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High ESG Standards Mean Higher Profits

This upsurge in ESG investment is partly because investors increasingly demand that companies behave ethically and govern themselves well, as a matter of principle

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Some 17 per cent of the US equity market, $6.6 trillion in value, is now held by funds specifically seeking to invest in stocks with a good record on environmental, social and governance (ESG) criteria.

This upsurge in ESG investment is partly because investors increasingly demand that companies behave ethically and govern themselves well, as a matter of principle.  Investors will no longer turn a blind eye to poor records on greenhouse gas emission or labour standards, or cosy old boys’ clubs in the boardroom.  But is also a sound investment strategy.  

ESG investing now goes far beyond avoiding a negative list of companies or sectors.  High ESG compliance lowers risk and hence the cost of capital, improves margins and increases stock-ratings.  Increasingly consumers chose to buy brands associated with ESG values, resulting in pricing power.  A study published by Harvard Business School found that firms following a high-sustainable strategy outperformed those with a low-sustainable strategy by 46 per cent.

India’s record on ESG compliance is mixed.  There are examples of the highest standards from long before ESG became a focus globally.  Tatas have been committed to extraordinary levels of social responsibility since the days of Jamsetji and have long lived up to high ethical standards.  Newer companies like Infosys and HDFC Bank have demonstrated genuine leadership in corporate governance. 

Yet, much of corporate India has failed consistently to do what is right.  A series of scandals and controversies has dented the reputation of India and that of some of our best-known companies.  In too many instances, the interest of promoters continue to be favoured against those of wider shareholders.  Boards have often failed to demand performance and to link rewards to delivery.

The treatment of employees and record on health and safety have been poor overall.  Environmental standards have been low and levels of corruption too often disturbingly high.  

The 2018 report on Corporate Governance in India by Institutional Investor & Advisory Services (IIAS), covering the top one hundred listed companies, assessed only three companies as leaders on governance (HDFC Bank, Infosys and Wipro).  The performance of five companies was rated as just basic.  The best performing tended to be widely-held companies, followed by MNCs then family-controlled companies. PSUs were typically poor on these scores.  

The suspicion must be that the overall performance among small and mid-cap companies is worse than that of the large companies.  We need an accepted index to measure ESG performance across all listed stocks to assess compliance and demonstrate improvement.

No doubt, ESG compliance has improved in recent years, not least as policy-makers and regulators have demanded change.  India’s record on renewable energy has been strong.  The Companies Act 2013 increased the rights of minorities, addressed related party transactions and introduced the requirement to spend two per cent of profit on social responsibility.  Listing requirements and codes of corporate responsibility have been updated.  Boards are now more diverse and independent.

Shareholders, led by the institutions, have demonstrated an increased willingness to exercise their rights and even vote against managements’ resolutions.  In 2012-13, institutional investors failed to participate in voting for 52% of resolutions; by last year this had fallen to 11%.  In 2017, according to InGovern, forty-five of the top one hundred companies had at least one resolution receive at least 20% votes against by shareholders.  Shareholder protest has forced a change of direction or management in a series of examples including at Fortis, Raymond, Infosys and the Tata Group.

It is in all of our interests to have better managed companies which deliver more, in better ways, for shareholders, customers and society.  While there is evidence of positive change, the pace and scale of improved ESG compliance needs urgently to be elevated a notch and spread from the best companies throughout corporate India.  

Boards and shareholders both have a responsibility to play a greater role in demanding better and more consistent performance from management.  If they do not rise to the challenge, future failures will trigger greater regulation from the government.  Let owners, directors and executives put their houses in order, raise standards and reporting, and deliver greater value before higher compliance costs are imposed or control is wrenched away from them.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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ESG Standards investment Magazine 15 september 2018

Alan Rosling

The author is an entrepreneur and strategic adviser. He co-founded Kiran Energy and was earlier an Executive Director of Tata Sons. He was a Special Advisor to the British Prime Minister during 1991-93. He now lives in Hong Kong but is frequently in India. He is the author of Boom Country? the New Wave of Indian Enterprise.

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