by Elsie Maio, Founder of Humanity, Inc and SoulBranding Institute
As if on cue, the bad news on Volkswagen exploded at deadline for this article. Its harsh flash illuminates the state of the art of ES+G analysis – that is, the practice of profiling the risk to investors of a company’s posture and practices on environmental, social and governance issues (ES+G). And, it’s a topical jumping off point to explore where this evolving ‘artform’ can go.
Summary
On one hand, the apparent ethical gap that harbored VW’s reported ‘crime of emissions’ is a question of Governance. And this particular governance lapse will likely have a material impact on VW’s bottom line as well as its long term performance in the marketplace for its products, for talent and capital.
And yes, even though ‘nobody saw this one coming’, according to industry insider Bahar Gidwani, co-founder and CEO of CSR Hub, the system did work. His specialty firm and others did send a warning flare with below-average rankings for certain of VW’s governance-related behaviors.
“Our system has strong scores for 11 of the 12 factors we track (for Volkswagen). The only weak score was a below average rating for “Board,” said Bahar. “This indicated that the company’s board structure and practices were not as well thought out and organized as they could be.”
Olga Emelianova, who leads MSCI’s ESG Research North America told me they had “flagged aggressive accounting practices, leadership turmoil…and in May 2015, Volkswagen was excluded from MSCI ACWI ESG Index.”
So this signal event in the auto industry, along with other long-standing evidence across companies and sectors, support the wisdom of supplementing traditional financial analysis with ES+G data. There is no question that ES+G factors have a material, measurable impact on company performance and are necessary to understand both the upside potential and the risk profile of companies. In my view, it is high time the mainstream investment community formally incorporate them.
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But let’s be clear, this new set of indicators may be necessary but it is not sufficient for the demands of the day: Knowing the source of vulnerabilities and advantages does not address them. They are symptoms. Cures are something else again, which I’ll discuss in the second part of this article.
Perhaps, as Gidwani suspects, the Volkswagen incident is isolated, and does not reflect the culture of the company. If so, there is something to learn here about rigorously tending the soul of an organization, in all its nooks and crannies. If instead, the unspoken code was ‘performance above all’ then the VW debacle presents a bold challenge to the old-timey excuse, “culture is too hard to manage.” The truth is, today, if you don’t cultivate your culture, it may well cultivate (bury) you.
Leaders know this. You will recognize them as the ones who are experimenting with frameworks and accessible, malleable technology. They use it to crowd-source employee values, build and nurture a positive, high-integrity, high-innovation talent base of thousands of employees, and empower them to create their own high-performance goals that fuel corporate KPIs. We’ve had the privilege to work with some of them.
In short, ES+G can help diagnose investment opportunities and risks. It’s up to company leaders to disseminate the ‘cure’.
Note to reader: As Elsie Maio finished this article, she was asked to be a guest on Marketplace Morning Report. Listen to her comments on VW with host David Brancoccio here- http://www.marketplace.org/shows/marketplace-morning-report/marketplace-morning-report-monday-october-12-2015
So, what is the state of the investment community’s capability to use ES+G? And how does that relate to business managers’ adapting to the challenges of the day?
A Fast-Developing Investment Tool: ES+G Capability
On the surface, you’d think that more information about what affects corporate performance is automatically a good thing, yes? After all, it’s demonstrated now that decisions management makes that affect environmental resources, the wellbeing of its labor force – whether those on contract around the world or near to home – and ethical behaviors, do materially hurt or help the bottom line. So yes, in that sense, reporting on ESG factors – as indicators of risk or opportunity – is a good thing for investors who are evaluating their options.
And Hazel Henderson, the renowned futurist, economist, and consultant on sustainable development, places ‘the new metrics’ of ES+G alongside the great levers of policy change, in her latest contribution to the UNEP’s Inquiry Global Report on Financial System Reform. She states “Today, public and NGO pressure on companies and governments has forced reforms… and continues to transform finance along with all the new metrics forcing formerly “externalized” social costs back on to financial balance sheets.”
Indeed, the harkening call of the 2015 CSR Investing Summit came from Kevin Parker, CEO of Sustainable Insight Capital Management: “What was moral has become material.”
With that claim and data to back it up, Kevin and other experts shut the door on any lingering debate from last year’s Summit over the relevance of ‘sustainable’ corporate behaviors to company performance. The conversation at this conference deftly slipped from the elective morality of ‘social responsibility’ to the stark legality of fiduciary responsibility, and back again. It suited everybody’s purpose to bask in the quantified certainty of ‘materiality.’
But the effort it takes to actually elicit adequate volumes of such quality data, collect it, turn it into useable information and apply it to investment analysis is like building a sub-industry itself. And that in fact is what’s happening. Different insiders alternately say this capability is in ‘embryonic’ stages, or three- to four-years away from being sufficiently mature.
“The whole education and research track is developing in front of our eyes,” said John Streur, CEO of Calvert Investments.
A sample of this mini-industry enthusiastically populated this summer’s CSR Investing Summit in New York, which was sponsored by ThomsonReuters, Deloitte, Calvert and other principal firms in the investment community. It included a wide range of functions – specialized investment-analysis, research, legal advisory, communications and other support firms from North America and Europe. They touted the capabilities of established tools and introduced offerings, including new indices against which to measure risk arising from ES+G company behaviors.
