The Importance of ESG Factors in Investment Decisions

Environmental, Social, and Governance (ESG) factors are rapidly rising in investor cognizance worldwide. But it isn't just conscientious backers and philanthropists filtering for ESG. When it comes to business; sustainability, equality, and a clean environmental record are essential facets of financial performance—and savvy investors are starting to embrace these determinants.

Interestingly, during a panel on 'Stakeholder Capitalism' in Davos in January, Jim Snabe, chairman of industrial giant Siemens, noted that the firm is putting its "remuneration system for the CEO and the executive team on an ESG base." This is particularly cardinal timing, especially in the wake of the UK's new corporate governance rules from the Financial Reporting Council (FRC). The regulations place higher emphasis on corporate culture and remuneration reporting to promote improvements in business integrity, equality, and diversification. Therefore, identifying latent reputational hazards arising from ESG risks has never been more critical—especially when attracting fresh capital. 

How to factor in ESG 

The 2020 Edelman Trust Barometer— an annual credibility survey revealed that government, business, and the media are not trusted. For the most part, this lack of faith is propelled by inequality. For businesses, greater cynicism translates to disinvestment. There has never been a more appropriate time to factor in ESG and embrace transparency.   

The pressure is on Remuneration Committees (REMCOs) to encourage compliance with proper ESG measures. In an effort to bolster compliance, REMCOs are similarly citing correspondence between sound remuneration policies and enduring investor value creation. The fact that investors are starting to emphasize ESG factors is understandable. The UK Corporate Governance Code endorses investor's right to this information by encouraging remuneration policies in promoting diversity and sustainability.

However, the required data isn't confined to executives anymore. It now incorporates all organizational representatives and all inequalities, including gender and ethnicity. This makes the matter of compliance that much more difficult and increases the need for the appropriate reporting instruments. This should incorporate both economic and worker information across the breadth of the organization. 

Being mindful of the need to promote equality will reflect generously on the company's bottom line, especially in light of government edicts to create an equal remuneration structure. In 2015, the UK government gave full support to a report recommending a target for all FTSE 350 boards to introduce 33% female representation by 2020. Still, according to the Hampton Alexander Review, while the FTSE 100 looks to be nearing the goal, 50% of the available roles within FTSE350 companies still need to be filled by women within the next year to satisfy the quota.

Reputational risks: Inequality

Companies failing to heed ESG factors as well as the FRC new rules, risk reputational damage. Inequality accusations generate a considerable hazard to businesses. In the UK, several companies face billion-pound lawsuits arising from multi-claimant equal pay cases. The BBC is the most high profile. In 2017, the broadcaster published a list of employees earning over £150,000. A vast discrepancy between genders in a few high profile positions led to widespread allegations of inequality, in turn prompting extensive restitution. Consequently, despite reparations, the BBC's reputation still suffers.

The BBC isn't alone, either. Various UK retailers have incurred their own share of gender discrimination charges—many of which are yet to be resolved, and all of which could have been avoided with appropriate remuneration management and reporting. Tesco could be a prime example of how social governance issues correlate to disinvestment. In 2018, the retail giant was slapped with a $4 billion equal pay claim, when it was alleged that female shop assistants earned significantly less than male warehouse workers for doing equal work. 

After the discovery, Tesco’s shares took a significant hit declining 25% over a 3-month period. Whether this was directly related is debatable, but one thing is certain. With a robust and comprehensive Total Reward management system, such vulnerabilities can be eliminated. Using data to distinguish disparities across employee demographics, pay grades, and job descriptions could have gone a long way to avoid the claims and, therefore, spare disinvestment. With lessons learned, organizations need to take an active role in improving their ESG base—especially when it comes to diversity and equality. 

About The Author: Ken Charman is CEO of uFlexReward, a consolidated HR and rewards data platform.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.