ESG and Impact Investing in Private Equity and beyond | London Business School

so it's it's my pleasure to introduce my colleague Janna siano with a professor of strategy and to prepare London Business School and when I was talking this morning about relationship between practitioner and academics and what we stand for I think Yanni's really embodies that and this is that is a passionate speaker and the teacher and I'm sure you will see in a moment and actually a really top-notch researcher who really doesn't compromise when he does research to obtain and is very careful in his data results and message and therefore I am so happy and he's passionate about who we are going to talk about now that is ESG and in general how it does have a positive impact so it's my pleasure to have yeah nice to talk Thank You Viennese thank you for inviting me good morning everyone you see I've been teaching a lot recently so I hope the coffee was good so it's really a true pleasure to be here with you today to share some of the work that me and my co-authors have been doing on this space of ESG sustainability corporate social responsibility at the risk of stating the obvious let me start by saying that all companies around the world these days they face some sort of social or environmental pressure right increasing demands and expectations by an increasingly diverse set of stakeholders companies are expected to be good stewards of the environment they are expected to care deeply about their local communities in other words they they face these pressures to care about stakeholders over and above in many cases in addition to shareholders and to increasing their financial performance in other words and as the the CEO of Blackrock said recently in his letter companies are expected to have a positive social impact to contribute to work towards an inclusive and sustainable growth in addition to of course being financially profitable and successful now the first question is why now why is it that companies are facing these pressures now more so than ever before well here I always use my favorite Spiderman code which is with great power comes great responsibility right the footprint of the motor business of a corporation is huge and it's increasing consider for instance some numbers that were put out recently by global justice now so these guys rated and ranked the hundred largest economic entities around the world and in a staggering number 69 of the hundred largest economic entities are actually companies and only 31 of them are actually countries and if you take the top ten corporations combined in terms of their revenue they are larger than the bottom 100 in 80 countries around the world now this data is corroborated especially when you take other measures like the total revenues of the top thousand companies and you compare that what percentage is it for the GDP of the OECD countries the numbers are increasing in recent years and that tells you a lot about how far-reaching the impact of the modern business corporation can be but you know the that kind of positive impact needs the right institutions the right people the right motives in place in order to materialize but the potential is there and these numbers say well you know what is the role of business visa vie the role of governments and countries when it comes to addressing big global challenges like climate change like extreme poverty in and inequality and so on now consider some companies like Unilever for instance Unilever is a company that whose goal and objective purpose is to make sustainable living commonplace we're talking about the company that through its products and services can reach 2 to 2.5 billion people on the planet on a daily basis but Unilever is not alone what we observe in practice is that many companies increasingly develop a sophisticated understanding of what are these social environmental challenges some may see them ask us as risks that need to be mitigated and managed others see them as profitable business opportunities at the end of the day they are massive problems in need a need of efficient and scalable solutions so what we increasingly see is that companies start bringing these considerations into the core of their organizational structures into their grower into the core of their strategies as well as into the core of their business models so increase in research in recent years we understand that if companies decide to go beyond compliance that constitutes extra teaching choice how responsible you choose to be towards the environment and towards the broader society is at the end of the day a strategic choice and as scholars we care a lot about strategic choices and we care in particular about what is the impact of integrating this environmental and social issues into corporate strategy in terms of a company's ability to establish and maintain a competitive advantage now this is not a question that is new he has been studied in the literature for a long time and many many many papers and have been written asking you know that sustainability pay or not but in recent years as I'm sure you know as well the emergence of more compatible more accurate and more reliable ESG data allow us to examine this issue across industries and across time and therefore in conjunction with a number of methodological as well as theoretical advancements in end academic literature they allow us to examine the question of the link between responsibility and financial performance in a more effective way and I think most scholars today given the accumulation of rigorous evidence and studies would agree that there is a positive causal link between truly integrating environmental and social issues in the way you do business and financial performance in the short run as well as in the long run however attitudes towards these companies have not always been positive as they appear to be today in fact in all of the work that I do I focus on the critical role of capital markets and how they evaluate assess react reward or punish corporate engagement with responsibility so let me take you back to the 1990s when all these ESG trends were not yet in the public eye and companies were not facing that kind of pressure that they're facing today now in fact the in this study that we did with my co-authors we try to understand how is it that investment analysts reacted to companies that were socially responsible