Almost two third out of 378 surveyed companies in Europe, the USA, Canada and the Asia-Pacific Region claim to pursue a sustainability strategy (source: KMPG). Yet, according to oekom research, as little as one in six of the companies from the MSCI World currently demonstrates a high level of commitment to sustainable development.

Innovation and performance

Companies often struggle in making the trade-off between financial and environmental, social, and governance (ESG) performance. Sustainable alternatives are often more expensive, and therefore jeopardize the company’s financial results, as is thought. However, as Robert G. Eccles and George Serafeim argue in their forthcoming Harvard Business Review article The Performance Frontier, this doesn’t have to be the case. By realizing major, organization-wide innovation which is focused on the sustainability issues that are most material to shareholder value, firms can simultaneously boost both financial and ESG performance.

Four steps towards alignment of financial and ESG interest

In the article, Eccles and Serafeim propose four steps a firm could take to align financial and ESG performance.

1.       Identify material ESG issues
By assessing which material issues are key in its sector, the company is able to select a number of issues to focus on.

2.       Quantify the relationship between financial and ESG performance
Assessment of the impact improvements in each issue would have on financial performance; for example cost reduction, revenue growth, or gross margin defense.

3.       Innovate products, processes, and business models
While minor or moderate innovations may enhance efficiency, it takes major innovation to improve performance in “bundles” of material issues. This includes the development of new products, processes, or business models.

4.       Communicate the company’s innovations to stakeholders
Using effective communication channels such as integrated reporting and social networks will help to engage shareholders and other stakeholders and convincingly deliver the story about how innovations have improved ESG and financial performance in order to justify their investments.

Overcoming barriers for change

Eccles and Serafeim acknowledge that following these steps is harder in reality than it may sound on paper. They describe a number of barriers which should be overcome in order to realize change.

• While short-term incentives may be effective for increasing performance quickly, they block long-term outlooks which are required for addressing sustainability issues. Linking remuneration to ESG performance and basing it on corporate-wide performance rather than division or unit level will help put the focus on the long term and improve cross-division collaboration.
• A shortage of expertise may be experienced when developing new strategies that address environmental and social challenges. Recruiting new, specialist talent will help tackle innovation challenges.
• Capital-budgeting limitations: Social or environmental value is typically hard to measure and while projects are creating value in other fields than financial ones, it can be difficult to express their value for corporations that apply high discount rates in calculating projects’ net present definition of value. By incorporating nonfinancial metrics into valuation methods and capital-budgeting processes, organizations will better understand the relationship between ESG and financial performance.
• Investor pressure can be hard when developing a sustainable strategy: a company needs farsighted investors that support their goals. Unilever for example gave up quarterly earning guidance in order to attract investors which are interested in the long-range prospects rather than short-term profits.

In conclusion, the authors suggest that corporations take responsibility and use their economic power to “pave the way to a sustainable society”.

Interested?

If you would like to know more about how to strategically approach sustainability in order to align financial and ESG performance, please contact us at hello@finchandbeak.com for more information.