Scrutiny of environmental, social, and governance (ESG) policies, and analyses of boardroom diversity have predominantly been the province of mid- and large-cap institutional investors. Small-cap companies should consider getting ahead of these curves though, not only because this scrutiny is inexorably headed their way, but also because it’s just good business.
ESG is about scale. ESG factors are essentially a continuum of non-financial performance issues that are weighed alongside traditional financial metrics in the decision–making process of an increasing number of institutional and retail investors globally.
- Some examples of environmental considerations may include: climate change, water usage/impact, renewable energy, emissions, management of hazardous materials, and green building practices.
- Some examples of social considerations may include: human rights, community relations, labor standards, customer privacy, data security, and product liability.
- Some examples of governance considerations may include: risk management, corporate culture, business ethics, materials sourcing, corporate compensation, board composition and political donations.
While the ESG nomenclature might be somewhat new, sophisticated investors have long analyzed non-financial risk elements that they view as complementary to more traditional key performance indicators. Supporters of incorporating ESG aspects into their investment considerations have undertaken research that depicts that companies that are more ESG-focused often outperform their peers with respect to return on invested capital, and have less volatile stocks. Put perhaps a bit differently, there are increasing data to support the conclusion that companies with more fulsome risk apertures – represented by ESG factors – are more likely to scale over time with greater aplomb.
More diverse companies… make more money. Public companies in the United States are predominantly operated and governed by a comparatively homogenous group – older, white men. And that group statistically errs on the side of hiring people with similar attributes. In 2017, a large executive search firm published data depicting that nearly 70 percent of the 421 board seats filled by Fortune 500 companies in 2016 were sitting or retired CEOs and CFOs – a group that is largely older, white men. To be sure, the buy-side is predominantly fine with sitting and retired CEOs and CFOs serving on corporate boards, and the continuing consideration of them for future board seats. But savvy investors are increasingly not fine with candidate pools for prospective directors that are substantially limited just to CEOs and CFOs. According to research conducted by a number of large consulting firms, companies with greater thought diversity outperform less diverse peers. As Larry Fink, CEO of BlackRock, admonished in his 2018 letter to shareholders, “[Diverse boards] are better able to identify opportunities that promote long-term growth.
Two concluding takeaways for officers and directors: (1) focus on ESG and boardroom thought diversity is not fleeting; and (2) shareholders can likely benefit from both.
Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. Prior to founding Third Creek, Epstein co-founded Enable Capital Management, LLC; Enable’s special situation hedge funds invested in more than 500 small-cap financings. Epstein speaks monthly at corporate governance and investor conferences, he writes the “Entrepreneurial Governance” column for Directorship magazine, and he’s the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (McGraw Hill, 2012).
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.