in the public equity space some people would say well they didn't care okay in the early 90s who cared about this yeah if the term ESG it was not even invented yet who cared about this CSR stuff nobody Galilee's analysts were going to ignore in fact that wasn't the case they cared but they don't didn't care in the way you might expect what we did find in this study is that if you were a socially responsible company the analysts were more pessimistic let me repeat that in other words if you were doing well on CSR ratings the analysts were much more likely to go conservative to issue a more pessimistic recommendation why is that the case well because of the shareholder value myth the idea that they're only in the best way to achieve financial performance in the long run is by an exclusive focus on shareholders now those trends have changed over time if we proceed from the 1990s to come down to the 2000 that trend has shifted and now analysts became neutral and then more positive towards companies that integrate ESG into the way they do business but it's not just about integration companies sorry the markets are becoming increasingly more sophisticated in the way we understand ESG in another study we looked at more broadly speaking access to capital fundamental issue for companies right why is it the case and does it even matter if you are as responsible company in terms of your access to capital and what we found in this study is that it enables it lowers capital constraints if you're a responsible company why is that the case what we even know the mechanisms responsible companies are more transparent companies responsible companies that pay attention to their stakeholders have more stable more long-term stakeholder relationships how does that translate for the market lower informational asymmetry lower risk of agency costs exactly what you need to allocate more capital and you see that increasingly in the public domain not just in our theoretical papers and empirical papers but very very publicly ing and Philips the first of its kind alone whose interest rate is explicitly linked to ESG metrics ing told Phillips that the better you do on sustainability metrics the lower the interest you're going to pay on your 1 billion loan and clearly you've seen I'm pretty sure you've seen the other trends like Larry Fink institutional investors a lot of pressure on companies to disclose on climate change and climate change related risks the whole idea of stranded assets events leading to some people to talk about a carbon emissions time bomb a bubble because the number of assets may be significantly overpriced because they're not accounting for climate change risk and again going back to my point about sophistication the other thing we found in a different study is that it's not just about ESG data it's out of everything together it's a much more sophisticated understanding if I look at companies and I differentiate between what they say and what they do in other words is externally oriented years reactions and internally oriented these reactions we're fine is the larger the gap the larger the detrimental impact that it has on its market value in other words the markets are able to see through if what you say doesn't follow with implementation or vice-versa right if they will implement a lot but you fail to inform the market about what it is that you're doing and that gap is not only apparent to the investment community more recently in another study we looked at they impact on customers what if you declare one policy on let's say on environmental issues about your products and then you do not implement we found significant evidence that that leads to lower customer satisfaction so you see that the pressures come from fundamental and key material stakeholders for companies whether it's their investors whether it's their customers increase increasingly from their own employees when it comes to corporate purpose for instance to be more responsible and more accountable if you like to all these stakeholders now that generates the very fundamental question which is how do I recognize these companies how do I know which of the companies are socially responsible versus those that might greenwash that might lie that might not be truthful in terms of what they're doing because there's a lot of information out there right there is gee these ratings and rankings this is the best place to work for there's the high reputation rankings there's the environmental reputation rankings this TSG reports there is sustainability reports this integrated reports it's endless now we actually have rigorous evidence about what is it that distinguishes what I would call a more traditional way of doing business versus a responsible way of doing business and this is this kind of evidence is what allows us to talk about the emergence of this idea of the responsible organization so in some of the research we did we were able to identify four pillars that allows allows us at least to some extent to detect this true commitment to detect in other words the extent to which responsibility is embedded into the corporate DNA those pillars are corporate governance stakeholder engagement transparency and accountability and the time horizon of decision-making so in my remaining time allow me to briefly go through those four pillars first of all corporate governance what distinguishes the responsible companies is that they put their foot where their mouth is they they do understand that they're managing the corporation for a set of stakeholders therefore responsibility is a formal board responsibility there is a subcommittee at the board level that oversees sustainability issues and which what is one of the most powerful tools we have in organizations incentives they incentivize both our executives as well as their employees on financial as well as non financial metrics stakeholder engagement here responsible companies do not deal with problems of their stakeholders at hook they have structures in place before during and after any stakeholder engagement process they train their managers they report publicly they report to the stakeholder to the board as well as are in as well as internally what was the outcome of the stakeholder engagement process they have structures in place when they sit with this town with the stakeholder to resolve an issue to bring up the opportunities the costs the risks