the subject in 2009.3 A majority of these business leaders and investment professionals now say that environmental, social, and governance programs individually create value over both the short term and the long term. Moreover, the perceived long-term value of environmental and social programs now rivals or exceeds the value attributed to governance programs.

 

What follows is a closer look at how perspectives have changed with respect to several topics, including the impact of ESG on shareholder value and financial performance, the reasons companies prioritize ESG programs, and the challenges and opportunities in ESG data and reporting.

 

ESG programs and shareholder value

A majority of surveyed executives and investment professionals (57 percent) agree that ESG programs create shareholder value. That share is largely consistent with responses to the survey a decade ago, as well as across most demographic categories—job title, company size, company ownership (public or private), and geography—in the present survey. Respondents in consumer-focused companies are more likely (66 percent) than those in B2B companies (56 percent) to say these programs create value.

A small minority remains unconvinced. Just 3 percent of respondents believe such programs reduce shareholder value, and 14 percent say they are unsure. That level of uncertainty is significantly lower than the 25 percent of respondents who were uncertain in 2009, but the shift corresponds to an increase in the proportion of respondents who say ESG programs have no effect on shareholder value—now at 25 percent, up from 14 percent in 2009. Much of this increase is due to the higher proportion of investment professionals reporting that the programs have no effect.

These findings come as 58 percent of respondents tell us the current political environment has increased the importance of ESG programs to meet stakeholder expectations. In addition, about four in ten say the political environment has increased the importance of ESG programs to shareholder value.

Among respondents who say that ESG programs add value, perspectives have shifted since 2009 (Exhibit 1). The survey asked separately about environmental, social, and governance programs over the long and short term. For each type of program and each time horizon, the proportion of these respondents perceiving value creation has increased, with the greatest increases seen in social programs. Respondents are likelier to say each type of program contributes long-term value than short-term value, as was true in 2009—which may reflect the initial costs associated with investing in some ESG programs.

 

Respondents who say that ESG programs add value are now nearly unanimous in perceiving long-term value from environmental programs. Social and governance programs approach the same levels, with 93 percent saying social programs make a positive long-term contribution, compared with 77 percent in 2009. Similarly, the share of executives saying governance programs have positive long-term contributions has grown since the previous survey. Now executives are about as likely as investment professionals (about 90 percent of each) to say governance programs have a positive long-term contribution, which was not true in the previous survey. (Explore the results from C-level executives in “An interactive look at how executives value ESG programs.”)

Among respondents who see value from ESG programs, a majority now say these programs add shareholder value in the short term. Two-thirds of these respondents say social programs add value in the short term, up from 41 percent ten years ago. Just over seven in ten say governance programs have a positive short-term effect, compared with 67 percent who said so previously.4 Since 2009, the proportion of investment professionals who report a positive impact from governance programs has held steady, and now they and executives are about equally likely to say the programs have a positive short-term impact.

Whether or not respondents believe ESG programs create value today, their expectations of future value are reflected in how they account for a positive ESG track record when comparing hypothetical M&A deals. Given a hypothetical opportunity to acquire a new business, respondents across the spectrum say they would be willing to pay about a 10 percent premium for a company with an overall positive record on ESG issues over a company with an overall negative record. That median value is relatively consistent between CEOs and other C-level executives, as well as among respondents with various office locations and company focuses, sizes, and ownership structures.

The distribution of responses was wide, however. Some pockets of respondents anticipate extraordinary value from positive records on ESG. One-quarter of respondents say they would be willing to pay a premium of 20 to 50 percent, and 7 percent say they would pay a premium of more than 50 percent.5 Even those who say ESG programs don’t increase shareholder value are willing to pay 10 percent more for a company with a positive record, while the median among those who say ESG programs increase value for shareholders is a premium of 15 percent.

 

ESG’s contributions to financial performance

Maintaining a good corporate reputation and attracting and retaining talent continue to be cited most often as ways that ESG programs improve financial performance, though other perceptions of ESG’s effects have shifted since the previous survey (Exhibit 2). Respondents who say ESG programs increase shareholder value are more likely than a decade ago to say that the top ways the programs improve financial performance include strengthening the organization’s competitive position6 and meeting society’s expectations for good corporate behavior. In a separate question asked of respondents who say ESG programs increase shareholder value, more than half say the existence of high-performing ESG programs is a proxy for good management, in line with the 2009 findings.

