Podcast transcript: Think ESG: Finding the path to ESG-linked financial value

32 min approx | 27 Jan 2023

“The important thing is, in a careful way, to educate your investors, so they understand what's material for you, and why you're tackling and investing in them, so you don't get pushback on why you're investing in those areas.”

Myles Corson

That was Tensie Whelan, a leading researcher on environmental, social and governance (ESG) reporting. Tensie is a Clinical Professor of Business and Society, and the Director of the Center for Sustainable Business at New York University’s Stern School of Business.

Environmental, social and governance, or ESG, performance, and how it is reported has gained significant attention across the market as investors continue to drive for more consistent and transparent ESG metrics that will help them better assess corporate health and long-term value creation.

Research shows they would like to see ESG reporting go even further. In the most recent EY Global Institutional Investor Survey, an overwhelming majority of investors, 89%, said they would like the reporting of ESG performance measured against a set of globally consistent standards, to become a mandatory requirement.

Welcome to the Better Finance podcast. I’m the host, Myles Corson from Ernst & Young, and I’m delighted to introduce a special Think ESG episode, featuring a conversation between Brian Tomlinson, an Ernst & Young Managing Director in our ESG Reporting practice, and Professor Tensie Whelan.

Brian had the opportunity to speak to Tensie on her research and findings, and what's driving some of the leading trends in ESG. The episode takes a look at ESG reporting from the investor perspective, and how the correlation between sustainability and financial performance can help companies see ESG data as a source of value. I’m excited to share their discussion with our listeners and I’ll now hand it over to Brian now.

Brian Tomlinson

Delighted to be in conversation with Professor Tensie Whelan from New York University (NYU) Stern's Center for Sustainable Business. Now, to set up this conversation, I just wanted to talk a little bit about what's driving some of the trends in ESG right now.

In the recent EY survey, institutional investors said they're looking more closely at ESG issues and additionally, institutional investors have been at the forefront of pushing ESG on corporate agendas through the shareholder proposal process and also, the work of investor coalitions, like the Climate Action 100+. Now, in a recent CEO survey conducted by EY, additionally, 80% of the CEOs said that they saw ESG as a value driver. That there is, basically, ESG is a source of conventional business benefits from reduced costs to operational efficiency. And Tensie and I'll talk a little bit about that deeper into the session. Also, risks are increasingly tied to ESG. If you look at the WEF, World Economic Forum risks report, a significant number of the top ten risks are directly tied to ESG themes.

So, whether risk of being appropriately managed or not, they exist and are a threat to value. ESG is also looking like a really strong source of strategy and product innovation — as companies start to try to respond to changing consumer preferences, and also trying to meet new social and environmental needs and expectations through their products. And increasingly, one of the things that we've seen in the last year or so, is just this huge regulatory push to engage with ESG and to bring ESG into part of the regulatory conversation.

Obviously, we've seen that with the SEC's climate disclosure proposed rule and impending rulemaking from the SEC on human capital, and then all the other engagements by regulatory and quasi-regulatory bodies through the EU and IFRS, among others. That's the context for this conversation. So, it's a great time to be speaking with Professor Whelan from NYU Stern.

In her work, she leads the sustainable business. She's produced a huge volume of incredibly useful academic research on ESG themes, in addition to giving thousands of current and future US executives, and executives from around the world their start in sustainability through her teaching and her executive ed programs. Prior to her work with NYU Stern, Tensie led the Rainforest Alliance, hugely increasing its impact and its footprint.

It's great to have you on this call today. I wanted to start by asking you about your recent work on the Return on Sustainability Investment, which we'll call ROSI from now on for brevity. In that work, you really look at the elements of sustainability investments that drive value. Can you give us an overview of your approach and some of your key findings in that work?

Tensie Whelan

I'd be delighted to and it's a pleasure to be with you today. I always enjoy our conversations and also appreciate all the great work you've been doing on these topics for many years. Looking at this question around Return on Sustainability Investment, one of the things that we find is that corporates are reporting on ESG and they're reporting on their financial performance — but they're not actually reporting on how the two relate.

We developed this methodology — ROSI — that looks and has identified nine mediating factors that drive better performance, when you embed sustainability core to your business strategy and your practice. Those nine factors include things, and you mentioned a few of them, like innovation, operational efficiency, risk mitigation, employee engagement, recruitment retention, supplier loyalty, improved media, customer sales, et cetera. So, a whole series of benefits that you can drive with sustainability strategy.