the the goals of the engagement process in other words is not a talk it's embedded it's structured and it's deep into the organization because in precisely the organization cares about its stakeholders third it's about the long term the decision-making time horizon and in particular the focus of these companies on the long term and also being effective communicators of their long term commitment but we found here is that you know these were public companies we could see who was in their investor base and we can break down investors into a more dedicated and more transient investors more dedicated ones are the ones that have more focused portfolios and trade less often those gravitated towards the responsible companies they were holding longer their play long-term strategies whereas in the traditional model you see much more diversified investors that hold my in less time are compared to the dedicated ones but also know when when they talk to their investment analysts we could get the transcripts of the calls to their investment analysts and you do some keyword analysis and it is really staggering the responsible companies have a much better balance between discussing financial and non-financial and between discussing short term and long term strategies and objectives the traditional companies are much more heavily focused on financial talk and on short term which kind of makes sense because that's also the kind of investors that I attract the more transient investors now the last pillar is about transparency and accountability we found that what distinguishes responsible companies is that very they collect ESG data in a much better way they are much more transparent about it the quality of their disclosures is much higher compared compared to traditional companies and they better be I mean if you are incentivizing your your employees and executives on ESG you better make sure that you gather USD in a way that is credible it's accurate and it makes sense and it's reliable in your context and how do they defuse accountability they well they do so by adopting for instance environmental health and safety standards human rights standards in their selection of partners in their supply chain so they diffuse that sense of accountability not only for themselves but throughout their usually their ecosystem so four pillars that allow us to talk about the emergence of this new and different type of corporation and you have sustainability if you like that allows all these other things that we typically talk about sustainability to materialize for instance sustainability may be better for employee recruitment and retainment and motivation it might be better from brand loyalty it might be better for access to finance and so on yes that's all true those are the mechanisms but in order for those mechanisms to materialize you need organizational structure and what the evidence shows is that those four pillars are constitute the key differentiating factors between a traditional company in a responsible one now the good news is that you know we now know what it is they've been the bad news is that there's no piecemeal approach it's not that our link is my transparency in some you know suddenly I'm a responsible company for instance they all come together because you see how they cause they reinforce each other and how you create synergies in terms of for instance the quality of yours is gee data and how you incentivize your people so that's in a nutshell what we currently know about this emergence of the responsible organization clearly there's a lot more research and a lot more than needs to be done to understand these processes better as academics as investors as public equity markets and indeed as private equity markets this is a space that Francesca and I run a survey a couple of years ago to understand the the state of ESG integration and and unfortunately we're lacking the data to see how this is actually done in the private equity markets but the learnings that we know in terms of how companies behave how can i distinguish how what are the mechanisms through which sustainability may be profitable it doesn't matter if it's from the public or the private side it's about how companies are implementing on the ground so just to conclude is really a true pleasure to be here with you today I'm actually quite thrilled to be seeing this ESG panel showing up increasingly more in private equity conference I've been to super return for a couple of years now and even there they have an entire pre conference day on ESG so it's really a space with unique capabilities if you like it's exactly because of the holding time horizons do you have the power you have to influence what's happening at portfolio companies all the way to the board level so I'm really looking forward to first your questions and then really engage in conversations about ESG in and performance in the private equity space in particular so thank you very much for your attention what time yeah there is I I fully on by into the ESG argument having studied an lbs myself or wonderful but the question I want to ask is in in in the outside world especially in industries like banking and industries like telecoms and he even industries like health care the the the the most of the annual sort of accounts and returns are heavily scrutinized by the regulator's particularly in the area of cost to income and pricing now that being the case how would you justify ESG which has a very long-term payoff and it may well increase your costs in the short run how would you actually get over the regulatory scrutiny um in that respect I do think that sustainability and and any SG and responsibilities is held to a double standard right because one could turn and say well yeah and R&D is a short-term cost until you actually invent something but we don't see R&D that way and marketing is a cost until you actually materialize sales but we don't see it that way all right so the I think that is I do see this I would call it cultural shift away from seeing this as a cost and more so towards investment now I do also think that we're going through this period of experimentation so of course you're going to see companies doing making a lot of errors you're going to see companies attempting to brainwash you're going to see companies do all kinds of things but the idea that any company going forward will afford to ignore these issues