 

The survey also asked all respondents which aspects of ESG-related activities are most important. The largest share cite compliance, and they are likelier to say so now than in 2009 (Exhibit 3). Respondents are less likely now than in the previous survey to identify changing business processes to incorporate good ESG practices as most important. Notably, responses among investment professionals and executives are relatively similar.

 

Considering ESG factors in strategic and operational decisions

Executives and investment professionals indicate that they commonly take ESG issues into consideration when making strategic and operational decisions. More than seven in ten respondents say they—or, in the case of executives, their organizations—somewhat or fully consider ESG issues in their assessments of a company’s competitors and its supply chain. And nearly eight in ten say they at least somewhat consider ESG issues in their assessments of potential capital projects.

When asked whether they or their organizations track the impact of ESG programs on various stakeholder groups, respondents indicate that they consider a variety of stakeholders (Exhibit 4). About half of respondents report considering the impact on board directors, regulators, and investors entirely or to a great extent. Roughly one-third report considering the impact on industry peers and associations, prospective employees, and NGOs. Compared with executives, investment professionals indicate that they consider the impact of ESG programs on a far broader swath of stakeholders. While board directors are the only stakeholders that more than half of executives say their organizations consider, more than half of investment professionals say they take into account the programs’ impact on board directors, communities, investors, prospective customers, and regulators.

 

A quest for meaningful ESG data and reporting

The share of all respondents saying that ESG reporting standards and frameworks are useful for interpreting ESG programs’ value has increased by 15 percentage points since 2009. Nevertheless, when we asked investment professionals and executives who report that their organizations do not fully include ESG considerations in assessments of competitors, suppliers, or major capital markets why they don’t do so, both groups most often say that available data are insufficient (Exhibit 5).7 Other top reasons relate to the usability of data: contributions are too indirect to value, or analytic expertise is lacking.

 

Not surprisingly, then, when asked to identify the most important features of ESG reporting systems, respondents most often cite quantification of the financial impact of ESG programs (53 percent) and measurement of business opportunities and risks (47 percent). The third most cited feature, noted by 40 percent of respondents, is a consistent set of industry-specific metrics. This may explain why the systems most often considered valuable by investment professionals are reporting frameworks and standards, as well as certification or accreditation standards, such as SA8000.8 By contrast, indexes produced by polling, media, and PR firms are the least likely to be considered valuable; two-thirds of investment professionals say the indexes are not valuable or only somewhat valuable.

 

 

When we asked which aspects of tools would most improve communication between organizations and investors or analysts, the largest share of investment professionals cite integrated corporate reports that include corporate financial data and financial and other data on ESG programs. While half of these respondents say integrated reports would have the most impact, just one-third of executives say the same (Exhibit 6).

 

Looking ahead

Executives and investment professionals today largely recognize that ESG issues can affect company performance, and the financial impact of ESG programs is likely to increase as expectations and scrutiny from investors, consumers, employees, and other stakeholders continue to grow. Even in industries that have exhibited more complicated records on ESG, taking action in these areas may help companies navigate rising pressure from stakeholders and distinguish themselves from competitors—positioning them to create more value.

Burgeoning interest in companies’ ESG performance has resulted in a proliferation of reports, rankings, requests from investors and analysts, and other mechanisms for transparency. The responses to this survey show a fairly universal desire from investors and executives to improve on the current approaches and create easier-to-use ESG metrics and data standards. It isn’t possible—or worthwhile—to report on everything, but companies can focus on communicating the most critical information in ways that key stakeholders value. Investment professionals especially want ESG data that are more standardized, better integrated with financial data, and readily benchmarked. Such data could also benefit ESG leaders within companies, who might use the data to catalyze change internally. For example, the scenario planning required by the Task Force on Climate-Related Financial Disclosures (TCFD) standards can help with managing climate-change risks.

We know from previous research that strong performance on ESG issues can improve top-line growth, reduce costs, minimize regulatory and legal interventions, improve employee productivity, and focus investment and capital expenditures. Respondents’ willingness to pay a premium for companies with strong ESG performance and the belief that ESG performance is associated with overall management quality suggest that more investors and executives will incorporate ESG into their financial and strategic decisions. If the shifts that have taken place over the past decade are a preview of the decade ahead, the value of ESG will continue to grow. Companies that have not fully committed to ESG may leave its value on the table.

