Tracking sustainability - ESG as an integral part of good corporate governance in capital market-oriented companies?

Climate change, Brexit, Corona - there have been easier times for German management in the past. After surviving the financial crisis and years of upswing, the challenges recently outpaced the sales figures in terms of dynamics. The call for sustainable action may be in keeping with the spirit of the times, but in times of crisis it often runs the risk of going unheard. Doesn’t recent experience, however, prove the importance of ESG for modern corporate governance of listed and other capital market-oriented companies?

In fact, the importance of each “ESG element” can be illustrated by the crisis scenarios mentioned at the beginning. “E” for Environment: Both climate change and the current pandemic represent direct environmental impacts on humanity and therefore also on the economy. The automotive and aviation industries - long the undisputed showpieces of the German economy - suddenly came under harsh criticism for their handling of the mobility transition. In the case of social issues - the “S” - it was often observed that companies that acted responsibly received recognition and contributed to economic success through their actions. This also applied to the “G” for governance in the context of corporate management: companies that had made provisions for times of need and crisis were able to benefit from this. On the other hand, those who simply steamed ahead were more exposed to economic losses.

It is therefore not surprising that - even outside of crisis situations - numerous capital market participants, including institutional investors, a key stakeholder group, have identified a connection between the proper treatment of ESG aspects in corporate policy on the one hand and profitability and value development, and thus also the return on investment, on the other. As the international communications agency Edelman was able to determine in a study in 2019, almost all participating investors expect ESG issues to be directly addressed by the board of directors. More than half of the investors perceived a positive influence of ESG initiatives on the growth of the company.

Activist shareholders, i.e. investors who often act aggressively, sometimes make a similar prioritisation. For example, TCI, led by investor Chris Hohn, already describes the details of its ESG investment policy on its website and has recently criticised Airbus, Google parent Alphabet, Moody’s and Microsoft, among others, for what it sees as inadequate handling of CO2 emissions and other climate issues. According to TCI, investing in a company that does not disclose its environmental impact is like investing in a company that does not publish a balance sheet.

One could almost think that TCI has taken its cue from the German legislator or the EU directive-maker in this assessment. Since April 2017, companies have had to disclose information on environmental, employee and social issues in their annual financial statements as part of their non-financial reporting. Incorrect or veiled disclosure of non-financial reporting is a criminal offence. In addition, non-financial performance criteria will also be used as a basis for the assessment of variable remuneration components of the executive board of a listed company. Against this background, the topic of ESG has already found its way into the supervisory boards of German companies.

A transparent ESG policy is not only important for the fulfilment of legal reporting obligations and for a modern remuneration system. It should also be reflected in the company’s position in the numerous and multi-layered ESG rankings. The corresponding ratings of agencies such as ISS ESG, MSCI or Scope Analysis are mainly based on publicly accessible sources including, naturally, the corresponding reporting of the companies. However, the desired reliability of such rankings is often questioned: The underlying methods are said to be too inconsistent and may lead to different results. There is no doubt that this point of criticism weighs heavily and it seems desirable that a certain unification or standardisation occurs here. However, companies should not use this aspect to relativize a vulnerable ESG strategy. Instead, they should bear in mind - especially with regard to possible financing via the capital market - that institutional investors consult corresponding sources when making their investment decisions.

However, if ESG issues and corresponding reporting become increasingly important for the capital market, the question also arises as to whether inadequate reporting can constitute (punishable) market manipulation. This would require sending false or misleading signals that could influence the price of a financial instrument. Consequently, reporting on climate and environmental issues, for example, would have to be relevant for the stock market price. One would generally assume that investors are only interested in the “hard”, i.e. financial KPIs such as turnover and earnings figures. But according to a study by Deutsche Bank, companies with positive news on climate protection outperform the overall market by more than 30%. Against this background, a connection between share price performance and non-financial reporting could certainly be considered possible. A detailed analysis would go beyond the scope of this article, and besides, a case-by-case examination would always be required; however, the idea of market manipulation - and thus possibly punishable - behaviour cannot be dismissed out of hand.

Problems with global warming and highly contagious viruses have shown: ESG-compliant action is not an end in itself. Capital market-oriented companies, especially those with foreseeable financing needs, are well advised to (increasingly) think about a viable and sustainable corporate policy that includes non-financial aspects. Not every aspect is considered a highly personal task of management: when developing and implementing an ESG strategy, the support of a corresponding ESG organisation in the company as well as the establishment of tracking, monitoring and management systems can be useful or even necessary. For small and medium-sized enterprises (SMEs) in particular, this can undoubtedly entail considerable financial burdens. However, it is always an investment in the future - not only for times of crisis.