The growing concerns about sustainability have led to ESG ratings becoming the talk among entrepreneurs. They have become key metrics that investors and issuers use to make decisions. According to ESG research, using these ratings helps issuers direct business on the right path, attract investments, and improve shareholders’ transparency.
ESG (Environmental, Social and Governance) issues must be the top concern for corporate boards and management. Earlier, ESG was only a tactic for public relations. However, it has become critical to a business’s long-term success in the current business climate. Consequently, most institutional investors expect their companies to approach ESG policies proactively. Apart from appeasing shareholders and improving public relations, a robust ESG policy also opens up access to capital, builds a stronger brand image, and promotes long-term sustainable growth for investors and companies.
Here are a few reasons why companies use environmental, social, and governance (ESG) ratings.
- To Increase Stock Liquidity
Both institutional and individual investors invest pools of capital in businesses that proactively operate in a sustainable and ethical manner. Sustainable investing has actively grown at rapid rates. Several ESG research and consulting firms have developed rating systems to measure companies upon ESG criteria and rank them compared to their competitors. ETFs and investment companies have raised huge capital for ESG compliant companies. Numerous investment firms also evaluate ESG ratings to assess portfolio risk and predict growth.
- To Unlock Competitive Advantage
Businesses that understand the significance of implementing ESG policies into their system can better identify opportunities and gain a competitive edge. Integrated and proactive ESG conditions increase a company’s profitability relative to the competitors. Companies that care for their employees and try to improve their conditions enhance their team diversity. Consequently, they return better to their community and follow sustainable environmental policies to strengthen their company’s brand. Most consumers, employees, and investors encourage good corporations and stay loyal to them.
- To Steer Away from Activists
Companies with weak governance are easy targets for proxy campaigns and contests from activists. Over the last few years, they commonly target management boards and teams that do not proactively address potential social and environmental issues. On the contrary, companies that follow ESG policies set the bar in the industry and prevent any activist intervention.
Many hedge funds and activist investment firms have established their ESG funds that collaborate with businesses to do ESG research and develop policies. For instance, Jeffrey Ubben from ValueAct Capital joined AES Corporation to continue the transition to renewable and clean energy sources.
- To Strengthen the Company
Investors looking for ESG compliant companies are value-based entities having a long-term perspective rather than focusing on immediate results. They understand that making changes in a corporation will take time. Therefore, investors including ESG into the mandate often work with companies to strengthen them. As a result, they build long-term value over a decade or two rather than having a short-term sugar high.
- To Attract the Best Talent
ESG investors are deeply concerned about the fact that the companies they work with embrace values aligning with their own. Acting with social and environmental responsibility is crucial to them. Employees who the company values are loyal and passionate about their organization and drive intangible good to strengthen the brand. Consequently, it improves the workforce’s overall productivity and helps the business grow.
Why do ESG Ratings Matter for a Business?
With increasing interest in the ESG criteria, investors objectively assess a company’s ESG performance before investing. As a result, numerous ESG research and rating agencies have flourished to evaluate a company’s global ESG performance and make the data available to the clients. These ratings help investors understand and identify ESG risks to business finance.
Factors affecting a company’s ESG rating include environmental (CO2 emissions, renewable energy usage, waste disposal, etc.), social (community relations, workplace policies, community relations, etc.), and governance (executive compensation, gender diversity, financial results, financial management, etc.)
Evaluators look at a company based on information like annual reports and media sources, while investors use these unique scores to estimate a company’s ESG performance. Businesses with a high ESG score anticipate opportunities and future risks in a better way. They focus on longer-term value creation and strategic thinking.
A strong ESG score enhances investment returns by directing more capital to the business. Over time, ESG evaluation may become standardized and even involve credit scoring agencies. In the broadest of terms, an ESG rating aims at measuring a company’s long-term sustainability and its social and environmental impact in the future. That is why companies use environmental, social, and governance (ESG) ratings to attract investors and build capital?