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Environmental, social and governance

Higher share prices reflect companies with good environmental, social and governance practices

Study of share-price movements of companies on the Hang Seng Corporate Sustainability Index over the past five years show they have outperformed the constituent stocks of the Hang Seng Index

PUBLISHED : Sunday, 24 September, 2017, 3:33pm
UPDATED : Sunday, 24 September, 2017, 3:32pm

There’s no formula, yet it proves the positive impact of good environmental, social and governance (ESG) practices on a company’s share price. Regulators and stakeholders have little doubt that such a link exists.

Supporting that view, the Hang Seng Corporate Sustainability Index, introduced by Hong Kong’s stock exchange, closely monitors a number of key performance indicators (KPIs) for 30 companies known for their early commitment to voluntary ESG disclosure. A study of share-price movements over the past five years show they have outperformed the constituent stocks of the Hang Seng Index, an outcome which can hardly be put down to coincidence or other extraneous factors.

“We can reference similar studies in the United States and China,” says Patrick Lo, risk advisory partner at RSM Hong Kong. “Companies with good ESG policies and practices typically have a better share price performance.”

Elements at work include increased investor confidence resulting from the perceived focus on correct corporate governance and risk management, reducing the chance of ill-conceived or ad hoc decision making. This can lead to better scores from credit rating agencies, meaning lower finance costs and making it easier to raise funds in the capital markets.

In parallel, an in-house culture built on product quality, customer loyalty, staff engagement and sustainability provides the foundation for operating efficiencies, reliability and improved profitability.

“Good ESG reporting leads to greater transparency on how the board is discharging its responsibilities,” Lo says. “It also helps the directors, executive and non-executive, form a good understanding of all stakeholders’ expectations. Their job is to ensure adequate internal control measures as a watchdog, but also to help senior management make sound decisions which enhance value and reflect long-term priorities and new ways of thinking.”

Visionary boards see the potential, understand the growth of ESG-related investment, and are getting prepared for that
Max Tsang, director, GCA Professional Services Group

Lo rejects any notion that the initial costs and greater workload associated with implementing ESG reporting might not appeal to smaller businesses. He prefers to highlight the potential benefits of cost savings from more efficient processes, a more stable workforce, and a lower risk of penalties for non-compliance.

“Remember that the ESG reporting guidelines issued by Hong Kong’s stock exchange are less comprehensive and contain significantly fewer KPIs requiring disclosure than the international standards,” Lo says. “I believe it is a good basis for transition and would not be surprised to see Hong Kong reporting expanded to require more disclosure.”

For Max Tsang, director of GCA Professional Services Group, there is no reason for companies to be dragging their feet. A well-thought-out ESG strategy can give a clear competitive advantage and help to outperform financially. Correctly applied, it can open the door to cost savings, stronger growth and lower risk, plus a potential boost to shares, provided the market hasn’t yet priced ESG into its current valuation.

“Investors often monitor the corporate governance aspect of a listed company most closely since it gives immediate insights into how profits are generated and retained for distribution,” Tsang says.

“But the environmental and social aspects are gradually gaining attention. Each industry can have its unique ‘scorecard’ of ESG factors to focus on. This provides a new landscape where companies can gain a competitive edge and where a dedicated boardroom can access a valuable pool of actionable tools to make real impact.”

He notes that institutional, endowment, government and sovereign-grade investors now monitor extensive ESG-related issues, guided by their investment objectives and social outlook.

Some may put the spotlight on energy efficiency, green power or the importance of affordable public transport. Others may be looking to encourage a greater percentage of women in the boardroom, policies which promote diversity, greater stakeholder engagement, or tougher emission standards.

“Visionary boards see the potential, understand the growth of ESG-related investment, and are getting prepared for that,” Tsang says. “Lagging boards only focus on meeting the minimum disclosure requirements; that is where independent directors can play a more proactive role.”