Obviously, when I lay out those different drivers, any kind of good management can drive innovation or risk mitigation or employee engagement. But what's interesting about sustainability and ESG, it really is becoming that next wave of good management that many sustainability strategies can drive better performance across a wide range of drivers. Let me give you a few examples. We've worked in automotive. We’ve worked in apparel. We’ve worked in food and agriculture, utilities. So, we've been working with big names across a variety of different industries to understand what are the drivers of better financial performance with sustainability in hand.

One example, we looked at the automotive sector where their waste reduction strategies for one company resulted in an annual contribution to EBIT of US$230m — a number they did not know they were generating through the adoption of practices, such as recycling paint and solvent. And when you recycle paint and solvent, you no longer buy the virgin stuff. You no longer have the waste disposal costs. They were selling some that was leftover. But what's interesting in accounting is actually you don't look at avoided costs, so they had no idea that they were avoiding not only through that strategy, but a variety of other practices — a whole host of avoided costs were included.

Another example, we worked with an apparel company looking at the benefits of their circular approach to apparel. They provided coupons to customers to bring back gently used clothing, which they then either upcycled or resold. And in looking at what the financial benefits to them were of doing that, there were a couple of different categories. One, of course, was that they had pretty good margins on the sale of the product itself. Secondly, when people brought back the coupon, it was highly successful in driving people to buy additional product. And thirdly, and this was actually the most important for them, they had struggled to reach younger women. With this circular approach, for no acquisition spend, they actually recruited and brought in a number of much younger women who over time, hopefully will convert to full customers — to the tune of, for them about US$2m net annually, which doesn't sound like a lot of money, but actually for a private, smallish apparel company, actually is quite significant. 

We see across virtually all sectors. We looked at another company. I'll give you one last example. A Canadian utility that was trying to decide whether to get out of coal earlier than is mandated by the Canadian government. They did their conventional analysis where they looked at what the regular costs would be. They came to us to say, “If you apply ROSI, what additional information might be helpful to us in making this decision?” And we looked at all of our nine mediating factors and we came up with three areas, one or two areas really. One was around employees because increasingly, employees do not want to work for companies with this kind of profile. And so, we saw benefits in terms of both retention and productivity. But then, the biggest chunk was around lower cost of capital, because increasingly, we're seeing that companies that have the potential to have stranded assets or have major regulatory issues or reputational issues are being penalized with a higher cost of capital. Based on this analysis, which came out to US$20m plus benefit to them over the course of the nine years where they would have made this decision, they decided to go ahead and exit coal earlier as a result of that analysis. It's a really useful framework to help companies begin to understand where value is being created within the company.


It's great to hear ESG just placed in the context of conventional business benefits that the finance function, CFO will be extremely interested in and which are then easily translatable into investor-facing settings, so they can become part of the equity narrative, which we again, we'll talk about a little bit later. And I love that framing of it being like the next wave of good management, but also that in order to understand the impact these ESG themes are having, you may actually need to do new things, like that notion that there are these benefits that absent new initiatives, we might have missed, and might not have been able to account for and make part of our narrative.

I know that you've done work looking at consumer attitudes to ESG and sustainability more broadly. And we know that consumer preferences are changing as consumers become more inclined to try to match that dollar spending with their “values.”

Some companies are increasingly finding that if they can find a legitimate way of linking a product to a sustainability theme, then there is a higher price point and wider margins. So, it’d be useful for us to get a sense of how you work around, that consumer preferences piece also plays out.


This research came from working when I ran Rainforest Alliance and hearing over and over again from CMOs, “Oh well. People say they want to buy the product but then they don't actually or they aren't willing to pay a premium.” So, sort of pointing out this green gap.

So, when I came to Stern, I said, “So, what's the research on this?” And what I found is that virtually all the research was surveys, surveying people as to whether they plan to buy and surveying them as to whether they actually bought. So, we didn't have comprehensive data on actual purchasing of sustainably marketed products. We then partnered with IRI, which is a market research firm that collects all of our barcode data for consumer packaged goods — food, personal care, household care products. We looked at 36 of the 40 CPG or consumer packaged good categories, more than 100,000 different products, looking at the claims. We looked over a five-year period and actually, every year we're updating the research.