The ability to develop indices, I learned, is a special challenge in this emerging field. It depends on the availability of adequate data to compare one with the other. Until recently, the flow of that information depended on the companies’ self-reporting – collecting and releasing it – via the burgeoning sub-business of CSR- and ‘sustainability’- communications and reporting.
Increasingly, however technology innovations such as that developed by San Francisco-based TruValue Labs is pulling data from a rich supply of secondary sources, as well as from bespoke data clusters that it gleans by trawling the Internet several times a day and digesting bits of information that are not formally reported.
Sharing the dais, and the sentiment, with these functional support specialists were the asset owners, managers, and financial advisors who attested to the validity of the approach itself. They retold how they had anticipated the timing of pitfalls like ‘the demise of coal,’ or Monday-morning-quarterbacked how ESG information would have foretold other risks and opportunities, had that information been available. Others identified the ESG factors that marked their unique approach to investing, such as one financial advisor who screens to include companies for clients’ portfolios that meet her ‘minimum 3 women on the board’ guideline, having correlated such diversity with superior company performance.
Demonstrating a less tangible, but nonetheless massive impact, one advisor talked about the high cost of management distraction when an ES+G issue hits the fan: “The CEO of a Fortune 50 company said it was the most significant issue they had to deal with in two years, when his company was outed for [operations deep in the supply chain that contradicted its specific claims as a sustainable brand].”
ESG Fever vs The Larger Need
At the same time, ES+G capability itself is not the only development that’s called for.
First, the apparent fervor to develop the functionality of ES+G, in data collection, analysis and other added value offerings, raised a couple of flags for me. Its momentum has the potential to draw attention and resources away from the basic need to hone in and refine our understanding of the material impacts and their root causes in the companies being studied. Potentially distracting and somewhat self-absorbed – not unlike ‘sustainability’ over the past few years.
For example, corporate communications and technology around ES+G are essential, but like shiny toys, these functions can easily balloon into hungry ecosystems that become an end in themselves. The danger is they will distract both the investing public and corporate management teams from their real purpose: to help business operations align in a substantive way with our changing world.
Second, several voices returned the conversation to the fundamental challenge facing business: to adapt to gross exogenous forces on the horizon. These include: the transfer of US wealth to women and millennials whose priorities differ from traditional wealth holders; the precipitous inequity in wealth distribution; the immediate constraints on operations and whole communities of shortages of natural resources such as water; impending challenges to the ecosystem on the broadest scale from climate change; and others.
These ‘bigger picture’ voices at the CSR Investing Summit saw the move to develop ES+G capacity as just one of several necessary, simultaneous actions to help decision-makers align their companies with the new realities of our world. They cited the need to lobby the stock exchanges around the world to include requirements for listing, and to directly engage policy makers, corporate decision-makers and the grassroots investor community as well.
They cited historical precedents for coordination among change agents, to challenge business as usual. “It will take the NGOs floating between the whale and the boat,” together with simultaneous pressure of the buying public, investors and on policy leaders. Calvert’s John Streur cites constructive engagement with companies by the investment community as crucial to moving company management along the curve of their own and the planet’s sustainability. We agree.
Third, a walk on the darker side. Ironically, more information about a company’s exposure to ES+G issues can produce knee-jerk responses that miss the point, or worse. For example, any information predictive of company risk or reward can be used simply to generate short-term financial gains. And in another vein, the leadership of companies could easily react to the release of unfavorable rankings and ratings of their company performance on ES+G criteria with counter-productive, traditional responses.
Gidwani illustrates with Volkswagen-gate, “Once performance (market share, revenue, profit) becomes paramount and the primary source of rewards and approval, other things recede into the background. VW needs to make a change in its reward and compensation culture more than it needs another layer of supervision or a new management team.”
In fact, traditional restructuring and more stringent controls are likely to be counter productive. (It’s tempting to point here to the current heightened expectations and “conduct risk” initiatives spilling over the errant banking industry.) In the uncharted waters of global business today, controls dampen the spirit of discovery and innovation needed to find a new course.
With no precedents to fix a course in today’s fluid business environment, the individual has to turn to inner reference points to generate innovative solutions. And so, cultivating in employees such values-based inner beacons as discernment, wisdom, cooperation, integrity, courage, innovation is a promising choice for management. We can’t legislate or regulate those qualities. Instead, with the aid of flexible technology and seasoned expertise, the exceptional organizations are learning how to celebrate and nurture these inclinations in thousands of employees at a time, while linking them to business strategy and outcomes.
So in this manner, ES+G capabilities could help companies to discover material possibilities. Perhaps the investment community will decide to train its strategic lens on ES+G factors closely enough to reveal a path of thriving transformation for all.
Article by Elsie Maio, who is a consultant and guide to business leaders seeking alpha + impact, she’s a thought-leader in sustainable marketing, alumna of McKinsey & Company and founder of Humanity, Inc/SoulBranding Institute. Contact her at- elsiemaio@soulbranding.com