If you do it, will they know?
The title is borrowed, loosely (humour me ;) on the Field of Dreams movie’s famous line “if you build it, he will come”. It refers to the widely held but misguided belief companies have that if they do it — if they manage their business well, address the risks and seize opportunities, pay careful attention to all the issues that matter to their long-term success — investors and other stakeholders will just know. Not only know, but also use this information in making their decisions about the company. Decisions like whether or not to invest in or lend money to the company and at what price, whether or not to insure its business and its assets, whether or not to purchase its goods or services, and whether or not to go work for the company. All of which can influence the company’s revenues, expenses, cash flows, reputation, and risk profile.
This is true of all relevant information about a company, including its business model, prospects, significant risks, and material environmental, social, and governance (ESG) issues. However, whereas companies are quite accustomed to talking about things like strategy and financial performance, they are much less likely to be talking about their ESG performance.
How will stakeholders know, if you don’t tell them? Another way to ask the question might be whether value is created by ‘doing’ or ‘saying’? The short answer is both.
Value creation is a two-step process
- First, companies need to address their material ESG or sustainability-related issues to better manage risks and seize opportunities in a way that improves their operating and financial performance and minimizes their negative impacts.
- Second, capital providers take this into account in establishing their forecast models and valuation metrics such as discount rates and earnings multiples.
However, the second step doesn’t just happen. For capital providers — and other stakeholders, by the way — to take a company’s sustainability-related performance into account when making their decisions, companies must proactively tell them how they manage their material ESG issues.
Investors are particularly skittish. They have capacity constraints in siphoning through and analyzing the hundreds of investment ideas presented to them on a daily basis. They’re looking for reasons to dismiss companies as potential investments. Can’t see a competitive differentiator? Never mind. Unable to ascertain management quality? Forget it. No clearly defined path to growth? No go. Similarly, if they are doing some fundamental analysis on your company, but they don’t know that you have a higher employee engagement level and retention rate than your industry, or that the electricity to power your energy-intensive manufacturing process is 100% renewable, they are not likely to reflect that in higher profit margin and lower cost of capital assumptions.
So no, if you do it, they will not know. Unless you tell them.
They say quality information is the lifeblood of capital markets. Lack of information causes market inefficiencies, which can translate into less available and more costly capital, lost revenues, or higher costs. Companies are far from powerless in making capital markets as efficient as possible. Their power resides in providing the best reporting possible. Today, that includes decision-useful ESG and sustainability reporting.