First of all, sustainably marketed products and CPG, and this is again purchasing, not people's intent, but actual purchasing, is about 17% of the total. So, it's still niche. But 32% of the growth in CPG comes from sustainably marketed products at a 30% premium. We see at those categories, price, consumers are willing to pay more. There is price elasticity around sustainable products. We also saw that in 2021, one out of every two new products introduced in consumer packaged goods had some type of sustainability attribute — one out of every two. And we've seen that grow up quite substantially every year, over the last five years. We also saw that in 2021, US$3.4b of carbon-labeled products and consumer packaged goods were sold, up from US$1.3b in 2020 and next to nothing in 2019.

Again, these trends are really significant. My final point is, even in areas where we see what you might think as market saturation — so yogurt for example. 70% of all yogurt has some type of sustainability claim on it. Conventional yogurt is at a negative 10% growth. Sustainably marketed yogurt is at a plus 10% growth. In dairy, also similarly pretty high. I can’t remember, I think it's around 60% market share of sustainably oriented products. When we first came out with this research back in 2019 and we showed that kind of growth, we also saw that negative 10% growth on the conventional and I think, plus 15% on the sustainable.

That same year, the two biggest dairy producers in the US declared bankruptcy, because they weren't keeping up with the consumer. This is really investor-relevant information, as well as corporate transformation to pivot critical  in terms of where the markets are going. And consumer packaged goods are a good bellwether because it's things that people put in them, on them, around them. What happens there happens first, and then, it moves out into apparel, into automotive and to other sectors.


It really indicates just the imperative of responding to ESG issues through product innovation. And just with those two issues that you highlighted, you get more growth through sustainability-linked products and then, those products can be sold at a premium, across any number of sectors that you are exposed to consumer preferences.

Let's move on also to the issue of return attribution around ESG, because I know you've done some work on this. Now, early in the evolution of ESG, there was always this concern that ESG-tagged funds were going to be a source of concessionary returns. Often these studies that demonstrated that link were often based on ethical investing approaches, which pursued extremely aggressive negative screens and therefore, narrowed the investable universe.

Now, in recent years, we've actually seen a slew of studies which have said that essentially, there is strong financial performance connected to companies that do a good job of managing their material ESG issues, mostly that focus on materiality is key, given the way that ESG issues vary systematically by sector. You've looked at ESG and financial performance as a meta study, which is essentially a study of studies — ESG and financial performance — and just wanted to get a quick summary of what the output of that meta study was.


It's a fascinating space to look at because it really has evolved. In addition to people looking at negative screens, they also confuse CSR, corporate social responsibility, with ESG. So, it's just a lot of mush which still exists to a certain extent to be clear.

But so, we did, as you said, a meta-analysis, looking at more than a thousand academic studies that were published between 2015 and 2020. And what we divided those studies into: studies looking at the correlation between ESG and corporate financial performance, and studies looking at the correlation between ESG and investment performance.

On the corporate side, we found that 58% of the studies demonstrated a positive correlation between better financial performance and ESG. I think, about less than 5% demonstrated a negative correlation.

On the investor side, we identified 33% of the studies found a positive or outperformance alpha coming from ESG portfolios versus conventional. About 26% found that ESG funds and portfolios performed similarly to conventional.

And I think a bit higher percentage, maybe around 8%, found a negative correlation. The other studies had mixed. So, the numbers don't add up to 100 because there were some studies that have a variety of different findings.

We also did a deep dive into climate and when we did that, we found that the alpha generated for investment portfolios actually increased substantially. This has been very volatile most recently, but at least at that point, focusing on reducing your climate change exposure resulted in better financial performance. One or two findings, pulling out from all the different studies, I think one is really important for investors to understand, which is that just reporting ESG does not necessarily result in better performance.

There're a couple of reasons. The first is that if companies are approaching this just as, “Let me respond to a bunch of these compliance questionnaires with a tick-the-box on whatever metrics they're asking me for,” as opposed to, “Let me build a strategy focused on my material ESG issues with performance-oriented KPIs, and then I will map to the reporting metrics.”

That are two very different approaches. And then unfortunately, we still see a lot of the former in terms of companies reporting whatever. The other thing that we should note is that reporting disclosures are very important because they give us an ability to have a common set of metrics. But by virtue of them being reporting standards, they are process- and output-oriented versus performance- and outcome-oriented.

For example, if you look at a reporting standard and chemical management is an important element for an apparel company, let's say. Because it's a reporting standard and they can't do benchmarking at scale, they'll just ask you, “Do you have a chemical management policy in place?” Not, “What are you doing about it?” But a company that, for example, has adopted a bio-based dye that reduces water use, energy use and toxic emissions, and creates something that they can sell to brands is a very different proposition, than a company that just has a chemical management policy. Yet the two would be treated the same under a reporting standard. So, that's just to illustrate some of the challenges around this type of research and also, managing to reporting standards — as opposed to managing to material issues, performance and impact.


