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On the Money

The link between business value creation and ESG

A new report from Bain & Co. and EcoVadis connects sound ESG management across supply chains with better margins.

Several links in a metal chain depicted in black and white

Image via Shutterstock/Madrolly

There is no market for virtue. Businesses and their investors require a compelling business case to meaningfully integrate the value of sustainability into business decision-making. 

Zooming out to the long-term lens, the business case for embracing sustainable operational practices is clear: Enterprises can’t thrive on a depleted planet populated by societies destabilized by the "threat multiplier" that is climate change. But here in the zoomed-in present, the business case for sustainability isn’t as black-and-white as narratives such as "doing well by doing good" assert. 

This is especially the case in public markets, where ownership time horizons can be days, minutes or nanoseconds, and company management is beholden to quarterly results. 

New research published this week by management consultant Bain & Company and sustainability ratings firm EcoVadis provides a refreshing take on the relationship between value creation and ESG, particularly in private markets. 

While BlackRock boss Larry Fink’s assertion that private markets are where dirty assets can (profitably) find refuge from sustainability scrutiny is true, it remains true, too, that private equity is "a place where you can take assets and clean them up," as Oxford professor and Sustainability Accounting Standards Board co-founder Bob Eccles has said

Strong ESG performance is a sign of a strong business. That’s the conclusion from Bain and EcoVadis’s assessment of how ESG activities — for example, embedding sustainability policies into management processes or managing carbon reduction programs — affect the 100,000 companies tracked by EcoVadis, of which 80 percent are private. 

One of the more common ESG critiques goes: ESG is a marketing exercise, not core to value creation — so while the marketing exercise provides a brand reputation boost, the value-add is ephemeral.

But ESG isn’t really about doing well by doing good. It’s about sound management in and for a changing world. And private companies with their private equity investors, who operate on a longer time horizon than public market investors, are uniquely positioned to advance portfolio companies on their ESG journeys.

Those on the ESG front lines — largely the institutional investors pushing for more disclosure and better performance from companies — have been put on a defensive footing this year. 

So the finding that ESG activities "have no strong negative correlations with financial outcomes" and that they are "associated with encouraging revenue growth and EBITDA margins" is refreshingly realistic and important for supporting the fundamental business case. That is, a case that demonstrates the measurable value of extending ESG ambitions beyond stakeholder communications and into the core business. 

While private markets are something like one-tenth the size of their public counterpart — roughly $10 trillion versus $124 trillion — they’re closer to the real economy, given private equity investors’ role as patient capital with a more direct role in transforming a business.

Change is needed with speed and at scale. And while the answer to short-termism in capital markets isn’t to take everything private, what is maybe the most significant development in securities markets this millennium? For former Securities and Exchange Commissioner Allison Herren Lee, it’s the explosive growth of private markets. 

So, findings like those in the private company-focused Bain/EcoVadis research that show the financial value of supply chain sustainability initiatives across the 100,000 EcoVadis-tracked companies — "margins 3 percentage points above those that don’t focus on their suppliers’ ethics, environmental and labor practices" — are a solid for-the-long-term business case win.

There is no market for virtue. But there is also no quantifiable fact sharp enough to poke holes in the anti-ESG ideology sustainable investors are working against. Except, maybe, the bottom line.

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