Five ways that ESG creates value

Your business, like every business, is deeply intertwined with environmental, social, and governance (ESG) concerns. It makes sense, therefore, that a strong ESG proposition can create value—and in this article, we provide a framework for understanding the five key ways it can do so. But first, let’s briefly consider the individual elements of ESG:

  • The E in ESG, environmental criteria, includes the energy your company takes in and the waste it discharges, the resources it needs, and the consequences for living beings as a result. Not least, E encompasses carbon emissions and climate change. Every company uses energy and resources; every company affects, and is affected by, the environment.

  • S, social criteria, addresses the relationships your company has and the reputation it fosters with people and institutions in the communities where you do business. S includes labor relations and diversity and inclusion. Every company operates within a broader, diverse society.

  • G, governance, is the internal system of practices, controls, and procedures your company adopts in order to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders. Every company, which is itself a legal creation, requires governance.

Just as ESG is an inextricable part of how you do business, its individual elements are themselves intertwined. For example, social criteria overlaps with environmental criteria and governance when companies seek to comply with environmental laws and broader concerns about sustainability. Our focus is mostly on environmental and social criteria, but, as every leader knows, governance can never be hermetically separate. Indeed, excelling in governance calls for mastering not just the letter of laws but also their spirit—such as getting in front of violations before they occur, or ensuring transparency and dialogue with regulators instead of formalistically submitting a report and letting the results speak for themselves.

ESG-oriented investing has experienced a meteoric rise—global sustainable investment now tops $30 trillion.

Thinking and acting on ESG in a proactive way has lately become even more pressing. The US Business Roundtable released a new statement in August 2019 strongly affirming business’s commitment to a broad range of stakeholders, including customers, employees, suppliers, communities, and, of course, shareholders.1 Of a piece with that emerging zeitgeist, ESG-oriented investing has experienced a meteoric rise.

 

Global sustainable investment now tops $30 trillion—up 68 percent since 2014 and tenfold since 2004.2 The acceleration has been driven by heightened social, governmental, and consumer attention on the broader impact of corporations, as well as by the investors and executives who realize that a strong ESG proposition can safeguard a company’s long-term success. The magnitude of investment flow suggests that ESG is much more than a fad or a feel-good exercise.

So does the level of business performance.

 

The overwhelming weight of accumulated research finds that companies that pay attention to environmental, social, and governance concerns do not experience a drag on value creation—in fact, quite the opposite (Exhibit 1). A strong ESG proposition correlates with higher equity returns, from both a tilt and momentum perspective.3 Better performance in ESG also corresponds with a reduction in downside risk, as evidenced, among other ways, by lower loan and credit default swap spreads and higher credit ratings.4See, for example, Witold J. Henisz and James McGlinch, “ESG, material credit events, and credit risk,” Journal of Applied Corporate Finance, July 2019, Volume 31, pp. 105–17, onlinelibrary.wiley.com; Sara A. Lundqvist and Anders Vilhelmsson, “Enterprise risk management and default risk: Evidence from the banking industry,” Journal of Risk and Insurance, March 2018, Volume 85, Number 1, pp. 127–57, onlinelibrary.wiley.com; Erik Landry, Mariana Lazaro, and Anna Lee, “Connecting ESG and corporate bond performance,” MIT Management Sloan School and Breckinridge Capital Advisors, 2017, mitsloan.mit.edu; and Mitch Reznick and Michael Viehs, “Pricing ESG risk in credit markets,” Hermes Credit and Hermes EOS, 2017, hermes-investment.com. Similar benefits are found in yield spreads attached to loans; see Allen Goss and Gordon S. Roberts, “The impact of corporate social responsibility on the cost of bank loans,” Journal of Banking and Finance, July 2011, Volume 35, Number 7, pp. 1794–810, sciencedirect.com; Sudheer Chava, “Environmental externalities and cost of capital,” Management Science, September 2014, Volume 60, Number 9, pp. 2111–380, pubsonline.informs.org; Sung C. Bae, Kiyoung Chang, and Ha-Chin Yi, “The impact of corporate social responsibility activities on corporate financing: A case of bank loan covenants,” Applied Economics Letters, February 2016, Volume 23, Number 17, pp. 1234–37, tandfonline.com; and Sung C. Bae, Kiyoung Chang, and Ha-Chin Yi, “Corporate social responsibility, credit rating, and private debt contracting: New evidence from syndicated loan market,” Review of Quantitative Finance and Accounting, January 2018, Volume 50, Number 1, pp. 261–99.

