Can Good Corporate Citizenship Be Measured?

If you spend time around corporate boardrooms these days, you’ll hear the abbreviation “E.S.G.” thrown around with such frequency it is almost a trope.

E.S.G. stands for “environmental, social and governance.” Basically, it refers to the three main ways to measure a company’s commitments to ecological sustainability, to its community and to corporate governance.

Big investors, like pension funds and others, have publicly declared that they now consider environmental, social and governance issues to be key metrics of their investment decisions. To pass muster, companies seeking their favor must show a proven track record of responsible stewardship in all three categories.

BlackRock, for one — the world’s largest asset manager, with more than $5 trillion — sent a letter to company chief executives earlier this year, suggesting that if they don’t take these issues seriously, the firm might pull its money.


But for all the happy talk about focusing on these issues, many on Wall Street have privately cast a skeptical eye, chalking up all the bluster on the topic to politically correct marketing efforts run amok. Some critics have gone so far as to say that financial firms are now trying to profit from the trend by offering mutual funds and exchange-traded funds that include only the stocks of companies with the “values” of certain social missions and governance structures.

That’s why a new study that tries to quantify and correlate stock performance with E.S.G. factors is generating a lot of chatter among the investor class.

The study, developed by a team of quantitative strategists led by Savita Subramanian at Bank of America’s Merrill Lynch Global Research unit, appears to be the most expansive, looking at several hundred companies over a decade starting in 2005.

And the results are as surprising for what the authors conclude as for what they do not.

The good news version: Investors who look at environmental, social and governance metrics are less likely to buy shares in companies with volatile stocks. Those investors are also significantly less likely to buy into companies headed toward bankruptcies. And “stocks that ranked within the top third by E.S.G. scores relative to their peers would have outperformed stocks in the bottom third by about 18 percentage points from 2005 to today,” the authors reported.

But the study also found, repeatedly, that if you’re looking for stocks that outperform their peers, simply looking at E.S.G. issues isn’t a panacea.

Even though the companies that rated the best on E.S.G. issues performed better, on average, than others, the study said that “this performance was not consistent, and was very similar to the performance of large versus small companies.”

Indeed, the authors found that in certain industries, like health care, technology and consumer staples, companies that scored highly on E.S.G. metrics actually underperformed their peers. And in the financial sector, “E.S.G. was generally a weak signal of future returns,” though there is some evidence that investors might have avoided some of the banks that struggled the most in the financial crisis.


The study has caused a bit of stir because, in truth, the results were so mixed.

Some large institutional firms that have backed the E.S.G. movement will most likely use the results to buttress their argument that these issues deserve more attention. Others may use them to debunk the E.S.G. effort.

Bank of America has been a big proponent of focusing on E.S.G. issues, remaking itself in recent years and publicly calling on others to follow suit.

The report suggested that companies that rank highly on these issues are meaningly less risky. E.S.G. metrics “have been a better signal of future earnings volatility than any other measure we have found,” with companies that rank highest in E.S.G. tending to rank lowest in volatility (and vice versa), the study said. It also found that stocks with superior E.S.G. scores “signaled higher future” return-on-equity in every industry sector it examined.

The study relied on a scoring system of E.S.G. factors for companies that was conducted by Thomson Reuters, which graded companies based on emissions and resource reductions, human rights, community engagement, work force diversity, training and development plans, board structure and compensation policy, and shareholder rights, among other things.

Still, some in the investment community remain wary. A survey of investors last year by RBC Global Asset Management found that less than 30 percent of investors believed they could outperform the market by investing in companies that score highly on E.S.G. metrics. “It is striking to see that asset owners remain doubtful of E.S.G.’s efficacy even as so much capital pours into E.S.G.-related investments,” Ben Yeoh, a senior portfolio manager at RBC Global Asset Management, said at the time.

Of course, one of the largest questions is whether anyone can properly measure a company based on soft factors like E.S.G. Goldman Sachs wrote a report titled “Measuring the Immeasurable: Scoring E.S.G. Factors.”

The phrase “environmental, social and governance” attempts to encompass a lot. It involves trying to measure a company’s environmental impact — that is, what it is doing about the environment and climate change — as well as its record on social issues and corporate citizenship. On the governance front, measurements include factors like whether shareholders are given a say on pay.

The phrase itself may be in need of a makeover. “The term is ugly because it is jargon that makes no sense to anyone outside the narrow confines” of the social responsibility investing industry, wrote Mike Tyrrell, the editor of SRI Connect, a website that focuses on that industry. Worse, “the term is misleading because it conflates two structurally different dimensions of corporate activity,” he added, smartly drawing a distinction between “sustainable development issues” and “corporate governance issues.”

It is only logical that companies that take these issues seriously should do well over the long term. But it will take more evidence — and perhaps more time — to prove itself as an investment thesis.



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