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- Is ESG Good for TSR?
What’s the Story?
Last month Kroll, a leading independent provider of risk and financial advice, published a detailed study of the impact of ESG on historic Total Shareholder Return (TSR) outcomes.
The study looked at 13,000 companies in four regions comprising 12 countries and 11 GIC sectors. The study covered January 2013 to December 2021, a period of nine years, and looked at TSR achieved, relative to the company MSCI ESG ratings.
In all of the regions considered TSR for ESG leaders exceeded the average, and the TSR result for average ESG companies exceeded that of the ESG laggards.
This strong ESG and TSR correlation was also seen in 9 of the 11 industrial sectors considered (the exceptions being heath care and consumer staples).
The Kroll study contains much detail over 106 pages, and include some useful observations on the history of ESG, it’s terminology and potential future direction.
The Kroll methodologies deployed for the purpose of the calculations are set out in detail alongside the granular TSR to ESG findings. The published study itself can be found here.
Why Does it Matter?
ESG is important to institutional investors, not just in connection with the global transition to Net Zero, but also in connection with responsible and sustainable business practices.
Many leading companies have always paid close attention to their business relationships, their reputation and the management of goodwill. This is often culture based and intuitively seen to be in shareholders’ best interests.
In recent times, ESG has become politicised, particularly in the USA. Some accuse advocates of ESG of “woke capitalism” which dilutes the healthy thrust of “invisible hand” economic forces.
The Kroll study is a hard quant-based look at an extensive set of companies, sectors and countries over nine years. The overarching conclusion is strongly in favour of the view that well-managed ESG delivers higher returns to shareholders. Moreover, the difference in TSR outcome on an annualised basis is not small; it is very material in most cases.
This is particularly important as ESG metrics are now commonly seen in executive compensation arrangements, both short-term incentives and LTIPs. Indeed, a recent study published by GECN confirms this strong ongoing trend.
While for executive incentives the nature of the ESG metrics selected and the target setting process may need improvement, the study supports this clear movement in the executive compensation market.
Newspoint view
This Kroll study is most welcome in that it provides a detailed quantitative assessment of an ESG value link to delivered TSR results, that hitherto has been supported only by intuitive argument.
The study deploys the relationship between ESG leaders and ESG laggards as defined by the MSCI ESG company rating. As there are now over 600 ESG rating methodologies worldwide, further studies against leading providers, such as Sustainalytics, Bloomberg, ISS and Moodys would be welcome.
Institutional investors generally support ESG within executive incentives but only when the metrics are strategically relevant, the impact is material, and the measure is well defined with targets of similar difficulty to the rest of incentive pay. Companies can expect increasing push-back where this is not the case. (see section C -Variable Remuneration).
A detailed sub-analysis of the E, S and G impacts on TSR, ideally by industry, would be a strong tool for company ESG metric selection for executive incentives.
We can now expect Kroll and others to explore the ESG and TSR correlations in even more detail as we move forward. As with much management theory, attribution of outcomes can be hazy, but excellent management intuition is often right, and is not based on wishful thinking.
A valuable outcome in time will be an understanding of the optimal ESG investment by category. As with most investment areas, excessive investment will see diminishing marginal returns. More numbers, and deeper insights are sure to follow.
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Damian Carnell - [email protected] +44 (0) 7989 337118
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