ESG Factors - The King Maker in COVID-19 / A Corporates' Zero Hour Moment
Milton Friedman, the economist, said that the only social responsibility a corporate has is to increase profits within the rules of the game. In simple terms “the role of business is to be in business”. One cannot think of a more germane time than now to puncture that theory. The virus is, without doubt, a social pandemic with corporate viability squarely in its clutches. Corporates are facing their zero-hour moment.
One may argue that environmental, social and governance (ESG) factors finally found resonance of late, after years of being challenged by mainstream finance. Has the virus provided a temporary pause on ESG and corporate sustainability assessments?
The answer is a resounding ‘no’; in fact research suggests it has further amplified the concept. Corporates have had sustainability thrust upon them by an act wholly outside of their control. Their response, albeit by accident, may be a boon for some and value destructive for laggards. ESG forces a company to wrestle with issues that aren’t black and white.
The impact, timing, and the value that the market attaches to these risks are often not aptly appreciated, thus making ESG risk management the kingmaker. In 2020, we have witnessed leadership being summoned across government, corporate, public health service, and of course the average citizen in society to take action. We collectively grapple with the new normal. We tap into emotional quotient balances and sharpen tool kits so that we are able to respond respectfully.
Who is taking note of corporate responses in this time?
In crises, traditional fundamentals of valuation is trumped by the markets’ assessment of reputation, loyalty, engagement, relevance and citizenship.
What should a company have in its quiver?
Strong appreciation for ESG factors – Companies with stronger ESG credentials place value on externalities, link them to their strategy and operate accordingly. Whilst ESG track records are ripe for debate, evidence exists to show that well-governed, responsive businesses endure market troughs better than their riskier counterparts.
Capital allocation response plan – Companies that consider stakeholders more acutely now stand to have a stronger workforce, client base, commitment and so on. Intangible value add is preparation for recovery after Covid-19.
We chose to look at Gallup research based on data after the 2008 global financial crisis as a past lesson.
Dividends and share buybacks – Cash distributions should be used effectively in the management of operational expenses. In the short term, dividend or buyback cuts might suggest a pecking order between shareholder and stakeholder. In the longer term the market will place greater weight on the strength of a business model.
Business continuity plans (BCP) – A comprehensive, practical yet evolving plan that outlines a playbook in the event of business disruption.
Board balance – Effective corporate governance in the form of a balanced, diverse board may prove useful when addressing softer issues like employee engagement and morale. Stakeholders look for evidence when assessing if companies have window dressed their responses.
Retrenchments – Rehiring costs way more. Companies will have to weigh up retrenchments, salary adjustments, and executives’ compensation plans in light of the cash reserves in place and legislative environment in a country.
The value of a business post Corona
Companies will be measured by their agility at this inflection point. Flexible methods of work, embracing trust, and valuing employee loyalty become the norm. Business preparedness becomes an agenda item on management committees.
We think that whilst these are robust responses in the short term, there are two more nuggets to note: Firstly, the clarion call for climate change strategy and a company’s response to United Nations Sustainable Development Goals (SDGs). Secondly, the companies of tomorrow will add long-term value, not by marketing ESG and philanthropy but by linking their strategy intricately to externalities that affect the business. Consider Covid-19 your dry run.
Business is unusual.