As investors continue to push for metrics to show progress on sustainability, it can be tempting for businesses to jump quickly to meet their demands. Not surprisingly, though, a recent study found that businesses that are ill equipped to make the right sustainability choices often see a decrease in market value.
So when should business leaders accelerate sustainability efforts and win Wall Street’s love? And when should they pump the brakes?
Conducted by researchers from Harvard Business School, the study involved 2,665 shareholder proposals between 1997 and 2012, and relied on guidelines by the Sustainability Accounting Standards Board (SASB) to determine whether sustainability efforts were financially material. Materiality, particularly related to sustainability, isn’t always a clear black-and-white issue, and it can be drastically different for businesses in different industries.
According to SASB’s materiality map, different aspects of sustainability, such as energy management, water management, air quality, greenhouse gas emissions, or biodiversity impact, can be more commonly material in some industries versus others. For example, greenhouse gas emissions are likely to be material for more than 50 percent of chemical manufacturers, but unlikely to be material in the aerospace and defense sector.
The study concluded that overall, businesses were quick to react to any suggestion to improve on a broad range of environmental, social and governance (ESG) issues, such as diversity, energy efficiency, water consumption, and product safety -- regardless of whether the proposal was even voted on and passed.
The simple act of investors shining a light on an issue tended to capture management’s attention and lead to improvements. But here’s the important piece for management to understand -- improvement on an ESG issue does not necessarily mean improvement in financial value for the company.
This is where materiality comes into play. When investors filed proposals on issues that were material to the companies involved, those companies largely saw their market valuation increase, “even several years after the proposal,” said George Serafeim, a professor at Harvard Business School and one of the study’s co-authors, in a recent article.
However, proposals on immaterial issues often led to a subsequent decrease in market valuation for the companies involved.
The linkage between high-performing companies and strong sustainability policies is gaining steam. According to the Principles for Responsible Investment Initiative, the number of funds that focus on ESG metrics grew from $4 trillion in 2006 to $59 trillion in April 2015. More and more investors are using sustainability metrics as a meaningful factor in their evaluations and pushing companies to do more. But businesses need to be smart, because according to the researchers in the HBS study, 58 percent of all the proposals reviewed involved immaterial issues -- and the majority of those corresponded to a decrease in companies’ market value.
Why are companies spending time on immaterial proposals by investors?
The study unsurprisingly concluded that “management struggled to distinguish between material and immaterial requests." Serafeim speculates that “perhaps management responds to immaterial investor requests because they mistakenly believe that doing so will increase the company’s value.”
For an example of what great looks like when it comes to evaluating materiality, look no further than Unilever, a company that is often lauded for both its sustainability practices and financial performance. Unilever not only takes a close look at what ESG issues are material and are not material, in the spirit of full transparency and open communication with stakeholders, it also publishes its materiality map on its website.
In 2015, Unilever evaluated 191 issues, grouped into 38 key topics. At the end of the process, the team identified 15 material issues (water, deforestation and sustainable agriculture topped the list), developed action plans, and updated its "sustainable living plan." Unilever’s approach is a textbook example of emerging best practices that focus on data-driven decision-making, communication and transparency.
Companies that want to take a page from Unilever’s playbook have an increasing number of resources to draw from. Organizations like SASB offer a number of tools, like a materiality map, and online learning opportunities.
Importantly, these resources are also being actively pushed to the investment community. Companies that want to stay ahead of the curve are best served by understanding what is -- and just as importantly, what isn’t -- material to their businesses health.
Tim Healy is the co-founder and CEO of EnerNOC.