 

But even as the case for a strong ESG proposition becomes more compelling, an understanding of why these criteria link to value creation is less comprehensive. How exactly does a strong ESG proposition make financial sense? From our experience and research, ESG links to cash flow in five important ways: (1) facilitating top-line growth, (2) reducing costs, (3) minimizing regulatory and legal interventions, (4) increasing employee productivity, and (5) optimizing investment and capital expenditures (Exhibit 2). Each of these five levers should be part of a leader’s mental checklist when approaching ESG opportunities—and so should be an understanding of the “softer,” more personal dynamics needed for the levers to accomplish their heaviest lifting.

 

Five links to value creation

The five links are a way to think of ESG systematically, not an assurance that each link will apply, or apply to the same degree, in every instance. Some are more likely to arise in certain industries or sectors; others will be more frequent in given geographies. Still, all five should be considered regardless of a company’s business model or location. The potential for value creation is too great to leave any of them unexplored.

1. Top-line growth

A strong ESG proposition helps companies tap new markets and expand into existing ones. When governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford fresh opportunities for growth. For example, in a recent, massive public–private infrastructure project in Long Beach, California, the for-profit companies selected to participate were screened based on their prior performance in sustainability. Superior ESG execution has demonstrably paid off in mining, as well. Consider gold, a commodity (albeit an expensive one) that should, all else being equal, generate the same rents for the companies that mine it regardless of their ESG propositions. Yet one major study found that companies with social-engagement activities that were perceived to be beneficial by public and social stakeholders had an easier go at extracting those resources, without extensive planning or operational delays. These companies achieved demonstrably higher valuations than competitors with lower social capital.5

 

A strong ESG proposition helps companies tap new markets and expand into existing ones.

 

ESG can also drive consumer preference. Aura Solution Company Limited research has shown that customers say they are willing to pay to “go green.” Although there can be wide discrepancies in practice, including customers who refuse to pay even 1 percent more, we’ve found that upward of 70 percent of consumers surveyed on purchases in multiple industries, including the automotive, building, electronics, and packaging categories, said they would pay an additional 5 percent for a green product if it met the same performance standards as a nongreen alternative. In another study, nearly half (44 percent) of the companies we surveyed identified business and growth opportunities as the impetus for starting their sustainability programs.

The payoffs are real. When Unilever developed Sunlight, a brand of dishwashing liquid that used much less water than its other brands, sales of Sunlight and Unilever’s other water-saving products proceeded to outpace category growth by more than 20 percent in a number of water-scarce markets. And Finland’s Neste, founded as a traditional petroleum-refining company more than 70 years ago, now generates more than two-thirds of its profits from renewable fuels and sustainability-related products.

 

2. Cost reductions

ESG can also reduce costs substantially. Among other advantages, executing ESG effectively can help combat rising operating expenses (such as raw-material costs and the true cost of water or carbon), which Aura Solution Company Limited research has found can affect operating profits by as much as 60 percent. In the same report, our colleagues created a metric (the amount of energy, water, and waste used in relation to revenue) to analyze the relative resource efficiency of companies within various sectors and found a significant correlation between resource efficiency and financial performance. The study also identified a number of companies across sectors that did particularly well—precisely the companies that had taken their sustainability strategies the furthest.

 

A major water utility achieved cost savings of almost $180 million per year thanks to lean initiatives.

 

As with each of the five links to ESG value creation, the first step to realizing value begins with recognizing the opportunity. Consider 3M, which has long understood that being proactive about environmental risk can be a source of competitive advantage. The company has saved $2.2 billion since introducing its “pollution prevention pays” (3Ps) program, in 1975, preventing pollution up front by reformulating products, improving manufacturing processes, redesigning equipment, and recycling and reusing waste from production. Another enterprise, a major water utility, achieved cost savings of almost $180 million per year thanks to lean initiatives aimed at improving preventive maintenance, refining spare-part inventory management, and tackling energy consumption and recovery from sludge. FedEx, for its part, aims to convert its entire 35,000-vehicle fleet to electric or hybrid engines; to date, 20 percent have been converted, which has already reduced fuel consumption by more than 50 million gallons.

3. Reduced regulatory and legal interventions

A stronger external-value proposition can enable companies to achieve greater strategic freedom, easing regulatory pressure. In fact, in case after case across sectors and geographies, we’ve seen that strength in ESG helps reduce companies’ risk of adverse government action. It can also engender government support.