It's really good to have it just reiterated that ESG is not a reporting exercise. Disclosure is an output of an underlying process, and that process is about improving the financial and operational efficiency of the business; reducing negative social and environmental impacts; and having all those positive impacts actually be quite complimentary.

And again, just on the investor side, I think it's really important to highlight just the different diversity of approaches that are being taken by institutional investors as they think about ESG. You do still have the existence of exclusionary screening in terms of, in some funds. You have some funds that are taking active management approaches. You have others that are looking at best-in-class. And that's going to influence the way in which the data spits out the results in terms of how ESG and financial performance marry up. But the overall picture to me, particularly at an issuer level is, those companies that are managing their ESG issues, their material ESG issues in a focused way tend to have better financial performance, tend to be more resilient over the long term, and also additionally, tend to attract a class of investor who has a longer-term time horizon, which can actually be very good in terms of reducing some of these short-term managerial pressures that can push against ESG, which can often have a medium- to long-term investment time horizon.

Companies are faced with a decision about how to disclose that information to the capital markets. Now, often the way a company talks about ESG doesn't mirror the way it's talked about its financials at all. Companies have often avoided talking about ESG in their regulatory filings, absent regulatory compulsion. That's starting to change as the value of ESG becomes more clear and as regulation incorporates ESG into its scope. Now, we coproduced a paper called, “ESG and the earnings call,” looking at how you can think about engaging ESG into that shorter-term disclosure forum. The earnings call is an absolutely critical forum for disclosing your equity story to the capital markets. The information that's disclosed in the earnings call really does move markets. And so therefore, it has this shorter-term time horizon. It's often, I think, somewhat been unfairly tagged as being a source of market short-termism. And it also therefore, means that it's perhaps the least auspicious forum to talk about ESG, given the often longer-term time horizon over which ESG issues play out.

So, how can a company start to incorporate ESG content into that shorter-term “market moving” disclosure setting?


We enjoyed working on that with you, Brian. So one of the interesting and fun elements, though frustrating, in terms of context setting, was to see how analysts said, “Well, we don't ask about ESG because the corporates don't break it up.” So therefore, it can't be important. And then the corporate leadership said, “We don't talk about ESG because the analysts didn’t bring it up.” So therefore, they don't care. So, and this circular conversation, which I do believe is getting better. It's not where it should be at all, but the sheer immediacy of many of these topics is forcing the conversations.

Unfortunately, in many cases, in a more reactive way than is really necessary, in terms of how companies could be much more proactive and strategic about it. We met with a variety of different companies as well as their analysts and came up with some ideas on how to improve this process. And it's not “one size fits all,” but it's a number of different ways in which you could approach this.

First is, you really need to build engagement around your broader ESG strategy as part of your business strategy. Looking at the long-term strategy of the company, building this into that strategy, sharing that in the same places that you would — whether it’s earnings day, special meetings or whether it's one time a year where you go into the longer-term approach and explain the material issues. The important thing is to, in a careful way, to educate your investors, so they understand what's material for you, and why you're tackling and investing in them, so you don't get pushback on why you're investing in those areas. That's one piece. In terms of integrating it into the quarterly calls themselves, most folks are not going to be interested in hearing exhaustive detail about how many gallons of water you saved. They may well be interested in, for example, how your climate change strategy allowed you to develop new services that you are providing to your customers that are bringing in new revenue. So, what you want to do is, pull out the most material strategies and identify as appropriate where the financial linkages are and what kind of benefits you see over the course of the year, so that you can highlight those for investors. That ties back to the Return on Sustainability Investment conversation that we had, that the best place for your ESG metric reporting is in your annual reporting. But in terms of the Return on Sustainability Investment, there will be elements that you can bring in throughout the full year.

Another area to think about too is the theater of managing the calls. Priming the pump with off-call conversations, with analysts, with longer-term investors. Inviting actually ESG investors to come in and be part of the call and ask those questions. But also, talking to some of the analysts who might have a particular area of focus where you would think a particular material ESG issue might be of interest to them and encourage them to ask questions about it, so that you can begin to build an expectation that this will be part of, though not dominate, but be part of the ongoing thread of conversation.

