While BP was benefiting from the revenue upside of drilling the world’s deepest wells, were any analysts, investors and its Board wondering about the risks associated with this strategy? Could this questioning have avoided what is proving to be one of the largest environmental disasters of our time, not to mention the untold economic ripple effect throughout our still struggling economy? Possibly — which begs the question as to why environmental, social, and governance (ESG) issues are not a common part of the analysis of companies.
These questions and others were discussed during panels at two recent global conferences – the 2010 Skoll World Forum panel “Social Good with Market Returns?” and the 2010 Ceres Conference panel “Canaries in the Data Mine: The Information Boom in ESG Data.”
At the Skoll World Forum, David Chen of Equilibrium Capital noted how smarter companies are not only valuing externalities from a risk perspective, but also from a value perspective. He gave the example of two power companies – one with 99% of its energy coming from coal and the other with 35% coming from wind. As an investor that will hold the asset for five years, he would rather hold the one with some position in the wind industry.
A few weeks later at the Ceres Conference, Chris McKnett of State Street Global Advisers shared the results of his longitudinal study looking at ESG ranking against stock performance over seven years. The headline result was that highly rated ESG companies do not outperform poorly rated ESG companies. Huh? How is that possible? He went on to explain that ESG data is often a secondary effect on stock performance and ESG data is most relevant is in choosing “best in class” companies within an industry.
Part of the “missing link” between Chris’ study and the action of an investor like David is the crisp articulation of how to economically impute ESG data, so it is no longer simply a secondary effect, but rather a driver of value creation and cost savings as well as risk mitigation.
We have focused on this issue in our Green Returns Project, creating a methodology for private equity firms to assess value creation opportunities in both current portfolios and in the due diligence process. The pilot program involving three companies in the Kohlberg, Kravis, & Roberts portfolio — U.S. Foodservice, Primedia and Sealy — resulting in savings of $16.4 million and the elimination of 25,000 metric tons of greenhouse gases in 2008.
In other parts of the capital supply chain, organizations such as B Lab and The Global Impact Investing Network are also active in articulating clear metrics that allow for investors to understand the bottom line impact resulting from ESG issues. Despite the focus of all three organizations and impressive results, broader uptake has been slow. Might that now change when investors clearly see the impact of not asking these questions of BP? I sincerely hope so.