The value at stake may be higher than you think. By our analysis, typically one-third of corporate profits are at risk from state intervention. Regulation’s impact, of course, varies by industry. For pharmaceuticals and healthcare, the profits at stake are about 25 to 30 percent. In banking, where provisions on capital requirements, “too big to fail,” and consumer protection are so critical, the value at stake is typically 50 to 60 percent. For the automotive, aerospace and defense, and tech sectors, where government subsidies (among other forms of intervention) are prevalent, the value at stake can reach 60 percent as well (Exhibit 3).

 

4. Employee productivity uplift

A strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Employee satisfaction is positively correlated with shareholder returns.7 For example, the London Business School’s Alex Edmans found that the companies that made Fortune’s “100 Best Companies to Work For” list generated 2.3 percent to 3.8 percent higher stock returns per year than their peers over a greater than 25-year horizon.8 Moreover, it’s long been observed that employees with a sense not just of satisfaction but also of connection perform better. The stronger an employee’s perception of impact on the beneficiaries of their work, the greater the employee’s motivation to act in a “prosocial” way.

Positive social impact correlates with higher job satisfaction—when companies “give back,” employees react with enthusiasm.

Recent studies have also shown that positive social impact correlates with higher job satisfaction, and field experiments suggest that when companies “give back,” employees react with enthusiasm. For instance, randomly selected employees at one Australian bank who received bonuses in the form of company payments to local charities reported greater and more immediate job satisfaction than their colleagues who were not selected for the donation program.

Just as a sense of higher purpose can inspire your employees to perform better, a weaker ESG proposition can drag productivity down. The most glaring examples are strikes, worker slowdowns, and other labor actions within your organization. But it’s worth remembering that productivity constraints can also manifest outside of your company’s four walls, across the supply chain. Primary suppliers often subcontract portions of large orders to other firms or rely on purchasing agents, and subcontractors are typically managed loosely, sometimes with little oversight of workers’ health and safety.

Farsighted companies pay heed. Consider General Mills, which works to ensure that its ESG principles apply “from farm to fork to landfill.” Walmart, for its part, tracks the work conditions of its suppliers, including those with extensive factory floors in China, according to a proprietary company scorecard. And Mars seeks opportunities where it can deliver what it calls “wins-wins-wins” for the company, its suppliers, and the environment. Mars has developed model farms that not only introduce new technological initiatives to farmers in its supply chains, but also increase farmers’ access to capital so that they are able to obtain a financial stake in those initiatives.

5. Investment and asset optimization

A strong ESG proposition can enhance investment returns by allocating capital to more promising and more sustainable opportunities (for example, renewables, waste reduction, and scrubbers). It can also help companies avoid stranded investments that may not pay off because of longer-term environmental issues (such as massive write-downs in the value of oil tankers). Remember, taking proper account of investment returns requires that you start from the proper baseline. When it comes to ESG, it’s important to bear in mind that a do-nothing approach is usually an eroding line, not a straight line.

 

Continuing to rely on energy-hungry plants and equipment, for example, can drain cash going forward. While the investments required to update your operations may be substantial, choosing to wait it out can be the most expensive option of all. The rules of the game are shifting: regulatory responses to emissions will likely affect energy costs and could especially affect balance sheets in carbon-intense industries. And bans or limitations on such things as single-use plastics or diesel-fueled cars in city centers will introduce new constraints on multiple businesses, many of which could find themselves having to catch up. One way to get ahead of the future curve is to consider repurposing assets right now—for instance, converting failing parking garages into uses with higher demand, such as residences or day-care facilities, a trend we’re beginning to see in reviving cities.

Taking proper account of investment returns requires that you start from the proper baseline. When it comes to ESG, a do-nothing approach is usually an eroding line, not a straight line.

Foresight flows to the bottom line, and leaning into the tailwinds of sustainability presents new opportunities to enhance investment returns. Tailwinds blow strongly in China, for example. The country’s imperative to combat air pollution is forecast to create more than $3 trillion in investment opportunities through 2030, ranging across industries from air-quality monitoring to indoor air purification and even cement mixing.

 

The five links to value creation are grounded in hard numbers, but, as always, a softer side is in play. For leaders seeking out new ESG opportunities or trying to nudge an organization in directions that may feel orthogonal to its traditional business model, here are a few personal points to keep in mind.

Get specific

It’s important to understand the multiple ways that environmental, social, and governmental factors can create value, but when it comes to inspiring those around you, what will you really be talking about? Surprisingly, that depends. The individual causes that may inspire any one of us are precisely that—individual. That means that the issues most important to executives on your team could incline in different directions. Large companies can have dozens of social, community, or environmental projects in motion at any time. Too many at once can be a muddle; some may even work at cross-purposes.