Finally, what we're beginning to see from investors is, actually, I was just talking to a major asset owner about this earlier and what he said is, when he's brought in to talk to somebody in and their ESG people are there. He doesn't want to hear from the ESG people because they know their stuff. He wants to hear from the CEO or whoever the appropriate person is to see if they know the stuff. You really need to be well educated around these topics, but also really encourage collaboration between the sustainability folks and the IR folks, and make sure that everybody is well versed in this. And it isn't a siloed operation, that it is really part of business strategy that everybody is behind, so that you're authentic in your reporting and your engagement with investors.


The earnings call is a bit of a barometer of the progress ESG is making. For many years, you talk to corporates and they say ESG can't be important because our investors are not raising it on earnings calls. Now, I always thought that was a bit of a misnomer because though they might not be, the sell-side analysts might not be raising it on earnings calls because the sell side is the only, really vocal sector of market participants that really talk on earnings calls. The buy side tend to not want to disclose their strategies by asking questions. There were obviously many other forums in which investors were raising ESG issues, particularly “in season” and “off season,” and “year-round” proxy engagements. So, one of the interesting things that happened during the COVID-19 pandemic was that the number of ESG issues raised on earnings calls just accelerated absolutely exponentially. We did a little test to see how that moved, just in terms of looking at transcripts, ESG references on earnings calls, looking at the difference from 2018 to 2020, and we're looking at 500%, 600%, 700% increases in references to ESG themes on earnings calls, just indicating that if it hadn't been there previously, it has certainly arrived. And I know companies, they want to do confidence building before they get to the stage of talking about ESG on earnings calls and you referenced that in your remarks. So, you might want to start perhaps with your sustainability report and then, you take elements of that sustainability report and talk about that to very ESG-focused investors on an ESG investor day. Some of that disclosure starts to make it into regulatory filings. And then actually, you get down to a nub of real financially material ESG issues tied to strategy that you can then talk about in the earnings call. And using the theater, as you said, year-round to decide how are we going to do it? Are we going to look at the sustainability attributes of a particular product? Are we going to look at how sustainability and ESG is part of our macro-framing? And we've seen companies do, in terms of strategy, we've seen companies do a variety of different approaches there. But I think the key thing here is also just one of consistency. You need to be talking about these themes in the same way using similar language but adjusted to the relevant audience and time horizon across your reporting ecosystem. It does start to look strange when companies are talking in there about ESG, say in the ESG report or the sustainability report in a completely different way to the way they may be talking about similar ESG themes, for instance, say in their 10k. And I'm sure we can all point to examples of companies that unfortunately are doing that. But I think the pressure is moving companies away from that.

You work with a lot of issuers in your research and your executive ed. What's the key takeaway that you give to issuers just on engaging with ESG and sustainability issues generally?


The key is to ensure that you're focusing on, as you've mentioned, what are the material environmental, social, governance issues for your company. Designing a strategy that embeds that in your business strategy is not separate. There is no daylight between them. Performance-oriented targets that you share throughout the company and the compensation it’s tied to. That you are transparent about your targets, you're transparent about your successes and your failures in terms of when you don't meet certain targets. That you set targets that are ambitious. We need ambitious and transformational engagement. That you support a culture of innovation that drives sustainability. If you look at what's happening here, this is about change management. Just in the same way that digitalization required internal change management across an organization, so does sustainability. Those companies that do change management well will win. So, really investing in that.

Other research we've done finds that our boards are generally not fit for purpose. They do not have training in ESG. They do not know the questions to ask. They do not have credentials in ESG. Some research that we did looked at 1,188 Fortune 100 board members — three had climate change credentials, eight had cybersecurity credentials. We're talking about property casualty companies with nobody with climate credentials on their board. We are seeing more and more courses set up for board members, and more openness to potentially bringing in folks like chief sustainability officers on to boards. That's another, from a governance perspective, an important element for issuers.

The opportunities in terms of competitive advantage and also, making a difference for your children and your grandchildren, those opportunities are real.


That's a perfect note to end on. Just a reminder that ESG really is a whole firm concept and it flows from the boards all the way through to brands. But by focusing on material issues, you can really narrow the strategic universe of issues that you're looking at to really focus on what matters to your business, your investors and your stakeholders.


The pace of change in ESG reporting continues to accelerate. Corporate leaders across organizations need to recognize, and address the ESG needs of investors and all their stakeholders in order to create sustainable, long-term value. Thank you to Tensie and Brian for sharing their perspectives with our listeners.

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