Ethical Performance
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ESG factors gaining recognition for boosting business performance

November 2015

Successful shareholder engagement on environmental and social issues helps companies improve both their financial performance and governance, showing that involvement that is “less confrontational” than hedge fund activism can achieve results, says a study co-authored by Elroy Dimson of University of Cambridge Judge Business School.

The authors find that environmental, social and governance “engagements” increase shareholder value when successful in changing company policy or actions, and do not destroy firm value even when such engagements are unsuccessful.
In finding that such engagement (particularly environmental and social) improve performance and governance, the study concludes that active ownership “attenuates managerial myopia” of the sort that focuses too much on short-term profit at the expense of long-term shareholder value and other stakeholders.

“This approach is differentiated from other styles of shareholder action, particularly hedge fund activism,” says the study. “Responsible investment initiatives are less confrontational, more collaborative and more sensitive to public perceptions; yet they achieve success.”

The study was co-authored by Elroy Dimson, Chairman of the Newton Centre for Endowment Asset Management at Cambridge Judge Business School, Oguzhan Karakas of Boston College, and Xi Li of Temple University.

The study is based on engagements by a large institutional investor (ranked in the top 100 globally for assets under management) that actively engages with companies in its portfolio via letters, proxy voting, email, phone and direct conversations with management. It looks at 2,152 engagements with 613 U.S. public companies between 1999 and 2009.

The study found that environmental, social and governance engagements generated a cumulative size-adjusted abnormal return of +2.3% over the first year following the initial engagement, and a +7.1% cumulative abnormal return for successful engagements over the first year, with returns gradually flattening out after a year. The success rate for engagements in this sample was 18%, and it took on average two to three engagements before success in achieving a change could be recorded.

Among examples of successful engagements cited in the study: Apple Inc. announced new environmental initiatives; Yahoo! Inc., following media attention related to China, announced new commitments to human rights and online freedom of expression; and Illinois Tool Works Inc. instituted a new corporate social responsibility report.

“To our knowledge, this study is the first to examine the impact of shareholder activism on environmental (E) and social (S) issues,” the study says. “After successful engagements, particularly those on ES issues,engaged companies experience improvements in their operating performance, profitability, efficiency, shareholding and governance.”

Similarly, new research from Alquity and Cass Business School finds companies with strong ESG disclosure are outperforming peers with an annual return of 9.4%, against a benchmark performance of 5.4%. The analysis of over 4,400 listed companies over the period 2011-2015, revealed that companies with strong and improving ESG disclosure in emerging markets realised an annual return of 9.4%, against the benchmark performance of 5.4%.

The research also found a marked increase in disclosure of ESG information in emerging markets. Emerging market companies have increasingly disclosed more ESG information over the last five years, as a means of attracting foreign investment with the greatest improvements in the Energy and Financial Services sectors.

The research concludes that ESG analysis is an effective tool in identifying winning stocks because companies with high and improving ESG disclosure provide better risk-adjusted returns, especially in emerging and frontier markets.

Alquity has called on the investment industry to understand the importance of ESG disclosure and noted that companies are reacting to higher levels of scrutiny from investors, regulators, commentators and the media following the global financial crisis. 

Roberto Lampl, head of Latin American Investments, said: “These results confirm Alquity’s view that greater transparency and disclosure of ESG criteria are vitally important in emerging and frontier markets where risks are greater due to less developed institutional oversight of businesses. Forward looking ESG provides investors with an indication of quality businesses, especially when the disclosure is voluntary.

“High profile disasters like BP’s Macondo crisis in the Gulf of Mexico and more recently the problems experienced by Volkswagen all point towards an increasing scrutiny of corporate behaviour.”

Global | ESG Performance


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