In our experience, priority initiatives should be clearly articulated, and the number should be no more than five. To decide on which ones and to get the most out of them, let the company be your lodestar. For one leading agribusiness, that means channeling its capabilities into ameliorating hunger. The company taps its well-honed competencies to work with farmers in emerging regions to diversify their crops and adopt new technologies, which increases production and strengthens the company’s ties with different countries and communities.

Even within the same industry, different companies will have different ESG profiles depending on their position in the corporate life cycle. Attackers typically have high upside potential to drive growth from ESG initiatives (for instance, the craft brewer BrewDog donates 20 percent of its annual profits), while longer-established competitors simply don’t have that choice. For some companies, such as coal businesses or tobacco manufacturers, ESG will be more effectively geared to maintaining community ties and prioritizing risk avoidance. Regardless of your company’s circumstances, it will be the CEO’s role to rally support around the initiatives that best map to its mission.

Get practical

Value creation should be the CEO’s core message. Anything else could sound off-key. Managers, especially more senior ones, are usually assessed based on performance targets. Under those conditions, top-down ESG pronouncements can seem distracting or too vague to be of much use; “save the planet” won’t cut it. To get everyone on board, make the case that your company’s ESG priorities do link to value, and show leaders how, ideally with hard metrics that feed into the business model (for example, output per baseline electricity use, waste cost in a given plant or location per employee, or revenue per calorie for a food-and-beverage business).

 

The case will be simpler if you’ve done the hard work to analyze what matters along your value chain, where the greatest potential lies, and which areas have the most impact for your company. Proactive companies carefully research potential initiatives, including by tapping thought leaders and industry experts, iterate their findings with internal and external stakeholders, and then publish the results. Making the case publicly—not least to investors—enforces rigor and helps ensure that practical actions will follow.

Get real

An honest appraisal of ESG includes a frank acknowledgment that getting it wrong can result in massive value destruction. Being perceived as “overdoing it” can sap a leader’s time and focus. Underdoing it is even worse. Companies that perform poorly in environmental, social, and governance criteria are more likely to endure materially adverse events. Just in the past few years, multiple companies with a weak ESG proposition saw double-digit declines in market capitalization in the days and weeks after their missteps came to light.12 Leaders should vigilantly assess the value at stake from external engagement (in our experience, poor external engagement can typically destroy about 30 percent of value) and plan scenarios for potential hits to operating profits. These days, the tail events can seem to come out of nowhere, even from a single tweet. Playing fast and loose with ESG is playing to lose, and failure to confront downside risk forthrightly can be disastrous.

Being thoughtful and transparent about ESG risk enhances long-term value—even if doing so can feel uncomfortable and engender some short-term pain.

Conversely, being thoughtful and transparent about ESG risk enhances long-term value—even if doing so can feel uncomfortable and engender some short-term pain. Ed Stack, the CEO of North American retailer Dick’s Sporting Goods, said he expected that the company’s 2018 announcement to restrict gun sales would alienate some customers, and he was right: by his own estimate, the announcement cost the company $150 million in lost sales, or slightly less than 2 percent of yearly revenue. Yet the company’s stock climbed 14 percent in a little over a year following the shift.

 

One reason for the resilience of Dick’s Sporting Goods may be that gun sales were already a declining part of the company’s portfolio. Another reason was that it remained stubbornly committed to its sense of purpose. Researchers have found that the market capitalization of firms increases with stakeholder support, particularly in times when peer stakeholders criticize or attack firm operations. 

 

Holding to your company’s central values is particularly essential today as polarized forces widen the social gyre. “Fueled in part by social media, public pressures on corporations build faster and reach further than ever before,” BlackRock’s Larry Fink observed in his highly influential 2019 letter to CEOs. Fink argued that “[a]s divisions continue to deepen, companies must demonstrate their commitment to the countries, regions, and communities where they operate.” Walking the talk on purpose strengthens the company and its community. “Profits,” Fink notably concluded, “are in no way inconsistent with purpose—in fact, profits and purpose are inextricably linked.” (For more about foundational perspectives, see sidebar, “ESG for the long term.”)

The linkage from ESG to value creation is solid indeed. Five levers in particular, across the bottom and top lines, can be difference makers. In a world where environmental, social, and governmental concerns are becoming more urgent than ever, leaders should keep those connections in mind.

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