Improving ESG Risk Mitigation Practices May Benefit Business and Shareholders
The Environmental, Social, and Governance (ESG) aspects of companies have been widely considered by investors and other market participants, consumers, and stakeholders. In two research studies released by Moody’s Analytics recently, it is revealed that companies that cultivate a more responsible ESG method and strive to mitigate ESG risks experience fewer ESG-related controversies and achieve better shareholder returns. More precisely, the ESG risk management policies and actions along with the ESG scores that measure them contain financially relevant information for shareholders.
Using data collected from Moody’s ESG Solutions and RepRisk, the research analyzed over 3,000 public companies from 2013 to 2019. The process drew a direct line from controversial ESG events that can be objectively measured – such as a chemical spill (environmental), the use of child labor (social), or corruption and bribery cases (governance) – and their business and shareholder impacts.
Considering the effects of ESG performance on firm market value, the research found that controversial ESG events have large and persistent negative effects on firm value. In addition, the more severe the event, the larger its impact. For a typical-sized firm involved in the research, moderate-to-severe ESG events resulted in an average -4% one-year excess equity returns or equal to a loss of approximately $400 million.
On the other hand, the research also presented that it is beneficial to companies to learn from their past ESG controversies and improve their internal ESG risk culture. Companies were likely to experience a reduction in the rate of future controversial ESG events by about 15% when their Moody’s ESG Assessments scores improved, which helped measure the extent to which they integrate sustainability into their strategies, risk management, and operations, from the perspective of both business and stakeholder exposure.
According to Doug Dwyer, Managing Director at Moody’s Analytics, who led the research, a responsible ESG risk management practice in a company may have an essential benefit that leads to a potentially material impact on equity returns. Furthermore, companies that intensively manage the risks caused by ESG controversies – such as reputational damage with significant financial and legal repercussions – tend to do a better job of increasing shareholder value.
To conclude, Dwyer also stated that both key findings indicate the importance of ESG controversies to a company’s financial conduct. What even more crucial is that companies can regulate their ESG risk management practice while still contributing to shareholders and other stakeholders at the same time.