A link exists between a company's ESG performance and its financial performance, according to a study published Thursday from ISS ESG, the responsible investment arm of Institutional Shareholder Services.
Firms with high or favorable ISS ESG corporate ratings tend to be more profitable through an economic value-added lens, the study found.
"While one can argue that the relationship between ESG and financial performance is perhaps due to the fact that more profitable firms have the resources to invest in areas that positively influence ESG, it could also be that profitability rises as a result of a company better managing its material ESG risks, or it could be a little bit of both," the study said. "If it is a little bit of both, then this means that good-ESG initiatives drive up financial performance, which then provides the monetary resources to invest to be an even better ESG firm, which then drives up performance again, and so on."
Moreover, companies with better ESG ratings are also less volatile, noted Anthony Campagna, global head of fundamental research at ISS EVA. "There's no sustainable connection between high ESG ratings and risk, it's actually the inverse," he said.
Investors may choose not to invest in a firm that has poor ESG, "thereby limiting its access to capital and raising its cost of capital," the study said. "Firms that get in trouble on the environment may be distracted by the regulatory headache (higher costs) and customers may avoid the firm (lowering revenue). If one does not treat employees right, this could lower morale, increase turnover and therefore lower productivity.
To determine a company's ESG rating, ISS ESG gives it separate scores on environment, social and governance factors and then tallies up the number. To arrive at company's EVA, ISS calculates the figure as net operating profit after tax minus a capital charge (weighted average cost of capital multiplied by capital invested). The EVA business sits within ISS ESG.