There’s an exciting development in the investment world. Investors are realizing that companies that are good at ESG (environmental, social and governance management) offer good returns. Why? Well that’s where it gets a little less clear. I’d like to offer an explanation using the integrated model.
We find empirical evidence across each of these approaches that incorporating ESG factors into investment decisions improves the investment selection process and enhances risk-adjusted returns.
But why is this the case? Mike Krzus recently added to this conversation with his article Integrated Reporting as a Strategic Initiative. In this he shares a couple studies. This first is a different Calvert study that confirms the correlation between ESG performance and valuation. The second study shows that the valuation boost is not universal. It only comes when ESG becomes a catalyst for innovation and performance. Krzus uses this data to make an argument for integrated reporting. He’s right. Here’s why.
The great challenges facing us on our planet are also enormous opportunities. The twin challenges of climate change and energy will drive the search for alternative fuels, new forms of transportation, new forms of energy-efficient construction, and retrofitting of existing buildings. Remaking the healthcare system should reverse the current pattern where the U.S. has poorer outcomes and higher costs than peer countries. The food system can be reformed away from the industrial model that maximizes cheap calories using methods that create pollution and use fuel and petrochemicals, to one that maximizes nutrition and guarantees more sustainable production methods. Manufacturing can shift to a whole new paradigm where low- or no-waste production and good product design to ensure sustainable products along their full life cycles. Education at all levels can use technology to broaden access at a much lower cost than the current bricks-and-mortar model.*
These challenges are coming at the same time that the knowledge economy is exploding. The transition to a knowledge economy began slowly in the 20th century as computers began to automate much of the routine work done inside businesses. It accelerated as the Internet made it possible to connect everyone to everything. To spread basic knowledge as never before. To collaborate on a global scale and put knowledge to work.
Putting our knowledge to work is how we will innovate our way out of the crises we face.
What does this have to do with integrated reporting? <IR> provides a framework for bringing together the three kinds of performance that we’re talking about here: financial, ESG and innovation.
Financial data explains monetary and tangible resources. Environmental and social data explain externalities. Innovation and governance data explain internalities. The three kinds of data together support integrated/systems thinking. (Read more here about externalities and internalities)
Most people assume that there is a great tension or even irreconcilable differences between these three perspectives. Sometimes there are. A company that endangers the environment has to spend money to reduce pollution even if it hurts the bottom line.
But the message here is that smart companies take these challenges as a spark for innovation. And they turn them into win-win propositions. Better environment, better innovation, better results. The integrated model helps us think more holistically about how to create these win-win solutions.
Want to see examples of the integrated model in action? Read our new paper called The U.S. Integrated Reporting Journey.
*Adapted from Chapter 6: Innovation Is the New Strategy in Intangible Capital: Putting Knowledge to Work in the 21st Century Organization.