is it's just not true no company is going to afford to ignore these issues but it will take time and I see it in my in my in my teaching in my engagement with companies people tend to have beliefs about this these issues right I should or should not you don't have beliefs I hope for a corporate fine model but you do have beliefs about the responsibility of your organization and sometimes those are deeply ingrained beliefs that change with societal changes think about the the millennial generation coming online and say we know I want to work for companies whose purpose is aligned with my own personal purpose think about you know recently I was teaching in some of let's say a scene industry and people are I felt it people are having exist tential crisis of should I even be working in this industry how are my kids gonna look at me when they found out eventually the industry I've been working in so I do feel that those societal changes are coming and a part of that is start looking at investments in responsibility in the way that in the same way that we look at rnd and so on and I mean on that point let me give you one piece of evidence with a quarter of mine we looked at what you know many people say oh honey you know when the crisis hits they're gonna drop everything and focus on financials that's wrong we looked at what companies actually did during the American the financial crisis of oh they're all seven oh nine and what you see is that the best of companies maintain their investments in innovation and sustainability and they cut back on employees and tangible assets so they reallocated their assets in such a way so that to maintain the key intangibles of risk you know of which innovation and responsibility where the critical ones and you know long behold after the crisis the ones that maintain those two intangibles was the Wanda that perform better all right so I do think that attitudes are changing in that respect there was a long answer but I think I hope I got to you find do we have you it is five more minutes I think we can take about one or two more questions yes here at the front it's coming on your you mentioned at the beginning of your speech Paul Polman that Unilever yes so I happen to know Paul personally as I worked with him in Procter & Gamble a long while ago and he's definitely for me one of the best responsible CEOs in Europe if not in the world yet very recently he's been put a lot under a lot of pressure at the time of the Kraft takeover bid yeah where they basically his shareholder said you've taken your eyes off the ball in terms of profitability because you were all in this responsible quest mmm-hmm so what did he miss where could he have avoided what became basically an issue that he had to quickly fix by going with private equity measures and raise the raise his profitability in a very short term and basically tarnishing his whole leadership of eight years with this event yeah so I'm going to avoid kind of criticizing him directly about what he did or he didn't do but I'll try to answer the question a bit more broadly than that remember when I told you about the results of this study right in terms of what these companies do and I said they have a better balance between long term and short term they have a better balance between financial and non-financial now that's one myth that a lot of people think about sustainability that you know you replace financials with non financials that you replace the short term with the long term and that's also wrong it's about the balancing the two I don't know if in that case you know they might have gone too far on one side or the other but what we know from the evidence is the balance between the two right because if you are going to achieve synergies between the two then you better know how they interact you know you better see your strategies integrated so the financials cannot be independent from the non financials the short-term cannot be independent from the long-term and I do think that in many ways the short termism of the markets not excessive short terms the short term is over market is a disciplinary mechanism that should be there to avoid situations in which you say oh this is a sustainable strategy and it's going to you know pay off in the long term well you don't just wake up one day and this is the long term you know long term is a series of short term so one we we did this study on performance you see that these short term effects yes some years they're not that great as others but there is lower volatility for instance because of this commitment now I don't want to go too much into details on that but I'll tell you two things from what I've read you Chris Kerry I'm an outsider right so I don't have inside information what happened but when the FT article kind of described how Paul Polman avoided the takeover you say oh yeah you know this is pure business this is someone that has the long term vision but when it bites it bites it can deal with that as well secondly I'm not sure you seen it but a couple of weeks afterwards Kraft decided to put 200 something million into it CSR programs after the failed takeover so in might the impact might have been also on the craft side right not so much on on and it's interesting given the sophistication of the markets that if a 200 million which I'm guessing from Kraft might not be that much a kind of a a responsibility leave quickly if it's going to be enough to potentially you know avert a failure in the next takeover bit but again your I didn't pointing out that it sustainability needs discipline it needs the short term discipline of the markets as well and that's right the role of the markets and so important and definitely we should in lose of the site that we're not replacing objectives here we're just simply complexified them and making them you know in in looking at them as a growth opportunities that's a big 0 of staring at me over there so I'm sorry I need to have to end but being delighted to catch up with more questions over coffee it is my true pleasure to now welcome on stage or in lover fat wave yeah sorry the vice president Investor Relations of Harper vest all right thank you you

Channel: London Business School

Views: 29,542

Rating: 4.8439026 out of 5

Keywords: Ioannis Ioannou, Private Equity, ESG, London Business School, LBS

Id: W_QV6yDBS70

Length: 28min 38sec (1718 seconds)

Published: Tue Jun 26 2018