Calculating the ROI of ESG: A New Set of Metrics for a New Kind of Value

Between 2013 and 2020, companies that consistently scored high on ESG factors saw 2.6x greater shareholder returns than average ESG scorers. And recent evidence links higher ESG scores to a 10 percent lower cost of capital.

Investing in ESG pays off, but while many forward-thinking leaders see it as an investment into their company’s future, some still see ESG as little more than a compliance cost. ESG creates real value, within and outside an organization — it simply comes down to how value is measured. Read on for six tips to calculate the ROI of your ESG strategy.

1. Focus on Managing Risk

ESG is first and foremost a risk management strategy. “An ESG strategy can have financial benefits for a company through proactive anticipation of external events that can have a negative impact,” says Nancy Landrum, professor of sustainability management at Loyola University Chicago. “Through environmental scanning, a company can identify these [risk management] issues and prepare in advance. The research shows that companies with higher ESG ratings are, generally, better managed and they perform better than companies with low ESG ratings.”

Elizabeth Tutino, a sustainability specialist at Equilibrium, sees risk management as a key source of value for ESG. “If an organization has the potential to be subjected to a carbon tax, for example, we can estimate the potential financial impacts of taxes, versus what we can do to reduce this,” she says. In this way, businesses can benefit from proactively predicting and managing future ESG concerns.

Green tech as well as specialized ESG advisory helps companies scenario plan and run simulations to understand ESG risks and mitigate expensive non-compliance issues and potential threats in their supply chain.

2. Think Long Term

One mistake many executives make when calculating the return on ESG activities is expecting a positive financial ROI too quickly. By nature, an investment in ESG is an investment in the future. Organizations will find that particular activities — such as installing solar panels, implementing a new diversity program, or even hiring for ESG roles — won’t have an immediate positive impact on their bottom line. For many ESG strategies, companies must think more long-term than they are used to.

But the benefits of longer-term thinking extend far beyond your ESG activities. Organizations that adopt long-term approaches to strategic initiatives see 47 percent higher revenue growth and faster-growing market caps, according to a study by McKinsey Global Institute in cooperation with FCLT Global.

“Strong ESG performance can result in decreased costs, increased profits, increased market share, better risk management, improved competitiveness, and a host of other benefits,” Landrum says.

3. Measure the Impact of Specific Projects

Calculating the ROI of an ESG strategy as a whole is difficult, but specific ESG-driven projects can provide more concrete returns. For example, “If we were a company that cared about water and we wanted to implement a water recycling system at our facility, we can calculate the ROI of installing the system versus the water that would be required to be purchased,” Tutino says.

As far as the E of ESG is concerned, many executives see switching to more sustainable materials or solutions as the “expensive” option, but this is an outdated misconception. “Where you’re reducing materials used, water, electricity, waste produced, and so on, this is good for your ESG story, but also good for your bottom line,” Tutino says. For instance, UPS has saved $400 million annually since 2013 by reducing delivery miles, and manufacturer Owens Corning expects to see $1.6 million in savings annually through its energy efficiency initiatives.

4. Accept the Costs of Doing Business

As with any business activity, ESG strategies will inevitably involve costs that don’t directly lead to improved profitability. “It would be really hard to calculate the ROI of reporting or activities like initial strategy development and materiality assessments,” Tutino says. “But you need these activities in order to get to a place where you’re able to pick specific projects to implement and calculate their ROI.”

Think of these costs as the costs of doing business. Even though ROI may be difficult to calculate in these instances, the overall value of a robust ESG strategy — measured over the long term — is undeniable.

5. Acknowledge Ambiguity

Although numerical measurement may be out of reach for some projects and strategies, they can still create value. ESG leaders may find this especially true when it comes to certain social and governance factors, which are only now steadily becoming more tangible and quantifiable. But this doesn’t make these factors any less important as part of a well-rounded ESG program. Although these terms can make executives uneasy, there’s a degree of ambiguity and the qualitative impact of ESG cannot be overlooked.

For example, few could deny that improving working conditions would result in greater well-being and stability for a workforce. In the long term, these changes may improve productivity and reduce staff turnover costs, but even without quantifiable results, the positive value created is evident. In this case, the uncertainty (or lack of quantifiability) does not negate the investment.

6. Consider What You’re Missing Out On

For public-facing organizations, ESG isn’t simply an internal consideration. Companies face mounting ESG pressure from two key populations: consumers and investors. On one hand, consumers are putting pressure on brand transparency and ESG performance. As many as 60 percent will base purchase decisions on these disclosures, according to the International Food Information Council. The same applies to acquiring and retaining talent as a new generation of employees becomes increasingly selective about where they work.

On the investor side, ESG assets are predicted to hit $53 trillion in the next three years, a trend only projected to continue. Companies that don’t perform well on ESG (or disclose performance ineffectively) could be missing out on more than they realize.

“Bloomberg reports that the amount of money held in sustainable mutual funds and ESG-focused exchange-traded funds is as high as $2.7 trillion,” says Joey Durr, a climate strategy associate at Equilibrium. “Investors are demanding transparency on the environmental impact of the companies that they’re investing in and consumers want more ethical brands. So there’s a strong case to implement ESG to attract investors and consumers.”

Beyond Financial Benefits

Although many ESG activities can have a positive impact on your bottom line, the value of ESG as a whole may be difficult to quantify using traditional business KPIs. This leads many to question the relevance of these legacy metrics in today’s corporate climate.

“The non-financial benefits of implementing an ESG strategy are increased resilience, improved image and reputation, increased goodwill, improved employee satisfaction and morale, and more,” Landrum says. As ESG strategies and reporting become as commonplace as their financial predecessors, it’s time to start thinking about new ways to measure value.